In a case involving policy rollouts of split-dollar life insurance arrangements entered into before the effective date of the 2003 final split-dollar regulations, the Tax Court held that two employees covered under life insurance policies that were the subject of several split-dollar arrangements realized income from a December 2003 rollout of the arrangements. The case is Neff v. Comr., T.C. Memo 2012-244, which, coincidentally, cited and relied on portions of the discussion of exit strategies for split-dollar arrangements in Tax Management Portfolios 386 and 828, Insurance-Related Compensation.

The court rejected the individual taxpayers' arguments that no termination or rollout of the split-dollar arrangements occurred, that they purchased from the employer (“N&J Management”) only “contract rights” for a discounted present fair value, that the split-dollar arrangements remained in effect, that they were not released from any indebtedness, and that they realized no compensation income from the transaction. The court found it obvious that a cancellation, unwinding, release or a rollout of N&J Management's interests in the arrangements occurred, even in the absence of a formal written termination of the arrangements, noting stipulations that, as of the end of December 2003, N&J Management was released from its obligation as employer to provide further funding on the life insurance policies and had no continuing interest or reimbursement rights with regard to those policies. Following the termination of the arrangements, the taxpayers had no risk of forfeiture of the economic benefit of the amount not reimbursed to N&J Management, had complete ownership of the policies and were free to transfer the cash value of the polices free of encumbrances. Further, the taxpayers had no service requirements or other employment-related conditions that they needed to fulfill.

Instead of applying the final split-dollar regulations, the court explained that Revenue Rulings 64-328 and 66-110 and Notice 2002-8 applied because the split-dollar arrangements involved in the case were entered into after January 27, 2002, but on or before September 17, 2003. Under those decisions, for each year a split-dollar arrangement was in effect, an employee was required to include in taxable income the total value or cost of the economic benefit received each year by the employee, less any amount contributed by the employee. According to the court, the taxpayers realized income under §61 or, alternatively, the taxable value of property transferred to them under §83, on the difference between the amount N&J Management paid in premiums on their behalf and that was owed by them and the amount they reimbursed N&J Management upon the rollout. The court noted that the taxpayers clearly realized an accession to wealth for the additional premiums N&J Management paid in the context of and related to their employment that constituted compensation income to them.

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--Mark Wolf

Compensation Planning Group