Writer Criticizes Proposed Regs on Split-Dollar Life Insurance
Plans
John Peluso of Guardian Life Insurance Co. of
Document Type: Public Comments on Regulations
Tax Analysts Document Number: Doc 2002-23101 (7 original pages) [PDF]
Tax Analysts Electronic Citation: 2002 TNT 198-20
Citations: (
=============== SUMMARY ===============
John Peluso of Guardian Life Insurance Co. of America, 
,
or H&D, July 5, 2002, p. 175.)
Among Peluso's suggestions were an amendment to include a broader statement
that the proposed regs don't apply to estate taxes or to gift taxes arising
from the transfer of an interest in a life insurance contract. He also noted
that it must be made clear that a contract treated as two or more separate
contracts would nevertheless be treated as one contract for purposes of section
7702 (qualification as life insurance) and section 7702A (treatment as a
modified endowment contract). Peluso's other suggestions focused on the
limitations on section 163(d) investment interest, the treatment of equity
split-dollar arrangements between employers and employees, and the taxation of
life insurance contract rights and benefits provided to employees.
=============== FULL TEXT ===============
From: postoffice@www.qai.irs.gov
Sent:
To: guy.r.traynor@irscounsel.treas.gov
Subject: Comment from Web Site
reg=Split-Dollar Life Insurance Arrangements
category=taxregs
CC:ITA:RU (REG-164754-01)
Re: Proposed Regulations Regarding Split-Dollar Life Insurance Arrangements
Dear Sir or Madam:
[1] Please find below the comments of The Guardian Life Insurance Company of
[2] Guardian respectfully reserves the right to request time to present oral
comments at the public hearing scheduled for
[3] If you have any questions, please call me at 212-598-8072.
Very truly yours,
John Peluso
Vice President and General Counsel
The Guardian Life Insurance
Company of
COMMENTS OF THE GUARDIAN LIFE INSURANCE COMPANY OF AMERICA
WITH RESPECT TO THE PROPOSED REGULATIONS AFFECTING THE TAXATION OF SPLIT-
DOLLAR LIFE INSURANCE ARRANGEMENTS
Background
[4] The Guardian Life Insurance Company of
[5] Guardian appreciates the significant investment of time and effort the
Department of Treasury and the Internal Revenue Service have devoted to
creating an appropriate tax treatment for modern split dollar arrangements. We
believe the proposed regulations would, with the modifications and clarification
described in this letter and in the letter submitted by ACLI, provide a
workable structure for treatment of split dollar life insurance arrangements
within the basic statutory provisions and tax principles that apply to life
insurance products.
I. Gift and Estate Tax Consequences
[6] The Preamble to the Proposed Regulations states at section 5 that the
gift tax consequences of the transfer of an interest in a life insurance
contract to a third party will continue to be determined under established gift
tax principles notwithstanding who is treated as the owner of the life
insurance contract under the proposed regulations. Section 5 of the Preamble
further states that the inclusion of life insurance proceeds in a decedent's
gross estate will continue to be determined under Internal Revenue Code (IRC)
2042 regardless of who is treated as the owner of the life insurance contract
under the proposed regulations.
[7] The statement that IRC 2042 governs the inclusion of life insurance
death benefits regardless of who was deemed to be the owner of the contract is
not entirely clear. It can be read to mean that IRC 2042 will be applied taking
into account as the contract owner the party who is treated as the owner of the
contract under the proposed regulations, regardless of who that party is.
[8] In addition, estate tax consequences can arise from the proposed
regulations under sections of the Internal Revenue Code other than 2042. For
example, proposed regulation 1.61-22(f)(3) provides that any amount paid by a
non-owner, directly or indirectly, to the owner of a life insurance contract
for current life insurance protection or any other economic benefit is treated
as included in the owner's gross income. Thus, where a split dollar life
insurance arrangement between a trust and a grantor of the trust is a
contributory arrangement under which the trustee pays the portion of the
premium equal to the value of the current life insurance protection provided
under the arrangement, it appears the grantor will be considered to receive
funds from the trust and may be considered to have a retained interest in trust
assets under IRC 2036, causing all or part of the trust assets to be included
in his or her estate. Even if it is possible to amend the split dollar agreement
to provide that the split dollar arrangement will become non contributory, it
is unclear whether such a modification of the arrangement would cause an
arrangement entered into prior to January 28, 2002 to lose the benefits of
grandfathering under Notice 2002-8, 2002-4 IRB 398.
