Legal Memorandum: Split-Dollar Life Insurance Plans

Issue: Where an employer has been offering its executives life insurance under a program requiring employee contribution under a formula that has not had income tax consequences and intends to change to a program requiring no employee contribution, what are the tax consequences to an employee of a lump sum payment that will be made reimbursing the employee for amounts already contributed?

The proposed change will convert the program from a "classic" equity split-dollar arrangement under which the employer and employee split the premium costs between them and the employer receives an interest in the policy proceeds to the extent of its accumulated premium contribution, to a modified "employer-pays-all" or "no-split" equity arrangement under which the employer pays the entire cost of premiums for employees who have participated more than five years, and the employer again retains an equity interest against the policy for the premium amounts.  See generally  Lawrence Brody and Lucinda Althauser, An Update on Business Split-Dollar Insurance, 133 Trusts & Est. 10, 10 (Apr. 1994).

In addition, under the revised plan the employer will pay out a "distribution" to these five-year employees by rebating their accumulated premiums-to-date.   The program otherwise retains its character as an equity-based, collateral assignment split-dollar premium arrangement.*FN1

Thus, there are two "events" that may result in tax consequences to the employee.  One event is the switch to employer-pays-all premiums.  The other is the payment of the lump sum distribution to the employees of their accumulated premiums-paid.

FOOTNOTES

*FN1           Note, however, that under the revised program the employer’s equity in the policy will increase each year because it will pay the entire premium; hence, the amount the employer receives from the policy proceeds when they are paid out will be greater.  This is not a tax consequence, but may […]