What is it?

1. What is it? An arrangement to share costs and benefits of a life insurance policy • typically between employer and employee, but can be used by others • can split premiums, death benefits and/or cash value, dividends, or ownership

2. When is it indicated? When employer wants: • To provide executive with low cost and low outlay life insurance benefit • An alternative to insurance-financed nonqualified deferred compensation plan for providing pre-retirement death benefit

3. What is it indicated? When employer wants: • To provide exclusive executive fringe benefit • To establish market for stock • facilitate cross-purchase buy-sell • enable non-stockholding employee to effect a one-way stock purchase at death of existing shareholder

4. Advantages 1.Executive can use employer funds to receive current benefit with minimal tax cost 2. Employer’s outlay fully secured 3. Can customize plan to meet specific objectives

5. Disadvantages • No tax deduction for employer’s share of premium payments • Employee pays income tax each year on current cost of life insurance protection under plan • 10 - 20 years before policy cash values are sufficient to maximize plan benefits • Must terminate plan when employee near age 65 • Unfavorable tax treatment under new regulations

6. Design Features: Premium Cost Split 4 major categories • Classic or standard split dollar plan • Level premium plan • Employer pay all • Offset plan

7. Design Features: Cash Value and Death Proceeds Split Purpose – reimburse employer for share of premium outlay when employee dies or terminates plan

8. Design Features: Cash Value and Death Proceeds Split Commonly used cash value / death proceeds split arrangements: • employer share is GREATER of: (1) aggregate premiums it has paid OR (2) policy cash value

9. Design Features: Cash Value and Death Proceeds Split Commonly used cash value / death proceeds split arrangements: • employer can only recover up to amount of aggregate premiums paid OR • employer entitled to entire cash value

10. Design Features: Policy Ownership Endorsement method • Employer owns policy • Employer responsible for premium payment • Employer receives death benefit = premiums paid

11. Design Features: Policy Ownership Endorsement method advantages • Employer has greater control over policy • Simple installation and administration • Avoid formal arrangement that might be deemed a loan for tax and legal purposes • Can use existing key employee policy without ownership change

12. Design Features: Policy Ownership Collateral Assignment • Employee or 3rd party is policy owner • Employee or 3rd party responsible for premium payment • Employer makes interest free loans = premium • Policy assigned as collateral to employer • Employer recovers aggregate premium payments from policy proceeds as collateral assignee at death of employee • Employee’s beneficiary gets remaining benefits

13. Design Features: Policy Ownership Collateral assignment advantages • Better protection for employee and employee’s beneficiary • Easier to implement using existing policies owned by employee

14. Tax Implications • Before September 18, 2003 • Taxed under “economic benefit” theory • Amount of economic benefit received by employee each year was determined by using IRS table that valued the pure insurance coverage for the employee

15. Tax Implications • After September 18, 2003 have two mutually exclusive regimes for taxing split dollar arrangements - economic benefit regime - loan regime

16. Tax Implications Economic benefit regime applies to - endorsement type plans - collateral assignment plans that are not equity-type plans Employee must count value of life insurance or other benefit provided under a split dollar plan as additional taxable income

17. Tax Implications Loan regime applies to - collateral assignment equity-type plans Employer paid premiums treated as loans from employer to employee If arrangement carries no stated interest rate, loan considered a “demand loan” and taxed under IRS code Sec. 7872

18. Tax Implications Rollout rules (transfer of contract) • Transfer of contract to non-owner generates income for non-owner equal to fair market value of contract less various sums paid by non-owner to transferor or taken as income by the non-owner • If contract subject to substantial risk of forfeiture, employee can delay tax to sometime after the rollout

19. Tax Implications Death benefits • Generally income tax free • Tax-free nature of death proceeds lost if policy transferred for value except for transfer • of policy to insured • to partner or partnership of insured • to corporation of which insured is shareholder or officer • in which transferee’s basis determined in whole or part by transferor’s basis

20. Tax Implications To avoid potential transfer for value situations in split- dollar plans • Do not start plan by transferring existing corporate-owed key employee policy to 3rd party beneficiary • Do not start plan by transferring an employee-owned policy to the corporation unless employee is shareholder or officer • At plan termination, do not transfer corporation’s interest in policy to 3rd party beneficiary

21. Tax Implications Gift taxes • May be federal gift tax imposed on premiums if person other than employee owns insurance policy used in split dollar plan • May be able to avoid gift tax if qualify for annual gift tax exclusion ($13,000 in 2011, indexed)

22. ERISA Requirements Split dollar plans are ‘welfare benefit’ plans under ERISA • must have written document, “named fiduciary,” and formal claims procedure • can escape ERISA reporting and disclosure if is ‘insured’ plan maintained for ‘a select group of management or highly compensated employees’ • if cover more than select group, must provide SPD

23. True or False? • Split dollar plans are best suited for executives in their late 50’s and early 60’s. • In most split dollar plans, the employer’s outlay is fully secured at all times. • The employer receives a tax deduction for its share of premium payments under a split dollar plan.

24. True or False? • Under the classic or standard split dollar plan, the employer and employee split the cost of the life insurance premium equally. • An employee who terminates employment before a split dollar plan matures can be held personally responsible for reimbursing employer for aggregate premiums paid. • The employee owns the policy under the endorsement method of policy ownership.

25. Employee Benefit & Retirement Planning True or False? 7. In an standard split dollar arrangement, the employee’s outlay is relatively low in the initial years of the plan. 8. The purpose of an offet plan is to reduce the employee’s income tax cost for the plan. 9. Recently, significant changes have occurred in the tax laws governing split dollar life insurance. 10. Split dollar plans are exempt from ERISA regulations.

26. Discussion Question Is a split dollar arrangement a useful compensation technique for a partner, proprietor, or shareholder employee of an S corporation?