collateral assignment split dollar method...under a collateral assignment split dollar plan (or, as...

Platinum Advisory Group, LLCMichael Foley, CLTC, LUTCFManaging Partner373 Collins Road NESuite #214Cedar Rapids, IA 52402Office: 319-832-2200Direct: [email protected]

Collateral Assignment Split Dollar Method

Preferred Client Use for Business Owners, Key Employees and High Net Worth IndividualsPrepared for: January 15, 2016

Clients, Business Owners, High Net Worth Individuals, Attorneys, Accountants and Trust Officers:

I hope you find this presentation informational and useful!

Thanks!

Mike

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Collateral Assignment Split Dollar Method

January 15, 2016

What is a collateral assignment split dollar method?Under a collateral assignment split dollar plan (or, as it is most commonly called, a collateral assignment split dollar arrangement,or SDA), generally an employee applies for a life insurance policy and is designated as its owner. The employer pays all or part ofthe insurance premium; this arrangement may be considered an interest-free loan to the employee. As stipulated by theagreement governing the SDA, the employee agrees to assign an interest in the life insurance policy to the employer as collateralsecuring the loan. Depending on how the SDA is structured, the employee may control all of the policy's cash value in excess ofthe assignment. The loan is either repaid at some point in the future, from the policy's death benefit or its cash value, or from otherassets, or the loan is forgiven.

When is a collateral assignment SDA used?A collateral assignment SDA may be used by an employer in several applications. One use is to provide low-cost life insurancecoverage on a key employee or (if a corporation) to a shareholder. It is most often used to cover an owner-employee. Theintention of a collateral assignment SDA is generally to give control of the life insurance policy to the employee. This arrangementworks best when the employing company is in a lower tax bracket than the insured shareholder/employee. The collateralassignment method might be the only plan that is practical when an existing policy owned by the employee is to form the basis fora split dollar contract.

Benefits of a collateral assignment SDA to the employer• May be used to attract and retain employees• Employer can choose which employees are covered--no IRS or ERISA approval required• Employer's premium costs may be recovered• Cash values may be used to fund future benefits

Strengths of a collateral assignment SDA for the employee• Employee owns the life insurance policy and may (depending on the agreement governing the SDA) control some or all of its

cash value• Employee can obtain a significant yet inexpensive amount of personal life insurance coverage• When structured properly, may provide the employee's beneficiary a death benefit that would be income tax free• Can be used to supplement the employee's group life insurance

Tradeoffs of a collateral assignment SDA for the employer• The employee owns the life insurance policy and may (depending on the agreement governing the SDA) control some or all

of its cash values• Premium costs won't be recoverable until a later date• Premiums are not tax deductible• There are costs and legal fees involved in drafting an agreement• Interest in the policy (depending on the agreement governing the SDA) may be limited to reimbursement of premium

payments and not full cash value

Caution: The Sarbanes-Oxley Act of 2002 makes it a criminal offense for a public company to lend money to its executives ordirectors. Since an employer's premium payments may be construed as loans to the insured employee, the option of a collateralassignment SDA may not be available to these individuals. For more information, see the section below on tax consequences.

Tradeoffs of a collateral assignment SDA for the employee


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• There may be premium costs required• If premiums are required, they are not tax deductible• Depending on how the SDA arrangement is structured, the employee must pay income taxes each year on either the

economic benefit of the life insurance protection or on imputed interest under the below-market loan rules

Establishing a collateral assignment SDATo establish a collateral assignment SDA the following legal and technical documentation is required:

• Policy application--The life insurance application must be approved through the life insurance company's underwritingprocedures.

• Corporate resolution (where appropriate) to authorize collateral assignment split dollar--The resolution must be authorizedand placed in the minutes of the corporation.

• Collateral assignment split dollar agreement--The agreement governing the collateral assignment SDA should be drafted bya legal professional. It should spell out how the premium and the death benefit will be split, the rights of each party to thecash value of the policy, ownership and conditions, and when the agreement will terminate.

• Collateral assignment form, recorded with the insurer--The collateral assignment ensures that the loan is repaid before anyproceeds are paid to beneficiaries.

• Collateral note--The collateral note must be adjusted with each premium payment to reflect the new loan balance.

