What is it?

1. What is it? • Contractual arrangement under which the costs and benefits of a life insurance policy are shared between the employer and employee • The agreement will provide how the parties will share the premium payments and the benefits if the policy either matures as a death benefit or is surrendered for cash • For estate planning purposes the employee may choose to have the trustee of his or her irrevocable life insurance trust (ILIT) enter into the contract with the employer • When is the use of such a device indicated? • When an employer wants to provide a key employee or shareholder employee with a valuable benefit at a relatively low long term cost

2. When is the use of such a device indicated? (cont'd) • When an employer seek an employer benefit that is highly flexible and avoids the aggravation in most other benefit plans • Employer can decide who will be covered and the terms and benefit levels each covered employee will receive • The employer can modify or terminate the plan to meet changing circumstances • When a corporation wants to facilitate the cross purchase of its stock • Two or more shareholders can purchase policies on each others lives and split the premium outlay with the corporation • Each will pay the pure insurance costs for the insurance on the other shareholders life • At death, the policyowner will receive the proceeds and use that cash to buy stock from the decedents shareholders estate

3. When is the use of such a device indicated? (cont'd) • When the shareholder- employee needs estate liquidity and would like to tap corporate dollars to amass the available cash for his or her estate • Whenever one party is willing to help another party subsidize the cost of providing financial security through life insurance • Such as a senior family member helping a junior family member • When an income and estate tax free benefit is desired as an alternative to the taxable benefit of a nonqualified deferred compensation plan • When there is a significant income tax bracket difference between the employer and employee • When the insured is in impaired health or for some other reason must pay a rating on a life insurance policy

4. Types of split dollar plans • Classic split-dollar • Corporation contributes an amount of premium equal to the increase in cash surrender value, while the participant contributes the balance of the premium • The corporation will receive the cash value at the earlier of the termination of the plan or the employee death • The employee holds the right to designate the beneficiary of the policy • The employee gets valuable insurance protection with a relatively small outlay for premiums in the early years and little or not cost to the employee in later years • If dividends are paid on the policy, the employee and employee may agree to offset the declining coverage to the employee by reinvesting dividends in term insurance on the employee’s life

5. Types of split dollar plans (cont'd) • Equity split dollar • The employee share of premium is equal to the cost of pure term insurance each year • The employers share is the remainder of the premium • At the time of the participants death, or when the plan terminates • The employer is repaid the lessor or the policies cash value or aggregate amount of employer premiums paid • The employee, or his or her beneficiary receives the excess of the total amount distributed from the policy over the employers share of the policy • Any cash value in excess of that due the employer inures to the benefit of the employee

6. Types of split dollar plans (cont'd) • Reverse split dollar • Employee benefit plan where the rules for the employer and employee are reversed for the purposes of sharing premium costs and benefits from a permanent life insurance policy • Notice 2002-59 effectively ended the viability of reverse split dollar plans • What are the requirements? • No nondiscrimination rules to be met • No IRS approval required prior to or after a plans installation • Can be established for as many employees as the employer desires

7. What are the requirements? (cont'd) • Employers install a split dollar plan by • Selecting the appropriate product • Selecting an ownership arrangement and drafting an agreement that answers the following questions: • What will each party receive upon an event • What are the respective rights and obligations of each party • Who may terminate the plan and under what terms or conditions • Does the insured have the right to purchase the policy upon plan termination and at what amount • How and under what circumstances may the plan be amended • Determining what (death benefits, premiums, dividends and cash values) will be split among the parties

8. What are the requirements? (cont'd) • Employers install a split dollar plan by (cont'd) • Drafting a corporate resolution authorizing the purchase of life insurance and stating the business reasons and advantages to be gained by the action • Completing beneficiary designations and filing the appropriate documents with the insurance company • What are the tax implications? • Treatment under regulations • Split dollar arrangement entered into after September 17th, 2003 • Under one of two mutually exclusive regimes • An arrangement will be treated as a life insurance policy owner providing economic benefits to the non-owner or • As the non-owner making loans to the owner

9. What are the tax implications? (cont'd) • Economic benefit treatment • Endorsement split dollar arrangement • The non-owner must take into account the full value of the economic benefit provided by the owner less any consideration paid by the non-owner • Economic benefit may consist of • The cost of life insurance protection provided by the non-owner (as measured by IRS Table 2001, until a new table is issued by the IRS) • The amount of cash value the non-owner has access to • The value of other benefits provided to the non-owner • Death benefits paid to the beneficiary of the non-owner are generally consider to be received income tax free

10. What are the tax implications? (cont'd) • Economic benefit treatment • Upon transfer of the policy to the non-owner , they are considered to receive the cash value of the policy and the value of all other rights in the policy • Minus any amounts paid for the policy and any benefits that were previously included in the-owners income • Loan treatment • The owner is considered the borrower and the non-owner is considered the lender • If the split dollar is a below market loan, the interest rate will be imputed at the applicable federal rate (AFR) • Each payment is considered a separate loan • The imputed interest is considered transferred from employer to employee

11. What are the tax implications? (cont'd) • Loan treatment (cont'd) • The imputed interest is considered taxable compensation to the employee • generally deductible by the employer (except for corporation-shareholder split dollar • The employee is treated as paying imputed interest back to the employer, which will be taxable income to the employer • This interest is not deductible by the employee • Calculation of the imputed interest • Depends on the type of below market loan • Demand loan – payable in full upon the demand of the lender • Term loan – all other below market loans

