AICPA Letter Suggests Changes to Proposed Split-Dollar Regulations
The AICPA has four concerns about the proposed regulations (REG- 164754-01)
relating to split-dollar life insurance, according to its letter to IRS
Commissioner Charles O. Rossotti.
Document Type: Public Comments on Regulations
Tax Analysts Document Number: Doc 2002-23894 (7 original pages) [PDF]
Tax Analysts Electronic Citation: 2002 TNT 205-18
Citations: (
=============== SUMMARY ===============
The AICPA has four concerns about the proposed regulations (REG- 164754-01)
relating to split-dollar life insurance, according to its letter to IRS
Commissioner Charles O. Rossotti.
Those concerns include a lack of clarification of what benefits are subject
to taxation by the non-owner employee, a lack of consistent application of
rules on granting basis in the insurance contract, a failure to account
properly for the cost-sharing between owners and non-owners, and a lack of
accounting for repayment of policy loans by non-owners.
The AICPA also believes the definition of "split-dollar
arrangement" should be clarified as to whether it refers to the
split-dollar arrangement or to the insurance policy; it prefers the former.
=============== FULL TEXT ===============
The Honorable Charles O. Rossotti
Commissioner of internal Revenue
Internal Revenue Service
Courier's Desk
Re: Comments on REG-16475-40, Proposed Regulations Relating to Split-Dollar
Life Insurance Arrangements
Dear Commissioner Rossotti:
[1] Enclosed are an original and eight (8) copies of the American Institute
of Certified Public Accountants' comments on the above-referenced regulations.
The comments were developed by members of the Split-Dollar Task Force and
approved by the Tax Executive Committee. We hope they will be helpful as you
complete this project.
[2] We would be pleased to meet with you to further discuss our comments
regarding the proposed regulations. You may contact Steven J. Leifer at (203)
353-5800 or steve@serpplus.com. or Marc A. Hyman, AICPA Technical
Manager at (202) 434-9231 or mhyman@aicpa.org to schedule a meeting or
if you have any questions regarding our comments.
Sincerely,
Pamela J. Pecarich, Chair
Tax Executive Committee
American Institute of Certified
Public Accountants
cc: Elizabeth Kaye, IRS Attorney, ITA
Erinn M. Madden, IRS Attorney, Executive Compensation, TEGE
Rebecca Asta, IRS Attorney, FIP
Lane Damazo, IRS Attorney, PSI
Pamela Olson, Treasury Assistant Secretary -- Tax Policy
David W. Brazell, Financial Economist, Treasury
Lon B. Smith, Associate Chief Counsel (FIP)
David B. Silber, Assistant to Branch Chief, FIP-2
Bob Misner, Senior Technical Reviewer, Executive Compensation, TEGE
Lindy L. Paull, Chief of Staff, JCT
AMERICAN INSTITUTE
OF CERTIFIED PUBLIC ACCOUNTANTS
Comments on Proposed Regulations [REG-164754-01]
Regarding the Tax Treatment of
Split-Dollar Life Insurance Arrangements
Approved by the
TAX EXECUTIVE COMMITTEE
Split-Dollar Task Force
Steven J. Leifer, Chair
John C. Boma
Robert L. Perez
R. Lee Wirthlin
Marc A. Hyman, AICPA Technical Manager
Submitted to the Internal Revenue Service
Executive Summary
[3] The American Institute of Certified Public Accountants is pleased to
respond to these proposed split-dollar life insurance regulations. In general,
we respect the difficulties inherent in attempting to define each and every
instance of economic benefit inuring to the parties in split-dollar life
insurance arrangements and in determining rules which would consistently apply
general principles of taxation to each instance. Also, we congratulate Treasury
for understanding the need for rules grandfathering certain existing
arrangements.
[4] However, we are concerned that the proposed rules: (1) fail to clarify
what specific benefits would be subject to taxation by the non-owner employee
opening up the determination of what are taxable economic benefits to
conjecture and subjectivity; (2) fail to consistently apply the rules on
granting basis in the insurance contract; (3) fail to account properly for the
cost-sharing between owners and non-owners; (4) and fail to account for
repayment of policy loans by non-owners.
[5] The term "split-dollar arrangement" should also be defined to
clarify whether it refers to the split-dollar agreement or to the insurance
policy. The AICPA believes that the term arrangement should refer to the
split-dollar agreement. Grandfathering existing "agreements" should
be emphasized over grandfathering existing "policies." To promote
clarity and, therefore, consistency in application, the final regulations should
explicitly list the policy (or other) modifications that would cause existing
arrangements to be or not to be grandfathered.
Specific Comments
I. Economic Benefit Plan Issues
A. Measurement of Economic Benefits in Equity Arrangements -- Proposed
reg. section 1.61-22(d) requires the owner and non-owner in an equity split
dollar life insurance arrangement to account currently for the benefits of the
contract. The proposed regulations state, that "any right in, or benefit
of a life insurance contract (including, but not limited to an interest in the
cash surrender value) provided during a taxable year to a non-owner under a[n
equity] split- dollar life insurance arrangement is an economic benefit. .
