Platinum Advisory Group, LLC Michael Foley, CLTC, LUTCF Managing Partner 373 Collins Road NE Suite #214 Cedar Rapids, IA 52402 Office: 319-832-2200 Direct: 319-431-7520 mdfoley@mdfoley.com www.platinumadvisorygroupllc.com Collateral Assignment Split Dollar Method Clients, Business Owners, High Net Worth Individuals, Attorneys, Accountants and Trust Officers: I hope you find this presentation informational and useful! Thanks! Mike Prepared for: Preferred Client Use for Business Owners, Key Employees and High Net Worth Individuals Page 1 of 6, see disclaimer on final page
Collateral Assignment Split Dollar Method What is a collateral assignment split dollar method? Under a collateral assignment split dollar plan (or, as it is most commonly called, a collateral assignment split dollar arrangement, or SDA), generally an employee applies for a life insurance policy and is designated as its owner. The employer pays all or part of the insurance premium; this arrangement may be considered an interest-free loan to the employee. As stipulated by the agreement governing the SDA, the employee agrees to assign an interest in the life insurance policy to the employer as collateral securing the loan. Depending on how the SDA is structured, the employee may control all of the policy's cash value in excess of the assignment. The loan is either repaid at some point in the future, from the policy's death benefit or its cash value, or from other assets, or the loan is forgiven. When is a collateral assignment SDA used? A collateral assignment SDA may be used by an employer in several applications. One use is to provide low-cost life insurance coverage on a key employee or (if a corporation) to a shareholder. It is most often used to cover an owner-employee. The intention of a collateral assignment SDA is generally to give control of the life insurance policy to the employee. This arrangement works best when the employing company is in a lower tax bracket than the insured shareholder/employee. The collateral assignment method might be the only plan that is practical when an existing policy owned by the employee is to form the basis for a split dollar contract. Benefits of a collateral assignment SDA to the employer May be used to attract and retain employees Employer can choose which employees are covered--no IRS or ERISA approval required Employer's premium costs may be recovered Cash values may be used to fund future benefits Strengths of a collateral assignment SDA for the employee Employee owns the life insurance policy and may (depending on the agreement governing the SDA) control some or all of its cash value Employee can obtain a significant yet inexpensive amount of personal life insurance coverage When structured properly, may provide the employee's beneficiary a death benefit that would be income tax free Can be used to supplement the employee's group life insurance Tradeoffs of a collateral assignment SDA for the employer The employee owns the life insurance policy and may (depending on the agreement governing the SDA) control some or all of its cash values Premium costs won't be recoverable until a later date Premiums are not tax deductible There are costs and legal fees involved in drafting an agreement Interest in the policy (depending on the agreement governing the SDA) may be limited to reimbursement of premium payments and not full cash value Caution: The Sarbanes-Oxley Act of 2002 makes it a criminal offense for a public company to lend money to its executives or directors. Since an employer's premium payments may be construed as loans to the insured employee, the option of a collateral assignment SDA may not be available to these individuals. For more information, see the section below on tax consequences. Tradeoffs of a collateral assignment SDA for the employee Page 2 of 6, see disclaimer on final page
There may be premium costs required If premiums are required, they are not tax deductible Depending on how the SDA arrangement is structured, the employee must pay income taxes each year on either the economic benefit of the life insurance protection or on imputed interest under the below-market loan rules Establishing a collateral assignment SDA To establish a collateral assignment SDA the following legal and technical documentation is required: Policy application--the life insurance application must be approved through the life insurance company's underwriting procedures. Corporate resolution (where appropriate) to authorize collateral assignment split dollar--the resolution must be authorized and placed in the minutes of the corporation. Collateral assignment split dollar agreement--the agreement governing the collateral assignment SDA should be drafted by a legal professional. It should spell out how the premium and the death benefit will be split, the rights of each party to the cash value of the policy, ownership and conditions, and when the agreement will terminate. Collateral assignment form, recorded with the insurer--the collateral assignment ensures that the loan is repaid before any proceeds are paid to beneficiaries. Collateral note--the collateral note must be adjusted