Taxation and Business Uses of Insurance - Structure and Taxation of Split-Dollar Coverage

Structure
Typically, there are two types of split-dollar arrangements.
Endorsement Method - Employer owns the policy and pays the premiums on the policy.

  • Employer will receive the total of all premiums paid if the cash value is surrendered or proceeds are paid as the primary beneficiary and then pays the remaining balance to the employee's secondary beneficiaries.
  • Employee is not a shareholder

Collateral Assignment Method - Employee owns the policy and the corporation loans its share of the premium payments to the employee.
  • Employer hold the policy as collateral
  • Employer will receive the total of all premiums paid if the cash value is surrendered or proceeds are paid to the employee's beneficiaries. The primary beneficiary is the employees' choice it is not the business or corporation.
  • Employee is a shareholder

Tax Considerations
As with any arrangement between an employer and employee both parties need to consider the tax consequences of the arrangement. With split-dollar coverage there are tax advantages and disadvantages for the employer and employee. The following table illustrates the major tax considerations.
Employer Employee
Premiums Paid Non-Deductible Non-Deductible and must report the benefit received for income tax purposes (employer paid premiums). The reportable amount is computed using Table 2001 (may be referred to as P.S. 58)
Death Benefits Received Tax Free - Unless paid to a C Corporation. The benefits are includable in calculating the AMT amounts Tax Free
Estate Tax N/A No incidents of ownership - not includable in gross estate. Incidents of ownership - includable in gross estate

Practice Question:
Janet works at ABC Corporation. She would like to purchase life insurance and make her husband the beneficiary of the policy. She is not a shareholder in the corporation. The corporation does allow employees to purchase life insurance under a split-dollar arrangement. Which type of arrangement should Janet choose and who will be the primary beneficiary of the policy?

A. Endorsement Method; Janet (herself)
B. Endorsement Method; Janet's husband
C. Endorsement Method; ABC Corporation
D. Collateral Assignment Method; Janet's husband
E. Collateral Assignment Method; ABC Corporation

Answer: C
Janet is not a shareholder in the corporation; therefore making it more beneficial for her and the corporation to use the endorsement method. Janet's husband would not be the primary beneficiary of the policy, ABC Corporation is the primary. Upon Janet's death ABC receives the benefits and retains the total of the premiums paid, then passes the remaining balance to Janet's husband. Under the collateral assignment method Janet's husband is the primary beneficiary and must give the corporation the remaining balance on the loan amount (total premiums paid). Business Overhead Expense Insurance
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