Rev. Rul. 78-420

ISSUE

Whether, for federal income tax purposes, certain life insurance arrangements should be treated as "split-dollar" arrangements as described in Rev. Rul. 64-328, 1964-2 C.B. 11, as amplified by Rev. Rul. 66-110, 1966-1 C.B. 12, and Rev. Rul. 67-154, 1967-1 C.B. 11.

FACTS

Situation 1.--A corporation entered into an arrangement with its key employee to purchase an insurance contract, in which there is a substantial investment element, on the life of the employee. The taxpayer is the son of the key employee and is also an employee of the corporation. Upon the father's retirement, the taxpayer became the owner of the life insurance policy on his father's life by means of a new arrangement between the corporation and the taxpayer.

Under the new arrangement, the corporation provides the funds to pay part of the annual premium to the extent of the increase in the cash surrender value each year. The taxpayer provides the balance, if any, of the premiums. The corporation is entitled to receive, out of the proceeds of the policy upon death of the taxpayer's father, an amount equal to the cash surrender value of the policy, or at least an amount equal to the funds it has provided for premium payments. The taxpayer has the right to name the beneficiary of the balance of the insurance.

Situation 2.--The same corporation as described in Situation 1 entered into a similar arrangement with the wife of the same taxpayer described in Situation 1 for the purchase of a life insurance policy that insures the life of the taxpayer. The wife is the owner of the policy and has the right to select the beneficiary. The corporation and the wife share in payment of the premiums in a manner similar to that described in Situation 1. Upon the death of the taxpayer, the proceeds will be distributed to the corporation and the beneficiary in a manner similar to that described in Situation 1.

LAW AND ANALYSIS

Section 61 of the Internal Revenue Code of 1954 provides that gross income means all income from whatever source derived. Section 1.61-1 of the Income Tax Regulations provides that gross income includes income realized in any form.

Under a typical "split-dollar" arrangement, an employer and employee join in purchasing an insurance contract, in which there is a substantial investment element, on the life of the employee. Generally, the employer provides the funds to pay part of the annual premium to the extent of the increase in the cash surrender value each year, and the employee pays the balance of the annual premium. The employer is entitled to receive, out of the proceeds of the policy, an amount equal to the cash surrender value, or at least a part thereof sufficient to equal the funds it has provided for premium payments. The employee has the right to name the beneficiary of the balance of any proceeds payable by reason of the employee's death. Although the employee must pay a substantial part of the first premium, after the first year the employee's share of the premium decreases rapidly, and in some cases it even becomes zero after a relatively few years. The employee thus obtains valuable insurance protection (decreasing each year, but still substantial for a long time) with a relatively small outlay for premiums in the early years, and at little or no cost to the employee in later years. The effect of the arrangement is that the earnings on the investment element, which at arm's length would go to the employer, are applied to provide current life insurance protection to the employee at either no cost to the employee or at a cost less than the employee would pay absent the arrangement. The employee receives an economic benefit represented by the amount of the annual premium cost that he is relieved of paying and would otherwise have to bear absent the arrangement.

Rev. Rul. 64-328 holds that when there is a "split-dollar" arrangement, in which the employer pays the portion of the premiums equal to the increases in the cash surrender value and the employee pays the balance, if any, of the premiums, and in which, from the proceeds payable upon the employee's death, the employer receives at least an amount equal to the funds it has provided, with the beneficiary receiving the balance, the value of the insurance protection in excess of the premiums paid by the employee must be included in the employee's income. Rev. Rul. 64-328 further states that the same income tax result follows if the transaction is cast in some other form that results in a similar benefit to the employee.

In Situation 1, the arrangement between the corporation and the taxpayer arose from the employer-employee relationship between the taxpayer and the corporation. The employee is relieved by the employer from paying premiums that the employee would otherwise have to pay to carry the policy in effect. Thus, the taxpayer is receiving an economic benefit under the arrangement. Rev. Rul. 64-328 states that the same federal income tax results if the transaction is cast in some form other than that described in Rev. Rul. 64-328 but results in a similar benefit to the employee. Although the life insured is not that of an active employee, the arrangement is the type contemplated in Rev. Rul. 64-328.

In Situation 2, the arrangement arises from the employer-employee relationship between the taxpayer and the corporation. Although the owner of the policy is the employee's wife, the policy is on the life of an employee. The employer would not have joined in such an arrangement with the employee's wife if the policy were on the life of a person not employed by the employer. In Situation 2 a benefit accrues to the husband similar to the benefit that would accrue were the husband the owner of the policy. The arrangement also is of the type contemplated by Rev. Rul. 64-328.

HOLDING

The life insurance arrangement discussed in Situations 1 and 2 should be treated for federal income tax purposes as "split-dollar" arrangements as described in Rev. Rul. 64-328. Therefore, the taxpayer must include in income the value of the insurance protection in excess of the premiums paid by him in Situation 1 or his wife in Situation 2. Further, in Situation 2, the value of the life insurance protection provided by the corporation which is included in the income of the taxpayer is deemed to be transferred by the taxpayer to his wife for purposes of section 2511 of the Code, and subject to the gift tax imposed by section 2501. See Rev. Rul. 76-490, 1976-2 C.B. 300.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 64-328, Rev. Rul. 66-110, and Rev. Rul. 67-154 are amplified.