[9] Given the importance of estate planning considerations to individuals
who enter into split dollar life insurance arrangements, the proposed
regulations should be amended to include a broader statement that the proposed
regulations do not apply to estate taxes or to gift taxes arising from the
transfer of an interest in a life insurance contract.
II. Changes in the Income Tax Treatment of Life Insurance Contracts Arising
from the Ownership Provisions of the Proposed Regulations
[10] Section 1.61-22(c)(1)(i) of the proposed regulations provides that
where two or more persons are named as owners of a life insurance contract and
each person has all the incidents of ownership with respect to an undivided
interest in the contract, each person is treated as the owner of a separate
contract. The proposed regulations should clarify that a contract treated as
two or more separate contracts under this provision is nevertheless treated as
one contract for purposes of IRC 7702 (qualification as life insurance) and IRC
7702A (treatment as a modified endowment contract).
III. Revenue Rulings Made Obsolete under the Proposed Regulations
[11] The Preamble to the proposed regulations states at section 7 that when
the proposed regulations are issued as final regulations the Internal Revenue
Service will make obsolete Revenue Ruling 64- 328, 1964-2 C.B. 11, and Revenue
Ruling 66-110, 1966-1 C.B. 12.
[12] These rulings have served as the basis of split dollar life insurance
arrangements for more than 35 years. Preserving these rulings as modified would
help to clarify that under the new regulations split dollar life insurance
arrangements remain a valid method for helping to finance needed life insurance
protection. We believe that these revenue rulings should be modified rather
than being made obsolete.
IV. Split Dollar Life Insurance Arrangements Between a Corporation and Its
Shareholder
[13] It is unclear under the proposed regulations whether a split dollar
life insurance arrangement between a corporation and its shareholder can be
taxed under the economic benefit regime or whether such arrangements must
always be treated under the loan regime.
[14] The proposed regulations provide at 1.61-22(b)(3) that all split dollar
arrangements except for those arrangements specified in proposed regulation
1.61-22(b)(3)(ii) will be subject to the loan regime under proposed regulation
1.7872-15. Only those arrangements specified in proposed regulation
1.61-22(b)(3)(ii) will be eligible for treatment under the economic benefit
regime of proposed regulation 1.61-22(d) through (g). Shareholder split dollar
is not included in 1.61-22(b)(3)(ii). Nevertheless, the proposed regulations
provide at 1.61-22(e)(1) that amounts received under a life insurance contract
subject to the economic benefit regime of proposed regulation 1.61-22(d)
through (g) can be received as a payment of compensation, a distribution under
IRC 301, a gift or other transfer depending on the relationship between the
owner and the non-owner.
V. Clarification of Cross Reference
[15] It appears a cross reference in proposed regulation 1.61- 22(b)(5) to
Treas. Reg. 1.61-2(d)(2)(ii)(A) was intended to refer to Treas. Reg.
1.61-2(b)(2)(ii)(A).
VI. Treatment of the First-Named as Sole Owner of the Contract
[16] We believe, for the reasons stated in the ACLI comment letter, that
treatment of only one of the parties to the split dollar arrangement as the
sole owner of the entire interest in the life insurance contract underlying the
arrangement violates general principles of tax policy, judicial authority and
the Internal Revenue Code and that both parties to the arrangement should be
treated as the owners of the contract in accordance with the economic substance
of the arrangement.