with each premium payment to reflect the new loan balance. Tax consequences of a collateral assignment SDA Caution: The following is not a comprehensive discussion of the tax consequences of a collateral assignment split dollar arrangement. You should consult additional resources. Premiums are not deductible Policy premiums are not deductible to the corporation or the employee. Tip: If the employer pays the employee a bonus to help fund his or her portion of the premium under the split dollar plan, the amount of the bonus is tax deductible for the employer but is taxed as income to the employee. Equity or non-equity, that is the question According to the Internal Revenue Service (IRS), any split dollar arrangement is a sharing of the costs and benefits of a life insurance policy between the owner and the non-owner of the policy. One of the "benefits" that may or may not be shared is the cash value of the policy. Generally, a collateral assignment is considered a non-equity SDA if the (non-owner) employer's interest is defined by the agreement governing the SDA as the greater of the cash value in the policy or the accumulated premiums paid. Conversely, if the (owner) employee has rights to any cash value, the SDA is considered an equity SDA. In September 2003 the IRS and the Department of the Treasury issued new regulations governing SDA taxation. These regulations provide two mutually exclusive regimes for taxing split dollar life insurance arrangements: the economic benefit regime and the loan regime. Generally, ownership of the policy determines the regime under which the SDA is taxed. If the employer owns the policy (as is usually the case in an endorsement SDA), the arrangement is taxed under the economic benefit regime. Conversely, if the employee owns the policy (as is usually the case with a collateral assignment SDA) the arrangement is taxed under the loan regime. However, any non-equity SDA (regardless of ownership) is subject to taxation under the economic benefit regime. An employee party to a non-equity collateral assignment SDA pays tax on the economic value of the insurance coverage If an employee is party to a non-equity collateral assignment SDA, each year the economic value of the insurance coverage must be reported on the employee's W-2 form and must be included in his or her taxable income. The new regulations governing the taxation of split dollar life insurance arrangements stipulate that an employee who entered an SDA prior to September 18, 2003 (and that has not been modified materially since), may determine the economic value of the life insurance coverage in one of two ways. One way is to base the valuation on IRS Table 2001. The other is to use the insurer's Page 3 of 6, see disclaimer on final page
lower published premium rates that are available to all standard risks applying for initial issue one-year term insurance. However, if the SDA was entered into after January 28, 2002, any such alternative rates used after December 31, 2003 to calculate the economic value of the insurance coverage must meet two criteria: They must be rates the insurer makes known and available to all standard risks applying for term insurance coverage from the insurer (which is as it has been), and They must be rates at which the insurer regularly sells term insurance to individuals who apply for such coverage through the insurer's normal distribution channels (which is a new and more restrictive requirement). This valuation is reduced by any amount the employee has paid in premiums. Because the employee has no access to any policy cash value, the economic value of the insurance coverage is the only economic benefit he or she must take into account. An employee party to an equity collateral assignment SDA pays tax on interest imputed to the employer's premium "loans" According to the new tax regulations, an equity collateral assignment SDA entered into (or materially modified) after September 17, 2003 will be taxed under the loan regime. Under this regime, the (non-owner) employer is treated as lending premium payments to the (owner) employee. Each payment is treated as a separate loan. Generally, these loans will be repaid from either the cash value of the life insurance policy (upon termination of the SDA) or the death benefit (upon death of the employee). Generally, the employee is expected to pay market-rate interest to the employer on the outstanding loan balances. If the employee is doing so, he or she incurs no annual tax liability. However (as is most often the case), if the employee is paying little or no interest to the employer, then the below market loan rules apply, and the employee must pay tax annually on the imputed interest. Under the loan regime, the employee is not taxed directly on his or her share of the cash value equity, either during the arrangement or upon rollout (the termination of the SDA). Options available to an employee party to an equity collateral assignment SDA with equity build-up The new tax regulations are a significant departure from previous IRS guidance governing the taxation of an equity collateral assignment SDA. In the past, the (owner) employee was subject to tax only on the economic value of the insurance coverage provided. The employee was not subject to tax on imputed interest on the (non-owner) employer's premium payments under the below market loan rules, nor was the employee faced with eventual taxation on his or her cash value equity build-up. Under the new regulations, however, after January 1, 2004, an employee with equity build-up in a collateral assignment SDA may face a tax liability on the equity build-up upon termination of the SDA. However, in accordance with IRS Notice 2002-8, an employee participating in an equity SDA entered into prior to September 18, 2003 may avoid taxation of any equity build-up by choosing one of the following alternatives: 1. Continue to treat and report the economic value of the life insurance protection as taxable income for the remainder of his or her life. If this is done, the IRS will not treat the SDA as being terminated or materially modified, and thus will not assert there has been a transfer of value to the employee (which would require taxation of the employee's share of the cash value). 2. Treat any premiums paid by the (non-owner) employer as loans made to the (owner) employee. All premium payments made by the employer since the inception of the SDA must be treated as loans entered into at the beginning of the first year in which such payments are treated as loans. 3. For an SDA entered into before January 28, 2002, the IRS will not assert there has been a taxable event (and thus will not require taxation of the employee's share of the cash value) if the SDA is either terminated or converted to the loan arrangement described above. Tip: This change must be made before January 1, 2004. Caution: An employee may be participating in an equity SDA that has not yet reached the crossover point--the point where the cash value of the policy exceeds the aggregate premium payments made by the employer--as of January 1, 2004. As a result, the employee need not choose one of the above alternatives by that date. However, to avoid future taxation of any developing equity, the SDA must be unwound (terminated) prior to reaching the crossover point. Page 4 of 6, see disclaimer on final page
Caution: The Sarbanes-Oxley Act of 2002 makes it a criminal offense for a public company to lend money to its executives or directors. While converting an equity SDA entered into before January 28, 2002 to a loan arrangement may satisfy the IRS, an employee of a public company with access to accumulated policy equity may still wish to terminate such an SDA before January 1, 2004. Doing so will not only avoid taxation of the accessible cash value but would also circumvent any suspicion of participation in criminal activity. Beneficiary generally receives proceeds free of income tax Generally, death benefit proceeds attributable to life insurance protection offered under an endorsement SDA are excludable from the income of the employee's beneficiary to the extent that the employee has either paid for the coverage or taken its economic value into account. Third party considerations A collateral assignment SDA may involve a third party, such as the covered employee's spouse, child, or irrevocable life insurance trust. In this instance, the third party owns the insurance policy, makes the collateral assignment to the employer in exchange for the employer's premium payments, and may (if it's an equity SDA) have rights to cash value equity. When a third party is the owner of the policy, that party should be the covered employee's named beneficiary. If the third party policyowner names another beneficiary (a three-party contract), the third party policyowner would be deemed to have made a gift of the full proceeds received upon the death of the insured. Depending on how the SDA is structured, the third party policyowner may be subject to income tax on the economic benefit of the insurance coverage on the employee or on imputed interest under the below-market loan rules. Further, the employee may be treated as having made a gift to the third party, which is subject to gift tax. Page 5 of 6, see disclaimer on final page
ABOUT MIKE FOLEY Mike specializes in Business Owner Benefits, Buy-Sell Agreement Funding, Business Continuation, Estate Planning, Key Person Benefits, Executive Benefits, and Deferred Compensation Plans for Business Owners, Key Employees and High Net Worth Individuals. Mike is an Independent Insurance Broker with over 27 years of experience representing over 100+ top insurance and financial services companies in the industry. This allows him to provide you the best product solutions based on your individual needs and circumstances. References available upon request. IMPORTANT DISCLOSURES Michael D. Foley, Platinum Advisory Group, LLC and Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. Platinum Advisory Group, LLC Michael Foley, CLTC, LUTCF Managing Partner 373 Collins Road NE Suite #214 Cedar Rapids, IA 52402 Office: 319-832-2200 Direct: 319-431-7520 mdfoley@mdfoley.com www.platinumadvisorygroupllc.com Page 6 of 6 Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016