RETURN TO FOREVER - What Game Shall We Play Today?

Using the Planning Power of Split Dollar Life Insurance for Income and Estate Tax Planning Benefits

I have mentioned in past blogs my love for music including the fact that I was a mediocre musician myself. As a horn player (trombone and baritone) I gravitated to horn bands and what is today known as smooth jazz. In my jazz pilgrimage I was a fan of The Crusaders, Grover Washington, Jr., and Chick Corea. Sadly, Chick Corea died recently.

One of the great groups in the jazz fusion genre was called Return to Forever which featured Chick Corea on keyboards, Stanley Clarke on Bass, Airto Moreira on drums and his wife Flora Purim provided the vocals. Airto and Flora are Brazilians. Flora Purim had a six-octave vocal range and was Downbeat Magazine's jazz singer of the year four times and was nominated for two Grammy awards. I saw Airto and Flora Purim perform back in the days when I was a Portuguese student at West Point. I don't think that there is a sound of an animal in the Amazon jungle that Flora couldn't imitate. One of her great recordings with Chick is a song called “What Game Shall We Play Today?”

The title of song seems to capture the essence of the back and forth between Government tax policy planners and taxpayers. The Biden Administration and several states are poised to increase taxes significantly. The estate and gift tax will be back with a "bite" that not only breaks the skin but sinks a family's efforts to accumulate and transfer wealth across multiple generations.

While my roots were cast in the retail life insurance industry while attending law school, I have been a Private Placement Life Insurance (PPLI) specialist for the last twenty years. From afar it looks like the retail life insurance industry has largely forgotten the power and glory of advanced marketing strategies such as Split Dollar life insurance focusing more on premium finance strategies. There is nothing wrong with that except life insurance producers threw out gold and silver with the bath water.

This article focuses on the use of Split Dollar life insurance and the use of the Leveraged Split Dollar Rollout™ technique combining the tax arbitrage of life insurance with the financial arbitrage of Split Dollar life insurance featuring the rollout or termination technique so that the policyholder ends up with a bunch of money with minimal tax consequences.

Overview of Loan Regime Split Dollar

a. Loan Regime Basics. The primary planning objective of the Loan Regime Method of Split Dollar is to provide a business owner or key executive with low-cost death protection and equity buildup in the cash value. In the loan regime, the business owner is the applicant, and owner of the policy and collaterally assigns an interest in the policy cash value and death benefit to the employer equal to its cumulative loans plus any accumulated interest payments. The Employer provides a series of loans to the business owner to all or most of the premiums. The Employer’s loans are not treated as taxable to the business owner provided the loan terms are arms-length in nature. The taxable gifts where the loans are extended to the trustee of a family trust.

b. The Impact of Below Market Rate Loans. Below-market rate or interest-free loans are sometimes used in Loan Regime Split Dollar where the Employer desires to provide premium financing to the executive through a loan with little or no interest. When no interest is charged by the Employer as a lender, the rules for below-market or interest-free loans follow under IRC Sec 7872 apply. Under Sec. 7872, if no interest or an inadequate rate of interest is charged on a loan, the IRS recharacterizes the loan into an “arm's length” transaction and imputes an interest rate equal to the applicable federal rate based upon the term of the loan that is deemed to have been received by the lender and paid by the Borrower.

c. Additional Loan Considerations. In order to avoid the application of the below-market rate loan rules in a Loan Regime Split Dollar loan, the parties should agree upon a stated interest at or above the appropriate applicable federal rate Demand loans may be used in Split Dollar plans. If the Split Dollar loan is a nonrecourse loan, meaning the policyholder is not personally liable, and is payable only from values in the policy with no further recourse to the borrower, the parties must represent in writing and attach to their tax returns in the first year of the plan that a reasonable person would expect that all payments under the loan will be made.

Treas. Reg. §1.7872-15(d)(1) provides that, except as provided in §1.7872-15(d)(2), if a payment on a Split Dollar loan is nonrecourse to the borrower, the payment is a contingent payment for purposes of §1.7872- 15. A contingent payment is subject to the imposition of unfavorable assumptions when testing the loan for adequate stated interest, thus causing the OID rules to apply. Section 1.7872-15(d)(2)(ii) describes the time and manner requirements for providing the written representation required by §1.7872-15(d)(2)(i). Section 1.7872-15(d)(2)(ii) provides, in part, that the written representation be signed