During the last four decades, a popular way to purchase permanent life insurance has been through so-called "split-dollar" life insurance arrangements, where two or more parties share the costs and benefits of the life insurance policy. Favorable tax treatment has been a major reason for the popularity of these arrangements. The IRS recently has announced changes in the taxation of split-dollar plans, and these changes cast doubt on the future utility of some of these arrangements and create a risk of potentially disastrous tax consequences for participants in certain existing split-dollar arrangements.

During the last four decades, a popular way to purchase permanent life insurance has been through so-called “split-dollar” life insurance arrangements, where two or more parties share the costs and benefits of the life insurance policy. Favorable tax treatment has been a major reason for the popularity of these arrangements. The IRS recently has announced changes in the taxation of split-dollar plans, and these changes cast doubt on the future utility of some of these arrangements and create a risk of potentially disastrous tax consequences for participants in certain existing split-dollar arrangements.

Many split-dollar strategies developed prior to the IRS’s change of position will simply not work as originally intended. Individuals and companies who currently are parties to a split-dollar life insurance agreement should have the agreement reviewed as soon as possible to determine how the changes will affect that particular agreement. For some, the new tax rules will have relatively minor implications, but for others the new tax rules will mean that the split-dollar arrangement should be terminated or at least substantially modified — possibly before January 1, 2004, a deadline set by the IRS for termination or modification of some plans without adverse tax consequences.


A wide variety of split-dollar plans exist today — all involving two or more people or entities splitting the costs and benefits of some sort of permanent life insurance. A split-dollar “policy” is not an insurance policy but refers to a contract between the parties that sets out their duties to split the costs and their rights to share in the proceeds of an insurance policy. An insured person may enter into an arrangement with family members or a trust for the family’s benefit, but most split-dollar plans involve a fringe benefit program in which an employer assists an employee in purchasing an insurance policy on the life of the employee for the benefit of the employee’s family. These employment-related split-dollar arrangements were sometimes used as a method of deferred compensation and sometimes as an estate-planning technique for the insured employee.

Unlike many other fringe benefit programs, split-dollar life insurance arrangements were not built upon statutory or judicial law. Instead, the tax consequences of split-dollar life insurance plans have been largely controlled by one Revenue Ruling published by the IRS in 1964.1 Although a Revenue Ruling is fairly weak authority in legal terms, split-dollar insurance has grown into a concept so popular that practically every employer has adopted some form of split-dollar insurance for one or more of its employees.

In a typical split-dollar agreement, the employer pays all or most of the policy premiums in exchange for an interest in the policy cash value and death benefit. In the past, the IRS took the position that the insured employee must recognize the “term cost” of the life insurance protection as income. “Term cost” is simply the cost of a one-year term policy on the insured employee with the same death benefit, i.e., what it would cost the employee to buy the same amount of insurance protection for one year under a term policy.2 In some arrangements, the employee actually pays the term costs. Term costs generally are quite low until a person reaches an advanced age and are usually significantly lower than the actual premiums paid on the policy.

For example, assume a male employee, age 40, entered into a split-dollar agreement with his employer before January 28, 2002, under which the employer pays all of the premiums, and in 2004 the employer paid a premium of $10,000 on a $1,000,000 life insurance policy insuring the life of the employee. The insurance company issuing the policy has quoted $200 as the cheapest premium it would charge on any $1,000,000 term insurance policy covering a 40-year-old male. The employee would be required to report $200 of taxable income on his 2004 personal income tax return attributable to the split-dollar agreement, even though the employer paid $10,000 of premiums.

Often, where the split-dollar plan is part of the employee’s estate plan, the insured employee will create an irrevocable life insurance trust (ILIT) to own the policy subject to the split-dollar plan. If done properly, this removes the life insurance proceeds from the employee’s gross estate for federal estate tax purposes. Where an ILIT owns the policy, the employee is deemed to have made a taxable gift to the ILIT in an amount equal to the term cost of the life insurance (the same amount taxed to the employee).

