Legal Memorandum: Lump-sum Payment as Ordinary Income

Issue: Under federal law, if an employer amends an employee life insurance benefit program and no longer requires employees to contribute to the premiums and offers a lump-sum payment as reimbursement for previous premiums paid, is there an argument that the lump sum payment should be treated as ordinary income?

The lump-sum payment could be treated as taxable under I.R.C. § 61 providing that gross income means all income from whatever source, including compensation for services, and I.R.C. § 83, providing that transfers of property to an employee in return for services may be taxable.

Revenue Ruling 66-110 interprets I.R.C. §§ 61 and 83.  It holds that a taxpayer must include in income any benefit received from a split-dollar life insurance plan that is over and above the current term-life value of the policy.   It requires current taxation of all "economic benefits for services" such as dividends*FN1 distributed to an employee and additional life insurance coverage paid for by the employer.  Rev. Rul. 66-110, 1966-1 C.B. 12, 13.  See generally Joan H. Vines, IRS Taxes Cash Surrender Value of Split-Dollar Life Insurance Policy Placed in Trust for Benefit of Executive, Tax Advisor 87 (Feb. 1997) (taxability of any benefit received from split-dollar life insurance arrangement); Bilello at 31 (taxability results if premiums are forgiven by employer in a reverse split-dollar arrangement); (tax treatment of deferred compensation under I.R.C. § 83).

The reasoning of  P.L.R. 9604001 just takes Rev. Rul. 66-110 one step further by including the "build-up" or cash surrender value of the policy as a "benefit" of the plan.  P.L.R. 9604001 reiterates that under Rev. Ruls. 64-328 and 66-110 the employee must include in gross income any benefit received from a split-dollar program.  Priv. Ltr. Rul. 9604001 (Feb. 1996).  Thus, the reasoning of Revenue Ruling 64-328 […]