H—Split-Dollar Funding Life Insurance Trust

Split-dollar offers a means of using employer-provided dollars to pay premiums for life insurance used for a variety of purposes, to include family income needs, estate taxes, and other estate settlement costs. When combined with an irrevocable life insurance trust, it is possible to take advantage of the gift tax laws while at the same time assuring that the proceeds will be received free of estate taxes.

These plans will likely be structured as: (1) an “equity collateral assignment plan” using a trust-owned policy with employer-paid premiums treated as loans to the employee under theloan regime(cash values owned by the trust but assigned to the employer as security for the loans); or (2) a “nonequity collateral assignment” plan using a trust-owned policy with the employee taxed under theeconomic benefit regime(employer entitled to all cash values). This last design offers the most flexibility and can be implemented as follows:

DURING LIFETIME,the employee establishes a trust and the trustee applies for, or obtains, insurance on the employee’s life. Thereafter, at the employee’s request, the employer and trustee enter into a split-dollar agreement providing for the allocation of premiums, cash values and death benefits on the trust-owned insurance policy. Under this agreement the employer pays all premiums and is entitled to all cash values (by virtue of a limited collateral assignment from the trust).

Each yearincomeis imputed to the employee in an amount equal to the “economic benefit” of the insurance protection received by the trust. This same amount is then imputed as agiftby the employee to the trust. Provided the trust is properly funded, and the beneficiaries given appropriate withdrawal powers, these imputed gifts will qualify for the gift tax annual exclusion of $16,000 in 2022. Of course, it is unlikely that they would exercise these powers, since to do so would defeat the purpose of the trust.

UPON DEATHof the employee, the policy proceeds are split between the employer and the trust. The employer is entitled to a death benefit equal to thegreater ofthe cash values or the cumulative premiums paid. The balance of the proceeds are paid directly to the trust and are income and estate tax free.

In recent years, split-dollar has largely been used as a transfer tax tool. However, because of increases in the transfer tax exemption – fewer and fewer people are exposed to estate taxes. Therefore, split-dollar arrangements were an infrequently used strategy limited to the very wealthy. However, the significant reductions in corporate tax rates established by the 2017 Tax Act have created new income tax strategies for business owners and executives using split dollar.