This reliance on term costs to value the taxable income to the employee (and the gift to the ILIT) has been the reason split-dollar arrangements have been so attractive. In effect, the employee gets the benefit of a permanent life insurance policy for the price of a very inexpensive term policy.

At some point in the employee’s life, however, the term cost of a policy is no longer a bargain, and some sort of exit strategy has always been an important part of split-dollar life insurance planning. Imagine, for example, the cost of a $5,000,000 term life insurance policy on an 85-year-old man. (Even if the employer no longer has to mail a check to the insurance company because the policy has sufficient value to carry itself, the IRS’s position has always been that the term cost continues to be deemed income to the insured employee for as long as the plan exists.) Without an exit strategy, an employee who lived to a ripe old age and was insured with a fairly large split-dollar policy would be required to recognize tens of thousands of dollars in phantom income each year and face the consequences of making large phantom taxable gifts if an ILIT were involved.

Split-dollar agreements look a lot like interest-free loans. The IRS, however, took the position in the 1964 Revenue Ruling that split-dollar arrangements would be considered by the IRS to be a taxable fringe benefit to the employee rather than an interest-free loan. Accordingly, for a very small income and gift tax consequence, an employee could provide significant benefits for his or her family, utilizing the generosity of the employer to accomplish these results.


Despite popular acceptance, the dearth of statutory and judicial support for split-dollar arrangements has always meant that the IRS could change its approach to the taxation of split-dollar arrangements simply by publishing new Rulings. During the last few years, the IRS has been indicating that it was revisiting the tax treatment of split-dollar arrangements and in particular the type of split-dollar arrangements referred to as “equity split-dollar.” In equity split-dollar, the employer is reimbursed only for premiums paid from proceeds or cash value. The cash surrender value of the policy eventually exceeds the reimbursement right of the employer, and this additional value in the policy is referred to as “policy equity.” The IRS has been displeased that the policy equity escaped income taxation, because the IRS considered policy equity to be a benefit provided to an employee. However, the IRS had some difficulty developing a legal theory that would justify taxing this equity.

In 2001 and 2002, the IRS published notices regarding split-dollar arrangements, each offering new explanations of how the IRS intended to tax split-dollar arrangements. The second of these notices, Notice 2002-8 (which revoked the 2001 Notice), was issued on January 28, 2002, and announced the IRS’s intention to publish new regulations that would codify a comprehensive approach to the taxation of split-dollar life insurance based upon two mutually exclusive tax regimes. Proposed regulations were published in late 2002, but final regulations have not yet been published. Unfortunately, the approaches announced in the Notice and the proposed regulations conflict with much of the widely accepted theory of taxation upon which most existing split-dollar plans are based.

According to the proposed regulations, once the final regulations are adopted, all new arrangements will fall under one of two regimes of split-dollar taxation. The ownership of the policy (an almost irrelevant detail in the old system) will determine which regime will apply to a specific arrangement. If the employer (or other party responsible for paying the premiums) owns the policy, then the arrangement will be taxed under the “economic benefit analysis.” If the employee owns the policy, the arrangement will be taxed as a “split-dollar loan.” The economic benefit analysis closely resembles the previous approach to split-dollar taxation, with the important exception that under equity arrangements subject to the economic benefit analysis, policy equity will be taxable income to the employee. Under split-dollar loan treatment, all of the premiums paid by the employer will be treated as a loan to the employee. If the loan does not bear an adequate rate of interest (as determined under the regulations), then the regulations set out a complex system of deemed interest flowing to the employee as income and back to the employer as interest.

Unfortunately, the tax treatment of existing agreements is somewhat less clear. Under the proposed regulations, it is clear that unless the premiums are treated as a loan, policy equity will be taxed as it accrues. It is equally clear that for existing plans, policy equity will not be taxed as long as the agreement remains in place. What is not clear is how the equity in an existing plan will be taxed if the plan is terminated during the life of the employee. The policy equity may escape taxation if the employee dies while the agreement is in place, but this is small comfort for many split-dollar participants because most equity plans were designed to be terminated at the point when the policy had built up enough cash value to repay the employer and still retain enough value to carry itself without further contributions from the employee. Terminating the split-dollar plan before death avoided the income (and possibly gift) tax implications of skyrocketing term costs as the insured aged. Therefore, continuing the split-dollar plan for the lifetime of the employee is simply not a viable option in most situations given the ever-increasing term costs.