.". See section 1.61-22(d)(3)(i). The proposed regulations fail to define
the language "any right in, or benefit of, a life insurance contract . .
." leaving the taxpayer to determine what specific benefits must be
valued. The preamble gives a single example in the compensatory context,
stating that gross income must include changes in the cash surrender value.
The proposed regulations reserve guidance on the valuation
of these economic benefits. The preamble discusses appropriate valuation
methodologies and notes that one potential approach would be to subtract the
net present value of the amount to be repaid to the owner in the future from
the current premium payment. The difference, presumably, would be the value
currently transferred to the non-owner. Using the premium actually paid as the
basis for valuation has merit.
However, taxing the non-owner employee based on
changes in cash surrender value is inconsistent with Treasury's view of split-
dollar arrangements. Elsewhere in the preamble, Treasury states that a
non-owner's interest in the life insurance contract in an equity split-dollar
arrangement is less like that of an employee covered under a nonqualified
deferred compensation arrangement and more like that of an employee who obtains
an interest in a specific asset of the employer, for example, where the
employer makes an outright purchase of a life insurance contract for the
benefit of the employee. If the employee is treated as acquiring an interest in
the insurance contract, changes in the cash surrender value of the contract
should not be reflected in the employee's gross or taxable income, because the
employee owns the contract.
B. Basis Attends a Transfer of Value --
Proposed reg. section 1.61-22(f)(2) denies the non-owner basis in the policy in
a split-dollar arrangement, even though the non-owner must include in income
amounts represented by the value of the policy. The preamble sets forth a
rationale for this result stating that one party is treated as the owner of the
entire contract. Therefore, no amount paid by the non-owner, whether or not
designated as a premium, and no amount included in gross income as an economic
benefit, is treated as an investment in the contract.
This treatment is inconsistent with the preamble's
stated view of split-dollar arrangements. If Treasury took the view that the
employee merely has an expectation or promise that the employer will transfer
something of value at a later date, this denial of basis would be arguably
appropriate. But if Treasury's view is that the employee is in the position of
someone who already has received an interest in a specific asset, then basis in
that asset should follow.
Although the proposed regulations provide special
rules to reduce the taxable income recognized by the non-owner employee if the
contract is transferred to that non-owner, they do not recognize the
non-owner's basis in the transferred property, consistent with the view that a
transfer has already taken place.
C. Deductibility/Inclusion Parity --
Proposed reg. section 1.61-22(f)(3) provides that any amount paid by the non-
owner to the owner is included in the owner's taxable income, rather than
serving to reduce the owner's cost for the policy. The owner also is denied a
deduction for any amounts paid, except to the extent that the non-owner is
taxed under section 83 when the contract is transferred to the non-owner.
Denying a deduction to the owner for any portion of
the premium, yet taxing the owner on amounts paid by the non-owner which serve
to reduce the owner's nondeductible cost is clearly inconsistent. Characterizing
as taxable income amounts which represent a sharing of costs, or a contribution
towards the cost of the insurance contract, results in the owner recognizing
income for a recovery of its own funds. If the owner's premium payments were
deductible, such a recovery into taxable income could be justified. Treating
the non-deductible amounts paid by the non-owner as taxable income to the owner
is incorrect.
D. Policy Loans Should Be Nontaxable --
Section 1.61- 22(e)(1) mandates that "specified policy loans" be
included in taxable income by the non-owner. Specified policy loans are defined
to include a loan where the non-owner's obligation to repay "is capable of
being satisfied" by repayment to the insurance company by the owner or non-owner.
Thus, in the employment context, a non-owner employee would be taxed on amounts
he or she receives and, in fact, repays.
This result is clearly inconsistent with taxing the
non-owner currently based on transfers of value that the proposed regulations
deem to have occurred. Because the regulations treat the employee as having
received an interest in a specific asset, further taxation on the basis of
borrowing against that asset where the employee is liable for repayment is not
warranted.
Policy loans generally are not subject to tax. In
order to find loans to the non-owner employees taxable, the regulations treat
the loan as if it had been made to the owner, who then paid such amounts as
compensation to the non-owner. If the non-owner is liable for repayment, compensation
treatment is incorrect. If at some point it becomes clear that the non-owner is
relieved of the repayment obligation, then compensation treatment would be
appropriate.
To the extent the proposed regulations treat a loan
as constituting a transfer of property to the employee and thus taxable, a
compensation deduction to the employer should follow. The regulations should
clarify that such a deduction will be allowed.
The proposed regulations treat death proceeds
received by the non-owner as excludable under section 101(a) as an amount
received under a life insurance contract. Amounts received by the non-owner as
a borrowing from the contract should be afforded similar, nontaxable treatment.
