Charles Ratner of Ernst & Young reports:
Well, now we have them. On Sept. 11, the Treasury Department and Internal Revenue Service issued the final split dollar regulations. If these regs look familiar, it's because they're a virtual composite of the two sets of proposed regulations put forth in 2002 and 2003. Pending a closer inspection of what the government has wrought, here's a quick look at what the final regulations do, what they don't do, and most importantly, what planners should be doing in their wake.
The regulations apply to split dollar plans entered into after Sept. 17, 2003, as well as to any pre-Sept. 17 plans that are materially modified after that date. As expected, the regulations leave traditional endorsement plans intact, except for the minor detail that we don't know how to figure the annual economic benefit. Presumably we can use Table 2001 until told otherwise.
The long-favored collateral assignment equity plans used by executives and business owners for estate liquidity, capital transfer and retirement income are history. These plans now must be structured as loans. While in certain situations, the loan structure may produce better tax economics than in the past, the juice by and large has been squeezed from equity split dollar, both for executive compensation and wealth transfer. That was no surprise.
What has taken many aback, however, is how the government utterly swept aside the comments made in response to the proposed regulations. Simply put, the government is intent on taking the full measure of taxation on any benefits derived by any party to a split dollar arrangement. Only time, and perhaps court challenges, will tell if that end justifies the analytical means used to get there.
The regulations do clarify certain technical matters such as the implications of “current access” to policy values. But what planners were really anxious to see was whether the government would offer any breathing room for the safe harbors under Notice 2002-8 and any clarification on the impact of policy exchanges on grandfathering of existing plans. Here, the government gives no quarter and no insight. True, there is an acknowledgement that any change in an existing arrangement made to take advantage of a safe harbor in Notice 2002-8 will not be a material modification. But, otherwise, nary a mention was made of existing plans.
More to the point, in an accompanying release, the Treasury noted specifically that the safe harbors in Notice 2002-8 will still expire on Dec. 31, 2003. The bottom line: There is no longer any reason to delay fully addressing the impact of Notice 2002-8 on existing plans.
It's been an interesting couple of years for split dollar. With the regulations now final, planners who have learned from this experience are busy figuring out whether split dollar can legitimately offer their clients sound tax economics that don't hinge on the performance of an over-funded product, the success of a wealth transfer technique or both. Alas, as foreshadowed by my column (“Split Dollar Interruptus,” Trusts & Estates, April 2003), those who have not learned from the experience are now busy selling soundbites, illustrations for over-funded products, wrapped in split dollar designs that will work only if the product does this and the client does that.
Sadly, their efforts to push the envelope will only cause the IRS to push back with still more regulations.