If the IRS pursues taxing policy equity upon termination of existing plans, the tax results could be startling. For example, if a life insurance policy subject to an employment-related split-dollar agreement has $5,000,000 of cash value at the time of rollout from the split-dollar arrangement, and the employer is entitled to a return of $1,500,000 for premiums paid, the employee would then have to recognize $3,500,000 of additional taxable income that year. If an ILIT owned the policy, the employee would also be deemed to have made a $3,500,000 taxable gift to the ILIT that year. Furthermore, if the ILIT was designed to provide for grandchildren and future generations, there would be a $3,500,000 generation-skipping transfer (GST) subject to the GST tax. To make matters worse, if the policy was owned by the ILIT, the employee would have no cash from the termination of the split-dollar arrangement with which to pay the tax.

There are two safe harbor rules provided for equity split-dollar plans entered into on or before January 28, 2002, and not modified after that date. The first safe harbor provides that there will be no taxation of policy equity if the arrangement is terminated before January 1, 2004. The second safe harbor allows the parties to an equity arrangement to switch to loan treatment before January 1, 2004, with no taxation of policy equity.

In some cases, these safe harbors may provide a viable solution for split-dollar participants. In other cases, however, the parties may need to take a new approach to achieve their original goals. Some commercial lenders are beginning to offer financing for life insurance purchases that would allow participants to avoid split-dollar arrangements altogether.


For publicly traded companies, there is another issue which management must face. The provisions of the Sarbanes-Oxley Act make it illegal for a publicly traded company to loan funds to officers, directors and certain other key employees on or after July 30, 2002. There are indications that split-dollar arrangements are considered loans governed by the provisions of the Sarbanes-Oxley Act, but the Department of Labor, which has jurisdiction over this issue, has not directly addressed this question. Therefore, most publicly traded companies have taken the position that no payments can be made on a split-dollar arrangement insuring the life of any of its employees covered by the Sarbanes-Oxley Act on or after July 30, 2002. These split-dollar plans for publicly traded companies generally have not been terminated because the final position by the Department of Labor has not yet been promulgated. The split-dollar plans of publicly traded companies, however, are also governed by the same income, gift and generation-skipping tax considerations governing split-dollar arrangements of non-publicly traded companies. Management must resolve the tax issues (possibly without the benefit of Final Regulations), the issues presented by the Sarbanes-Oxley Act (possibly without a final position from the Department of Labor), and make these decisions before January 1, 2004, if the employer wishes to avail itself of the safe harbor rules.


Because of the safe harbor provisions, which expire on January 1, 2004, because of the need for all later arrangements to make a choice between compensation and interest-bearing loan treatment and because of the severe tax consequences of improperly handling existing split-dollar arrangements, every split-dollar arrangement should be reviewed as soon as possible. Many of the tax benefits formerly offered by split-dollar arrangements are disappearing, and it will take careful and creative planning to find satisfactory alternatives. The once settled and sleepy world of split-dollar arrangements has now turned into a complex and vexing series of issues which all persons involved should address promptly.


  1. Rev. Rul. 64-328, 1964-2 CB 11. 

  2. The IRS published a table setting out these term costs, and these costs are sometimes referred to as PS-58 rates in reference to the IRS table. Parties also were allowed to use the insurance company’s lower published term rates in lieu of the PS-58 rates. This option led to widespread use of fantastically low rates published by the insurance companies, but the policies were not really available to regular policyholders. Under the new tax regime, parties to arrangements entered into before January 28, 2002, may continue to use the PS-58 rates or the insurance company’s lower published rates. For all arrangements entered into after January 28, 2002, the parties must use either the IRS’s updated table or rates the insurance company actually offers to policyholders. 

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