12. What are the tax implications? (cont'd) • Effective date of regulations • All arrangements entered into after September 17th, 2003 • All arrangements materially modified after September 17th, 2003 • Not considered material modifications • Change in premium payment method (annually to monthly) • Changing of beneficiary (unless they are a party to the arrangement) • Change in the interest rate payable on the policy loan • Change related to preserving the status of the policy under IRC 7702 • Ministerial changes • Change made solely under the terms of the split dollar agreement if the change is dictated by the arrangement, is non-discretionary to the parties and was made under a binding commitment in effect on or before September 17th, 2003 • 1035 exchanges are NOT on the list

13. What are the tax implications? (cont'd) • Notice 2002-8 (split dollar agreements entered into before September 17th, 2003) • Cash value in excess of the employers contributions will not be considered transferred to the employee for purposes of IRC section 83 • Where the value of the current life insurance protection is treated as an economic benefit provided by an employer to an employee • The IRS will not treat the arrangement as having been terminated • As long as the parties continue to treat and report the value of the life insurance protection as an economic benefit • The parties to the arrangement may treat premium or other payments by the employer as loans. The IRS will not challenge reasonable efforts to comply with the rules regarding original issue discount and below market loans

14. What are the tax implications? (cont'd) • Notice 2002-8 (split dollar agreements entered into before September 17th, 2003) • Split dollar arrangement entered into before September 28th, 2002 • Where employer has received or is entitled to receive full repayment, the IRS will not assert there has been a taxable transfer of property to an employee upon termination of the arrangement if: • The arrangement is terminated before January 1, 2004 • For all periods after January 1, 2004, all payments from the employer since the beginning of the arrangement are treated as loans for tax purposes • Parties to the arrangement report the tax treatment in an manner consistent with this loan treatment

15. Value of economic benefit • Employee is taxed on value of economic benefit • Value of this benefit is calculated using government premium rates • P.S. 58 rates • Used in prior years and revoked by the IRS • Exception – for split dollar plans entered into before January 28th, 2002, where the use of P.S. 58 rates was the basis for the calculation, the employer and employee may continue to use the P.S. 58 rates • Table 2001 • New table created by the IRS for use in calculating the value of the economic benefit • If the insurer published rates for individual, initial issue, one year term policies, and these rates are lower than the P.S. 58 rates or Table 2001 rates, these insurer rates may be substituted • Only standard rates may be substituted

17. Value of economic benefit (cont'd) • Using the insured’s term insurance rates • Insurer must make the availability of these rates known to those who apply for term insurance • The insurer regularly sell term insurance at those rates to individuals who apply for term insurance coverage through the insurer’s normal distribution channels • In other words – insurer cannot create term rates to be used solely for calculating the economic benefit, if they do not offer those rates to the public • Private split dollar plans • One advantage is the smaller gift tax associated with the transfer of the premium for the pure term insurance protection • Table 2001 would create a lower gift-tax cost

18. Estate and Gift tax Issues • The insured’s ILIT is the policyowner and a collateral assignment agreement is formed with the insured’s employer • Employer contributions to the plan are taxable to the employer under the economic benefit theory and such contributions are treated a gifts by the employee to the trust to the extent of any economic benefit • Plans entered into before January 28th, 2002can use the P.S 58 rates as a measure of the economic benefit • All others would use IRS Table 2001 • Critical issues are presented for the split dollar arrangements entered into by the employee ILIT • Imputed interest and gift tax issues

19. Planning concepts • Endorsement plans • Policies are owned by the employer • May be used to fund nonqualified deferred compensation arrangements • Policies are intended to be held through the life of the employee • For plans entered into prior to September 28th, 2002 and for rates to be used after December 31st 2003 : They can use the insurer’s term rates • Provided rates are generally known to applicants for term insurance and • The insurer normally sells term insurance at those rates through their normal distribution channels • Otherwise it must use Table 2001

20. Planning concepts (cont'd) • Endorsement plans (cont'd) • Estate planning using third party split dollar • Each years economic benefit is taxable income to the employee and constitutes a gift from the employee to the trust • It gets larger and larger each year and ultimately exceeds the annual gift tax exclusion • A policy distribution to the employee will be taxable income to the employee to the extent it’s value exceeds consideration paid by the employee • But annual income and gift tax charges will cease • To avoid inclusion of the policy in the insured estate, the insured must survive for three years after the transfer of the policy to the ILIT from the insured • The insured could make a taxable gift to the ILIT and have the ILIT purchase the employers interest in the policy. May avoid the three year rule

21. Planning concepts (cont'd) • Collateral assignment plans • Typically provide for a rollout at retirement • Some remain in place until death • There is a substantial economic cost to the employer that may preclude the arrangement surviving retirement • Therefore rollout is a typical eventuality • Employee does not have to report policy equity at rollout (under IRC section 83) • If the plan was terminated prior to January 1st, 2004 or • The parties restructure the arrangement as an IRC 7872 below market loan • The alternative is taxation of the equity

22. Planning concepts (cont'd) • Collateral assignment plans (cont'd) • Simply having the employee return the policy to the employer as a converted endorsement method will not work • Employee has income attributed under IRC section 83 • If the plan stays put after 2003 • One year term costs continue to be imputed • The employee can continue to utilize tax-free policy loans • If the agreement provides the employer be repaid at the earlier of death or the sixteenth year, failure to do so can cause the employee to be subject to current taxation on income

23. Planning concepts (cont'd) • Collateral assignment plans • For existing collateral assignment equity plans owned by an ILIT • Rollout financed by a combination of cash value and bonus: • Bonus results in both income and gift tax over to the ILIT • If the plan is terminated from cash value but premiums are still needed • Ascertain if policy can be reconfigured for a lower outlay • Consider funding the trust now on a tax efficient basis to enable it to rely more on cash value and rely less on the less tax –efficient bonus course of action • Using a Grantor Retained Annuity Trust (GRAT) with the ILIT as the remainder interest • Gift tax is small, but the appreciating asset in the GRAT would deliver significant value to the ILIT at termination