[17] Even given the position of the Internal Revenue Service in the proposed
regulations that a life insurance contract cannot be jointly owned where the
joint ownership would result from a split dollar life insurance arrangement,
there seems little justification for the rule of convenience found at proposed
regulations at 1.61- 22(c)(1), which treats the contract owner whose name
appears first on the records of the insurance company as the sole owner of the
contract without reference to the substance of the contract between the
parties. There is little reason to suppose that parties entering into split
dollar arrangements in the past had any reason to believe that the order of
names on insurance company ownership forms had a substantive effect.
[18] If the rule treating the first-named joint owner of a life insurance
contract as the sole owner of the contract is not eliminated, the proposed
regulations should be amended to clarify that the parties can change the order
in which the joint owners of the life insurance contract are named to better
reflect the relationship of the parties, that such change of the order in which
contract owners are listed will not be considered a modification of the split
dollar arrangement for purposes of eligibility for grandfathering, and that the
change in the order in which joint owners are listed will not be considered a
transfer of an interest in the life insurance contract for income tax or estate
tax purposes, and will not result in a transfer for value of the life insurance
contract.
VII. Treatment of a Donor or an Employer or Service Recipient As the Owner
of the Life Insurance Contract
[19] The proposed regulations provide at 1.61-22(c)(1)(ii) that a donor,
employer or service recipient will be treated as the owner of a life insurance
subject to a split dollar arrangement regardless of whether he or she is the
named owner of the contract, and that the life insurance contract will be
subject to the economic benefit regime, if the only economic benefit provided
to the donee, employee or service provider under the arrangement is current
life insurance protection. The Preamble to the proposed regulations appears to
state at section 5 that the loan regime will not apply and a donor who is not
the named owner of the life insurance contract will be treated as the owner of
the contract under proposed regulation 1.61-22(c) where the donor or the
donor's estate is entitled to receive the lesser of the aggregate premiums
advanced by the donor or the cash surrender value of the contract. The Preamble
seems to indicate that the donor's gift to the trust in this case is more than
the cost of current life insurance protection.
[20] The proposed regulations should clarify how proposed regulation
1.61-22(c)(1) applies to treat the donor as the owner of the contract where the
donee's benefit under the contract is not limited to current life insurance
protection.
VIII. Non-equity Split Dollar Life Insurance Arrangements
[21] The proposed regulations at 1.61-22(d)(2) provide that the employer or
donor is treated as the owner of the life insurance contract underlying a split
dollar arrangement, thereby subjecting the arrangement to the economic benefit
regime, where the only benefit provided to the employee or donee under the
split dollar arrangement is current life insurance protection. In cases where
the employee or donee is the named owner of the life insurance contract and
retains the right under the split dollar agreement to take loans from the life
insurance contract, it is unclear whether the right to take the loan would
prevent the arrangement from qualifying as a non- equity loan eligible for
economic benefit treatment.
IX. Taxation of Life Insurance Contract Rights and Benefits Provided to an
Employee
[22] The proposed regulations at 1.61-22(d)(3) are concerned with the the
[sic] case of an equity arrangement (an arrangement not described at paragraph
(d)(2), which governs non-equity arrangements) that is subject to the economic
benefit regime. Because we are told that the arrangement is an equity
arrangement subject to economic benefit provisions, the arrangement must be an
equity endorsement arrangement. While such arrangements are rare, it is
possible that an employer or donor who was the actual owner of a life insurance
contract might promise to transfer an economic benefit other than current life
insurance protection to an employee or donee under a split dollar arrangement.
The proposed regulation states that any right or benefit in the life insurance
contract, including but not limited to interest in the cash surrender value, is
an economic benefit if it is provided during a taxable year to a non-owner.
