Private Split Dollar Life Insurance

Private Split Dollar Life Insurance – People may be surprised to learn that the 2017 tax reform imposed an excise tax on nonprofits that earn more than $1 million from skydiving.

Many people are surprised that this 21% excise tax can affect many non-profit entrepreneurs, especially when considering non-profit organizations such as the local YMCA or Girl Scout Council.

Private Split Dollar Life Insurance

But what about the CEO of a large healthcare organization, the CEO of a large fund, or the CEO of a large credit union? These positions in tax-exempt organizations are considered to have taxable compensation and benefits.

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Not surprisingly, excise taxes are a financial problem. It also focuses on damages and creates issues of awareness and scrutiny for stakeholders, legislators and the public.

Nonprofits and other tax-exempt businesses were already at a disadvantage when competing with corporations for talent. This excise tax undermined the ability of exempt individuals to recruit, retain, reward and provide pensions to key executives.

As a result, tax-exempt organizations are increasingly using split-dollar life insurance as an alternative to traditional qualified extended benefit plans.

Before the Tax Cuts and Jobs Act of 2017, this approach was already a popular strategy for tax-exempt organizations.

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Two of the most notable examples are Jim Harbaugh at the University of Michigan and Dabo Swinney at Clemson University, two high-profile college football coaches who receive life insurance as part of their compensation packages.

Under a distributed loan agreement, the employer agrees to lend the executor to pay the premiums for a cash life insurance policy owned by the employee. The policy is issued to the employer to ensure that the loan is repaid from the cash value of the policy, in the event of death or both.

Policies that fund split-dollar plans are generally designed to accumulate cash value and reduce the amount of mortality purchased unless there is a greater need.

With the introduction of the 21% excise tax, split dollar loan offers have become more attractive as bonus loans are not considered salary. 21% is tax exempt if the loan is considered a loan for federal tax purposes.

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“Dollar splitting is a strategy that allows you to split the costs and benefits of permanent life insurance between two people,” said Michael Fontanini, Lion Street’s vice president of advanced sales and design. – Employee bonus loans build up cash that can then be withdrawn tax-free in retirement as an insurance withdrawal or loan. The tax-exempt employer repays the loan, as well as accrued interest on the death benefit, and the remaining death benefit is paid to the employee.

Keep in mind that the nature of the split dollar loan is important and any income associated with below market rate loans will be considered capital gains and subject to excise tax. If the loans are properly paid or subject to market interest equal to or greater than the applicable federal interest rate, the Internal Revenue Code generally does not apply and there is no imputed income at all.

Also, if the loan is structured below market, it should be a demand or hybrid loan. These types of loans report income each year when they otherwise fall due. To ensure the most favorable tax treatment, it is important to ensure that all split dollar credits are structured correctly.

The history of the split dollar in the tax code dates back to the 1960s. however, it has been significantly modified and improved over the past 17 years. In 2003, the IRS issued Comprehensive Dollar Rules clarifying the taxation of then general agreements and those entered into thereafter.

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Under current tax law, the type of split dollar agreement most often used in income tax and income planning contexts is the loan agreement/security agreement. Loans to the employee for insurance premiums allow the employer to retain an interest in the policy values ​​as collateral. This assignment is usually released upon termination or upon death.

Although the employee may pay interest on the loan each year, the interest is usually charged to him as an annuity, whereby the employee is taxed for the interest each year, or the interest is credited and refunded upon termination or death. . Unless they are structured as demand or hybrid loans, you should avoid below-market loans that charge non-conforming interest rates, as the total return on conventional term loans in the initial month is equal to all interest rates. discounted at the relevant AFR during the term of the loan.

Scott Richardson is CEO and founder of IZALE Financial Group, which creates sustainable dollar plans for credit unions and other nonprofit organizations. “The structure of the loan is important in modeling the cost of the plan,” he said. Loans can be provided as demand or term or a hybrid of the two. “

Demand notes are returned at the request of the borrower and are equal to the average short-term federal interest rate for January and July of each calendar year published by the IRS in June.

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A term loan uses the applicable AFR during the month of the loan and is based on the stated or expected term of the loan. Short-term AFR for loans up to three years, medium-term AFR for loans between three and nine years and long-term AFR for loans over nine years. A hybrid loan is a term loan that is paid upon death, retirement or earlier and within a certain period of time. With all term loans, each advance is a new loan subject to a new AFR per term.

A technique that Richardson often uses with credit unions is for the employer to make a one-time early loan to the employee, payable upon death, and the excess over the first year’s premium is deposited into a premium deposit account with the life insurance company. . This applies to AFR for all loans so that all policies are locked in for the life of the loan, usually until the death of the insured. “The life insurance company takes money from the premium deposit account every year for 2+ years to pay the premium,” he said.

An exempt entity designated by the IRS must file a Form 990 each year. The organization must report the total remuneration paid on line 5 of the Part IX functional cost declaration for current employees and key personnel. to such persons for the organization’s fiscal year, which may differ from the calendar year.

“All loans made and issued by a principal of a tax-exempt entity under the debt regime’s split dollar agreement appear elsewhere on Schedule L,” said Janis Forgeis, real estate and wealth advisor at PRW Wealth Management. “Schedule J shows the annual interest expense paid to the estate agent in compensation.”

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Forgay suggested caution for organizations implementing a split-dollar plan. “To avoid private insurance, all formalities for accepting a compensation plan must be followed. These include a written plan and formal board approval.

On June 11, 2020, the Treasury Department and the IRS published detailed proposals interpreting IRC §4960. The proposed regulations provide additional information about tax penalties for exempt employers and entities that pay certain employees more than $1 million in salary or severance pay.

One of the most useful parts of the proposed regulations is the definition of who is a covered employee, which includes a number of tax-exempt and non-exempt exceptions.

The proposed rules affected the dollar split of £4,960 in excise duty. By default, interest is not federally taxable, but a below market rate loan (where the policy is structured using the loan method) is treated as capital interest. Until the final regulations are issued, the organization may rely on the proposed regulations, or the organization may interpret the statutory provisions in good faith.

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As with any beneficial plan, success may depend on the quality of plan management. The company’s employee benefits change over time, and it is important to document not only why the distributed money is being used, but also the purpose of the plan for both the employer and the employee.

Jordan Walker, director of business insurance solutions at Lincoln Financial Distributors, said administration should include two things: accounting planning and business management.

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