With new and tougher tax rules governing split-dollar life insurance contracts on the horizon, CFOs, CEOs and their companies could be taking out the policies like they’re going out of style.
Those thinking of buying split-dollar policies should do it soon before new final tax rules are issued by the Internal Revenue Service, advises management consultant Towers Perrin. The U.S. Treasury has proposed the new regs as a way of cracking down on executives who abuse the arrangements by using them to avoid taxes.
Since the proposed regs aren’t binding until final regulations are issued, and then only for split-dollar arrangements entered into after that date, companies and executives who are interested in a split-dollar program may want to get them in under the wire and possibly take advantage of the current tax rules.
You may recall that Ken Lay, Jeff Skilling, and other former Enron executives reportedly used split-dollar arrangements to “shelter” their deferred compensation from company’ creditors. That may be one of things that’s gotten the attention of the rulemakers.
Under certain conditions, the new rules could mean “significantly less favorable tax treatment” for executives, says Towers Perrin.
In a split-dollar life insurance policy, the employer and employee agree to split the premiums or benefits, or both, of a life insurance policy. These arrangements are generally extended to senior execs as part of compensation packages, or to make gifts to one or more family members.
Split-dollar plans come in two flavors. They can, on the one hand, be either employee-owned, which means that the corporation pays for premiums that are eventually repaid by the executive’s heirs. Or they can be employer-owned, meaning that the company is treated as providing life insurance to the executive as part of compensation.
The plans have come under fire recently as the IRS has noticed executives attempting to avoid taxes by using inappropriately high current-term insurance rates, prepayment of premiums, or other tricks to understate the value of taxable policy benefits.
Under the new rules, executives get less favorable tax treatment under the employer-owned policy. They might, for instance, be taxed currently rather than when the split with the employer is terminated. The result? More value to the pay package — and more paid to Uncle Sam.
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