Tax consequences of a collateral assignment SDACaution: The following is not a comprehensive discussion of the tax consequences of a collateral assignment split dollararrangement. You should consult additional resources.

Premiums are not deductiblePolicy premiums are not deductible to the corporation or the employee.

Tip: If the employer pays the employee a bonus to help fund his or her portion of the premium under the split dollar plan, theamount of the bonus is tax deductible for the employer but is taxed as income to the employee.

Equity or non-equity, that is the questionAccording to the Internal Revenue Service (IRS), any split dollar arrangement is a sharing of the costs and benefits of a lifeinsurance policy between the owner and the non-owner of the policy. One of the "benefits" that may or may not be shared is thecash value of the policy. Generally, a collateral assignment is considered a non-equity SDA if the (non-owner) employer's interestis defined by the agreement governing the SDA as the greater of the cash value in the policy or the accumulated premiums paid.Conversely, if the (owner) employee has rights to any cash value, the SDA is considered an equity SDA.

In September 2003 the IRS and the Department of the Treasury issued new regulations governing SDA taxation. Theseregulations provide two mutually exclusive regimes for taxing split dollar life insurance arrangements: the economic benefit regimeand the loan regime. Generally, ownership of the policy determines the regime under which the SDA is taxed. If the employerowns the policy (as is usually the case in an endorsement SDA), the arrangement is taxed under the economic benefit regime.Conversely, if the employee owns the policy (as is usually the case with a collateral assignment SDA) the arrangement is taxedunder the loan regime. However, any non-equity SDA (regardless of ownership) is subject to taxation under the economic benefitregime.

An employee party to a non-equity collateral assignment SDA pays tax on theeconomic value of the insurance coverageIf an employee is party to a non-equity collateral assignment SDA, each year the economic value of the insurance coverage mustbe reported on the employee's W-2 form and must be included in his or her taxable income.

The new regulations governing the taxation of split dollar life insurance arrangements stipulate that an employee who entered anSDA prior to September 18, 2003 (and that has not been modified materially since), may determine the economic value of the lifeinsurance coverage in one of two ways. One way is to base the valuation on IRS Table 2001. The other is to use the insurer's


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lower published premium rates that are available to all standard risks applying for initial issue one-year term insurance.

However, if the SDA was entered into after January 28, 2002, any such alternative rates used after December 31, 2003 tocalculate the economic value of the insurance coverage must meet two criteria:

• They must be rates the insurer makes known and available to all standard risks applying for term insurance coverage fromthe insurer (which is as it has been), and

• They must be rates at which the insurer regularly sells term insurance to individuals who apply for such coverage through theinsurer's normal distribution channels (which is a new and more restrictive requirement).

This valuation is reduced by any amount the employee has paid in premiums.

Because the employee has no access to any policy cash value, the economic value of the insurance coverage is the onlyeconomic benefit he or she must take into account.

An employee party to an equity collateral assignment SDA pays tax on interestimputed to the employer's premium "loans"According to the new tax regulations, an equity collateral assignment SDA entered into (or materially modified) after September17, 2003 will be taxed under the loan regime. Under this regime, the (non-owner) employer is treated as lending premiumpayments to the (owner) employee. Each payment is treated as a separate loan. Generally, these loans will be repaid from eitherthe cash value of the life insurance policy (upon termination of the SDA) or the death benefit (upon death of the employee).

Generally, the employee is expected to pay market-rate interest to the employer on the outstanding loan balances. If theemployee is doing so, he or she incurs no annual tax liability. However (as is most often the case), if the employee is paying littleor no interest to the employer, then the below market loan rules apply, and the employee must pay tax annually on the imputedinterest.

Under the loan regime, the employee is not taxed directly on his or her share of the cash value equity, either during thearrangement or upon rollout (the termination of the SDA).

Options available to an employee party to an equity collateral assignment SDA withequity build-upThe new tax regulations are a significant departure from previous IRS guidance governing the taxation of an equity collateralassignment SDA. In the past, the (owner) employee was subject to tax only on the economic value of the insurance coverageprovided. The employee was not subject to tax on imputed interest on the (non-owner) employer's premium payments under thebelow market loan rules, nor was the employee faced with eventual taxation on his or her cash value equity build-up. Under thenew regulations, however, after January 1, 2004, an employee with equity build-up in a collateral assignment SDA may face a taxliability on the equity build-up upon termination of the SDA.

