Quick head's up on split dollar changes by the IRS

Author, Stephen J. Smith

January 11, 2001

A relatively hot topic in some quarters has been the movement to use split-dollar as a technique to maximize the leverage (in the sense of after-tax benefit) of the money spent to purchase life insurance.

IRS Announces Major Change. Yesterday, the IRS issued a lengthy, formal notice stating that in general, it will no longer accept certain ways of calculating (and, in the IRS's view understating) the benefits to the employee. The key idea is that the IRS will attempt to stop what it believes is a gap between the artificial tax rules for calculating the taxable employee benefit and the real world cost of the employee's benefit.

One example of a change. The so-called P.S. 58 table rates are largely no longer available except for years ending in 2001 (and possibly not event in all cases for 2001, such as where you use the P.S. 58 rates to overstate the employer's share and then subtract from the whole cost to understate the employee's share - I am not sure on a quick reading of the notice). The notice contains a temporary replacement table of rates it calls "Table 2001."

Another example. The IRS states that it will challenge the use of special rates (published by insurance companies mainly for split-dollar valuation purposes) that the IRS suspects understate the cost of the employee's share of the benefits (because they are rates at which the insurers do not really issue a lot of policies - phony rates, the IRS is in effect alleging).

Some Timing Issues. Buried in the minutiae of the notice is a statement that with respect to life insurance contracts issued after 3/1/2001, there is "no assurance" that any published rates (of insurers) can be used after 12/31/2003.

In my view, the IRS announcement really changes things for split dollar (although not for the year 2001 in many cases). The question will be to what extent, going forward on new initiatives, it is "worth it" to put a split-dollar wrapper around the garden variety purchase of life insurance.

Steve Smith

Disclaimer: This article is not intended to offer legal advice in any particular situation but rather is intended solely to alert the reader to a new development and the possible need for individualized advice.