[23] The proposed regulations should clarify the point at which the right or
benefit is considered to be provided to the non-owner and subject to current
taxation as an economic benefit. In general, under an endorsement split dollar
life insurance arrangement all rights and benefits under the life insurance
contract belong to the contract owner at the termination of the arrangement. It
would not appear reasonable to tax the employee or donee on a benefit provided
until the time the benefit would no longer revert to the employer at
termination of the split dollar arrangement. If prior to termination of the
endorsement split dollar arrangement the employee or donee acquires a right or
benefit that will not revert to the employer or donor at the termination of the
arrangement, and the proposed regulations are intended to tax the employee or
donee as soon as the right or benefit has accrued and is nonforfeitable, the
proposed regulation should clarify how the parties are to value contract rights
or benefits that fluctuate in value during the years prior to the death of the
insured. For example, if the employee or donee has a nonforfeitable right to
the cash surrender value of a variable life insurance contract at some time in
the future and the cash surrender value rises and falls with the stock market
as each year, how will the parties value the economic benefit each year? Unlike
the treatment described at proposed regulation 1.61-22(e)(1) for transfers of
policy dividends, proceeds of a specified policy loan, or proceeds of a
withdrawal from or partial surrender of the contract, it is not apparent
whether the taxation of rights and benefits under proposed regulation
1.61-22(d)(3) occurs annually as the rights accrue or only after they are
received by the employee or donee.
X. Limitations on Section 163(d) Investment Interest
[24] The proposed regulations at 1.7872-15(e)(2)(iii) provide that where a
split dollar loan between a lender and a borrower is restructured as one loan
between the lender and a third party who is an indirect participant and a
second loan between the indirect participant and the borrower, the indirect
participant may treat a portion of the imputed interest from the indirect
participant to the lender that is taken into account by the indirect
participant as investment interest deductible under IRC 163(d). The portion of
the imputed interest from indirect participant to lender that may be treated as
investment interest is limited to the amount of the imputed interest to the
indirect participant from the borrower that is recognized by the indirect
participant.
[25] In view of the potential significance of this deduction in cases where
a split dollar loan is restructured into two loans involving an indirect
participant, such as split dollar loans from an employer to a trust created by
an employee, the proposed regulations should provide additional information as
to the operation of the IRC 163 deduction in this context. It is unclear, for
example, whether the deduction would be available if the borrower were the
indirect participant's grantor trust, so that the indirect participant would
not recognize interest income from the borrower.
XI. Treatment of Equity Split Dollar Arrangements Between Employers and
Employees
[26] The proposed regulations at 1.7872-15(e)(5)(iii) provide that the
forgone interest on split dollar loans whose benefits are not transferable and
are conditioned on the future performance of substantial services by an
individual is calculated using the AFR appropriate for the loan's term and not
the blended annual rate. It is not clear whether, or under what circumstances,
a split dollar loan in an employment context will qualify as a demand loan for
which the appropriate AFR is the blended annual rate for the year.
[27] Thank you for you[r] consideration of these comments, The proposed
rules for the taxation of split dollar life insurance arrangements are of great
concern to Guardian as an issuer of life insurance products and to many of our
clients, particularly owners and employees of small businesses, for whom split
dollar life insurance funding is of great assistance in obtaining needed life
insurance. We hope that these comments, along with the comments of other
taxpayers concerned about the proposed regulations on the taxation of split
dollar life insurance arrangements issued on July 3, 2002, will assist the
Department of Treasury and the Internal Revenue Service in shaping clear and
reasonable rules for the taxation of split dollar life insurance arrangements.
Very truly yours,
John Peluso
Vice President and General Counsel
The Guardian Life Insurance
Company of America
New York, NY
Code Section: Section 7872 --
Below-Market-Rate Loans; Section 7702 -- Life Insurance Contract Defined;
Section 163(d) -- Investment Interest; Section 61 -- Gross Income Defined;
Section 83 -- Property Transferred for Services; Section 264 -- Nondeductible
Premiums
Geographic Identifier:
Subject Area: Benefits and pensions
Insurance company taxation
Industry Group: Insurance
Cross Reference: For a summary of
REG-164754-01, see Tax Notes,
for the full text, see Doc 2002-16108 (24 original pages) [PDF],
2002 TNT
135-10 
,
or H&D,
Author: Peluso, John
Institutional Author: Guardian Life Insurance Co. of