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A Valuable but Complex Business Arrangement for Physicians
By Gary A. Cook; MSFS, CLU, RHU, CFP® CMP™
Split dollar arrangements can be a complicated and confusing concept for even the most experienced insurance professionals or financial advisors.
Moreover, for most physicians and healthcare executives they seem to be fraught with even more confusion.
The Basic Concept
This concept is, in its simplest terms, a way for a medical practice to share the cost and benefit of a life insurance policy with a valued physician employee.
In a normal split dollar arrangement, the employee doctor will receive valuable life insurance coverage at little cost to them. The medical practice business entity pays the majority of the premium, but is usually able to recover the entire cost of providing this benefit.
Approaches and Structures [IRS Notice 2002-8 and 2002-59]
Following the publication of IRS Notices 2002-8 and 2002-59, there are currently two general approaches to the ownership of business split-dollar life insurance: Employer-owned or Employee-owned. (In addition, Proposed Regulation 164754-01, substantially changed split-dollar arrangements even further.
Both the medical practitioner and his/her financial advisor should research this area thoroughly before proceeding or making any recommendations. Regardless of the method used, a written agreement must be prepared to spell out the rights and obligations of the parties.
[1] Employer-owned method [IRS Tables and PS38 Rates]
In the employer-owned method the employer is the sole owner of the policy. A written split-dollar agreement usually permits the employee to name the beneficiary for most of the death proceeds. The employer owns all the cash value and has the unfettered right to borrow or withdraw it as necessary.
At the end of the formal agreement, the healthcare business entity can generally (1) continue the policy as key person insurance, (2) transfer ownership to the insured and report the cash values as additional income to the insured, (3) sell the policy to the insured, or (4) use a combination of these methods. This is commonly referred to as “rollout.”
Medical practitioners, and their advisors, should be careful not to include rollout language in the split-dollar agreement. Many plans are set up with the intent—although not in writing—to transfer the policy to the insured after a certain number of years.
The reason the rollout should not be included is that if the parties formally agree that after a specified number of years—or following a specific event—related only to the circumstances surrounding the policy, that the policy will be turned over to the insured, the IRS could declare that the entire transaction was a sham and that its sole purpose was to avoid taxation of the premiums to the employee.
If that happens, the IRS may deem that the premiums paid should be considered income to the employee when they were paid. If this comes up in an audit years after the inception of the agreement, it may generate substantial interest and penalties in addition to the additional taxes due. The death proceeds available to the insured employee’s beneficiary are considered a current economic benefit. Also called reportable economic benefit (REB), it is an annually taxable event to the employee.
If an individual policy is involved, the REB is calculated by multiplying the face amount times government’s rate tables, or the insurance company’s alternative term rates, using the insured’s age.
If a second-to-die policy is involved, the government’s PS38 rates or the company’s alternative PS38 rates will be used.
Any part of the premium actually paid by the employee is used to offset any REB dollar-for-dollar.
The employer-owned method is primarily used when the employer wishes to maintain as much control as possible over the life insurance policy or for officers and executives of publicly-held corporations. This employee perquisite can be used to reward key employees with current inexpensive death protection and simultaneously provide a potential handcuff for them by informally funding a deferred compensation agreement.
[2] Employee-owned method [Code § 7872]
With the employee-owned method, the insured-employee doctor is generally the applicant and owner of the policy. Any premiums paid by the practice are deemed to be loans to the employee and the employee reports as income an imputed interest rate on the cumulative amount of loan based on Code § 7872.
A collateral assignment is made for the benefit of the business to cover the cumulative loan amount. In some cases, the assignment may allow the assignee to have access to the cash values of the policy by way of a policy loan. This method is unavailable for officers and executives of publicly- held corporations because of the current restrictions on corporate loans (the Sarbanes-Oxley Act).
The employee-owned method is somewhat similar to the older collateral assignment form of split-dollar. The benefits for the employee are both the ability to control large amounts of death proceeds as well as developing equity in the policy.
Whether or not this new method catches on will depend greatly on the imputed interest rate published by the IRS every July. If set low enough, this may be an excellent opportunity for the employee to use inexpensive business dollars to pay for life insurance.
Illustrative Example:
Dr. Charles Tryon is a valuable member of a team of surgeons at St. Mary’s Hospital. He has recently developed a new technique for treating brain aneurysms. The hospital would like to keep him on staff for years to come.
Dr. Tryon is married and has one small child and his wife is pregnant. He has requested that the hospital provide him with more life insurance. The hospital’s board of directors meets with a number of financial advisors to review their options and they settle on an employer-owned method split dollar arrangement.
As a result, they will purchase and pay for a life insurance policy on Dr. Tryon, providing him the bulk of the death benefit for his family, as long as he is a member of their hospital staff. They have also agreed to bonus Dr. Tryon the amount equal to the Reportable Economic Benefit, in order to keep his insurance cost at a minimum.
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Assessment
The above is not intended to be a complete treatise on the split dollar concept. There are many different variations that continue to change and develop daily. Due to the complexity of split dollar and potential tax implications it is recommended that when considering a split dollar arrangement, an experienced team of advisors be consulted.
Conclusion
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Filed under: Insurance Matters | Tagged: Insurance Matters |
The Leading Business Education Network for Doctors, Financial Advisors and Health Industry Consultants 
I think the post above made some interesting points.
And, on a related side note, I found a used version of Auditing After Sarbanes-Oxley [Illustrative Cases], which is directly related to this topic, at a local used bookstore.
Amanda
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Split-Dollar Life Insurance
Life insurance can be an important part of a doctor or business owner’s financial strategy. It can also be a great benefit to offer to key employees. However, sometimes the cost can be prohibitive. With split-dollar life insurance, the cost of life insurance can be managed by splitting it up.
To be clear, split-dollar life insurance is not an insurance product but rather an arrangement to purchase and fund life insurance between two parties, generally an employee and an employer.
Basically, an agreement is made under which a life insurance policy is purchased on an individual. The employer will pay all or a portion of the premiums on the policy, depending on the arrangement. When the individual dies, the employer receives a portion of the death benefit equal to the amount paid in premiums. The remaining benefit goes to the individual’s beneficiaries.
For example, if a $200,000 policy were purchased for an individual who died after the employer had paid $28,000 in premiums, then the employer would get back the money it had paid in premiums and $172,000 would go to the insured individual’s beneficiaries.
This agreement is attractive to both parties because the employer recoups its money and the employee receives a life insurance policy at a better rate because the company is picking up all or a portion of the cost. The death benefit is free of income tax for both parties as well.
A split-dollar life insurance arrangement can be used for a variety of reasons:
• Split-dollar life insurance can be used to fund a buy-sell agreement.
• It can be used as a benefit to recruit and retain quality executives.
• Business owners who might not otherwise be able to afford life insurance might benefit from a split-dollar arrangement.
There are different ways to set up split-dollar life insurance. Usually, the individual owns the policy and designates beneficiaries, then by absolute assignment transfers to the employer an amount equal to the premiums paid by the employer. In this case, the individual retains all ownership rights, but when the individual dies, the employer is reimbursed before the individual’s named beneficiaries are paid. If the individual leaves the company, any cash value in the policy would be used to repay the company.
In other arrangements, the policy can be purchased by the employee and assigned to the employer as collateral in exchange for the employer paying the premiums. Because the company holds the policy as collateral, it can be confident that it will recoup the money spent on the insurance premiums.
In some cases, the employer can take out a life insurance policy on the employee. The employer names itself as a beneficiary of an amount equal to the cash value and designates that any funds in excess of that amount will be paid to the individual’s beneficiaries.
Israel
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