Split-Dollar Life Insurance is not a specific type of insurance product, but rather a specialized **method of ownership and funding** used to share the costs and benefits of a permanent life insurance policy between two parties. Typically, this arrangement exists between an employer and a key executive (Executive Split-Dollar) or between a wealthy individual and an Irrevocable Life Insurance Trust (Private Split-Dollar). The strategy is governed by complex IRS Final Regulations issued in 2003, which bifurcated the taxation of these plans into two mutually exclusive regimes: the **Economic Benefit Regime** and the **Loan Regime**. Mastering these regimes is essential for fiduciaries and corporate planners to ensure tax compliance and successful exit strategies.

I. The Regulatory Framework: Choosing the Tax Regime

The taxation of a split-dollar arrangement depends entirely on which party **owns** the policy. The 2003 Final Regulations dictate that the ownership structure determines the tax treatment, removing the ambiguity that existed in prior decades.

1. The Economic Benefit Regime (Endorsement Method)

This regime applies when the **employer (or donor) is the owner** of the policy, and the employee (or trust) is given the right to designate the beneficiary for a portion of the death benefit.

• **Structure:** The employer pays the entire premium and retains ownership of the cash value and the death benefit equal to its cumulative premium payments (or the cash value, whichever is greater). The employee is “endorsed” the right to the remaining pure death benefit protection.
• **Taxation:** The employee is taxed annually on the value of the economic benefit received—specifically, the cost of the term life insurance protection. This cost is calculated using the lower of the IRS **Table 2001** rates or the insurer’s alternative one-year term rates. As the employee ages, this term cost rises exponentially, creating a growing tax liability.
• **Use Case:** Best suited for non-equity arrangements where the primary goal is providing death benefit protection to the employee rather than cash value transfer.

2. The Loan Regime (Collateral Assignment Method)

This regime applies when the **employee (or trust) is the owner** of the policy, and the employer (or donor) advances the premiums. The premium payments are treated as **loans** from the employer to the employee.

• **Structure:** The employee owns the policy but collaterally assigns it to the employer to secure the repayment of the premium loans. Upon death or termination of the agreement, the employer is repaid the principal amount of the loans, and the employee (or trust) retains the remaining cash value and death benefit.
• **Taxation:** The transaction is governed by IRC Section 7872 (below-market loans). If the employer charges adequate interest (based on the **Applicable Federal Rate – AFR**) and the employee pays it, there is no additional tax. If the interest is not charged or is accrued, the foregone interest is treated as taxable compensation to the employee.
• **Use Case:** This is the preferred method for wealth transfer and equity accumulation, as the employee/trust retains the excess cash value growth above the loan repayment amount.

II. Private Split-Dollar for Estate Planning

Private Split-Dollar involves an arrangement between an individual (Grantor) and their Irrevocable Life Insurance Trust (ILIT). This is a powerful technique to minimize Gift Taxes.

1. Minimizing Gift Tax Leverage

Normally, if a Grantor pays a \$1 million premium into an ILIT, the entire \$1 million is a taxable gift. Under a Private Split-Dollar Loan Regime, the Grantor lends the \$1 million to the ILIT.

• **The Leverage:** The Grantor does not make a gift of the principal. Instead, the gift is limited only to the **annual interest** required to service the loan (based on the Long-Term AFR). If the AFR is low (e.g., $3.0\%$), the taxable gift is only $\$30,000$ rather than $\$1$ million. This preserves the Grantor’s Lifetime Gift Tax Exemption for other assets.
• **Interest Rate Sensitivity:** This strategy is highly attractive in low-interest-rate environments. The loan rate can be locked in for the life of the loan using the Long-Term AFR at the time of inception. If the policy’s internal crediting rate (e.g., $6.0\%$) exceeds the locked loan rate (e.g., $3.0\%$), the arbitrage (the “spread”) accumulates inside the trust completely free of gift and estate taxes.

III. Exit Strategies: The Rollout

A Split-Dollar plan is rarely designed to last forever. As the insured ages, the costs (either the Table 2001 term costs in the Economic Benefit Regime or the accrued loan interest in the Loan Regime) become prohibitive. A well-designed plan includes a **”Rollout”** strategy to terminate the arrangement and transfer full unencumbered ownership to the employee or trust.

1. Cash Value Rollout (Self-Financing)

The most common exit strategy utilizes the policy’s own accumulated cash value.

• **Mechanism:** Once the policy has sufficient cash value (usually year 15-20), the policy owner withdraws or borrows enough cash from the policy to repay the employer’s cumulative premiums.
• **The Risk:** This requires the policy to perform well. If interest rates drop or the dividend scale is cut, the cash value may not be sufficient to repay the employer without collapsing the policy. This highlights the need for conservative initial modeling.

2. Bonus Rollout

The employer can choose to forgive the loan (in Loan Regime) or transfer the policy (in Economic Benefit Regime) as a taxable bonus to the executive.

• **Taxation:** The amount forgiven is fully taxable as ordinary income. To prevent a liquidity crisis for the executive, the employer often providing a “gross-up” cash bonus to cover the taxes.

3. Crawling Rollout

Instead of a single lump-sum exit, the employer forgives the loan principal in installments over several years. This spreads the tax liability for the executive and allows the policy cash value to remain intact longer to compound.

IV. Critical Compliance Risks: Sarbanes-Oxley and 409A

Implementing Split-Dollar plans requires navigating corporate governance laws.

• **Sarbanes-Oxley Act (SOX) of 2002:** Section 402 of SOX prohibits public companies from extending personal loans to directors or executive officers. This effectively **bans Loan Regime Split-Dollar** plans for public companies. Public companies must use the Economic Benefit (Endorsement) method or taxable executive bonus plans instead. Private companies are generally exempt from this restriction.
• **IRC Section 409A:** This section governs non-qualified deferred compensation. While most Split-Dollar plans are structured to be exempt from 409A, poorly drafted modifications or rollout provisions can accidentally trigger 409A violations, resulting in immediate taxation and a $20\%$ penalty on the deferred amount.

V. Evaluating Plan Viability

Fiduciaries must review existing Split-Dollar plans annually. The critical metric is the **Crossover Point**: the year when the cost of maintaining the plan (tax cost or loan interest) exceeds the cost of simply owning the policy outright. Plans implemented in the 1990s or early 2000s may now be “underwater” due to lower-than-projected interest rates, requiring immediate remediation (e.g., a rescue loan or 1035 exchange) to prevent the policy from imploding under the weight of the debt.

Disclaimer: This content is for informational purposes only and does not constitute legal, tax, or financial advice. Split-Dollar arrangements are subject to complex IRS regulations; implementation and termination require the counsel of a specialized tax attorney.