Sapers & Wallack
Bulletins: AALU Washington Reports
IRS Extends Time to File Election to Treat Split-Dollar Loan Payment
SEE THE CIRCULAR 230 DISCLAIMERS APPENDED TO THE CONCLUSION OF THIS WASHINGTON REPORT.
The Internal Revenue Service, in a series of private letter rulings (PLRs 200923002, 200923017 – 021) has granted a nonprofit corporation an extension to file written representations that would allow loan payments made under a split-dollar life insurance plan to be treated as noncontingent payments.
Under final regulations effective September 17, 2003, a split-dollar life insurance arrangement may be taxed under either the “economic benefit” regime (if the donor or employer is the deemed owner of the life insurance contract) or the “loan” regime (if the done or employee is the deemed owner of the life insurance contract). (For an analysis of the final split-dollar regulations, see our Bulletin No. 03-95.)
Under the loan regime, income is imputed to the done or employee to the extent required under the section 7872 regulations. Generally, no income will be imputed if the split-dollar agreement requires “adequate stated interest” to be paid or accrued at or above the “applicable Federal rate” in effect on the date the loan is made.
Nonrecourse loans (loans as to which the lender agrees to look only to the collateral – the life insurance policy and proceeds – for repayment) are tested differently for purposes of Section 7872 compliance, however. Where, as is typical, a split-dollar loan is nonrecourse to the borrower, the payment is treated as a “contingent” payment. To avoid contingent payment treatment (which generally will result in the imposition of unfavorable assumptions when testing the loan for adequate stated interest), the parties to the loan must represent in writing (and must attach to the parties’ returns) no later than the due date for the return of the borrower or lender for the year in which the first split-dollar loan is made that a “reasonable person” would expect that all payments under the loan will be made. In PLRs 200923002 and 200923017 – 021 the taxpayers (Employer and employees) requested an extension of time to file the required written representations.
Employer is a section 501(c)(3) tax-exempt nonprofit corporation. In “Year 2,” a consulting team (“Company A”) recommended implementing a split-dollar life insurance plan (SDP) with several key employees. Neither Employer nor the employees had any prior experience or knowledge regarding split-dollar life insurance arrangements.
Company A explained to Employer that the SDP was intended to be subject to the split-dollar regulations and was designed to utilize nonrecourse premium loans to the employee participants secured by the policy. The loans were to each have a stated interest rate equal to or in excess of the applicable federal rate (AFR) so as not to be “below-market split-dollar loans”.
At the time the SDP was implemented, calculations prepared by Company A projected that the proceeds of the insurance policy securing the loans were expected to be sufficient to pay all interest and principal due. Company A did not advise the Employer or the employee participants in the SDP regarding the resulting tax consequences if payments on the loans were treated as contingent payments under the Split-Dollar Regulations.
After the SDP was implemented, Employer contracted with Company A to serve as the third party administrator of the SDP. Employer represented that, because it lacked knowledge and experience with split-dollar life insurance arrangements, Employer and employee participants relied on Company A’s guidance in developing, implementing, and administering the SDP. Employer further represented that Company A was aware of Employer and employee participants’ reliance on its expertise regarding the SDP.
In Year 4, Company A discontinued acting as third party administrator of the SDP, and Employer contracted with Company B to serve as its new third party administrator and to consult on Employer’s SDP. Company B was formed in Year 4 by the members of Employer’s original consulting team from Company A. At the end of Year 5, Company B ceased serving as Employer’s third party administrator, so in Year 6, Employer hired Company C to serve as the third party administrator of its SDP. Upon an extensive review of Employer’s SDP documents, Company C asked for a copy of the written representations that should have been executed and filed with Employer’s (and employee participants’) tax returns for Years 3 and 4. Employer informed Company C that it was unaware of the need to make the written representations because its previous third party administrators had not informed Employer of this requirement. Company C explained that the written representations were necessary to ensure that payments on the Loans were not treated as contingent payments. Subsequently, Company C and Employer sought assistance from counsel and filed a request for an extension of time to make the written representations.
