This year at the Heckerling Institute on Estate Planning, Donald O. Jansen, Mary Ann Mancini, and G. Michelle Ferreira presented “Split Dollar is Still Alive and Kicking – Fundamentals and Intergenerational Update” – an interesting and educational look into the foundations and recent developments of split-dollar arrangements.
Treasury Regulations Section 1.61-22(b) defines “split dollar” as an arrangement between an owner and a non-owner of a life insurance premium contract that satisfies the following criteria:
- Either party to the arrangement pays, directly or indirectly, all or any portion of the premiums on the life insurance contract, including a payment by means of a loan to the other party that is secured by the life insurance contract;
- At least one of the parties to the arrangement paying premiums is entitled to recover (either conditionally or unconditionally) all or any portion of those premiums and such recovery is to be made from, or is secured by, the proceeds of the life insurance contract; and
- The arrangement isn’t part of a group-term life insurance plan described in Internal Revenue Code Section 79 unless the group-term life insurance plan provides permanent benefits to employees.
Jansen kicked off the presentation with the history and uses of split-dollar arrangements between employees and employers—particularly focusing on employee fringe benefits, cross purchase agreements, nonqualified deferred compensation and estate tax planning. Jansen and Mancini also delved into the structure and nuances of the two split-dollar regimes: the economic benefit regime and the loan regime.
Under the economic benefit regime, the employer or donor owns the life insurance policy and endorses the economic benefit of the policy to the employee or donee, which may result in income, employment and/or gift tax consequences. The economic benefit regime is beneficial when the employer wants to own and control the cash value of the policy.
Under the loan regime, the employer or donor loans the policy premiums (usually at the current applicable federal rate) to the employee or donee, who owns the policy. The employer’s interest in the cash value of the policy is limited to the premium loans made (plus accumulated interest), and the remaining cash value is owned and controlled by the employee or donee and can grow tax-free.
Intergenerational Split Dollar
After providing a comprehensive background of split-dollar arrangements, Jansen and Mancini turned the presentation over to the star of the show: Michelle Ferreira. Last year, Ferreira successfully defeated the Internal Revenue Service in Estate of Marion Levine v. Commissioner, 158 T.C. No. 2 (2022), which focused on the estate tax consequences of intergenerational split-dollar life insurance planning arrangements.
Intergenerational split dollar is an estate planning strategy in which a grandparent (Gen 1) funds an irrevocable life insurance trust (the ILIT) that benefits their grandchildren (Gen 3). The ILIT subsequently purchases a life insurance policy on the life of Gen 1’s child (Gen 2). Gen 1 advances the life insurance premiums to the ILIT and takes back a receivable under which Gen 1 is entitled to the greater of: (1) the premiums paid; or (2) the cash value of the life insurance policy at the time of Gen 2’s death. According to Ferreira, intergenerational split-dollar arrangements are best for clients who aren’t doing “deathbed planning” and who:
- Have sufficient liquidity to live for the rest of their life without the need of the cash used for the insurance policies and liquidity to purchase the life insurance policies;
- Face an estate tax bill sufficient enough to justify the costs of planning; and
- Have insurable children who themselves have sufficient net worth for to qualify for large life insurance policies.
Estate of Marion Levine v. Comm’r
In 2008, Marion Levine entered into an intergenerational split-dollar arrangement by which her revocable trust paid $6.5 million dollars for two life insurance policies on her daughter and son-in-law’s lives. The policies were held in an ILIT, of which South Dakota Trust Company, LLC was the trustee. Importantly, only an Investment Committee could make decisions regarding the investments within the ILIT, including the decision to terminate the policies. As is necessary with intergenerational split-dollar arrangements, the ILIT agreed to pay the revocable trust the greater of: (1) the total amount of the premiums paid for these policies (that is, $6.5 million); and (2) either (a) the current cash surrender values of the policies on the death of the last surviving insured or (b) the cash surrender values of the policies on the date that they were terminated, if they were terminated before both insureds died.
At Levine’s death, her estate reported only one asset: the receivable, which was valued at $2.2 million (that is, the present value of the right to receive the payments in the future). The IRS took the position that the estate should include the current value of the cash surrender values of the life insurance policies ($6.2 million) or the value of the premiums paid ($6.5 million) under IRC Sections 2036 and 2038.
The Tax Court found that Sections 2036 and 2038 didn’t apply because Levine and her estate didn’t have the right to determine who could use possess or enjoy the income from the life insurance policies. The ILIT that owned the policies had an independent, corporate trustee, and only the Investment Committee retained the right to terminate the policies.
The IRS also argued that the special valuation rules under Section 2703 applied to the split-dollar arrangement and that by entering into the split-dollar arrangement, Levine restricted her right to control the $6.5 million and the insurance policies. According to the IRS, this restriction is what should be disregarded when determining the value of the property. The estate contended that the special valuation rules of Section 2703 only apply to property owned by Levine (that is, the receivable, which didn’t have any restrictions), and not the insurance policies, which she never owned at all. The court agreed, and only the $2.2 million receivable was considered included in the estate.
In closing, Ferreira offered the following planning tips for split-dollar arrangements:
- The client shouldn’t have the ability (alone or in conjunction with any other person) to unwind the split-dollar arrangement, and the person who can unwind the arrangement shouldn’t be acting on behalf of the client.
- Independent members should serve as fiduciaries. If a fiduciary isn’t being paid for their services, it must be clear that the fiduciaries wouldn’t benefit personally from the arrangement.
- The ILIT should be the only owner of the insurance policies. Preparation of all forms, drafting, applications for insurance and other legal trust instruments and assignments clearly indicate who the owner of the life insurance policies is.
- The legal documents should be carefully drafted, signed, kept, monitored and prepared to comport with the holdings in the controlling cases and split-dollar regulations. Gift and estate tax returns should be timely filed and valuation reports prepared and included with the returns to report the value of the receivable.
Katie Coeyman is a Tax and Estate Planning Attorney with Schechter