E. Economic Rights Should Be Enumerated --
Section 1.61- 22(g) states that on the transfer of a life insurance contract to
a non-owner, the amount to be taken into account by the parties is based upon
the fair market value of the contract. Proposed reg. section 1.61-22(g)(2)
defines fair market value as "the cash surrender value and the value of
all other rights under such contract . . . other than the value of current life
insurance protection."
Cash surrender value is generally considered to represent
the fair market value of a life insurance contract. Referring to "other
rights" and suggesting that they can be valued for purposes of determining
compensation introduces the possibility that all sorts of intangible conditions
incident to the policy can or should be valued. Rather than leaving the
question of fair market value open to creative conjecture and interpretation,
the final regulations should enumerate the specific rights envisioned by the
proposed regulations.
F. Good Faith Reporting Should Be Sufficient for
Amount of Death Benefit Exclusion -- Proposed reg. section 1.61-
22(f)(2)(ii) provides an exclusion under section 101(a) for amounts received by
a beneficiary (other than the owner) by reason of the death of the insured to
the extent that (1) such amount is allocated to the non-owner pursuant to a
split-dollar arrangement, the cost of which was paid by the non-owner, or (2)
"the value of which the non-owner actually took into account pursuant to .
. ." the split-dollar regulations.
The proposed regulations imply that the exclusion
of the death proceeds is dependent on the non-owner's having taken into account
-- i.e., included in taxable income -- the correct amount of the benefit
provided, As long as the owner has appropriately reported the split-dollar
arrangement, the beneficiary's exclusion should not depend on reporting by the
non-owner, over which the beneficiary has little or no control. If the parties
report the split-dollar arrangement on their respective tax returns in good faith,
the amount to be taken into account by the non-owner should not affect the
amount of the death benefit excluded by the beneficiary.
II. Grandfathering Issues
A. Definition of "Grandfathered" -- The term
"grandfathered arrangements" should refer to arrangements that are
entered into prior to the issuance of final regulations.
B. Definition of "Arrangement" or
"Contract" -- The proposed regulations generally define a
split-dollar life insurance arrangement as any arrangement: (1) that is not
part of a group term life insurance plan described in section 79; (2) between
an owner and a non-owner of a life insurance contract; (3) under which either
party to the arrangement pays all or part of the premiums; and (4) where one of
the parties paying the premiums is entitled to recover (either conditionally or
unconditionally) all or any portion of those premiums and such recovery is to
be made from, or is secured by, the proceeds of the contract.
This definition is intended to apply broadly and
would, for example, cover an arrangement under which the non-owner of a
contract provides funds directly to the owner with which the owner pays the
premiums, as long as the non-owner is entitled to recover the funds from the
contract proceeds (for example, death benefits) or has an interest in the
contract securing this right of recovery. In addition, the amount to be
recovered by the party paying the premiums need not be determined by reference
to the amount of those premiums. This definition excludes insurance contracts
in which the only parties to the arrangement are the policy owner and the life
insurance company acting only in its capacity as issuer.
However, the regulations do not specify whether the
word "arrangement" is defined as the legal contract (the "split-
dollar agreement") or the life insurance contract (the
"policy"). Because the proposed regulations define an arrangement as
"any agreement between an owner of a life insurance contract and non-owner
of the contract," the intent appears to be to define "arrangement"
as the "split-dollar agreement" and not the "policy"
itself. We agree with this intent, but request that it be clarified. Making
this distinction is critical for our members who must interpret the regulations
when advising clients and during tax return preparation.
The AICPA believes that the split-dollar agreement
defines the rights and the ownership of the policy. This is a particularly
important distinction for all arrangements entered into prior to the final
regulations. The ability of the parties to make changes within a policy
without violating the status of the arrangement is critical. Without
clarification, a taxpayer who may have to make changes to an existing insurance
contract due to carrier insolvency, a takeover or financial downturn, or who
may wish to change to a more suitable policy, for example utilizing section
1035, might become subject to the new, final regulations and, therefore, be
unduly burdened.
C. Modifications Should be Specifically, Listed
-- The regulations would make a significant change in the treatment of
split-dollar arrangements. Accordingly, it is very important that taxpayers be
able to determine with certainty whether existing arrangements might be
subjected to the new rules. In order to avoid confusion and reporting
inconsistencies, as well as to provide needed clarity on how to apply the
regulations, the final regulations should specifically list the "material
modifications" which would cause an arrangement to lose its grandfathered
status. For example, a change in the insurer might not be a material
modification to an arrangement, which would be grandfathered; however, a change
in the insured might be a material modification which would cause the
arrangement to be subject to the final regulations.
Code Section: Miscellaneous
Geographic Identifier:
Subject Area: Insurance company taxation
Industry Group: Insurance
Cross Reference: For summary of
REG-164754-01, see Tax Notes,
for the full text, see Doc 2002-17108 (24 pages) [PDF],
2002 TNT 135-10 
,
or
H&D,
Institutional Author: American Institute of Certified Public Accountants