Split Dollar Life Insurance Agreements and the Tax Code | Free human rights
A recent decision of the Tax Court De Los Santos v. Commissioner illustrates the complexity of split dollar life insurance arrangements. Taxpayers who participate in these or other types of life insurance arrangements should consult a competent tax advisor to ensure that the arrangement is reported correctly on all applicable tax returns.
In 2003, the Treasury Department issued final regulations regarding the taxation of two dollar life insurance contracts. Fractional dollar life insurance agreements of the type at issue in this case fall into one of two categories: “netting agreements” or “shareholders’ agreements”. Reg. § 1.61-22 (b) (2) (ii), (iii). In both types, the “owner” of the life insurance policy pays the premiums and the “non-owner” has a current interest in the policy.
In the case of any dollar sharing agreement, “the economic benefits are considered to be provided to the non-holder of the life insurance contract”, and the non-holder “shall take into account the total value of all the benefits. economic ”, less any consideration paid for this purpose. Reg. § 1.61-22 (d) (1). “Depending on the relationship between the owner and the non-owner, the economic benefits may constitute an indemnity payment, a distribution under section 301”, or a transfer having another fiscal character. Identifier. This means that the economic benefits under a “compensation arrangement” will generally constitute the payment of compensation to the service provider and that the economic benefits under a “shareholder agreement” will generally constitute a distribution to the service provider. shareholder. Our Country Home Enters., Inc. v. Comm’r, 145 CT 1, 51 (2015).
Indeed, the regulations provide that “[t]a provision by a company to its shareholder under a split dividend life insurance agreement. . . economic benefits. . . is treated as a distribution of goods. Reg. § 1.301-1 (q) (1) (i).
Readers will find the details and factual background of the From Los Santos case below:
De Los Santos v. Comm’r, 156 TC n ° 9 | April 12, 2021 | Lauber, J. | Dkt. No. 5458-16
Short summary: The taxpayer’s husband is a doctor. In 2011 and 2012 (“Years of Issue”), he was the sole shareholder of Dr. Ruben De Los Santos MD, PA, an S corporation incorporated in Texas (“S Corp.”). The S Corp. employed a taxpayer husband and a taxpayer wife, the latter being office manager for the medical practice. Four other employees also worked for S Corp.
Before the years in question, the S corp. had adopted a benefit plan to provide its employees with life insurance and other benefits. Under the plan, taxpayers were entitled to a death benefit of $ 12.5 million and the four core employees were entitled to a death benefit of $ 10,000 and certain flexible benefits. To fund the promised death benefits, the S Corp. used the Legacy Employee Welfare Benefit Trust (“Trust”), which has taken out a life insurance policy ensuring the lives of taxpayers. The policy was a “flexible premium variable universal life insurance” policy with capitalization values based on the investment experience of a segregated fund.
During the period 2006-2010, the S Corp. paid $ 1,862,349 to the Trust and treated these contributions as tax deductible medical practice expenses. In 2007-2012, the Trust paid total premiums of $ 884,534 on the policy. As a result of these premium payments and the associated investment gains, the “accrual value” of the policy was $ 640,358 at the end of 2011 and $ 744,460 at the end of 2012.
Taxpayers filed joint federal income tax returns for 2011 and 2012 on a timely basis. They did not report any income on those returns related to their participation in the plan. On December 4, 2015, the IRS issued a deficiency notice to taxpayers, establishing that the economic benefits they received under the plan were currently taxable to them as ordinary income. The taxpayers filed a petition with the United States Tax Court challenging the determination.
After the parties filed counterclaims for partial summary judgment, the Tax Court ruled that the plan was a compensatory split dollar life insurance arrangement and that the economic benefits accruing to taxpayers generated current taxable income. . See From Los Santos, TC Memo. 2018-155. Subsequently, the taxpayers filed a second summary judgment motion arguing that the characterization of the payments should be treated as a distribution under section 301 of the Code.
Key questions: Has the Split Dollar Compensatory Life Insurance Agreement Resulted in Ordinary Income for Taxpayers or Distributions Under Section 301 of the Code?
Primary holdings: Since the split dollar compensatory life insurance plan provided benefits to the taxpayer-husband in his capacity as an employee of S Corporation, these benefits cannot be characterized as distribution by a corporation to a shareholder in the regard for his actions. In addition, for the purposes of taxing employee benefits, the taxpayer-husband is treated as a member of a partnership and the economic benefits he has realized are therefore taxable under section 707 ( c) as guaranteed payments, that is to say, ordinary income.
