Using Commercial Lending to “Juice” the Funding of Loan Method Split Dollar Arrangements

In past articles, I have vigorously defended the notion that I know "Squat." Most readers would view such a claim as sheer lunacy and maybe in certain circles it would be a great insult. However, as a lifetime lover of the Iron Game (weightlifting), the "squat" is a critical part of any lifter’s DNA. The declaration of knowing “squat” would make them proud!

My passion started early. Even as I get “longer in the tooth," I can still trace the steps of my weightlifting passion. It started at around age six in the weight room of Balboa High School in the Panama Canal Zone when I lifted a 50 lb. dumbbell. About eight years later, I suffered a serious knee injury playing football and the coach at the junior college (Canal Zone College), Morris Finkelstein (of blessed memory), personally took it upon himself to help rehabilitate me in the weight room with Mr. Johnson, the Jamaican trainer. After recovering, I became a member of the Balboa YMCA which had the only complete weight room in the Canal Zone.

The YMCA became my Mecca where I spent hundreds of hours perfecting the squat and a few other lifts. My neighbor and childhood friend, Mark Givens had the best collection of lifting magazines from York Barbell - Strength and Health, and Muscle Development, in the Canal Zone. He gravitated towards bodybuilding while I gravitated towards powerlifting. In high school I had an opportunity to visit York Barbell which was the weightlifting equivalent of a pilgrimage to Mecca for a weightlifting enthusiast.

During that era, Arnold Schwarzenegger became the face of bodybuilding and went on to a substantial career in business, acting and politics. His Terminator series made him a Hollywood icon. Personally, my favorite Arnold movie was Conan The Barbarian probably because I enjoyed Hercules” movies as a child featuring Reg Park (a former Mr. Universe) as Hercules.

This article focuses on how a business can use a commercial loan to help finance a business’ obligation in a Loan Regime Split Dollar Arrangement and deduct the interest payments for its tax purposes, without running afoul of the limitations of IRC Sec. 264. The use of commercial lending provides an additional source of funding and leverage on an after-tax basis to provide funding for the purchase of life insurance policyholder using Loan Regime Split Dollar Arrangement.

Loan Regime Method of Split Dollar Review

I have been on a rant for weeks about the magic of the Loan Regime Method of Split Dollar life insurance due to the current loan interest rate environment. The current long term AFR in August 2020 is 1.12 percent. In the loan regime method of split dollar, the policyholder is typically the business owner or key executive. Alternatively, an irrevocable trust may own the policy for the benefit of the business owner.

The Trust removes the policy from the reach of personal and business creditors while allowing the business owner to remain as a discretionary income beneficiary of the Trust. The Trustee may use request tax-free loans and withdrawals from the policy for tax-free distribution to the business owner. The policy death proceeds are received income and estate tax-free. The Trust may also be multi-generational.

In the Loan Regime Method of Split Dollar, the business makes a one-time loan locking in the long-term AFR. The policyholder funds the policy using the loan proceeds to fund the policy on a non-MEC basis. The business receives a collateral assignment in the policy cash value and death benefit equal to the loan plus any accrued interest.

What if the business has a better use of its existing capital which would allow it to receive a higher rate of return on business operations? In those circumstances, a business can obtain a commercial loan from a bank for its business operations or alternatively use some or all of the proceeds from the commercial bank loan to extend to the policyholder as part of the Split Dollar Arrangement.

Overview of Borrowing to Purchase Life Insurance

Several decades ago, leveraged Corporate Owned Life Insurance (aka COLI) was the best corporate tax shelter on Planet Earth. Members of the Fortune 500 could not buy enough of it! Congress shut this down so