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2004
Index (back)
Report 9
Thursday, January 8
9:00 - 9:45 a.m.
Split Dollar Has Split - So How Do We Finance Premiums
Now?
Donald O. Jansen
Reporter: Carol Warnick Esq.
If plans are entered into or significantly modified since
September 18, 2003, they are now under the new regime.
There are 2 types of regimes the taxpayer can choose from.
(1) Economic benefit regime (old endorsement split dollar)
Premium measures economic benefit, but cash value will be
taxed
(2) Or can choose loan regime employee owns entire cash value.
Must use higher applicable federal interest rate.
It has been implied there is a demise of split dollar but
it is not dead, just more expensive.
Many ways of financing premium payments. Can be simple...just
pay the premium out of your pocket., or maybe a family entity
can pay the premiums. A trust might be a remaindermen in a
GRAT remainder interest can give money to the trust to pay
the premiums.
He is going to cover 3 other approaches to financing premium
payments.
1. Loan approach -- by employer, by insured, by a third party
2. Using employer money, bonus plan, split dollar, undivided
ownership of the policy between employer and employee
3. Sale to a defective trust where assets will produce enough
to pay premium and pay back principal to the note
1. Employer loan
Employer has to comply with new split dollar loan regs. But
he has to pass some initial hurdles.
1. split dollar arrangement
2. correct ownership of policy
3. have a real, bona fide loan (not a sham loan)
Applies if the employee is the owner or his trust is.
Exception.....page 7 special exceptions
if employer has all the cash value, regs treat it as if the
employer owns the policy
Regs say if the employer is direct or indirect source of
payment of interest on the loan, interest is disregarded.
Example of indirect source of payment in regs. Employee was
to pay back loan in a lump sum at maturity date, along with
premiums. Also had a deferred comp plan which would pay out
the amount of the interest at that same date. If you have
an agreement to bonus the money annually, it is an interest
free loan.
If no loan, all the money is income on the front end. If
employer is going to be the source of the interest or the
premium payments, be careful. Do not tie the deferred comp
agreement to the loan in any way. Or make it subject to a
substantial risk of forfeiture
If employee pays applicable federal interest rate, no consequences.
Demand loan AFR is the blended fed rate published in July
of each yr. 1.52% in 2003 usually lowest interest rate but
most volatile.
Term loan rates determined differently page 13 short, mid,
long term. Higher than demand rate but can lock it in. Can
be conditioned upon continued employment by the employee.
If do not charge it you have income and gift tax consequences.
Page 13 On a demand loan these are annual.
Term loan pg 14 one-time income and one-time gift tax consequence
in the month you enter into the loan.
Pg 15, #5 example in regs 15 yr interest free loan discounted
back was a $64,000 dividend to that shareholder in the month
which it was entered into.
Pg 15,16 and 17 Special rules tied to life expectancy or
conditioned on employment, or a family loan figured as if
it were a demand loan if to a life insurance trust would make
a front end gift to the ILIT
A loan every time an employer pays a premium different AFRs,
etc.
SECOND TYPE OF LOAN
pg 25
Insured loans money to ILIT to hold down the gift, he can
loan the money to the trust.
Various loan formats separate loan each year using AFR but
if he has the money on a universal life policy, do a single
premium loan at the front end compounds the money interest
free.
The fly in the ointment are the MEC (modified endowment contract)
rules. If you put the premiums in the policy too fast, then
for the lifetime of the insured it is taxed as if it were
a tax deferred annuity. If you borrow, the income comes out
first, basis stays in contract. (pg 26). If you do not need
to borrow, or do not need to touch cash value, it is OK. When
insured dies, it is still a life insurance policy.
Page 26 income tax consequences spit-dollar loan regime applies.
Must pay APR also, when it is the insured loaning money to
the trust make it a grantor trust insured pays interest to
himself a non tax event.
In order to make it a grantor trust, choose a defect that
will get you the right income tax consequences 3 most popular
pgs 27, 28, 29
1. Nonadverse party has the ability to add a beneficiary
to the trust other than an after born child likes to use a
trust protector for this.
2. Power of any person to reacquire trust property and substitute
with equivalent value. Must not be done in a non fiduciary
capacity again he likes using a trust committee or a trust
protector.
3. If the income of the trust maybe applied to pay premium
on an insurance policy on the life of grantor or grantor's
spouse, then you have a grantor trust. Can you trigger this
defect if you have no income in the trust? He also uses another
string as well.
What if grantor trust status ends while grantor alive? Tax
consequences of outstanding loan? Pg 30 No direct authority.
Probably treated as if the grantor transferred the trust assets
to the trust on that date and any liabilities of the trust
to a third party are treated as money received and will result
in gain to the grantor to the extent that the discharge of
indebtedness exceeds the basis of the assets in the trust.
What if the loan is to the insured? That is a worry.
What if grantor trust status ends because of death of grantor?
Is that a sale or exchange? Do we get a step up in basis?
Pg 31 he cites articles in this area opinions vary
Always plan to have the note paid off well within the life
expectancy of the grantor so there is no issue.
Gift tax consequences of loaning money to the trust must
charge the AFR and have a bona fide loan. Make it clear this
is a valid loan with notes, etc. Pay interest each year to
show it is a real loan, otherwise it could all be a gift at
the front end.