Key points of law:
- The purpose of summary judgment is to speed up litigation and avoid costly, unnecessary and lengthy trials. See FPL Grp., Inc. & Subs. v. Comm’r, 116 TC 73, 74 (2001). The Tax Court may render summary judgment on a matter for which there is no genuine dispute of material fact and a decision may be rendered in law. Rule 121 (b); Arts, Inc. & Subs. v. Comm’r, 118 CT 226, 238 (2002).
- In 2003, the Treasury Department issued final regulations regarding the taxation of two dollar life insurance contracts. Fractional life insurance agreements of the type at issue in this case fall into one of two categories: “compensatory agreements” or “shareholder agreements”. Reg. § 1.61-22 (b) (2) (ii), (iii). In both types, the “owner” of the life insurance policy pays the premiums and the “non-owner” has a current interest in the policy.
- In a “compensatory agreement”, the agreement “is entered into in the course of the provision of services” by a service provider for a recipient of services. Reg. § 1.61-22 (b) (2) (ii) (A). In a “shareholder arrangement”, the arrangement “is made between a corporation and another person in his capacity as a shareholder of the corporation”. Treas. Reg. § 1.61-22 (b) (2) (iii) (A).
- In the case of any split dollar arrangement, “the economic benefits are considered to be provided to the non-owner of the life insurance contract” and the non-owner “must take into account the total value of all economic benefits” , less any consideration paid therefor. Reg. § 1.61-22 (d) (1). “Depending on the relationship between the owner and the non-owner, the economic benefits may constitute an indemnity payment, a distribution under section 301” or a transfer having another fiscal character. Identifier. This means that the economic benefits under a “compensation arrangement” will generally constitute the payment of compensation to the service provider and that the economic benefits under a “shareholder agreement” will generally constitute a distribution to the service provider. shareholder. Our Country Home Enters., Inc. v. Comm’r, 145 TC 1, 51 (2015).
- Section 301 governs the distribution of property by a corporation to its shareholders. However, not all payments from a company to a shareholder constitute “distributions” within the meaning of section 301. On the contrary, section 301 (a) requires that the transfer be made “by a company to a shareholder. with regard to his actions ”. The expression “in respect of its shares” means that the distributed must receive payment in its capacity as a shareholder. “” Section 301 is not applicable to an amount paid by a company to a shareholder unless such amount is paid to the shareholder in his capacity as such. Reg. § 1.301-1 (c).
- Therefore, a payment is not a “distribution” if the shareholder receives it in his capacity as a creditor of the company. Loftin & Woodard, Inc. v. United States, 577 F.2d 1206, 1242 (5e 1978). There is also no “distribution” payment if the shareholder receives it in his capacity as an employee of the company. Haber vs. Comm’r, 52 TC 255, 268 (1969), aff’d by curiam, 422 F.2d 198 (5e Cir. 1970). “These transfers are not made with respect to shares because, except for the obvious reason that the shareholder’s status as a shareholder is incidental, the company receives equal value in return. . . “
- “The supply by a company to its shareholder pursuant to a split dollar life insurance agreement.” . . economic benefits. . . is treated as a distribution of goods. Reg. § 1.301-1 (q) (1) (i).
- The dollar split regulations govern the taxation of these arrangements, not only for income tax and donation purposes, but also for employment tax purposes. Reg. § 1.61-22 (a) (1). And it is well established that an S corporation “cannot avoid federal employment taxes by characterizing compensation.” . . as distributions of the net income of the company. Consultants in veterinary surgery, PC c. Comm’r, 117 TC 141, 145-46 (2001).
- Subchapter S governs the tax treatment of S corporations and their shareholders. Article 1372 provides that “for the purposes of applying the provisions of this subsection. . . that relate to employee benefits – (1) Company S should be treated as a partnership, and (2) any 2 percent shareholder of Company S should be treated as a partner in such a partnership. A “2% shareholder” is defined to include “anyone who owns. . . more than 2 percent of the outstanding shares of this company. “1372 (b).
- The term “benefits” is commonly understood to mean “any form of employee compensation provided in addition to salary or base salary, such as pension, insurance coverage, vacation, etc.”. Webster’s New World Collegiate Dictionary 568 (4e 2010). Although the term “employee benefit” is not defined in the Code, all available evidence suggests that Congress intended to adopt the common understanding of the term, that is to say, that a “benefit in kind” includes any benefit provided by the employer that supplements an employee’s salary, including life insurance benefits.
Overview: the From Los Santos The ruling shows the complexity that arises when taxpayers enter into split dollar life insurance deals. Taxpayers who participate in these or other types of life insurance arrangements should consult a competent tax advisor to ensure that these arrangements are reported correctly on all applicable tax returns.