Opinion ID: 4320610
Heading Depth: 3
Heading Rank: 2

Heading: Split-Dollar Life Insurance Regulations

Text: The tax treatment of split-dollar life insurance arrangements is set out by regulation. See 26 C.F.R. § 1.61-22. Tax regulations “are entitled to great weight and are to be sustained unless unreasonable and plainly inconsistent with the revenue statutes.” Brooks v. United States, 473 F.2d 829, 832 (6th Cir. 1973) (citing Bingler v. Johnson, 394 U.S. 741, 750 (1969); Comm’r v. S. Tex. Lumber Co., 333 U.S. 496, 501 (1948)). The regulations define a split-dollar life insurance arrangement as: any arrangement between an owner and a non-owner of a life insurance contract that satisfies the following criteria— (i) Either party to the arrangement pays, directly or indirectly, all or any portion of the premiums on the life insurance contract, including a payment by means of a loan to the other party that is secured by the life insurance contract; (ii) At least one of the parties to the arrangement paying premiums . . . is entitled to recover (either conditionally or unconditionally) all or any portion of those premiums and such recovery is to be made from, or is secured by, the proceeds of the life insurance contract; and (iii) The arrangement is not part of a group-term life insurance plan . . . unless the group-term life insurance plan provides permanent benefits to employees . . . . No. 17-1131 Machacek, et al. v. Commissioner Page 5 26 C.F.R. § 1.61-22(b)(1). Arrangements satisfying the criteria set out by § 1.61-22(b)(1) are generally referred to as “traditional” split-dollar arrangements. It is undisputed that John Machacek’s life insurance policy does not qualify as a traditional split-dollar arrangement. However, the split-dollar regulations also apply to any arrangement qualifying either as a “compensatory” arrangement or a “shareholder” arrangement, regardless whether those arrangements satisfy the criteria for a traditional arrangement. See 26 C.F.R. § 1.61-22(b)(2). An arrangement qualifies as a “compensatory” arrangement if: (A) The arrangement is entered into in connection with the performance of services and is not part of a group-term life insurance plan . . . ; (B) The employer or service recipient pays, directly or indirectly, all or any portion of the premiums; and (C) Either— (1) The beneficiary of all or any portion of the death benefit is designated by the employee or service provider or is any person whom the employee or service provider would reasonably be expected to designate as the beneficiary; or (2) The employee or service provider has any interest in the policy cash value of the life insurance contract. 26 C.F.R. § 1.61-22(b)(2)(ii). The Tax Court found that John Machacek’s life insurance policy qualifies as a compensatory split-dollar arrangement. An arrangement qualifies as a “shareholder” arrangement if: (A) The arrangement is entered into between a corporation and another person in that person’s capacity as a shareholder in the corporation; (B) The corporation pays, directly or indirectly, all or any portion of the premiums; and (C) Either— (1) The beneficiary of all or any portion of the death benefit is designated by the shareholder or is any person whom the shareholder would reasonably be expected to designate as the beneficiary; or (2) The shareholder has any interest in the policy cash value of the life insurance contract. No. 17-1131 Machacek, et al. v. Commissioner Page 6 26 C.F.R. § 1.61-22(b)(2)(iii). The parties appear to concede that John Machacek’s life insurance policy is not a shareholder arrangement. The split-dollar life insurance regulations apply “to any split-dollar life insurance arrangement,” regardless whether the arrangement is a traditional, compensatory, or shareholder arrangement.2 See 26 C.F.R. § 1.61-22(j)(1)(i). When an arrangement is governed by the splitdollar life insurance regulations, the non-owner of the policy “must take into account the full value of all economic benefits.”3 26 C.F.R. § 1.61-22(d)(1). However, “[d]epending on the relationship between the owner and the non-owner, the economic benefits may constitute a payment of compensation, a distribution under section 301, a contribution to capital, a gift, or a transfer having a different tax character.” Id. The split-dollar regulations make no reference to Subchapter S. However, 26 C.F.R. § 1.301-1—the regulation purporting to govern the distribution of property by any corporation to its shareholders with respect to their stock—addresses the treatment of economic benefits flowing from split-dollar life insurance arrangements. Section 1.301-1(q)(1)(i) states that “the provision by a corporation to its shareholder pursuant to a splitdollar life insurance arrangement, as defined in § 1.61-22(b)(1) or (2), of economic benefits described in § 1.61-22(d) . . . is treated as a distribution of property.” 26 C.F.R. § 1.301- 1(q)(1)(i). By its terms, this regulation applies to all three types of split-dollar arrangements: traditional arrangements defined by § 1.61-22(b)(1); compensatory arrangements defined by § 1.61-22(b)(2)(ii); and shareholder arrangements defined by § 1.61-22(b)(2)(iii). There is minimal case law concerning the interplay of Subchapter S and the split-dollar regulations, and we are aware of no case dealing with the issue presented here. Thus, the application of 26 C.F.R. § 1.301-1(q)(1)(i) to economic benefits provided to shareholderemployees pursuant to a compensatory arrangement appears to be an issue of first impression. 2 The split-dollar regulations apply only to arrangements that were entered into, or materially modified, after September 17, 2003. See 26 C.F.R. § 1.61-22(j)(1)(i). It is undisputed on appeal that John Machacek’s life insurance policy satisfies this temporal requirement. 3 This appeal concerns split-dollar arrangements in which an employer both owns the policy and pays the premium. Because such arrangements provide a benefit to the non-owner, they are taxed according to the “economic benefit regime” described herein. In situations where the policy is owned by the employee, the arrangement is covered by the “loan regime.” See 26 C.F.R. § 1.7872-15. The loan regime is not at issue here. No. 17-1131 Machacek, et al. v. Commissioner Page 7