Legal Memorandum: Split-Dollar Life Insurance Plans

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, can such an arrangement potentially lower the tax consequences to the employee in the long-run?

The same tax rules apply to this portion of the revised program as apply to the original program.  Revenue Ruling 64-328 requires each employee to include in his or her gross income the annual value of the insurance protection provided to him or her in excess of the portion of the premium paid by him or her.  Rev. Rul. 64-328, 1964-2 C.B. 11, 13 (Nov. 27, 1964).  The value is measured as the cost of a comparable amount of term life insurance for that year.  Id.*FN1  See Ben. Coordinator (RIA) ¶ 14,403 (1997) for an illustration of the calculation where the employer pays the entire premium.

Under the original program, application of Rev. Rul. 64-328 in the early policy years results  in no current tax to the participating employee, because the cost of the premiums paid by the employee exceeds the annual term-life value of the policy (i.e., the policy’s annual value, which was the economic benefit they were receiving from the employer’s payments).*FN2  Thus, the program operates as a form of deferred compensation for the employee.  For a discussion of how this result is obtained, see Mark H. Sokolsky and Ana M. Flynn, Split-Dollar Life Insurance Plans, Ben. Coordinator (RIA) ¶¶ 3,721–3,725 (1997).

Under the revised program, this rule continues to apply.  Revenue Ruling 64-328 in fact includes a reference to arrangements such as this revised program when it describes split-dollar arrangements:

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