“Section 9100 relief” is relief from certain regulatory deadlines that may be granted upon conditions prescribed in regulations. Under, Treas. Reg. § 301.9100-3(a), where an automatic extension of time is not available (as in the instant ruling) the taxpayer must provide evidence satisfactorily establishing that the taxpayer acted reasonably and in good faith and that granting relief will not prejudice the Government.
A taxpayer will be deemed to have acted reasonably and in good faith if the taxpayer satisfies at least one of the following five criteria: (i) the request for relief was made before the Service discovered the failure to make the regulatory election; (ii) the failure to make the election was due to intervening events beyond the taxpayer’s control; (iii) after exercising reasonable diligence, the taxpayer was unaware of the necessity for the election; (iv) the taxpayer reasonably relied on the written advice of the Service; or (v) the taxpayer reasonably relied upon a qualified tax professional, including a tax professional employed by the taxpayer, and that tax professional failed to make or failed to advise the taxpayer to make the election.
The regulations provide that a taxpayer has not reasonably relied on a qualified tax professional if the taxpayer knew, or should have known, that the professional was either (i) not competent to render advice on the regulatory election, or (ii) not aware of all relevant facts. In addition, a taxpayer will not be deemed to have acted reasonably and in good faith if the taxpayer does one of the following: (i) seeks to alter a return position for which an accuracy-related penalty has been or could be imposed under section 6662 at the time the taxpayer requests relief and the new position requires or permits a regulatory election for which relief is requested; (ii) was informed in all material respects of the required election and the subsequent tax consequences, but chose not to make the election; or (iii) uses hindsight in requesting relief.
The regulations also state that the interests of the Government are prejudiced if granting relief would result in the taxpayer having a lower liability in the aggregate for all years to which the regulatory election applies than the taxpayer would have had if the election had been timely made (taking into account the time value of money).
Given the foregoing requirements, Employer and the participating employees made the following representations: The granting of Section 9100 relief would not result in Employer or participating employees having a lower tax liability in the aggregate for all years to which the election applies than it would have had if the election had been timely made (taking into account the time value of money). Neither Employer nor the employees knowingly choose not to file the election. They did not use hindsight in requesting relief. Finally, Employer and the employees represented that they were not seeking to alter a return position for which an accuracy-related penalty has been or could be imposed.
On these fact, the Revenue Service concluded that the requirements for granting a reasonable extension of time to file the written representations as required under the split-dollar regulations were met, and that the taxpayers, Employer and participating employees, were granted a period of time not to exceed 30 days from the date of the letter ruling to prepare and have both parties sign the written representations. Provided that the written representations are timely signed by both parties as required by this letter and filed with the Taxpayer’s tax return for Year 6, each written representation will be deemed effective for all years in which the corresponding split-dollar arrangement has been in effect.
The ruling cautions that “[n]o opinion is expressed with regard to whether the tax liability of [taxpayers] is not lower in the aggregate for all years to which the election applies than such tax liability would have been if the election had been timely made (taking into account the time value of money).” That issue will be resolved on audit.
The nonrecourse/contingent payment loan rules as applied to split-dollar life insurance arrangements may be a trap for the unwary. These rulings provide some welcome news for those who may have failed to file the required representations (and who otherwise meet the requirements for relief).
Any AALU member who wishes to obtain a copy of any of the items discussed in this Washington Report may do so through the following means: (1) use hyperlink above next to “Major References,” (2) log onto the AALU website at http://www.aalu.org/ and enter the Member Portal with your last name and birth date and select Current Washington Report for linkage to source material or (3) email Anthony Raglani at raglani@aalu.org and include a reference to this Washington Report.
NFP Securities, Inc. does not provide tax or legal advice. Any decision whether to implement these ideas should be made by the client in consultation with professional financial, tax, and legal counsel.
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