However, in accordance with IRS Notice 2002-8, an employee participating in an equity SDA entered into prior to September 18,2003 may avoid taxation of any equity build-up by choosing one of the following alternatives:

1. Continue to treat and report the economic value of the life insurance protection as taxable income for the remainder of his orher life. If this is done, the IRS will not treat the SDA as being terminated or materially modified, and thus will not assert therehas been a transfer of value to the employee (which would require taxation of the employee's share of the cash value).

2. Treat any premiums paid by the (non-owner) employer as loans made to the (owner) employee. All premium payments madeby the employer since the inception of the SDA must be treated as loans entered into at the beginning of the first year inwhich such payments are treated as loans.

3. For an SDA entered into before January 28, 2002, the IRS will not assert there has been a taxable event (and thus will notrequire taxation of the employee's share of the cash value) if the SDA is either terminated or converted to the loanarrangement described above.

Tip: This change must be made before January 1, 2004.

Caution: An employee may be participating in an equity SDA that has not yet reached the crossover point--the point where thecash value of the policy exceeds the aggregate premium payments made by the employer--as of January 1, 2004. As a result, theemployee need not choose one of the above alternatives by that date. However, to avoid future taxation of any developing equity,the SDA must be unwound (terminated) prior to reaching the crossover point.


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Caution: The Sarbanes-Oxley Act of 2002 makes it a criminal offense for a public company to lend money to its executives ordirectors. While converting an equity SDA entered into before January 28, 2002 to a loan arrangement may satisfy the IRS, anemployee of a public company with access to accumulated policy equity may still wish to terminate such an SDA before January1, 2004. Doing so will not only avoid taxation of the accessible cash value but would also circumvent any suspicion of participationin criminal activity.

Beneficiary generally receives proceeds free of income taxGenerally, death benefit proceeds attributable to life insurance protection offered under an endorsement SDA are excludable fromthe income of the employee's beneficiary to the extent that the employee has either paid for the coverage or taken its economicvalue into account.

Third party considerationsA collateral assignment SDA may involve a third party, such as the covered employee's spouse, child, or irrevocable life insurancetrust. In this instance, the third party owns the insurance policy, makes the collateral assignment to the employer in exchange forthe employer's premium payments, and may (if it's an equity SDA) have rights to cash value equity.

When a third party is the owner of the policy, that party should be the covered employee's named beneficiary. If the third partypolicyowner names another beneficiary (a three-party contract), the third party policyowner would be deemed to have made a giftof the full proceeds received upon the death of the insured.

Depending on how the SDA is structured, the third party policyowner may be subject to income tax on the economic benefit of theinsurance coverage on the employee or on imputed interest under the below-market loan rules. Further, the employee may betreated as having made a gift to the third party, which is subject to gift tax.


Platinum Advisory Group, LLCMichael Foley, CLTC, LUTCF

Managing Partner373 Collins Road NE

Suite #214Cedar Rapids, IA 52402

Office: 319-832-2200Direct: 319-431-7520

[email protected]

January 15, 2016Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016

ABOUT MIKE FOLEY

Mike specializes in Business Owner Benefits, Buy-Sell Agreement Funding, Business Continuation,Estate Planning, Key Person Benefits, Executive Benefits, and Deferred Compensation Plans forBusiness Owners, Key Employees and High Net Worth Individuals.

Mike is an Independent Insurance Broker with over 27 years of experience representing over 100+top insurance and financial services companies in the industry. This allows him to provide you thebest product solutions based on your individual needs and circumstances. References availableupon request.

IMPORTANT DISCLOSURES

Michael D. Foley, Platinum Advisory Group, LLC and Broadridge Investor Communication Solutions,Inc. does not provide investment, tax, or legal advice. The information presented here is not specificto any individual's personal circumstances.

To the extent that this material concerns tax matters, it is not intended or written to be used, andcannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law.Each taxpayer should seek independent advice from a tax professional based on his or herindividual circumstances.

These materials are provided for general information and educational purposes based upon publiclyavailable information from sources believed to be reliable—we cannot assure the accuracy orcompleteness of these materials. The information in these materials may change at any time andwithout notice.

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