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ING: "Grandfathering" Guidance from IRS

Regarding Split Dollar Arrangements and Employer Owned Life Insurance

04-29-2008

The IRS recently released guidance concerning the relationship of "grandfathering" provisions for split dollar arrangements and the notice and consent provisions of IRC § 101(j). In Notice 2008-42 (the "Notice"), the IRS indicates that modifications to a split dollar arrangement will not impact grandfathering for purposes of the notice and consent requirements of § 101(j) unless there is a change to the underlying life insurance contract. Thus the IRS has drawn a distinction between a) what constitutes a modification of an arrangement for purposes of grandfathering under the final split dollar regulations, and b) what constitutes a material change of an employer owned life insurance arrangement under § 101(j).

Important Reminders

Notice 2008-42 provides reminders for situations where life insurance is owned by an employer:

1. All new purchases of life insurance by a business must comply with § 101(j). Any time a business is purchasing a life insurance policy, the parties must sign a special "Notice and Consent" form if the insured is an employee of the business (even if the insured is also an owner of the business). Failure to execute a "Notice and Consent" could produce unwanted income taxation for the business.

Under § 101(j), where the owner of the policy is an employer and where the insured is an employee of the business, death benefits received by the business may be excluded from its gross income so long as two conditions are met: (i) the policy is held on an appropriate insured, and (ii) the corporation satisfies all of the new disclosure and consent requirements.

If, on the other hand, one or both of these requirements is not met, then death benefits received by the business will be taxed as ordinary income to the extent they exceed premiums paid by the business.

To avoid paying income taxes on life insurance death benefits, employers should purchase insurance only on key employees (as defined by § 101(j)) and get written consent from the employee before the life insurance policy is issued.

Note: Although the ING Life Companies do not require such a notice to be submitted with employer-owned policies, a specimen form for obtaining notice and consent is available. Employers should consult with their tax and legal advisors to tailor the form to their specific needs

2. All changes to existing employer-owned life insurance contracts should require new Notice and Consent forms. Employer-owned life insurance which was purchased prior to August 17, 2006 is "grandfathered" from the requirements of § 101(j), unless the contract is subject to material change on or after that date. Thus, any increase in death benefit, change in riders, or § 1035 exchange of existing employer-owned life insurance contracts should be accompanied by a written and signed Notice and Consent form. Employers may even want to consider getting new Notice and Consent forms for changes to policies issued after August 17, 2006 since part of the written consent involves the amount of insurance contemplated by the arrangement.

3. All parties to split dollar arrangements which were entered into prior to September 18, 2003 should carefully evaluate the impact of loss of grandfathering status prior to making any material modifications to such arrangements. The final regulations for split dollar arrangements apply to arrangements entered into after September 17, 2003. Certain aspects of split dollar arrangements entered into on or before that date are grandfathered from application of the final regulations. One particularly important element of grandfathering is the choice of rates to apply to such arrangements for measuring the economic benefits costs of life insurance coverage for the employee.

According to Notice 2002-8 and the final split-dollar regulations published on September 11, 2003, split-dollar arrangements entered into prior to January 28, 2002 and not materially modified since September 17, 2003 can use Table 2001 or the insurer's published yearly renewable term ("YRT") rates. Arrangements entered into between January 28, 2002 and September 17, 2003, and which have not been materially modified since September 17, 2003, may use an insurer's YRT rates if they are (i) made generally known and available, and (ii) are regularly sold to those applying to the insurer for term insurance. If an insurer does not have rates which meet these tests, the arrangements must use Table 2001. All arrangements entered into or materially modified after September 17, 2003 must use Table 2001.

Thus, parties to "grandfathered" split dollar arrangements should evaluate the impact of the potential loss of using insurance carriers YRT rates before making any modifications to such arrangements.

Please contact the BUA Sales Team 800-792-6795 with any questions.