Clock is Ticking on Split-Dollar Insurance

THE SAD BUT TRUE fact is that the IRS changed the rules on split-dollar insurance in the middle of the game. If you or anyone in your company has what is commonly called a split-dollar life insurance plan (Split-$ Plan), this article is must reading. What did the IRS do? Issued Notice 2002-8 in 2002 giving you until Jan. 1, 2004, to terminate your Split-$ Plan. Or you can use any one of the three

THE SAD BUT TRUE fact is that the IRS changed the rules on split-dollar insurance in the middle of the game. If you or anyone in your company has what is commonly called a “split-dollar life insurance plan” (Split-$ Plan), this article is must reading.

What did the IRS do? Issued Notice 2002-8 in 2002 giving you until Jan. 1, 2004, to terminate your Split-$ Plan. Or you can use any one of the three choices offered by the notice and keep your Split-$ Plan alive. But there’s a problem: Each of the choices is a complex and expensive mess that, in effect, forces you, economically, to end your Split-$ Plan.

Several months ago (June, pg. 50) this column carried an article about this IRS-created dilemma and offered the reader “Free help with your Split-$ Plan problem.”

Surprise!

We never anticipated the number of responses — 26 so far and one to three more each week. The two most surprising facts are: 1) Only three of the readers were notified by their insurance professionals that a problem existed; 2) none of the professionals — all but two of the readers contacted their professionals — had a clue of what to do.

With the firsthand knowledge of the chaos among readers involved with a Split-$ Plan, it became my duty to write this second article. What is particularly frustrating is that exactly what you should do depends on a host of factors: your age, health, the purpose of buying the Split-$ Plan in the first place, if the purpose is still the same, the exact type of policy, and it goes on and on. I can’t write a comprehensive article that touches all the bases. Or review all the choices, possibilities and tax traps.

Instead, once again, I have made arrangements for readers of this column to have their Split-$ Plans analyzed for free. (But this time, we are in a bit of a hurry. In most cases, decisions must be made before New Year’s Eve 2003).

So, if you need help with your Split-$ Plan problem, here’s what to do. Send your name, address and phone numbers (day, evening and cell) along with your Split-$ Plan info to: Split-$ Plan Changeover, Irv Blackman, 3830 Estes Ave., Lincolnwood, IL 60712. Call Irv (847/674-5295) if you have a question.

Fair-market value rules

It was a long time ago — 1959 to be exact — when the IRS launched Rev. Ruling 59-60. It’s been the law of the land ever since. And I like it.

In a nutshell the ruling says, fair-market value is defined as the price a willing buyer will pay a willing seller, when neither is under any compulsion to buy or sell and both parties are aware of all the facts and circumstances concerning the asset to be sold.

We’ve been working with this definition for more than 40 years. My office understands it and has used it to value hundreds of businesses without a peep from the IRS. Yet, sometimes the IRS wants to fight with the clear logic of its own ruling.

Here’s a real case that may save you some big bucks when you must value your business for tax purposes. The case, Estate of Beatrice Ellen James Dunn (30 F3d 339), involved millions of dollars. Instead of reviewing the complicated issues concerning the technical aspects of the case, the key issues can be made clear by a simple example, which follows:

Suppose Joe wants to sell the stock of his company (Success Co.) to Bill for its FMV. The only asset inside Success Co. is $1 million worth of equipment (at FMV) that is fully depreciated. So its tax basis is zero. If the equipment is sold the company will be socked with a $340,000 tax bill. Bill is willing to pay Joe the FMV of his Success Co. stock. Bill wants that $1 million worth of equipment. Joe only will sell the Success Co. (a C corporation) stock because he wants a capital gain.

Bill explains it to Joe this way: “I am willing to pay you $1 million only if I buy the equipment from Success Co. Then, I’ll own the equipment and can depreciate the entire $1 million cost.

“But understand this, Joe: Success Co. must pay $340,000 in tax on its $1 million in profit. Success Co. will only have $660,000 left. When you liquidate Success Co. to get that $660,000, you’ll be hit again, this time with a $130,000 capital gains tax.

“You’ll only have $530,000 left, after all federal taxes, from your $1 million sale.

“On the other hand, if I pay you $1 million for the stock, I’ll have to liquidate Success Co. to get the equipment out. Then, I’ll be stuck with the $340,000 tax bill. No thanks.

“How about this way? I’ll pay you $660,000 for the stock (the after tax cost of liquidating Success Co.). You’ll wind up with the same $530,000. And it will only cost me $1 million even ($660,000 to you and $340,000 to the IRS).

“Or put another way, Joe, the FMV of your stock is only $660,000, not $1 million.”

Joe and Bill shook hands. The deal was done.

Now back to the issue in Dunn: Dunn’s estate wanted a discount for the company stock being included in her estate of 34% of the built-in gain on the fully depreciated equipment (actually 100% of the tax burden if the equipment was sold). The IRS offered only a stingy 5% discount. The tax court sided with Dunn’s estate.

A big victory. Make sure to show this article to your appraiser when you have your business valued for tax purposes, particularly for gift or estate taxes.

Irving Blackman is a partner in Blackman Kallick Bartelstein, 300 S. Riverside Plaza, Chicago, IL 60606; tel. 312/207-1040, or via e-mail at [email protected].

TAGS: Taxes