Split Dollar Rules Application 6

Effective September 17, 2003, the IRS issued final regulations governing the taxation of "split-dollar" life insurance policies. In this section of the memorandum, the focus is on the applicability of these regulations to the LLC part of the transaction.

In the overview of the final regulations, included at the beginning of the regulations in order to provide guidance on the taxation of split-dollar life insurance arrangements, the Treasury Department states as follows:

The final regulations generally define a split-dollar life insurance arrangement as any arrangement between an owner of a life insurance contract and a non-owner of the contract under which either party to the arrangement pays all or part of the premiums, and one of the parties paying the 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 contract. The definition does not cover the purchase of an insurance contract in which the only parties to the arrangement are the policy owner and the life insurance company acting only in its capacity as issuer of contract. (Emphasis added.)

The Regulations state that the "owner" of a life insurance contract is the person named as owner on the contract. Reg. §1.62-22(c)(1)(i). In the present scenario, the LLC is the named owner of any life insurance policies involved in the transaction. Thus, it is the "owner" under the split-dollar regulations. Under the overview language quoted above, therefore, the regulations appear not to apply to the LLC situation because the only parties to the arrangement are the policy owner and the life insurance company.

Support for this conclusion is formed in another part of the regulations. Reg. §1.61-22(c)(1)(iv) is entitled "Life insurance contracts owned by partnerships," and is stated to be "Reserved," indicating that a future amendment to the regulations is planned. Since this part of the regulations, when issued, will be directly on point, it is reasonable to conclude that other parts of the regulations were not intended to apply to this situation.

This conclusion is consistent with the highly formalistic approach of the regulations, particularly with respect to determining a policy's owner. The Treasury Department indicated its unwillingness to look beyond the formal designation of owner in determining tax consequences. In the regulations' overview, the Department states as follows:

Several commentators argued that determining tax ownership based on the whom the parties name as policy owner of the life insurance contract represents a departure from general tax principles. Commentators suggested that a split-dollar life insurance arrangement is like any co-ownership situation in which two or more parties agree to share in the costs and benefits of a policy such that each party will be entitled to exercise certain rights with respect to the underlying policy and will have certain responsibilities.

The IRS and Treasury disagree with that argument. Split- dollar life insurance arrangements are structured in myriad ways, some formally as loans to the employee...some formally as co-ownership arrangements..., and some as arrangements in which the employer is, in form, the sole owner (for example, endorsement arrangements)....

In addition, this rule provides a clear objective standard so that both taxpayers and the IRS can readily determine which regime applies under the final regulations.

Therefore, pending issuance of an amendment to the regulations specifically relating to the ownership of life insurance by a partnership or limited liability company, it appears that the LLC part of the present scenario is not within the scope of the final split-dollar regulations.