Is inadequate security enough to cause IRS to discount the
loan? One theory - 7872 rules. Other theory says 7872 is silent
so if you do not have enough security, they might discount
it. Frazee v. Commissioner, a 1992 case, took the 7872 approach
Try to have other assets in there to provide security, or
have beneficiaries secure the note.
Estate Tax Consequences no problem under 2042 no incidence
of ownership - what about 2036? Is it a transfer where the
insured retained the right to the income? if you do not have
enough security, could be an issue. He suggests maybe a 10%
additional gift to the trust.
THIRD TYPE OF LOAN Third party financing
Trust borrows money to pay premiums usually balloon notes....most
have interest being paid currently - some allow interest to
be accumulated
Where to you get the loans? banks, or specialized institutions
AIG, Bank of Scotland - LIBOR plus a spread of 1 1/4 to 2
1/2 percent
Read your loan documents may say for 15 yrs but have a clause
that renews every year and allows them to pull the plug.
3rd party lenders will demand security want the assets in
the trust to exceed the loan by 10% - will require outside
collateral or guarantees.
Income tax consequences of 3rd party loan. He does not think
it is subject to 7872.
Should it be a grantor trust? Most of the time, no. Unless
there are other reasons (other assets in the trust and want
grantor to pay taxes or with crummey powers.)
If you do make it a grantor trust, same issues apply when
it is no longer a grantor trust....aim to have it paid off
before grantor dies.
Gift tax consequences. He does not think it is a gift, but
if there is a lot of money involved he will have the trust
pay a guarantee fee charge what a bank would change for a
letter of credit.
He indicated he would go over the rest of his outline in
the special session.
9:45 - 10:30 a.m.
When the Kids Won't Play Well Together: Tax-Free Corporate
Divisions in Family Succession Planning
Michael V. Bourland
Reporter: Gene Zuspann Esq.
Family business succession planning often involves inter-generational
conflicts between subsequent generations. These difficulties
are compounded if the business entity form is a corporation.
The goal of such divisions is to allow different family members
or groups to own and control their own business without causing
a tax on the division of the corporation.
Divisions of the family business can often be accomplished
under IRC §355.
In his materials and presentation, the "distributing
corporation" owns the "controlled corporation"
and will distribute the stock of the controlled corporation
in the §355 transaction.
Requirements of §355:
-The distribution to a shareholder is with respect to the
shareholder's stock
-The distributing corporation must distribute stock in the
controlled corporation which the distributing corporation
controls immediately before the distribution (80% voting control
and 80% of total shares of all other classes of stock)
-The plan cannot be a device for the distribution of earnings
and profits of the distributing corporation, the controlled
corporation or both
-There is no bright line test
-This is a facts and circumstances test
-Facts to be reviewed - whether the distribution is pro-rata,
whether an sale occurs shortly after the distribution, and
the nature of and use of the assets in the controlled corporation.
-There must have been an active trade or business for 5 year
period ending on the date of distribution. The business must
not have been acquired in the 5 year period.
-There must be a significant corporate business purpose.
The purpose must be a non-federal tax purpose. It also must
not be a shareholder purpose, however the shareholder purpose
may be so nearly coextensive with the corporate purpose as
to preclude any distinction.
-The dispute between the shareholders must be to such an
extent that the corporations business will be affected negatively
if the division of the corporation is not carried out.
-There must be a continuity of interest in the controlled
corporation by the shareholders of the distributing corporation.
-There must be continuity of the business enterprise - the
business enterprise that existed before the division must
still exist after the division.
Tax effect of the division
-If §355 met then neither gain or loss are recognized.
-If the requirements are not met, the distributing corporation
can recognize gain (but not loss)
-Disguised sale rules - intended to prevent the sale of a
corporation carried out the pretext of a tax-free corporate
division.
-Distributions part of a prohibited plan.
The controlled corporation will not recognize gain or loss,
even if the tax-free corporate division provisions are not
followed. The basis of assets in the controlled corporation
are a substituted basis in the hands of the distributing corporation.
He then went back to page 5 of the outline to review some
diagrams of the various transactions.
These consist of one for a pre-succession division, in which
the founder is still alive. Some children receive stock in
one corporation (the controlled corporation) in exchange for
all of their stock in the distributing corporation. The parents
also receive part of the stock in the controlled corporation
but give up no stock. The result is that the parents now own
part of both corporations but the children each own stock
in only one of the corporations.
He then reviewed a post-succession division. In this case,
some children retain all of their stock in the distributing
corporation and some children give up all of their stock in
the distributing corporation for all of the stock in the controlled
corporation.
Finally, he analyzed the two transactions using the various
tests of §355 set out above.
In the past, PLR's were used in advance to protect against
the negative results of failing the tests. However, in Rev
Proc 2003-48, the Service indicated that it will not longer
issue comfort rulings.
Estate Planners points to remember (The outline indicates
that "the complex and voluminous nature of the tax law
pertaining to tax-free corporate divisions renders an exhaustive
understanding of it by estate planners quite impractical.")
-Corporate business purpose
-Be diligent
-Give diplomacy a chance - the cost of doing the division
may outweigh the tax benefits of accomplishing it tax-free.
-The division should be incorporated in the current estate
plan
The presentation was very well organized and given in a great
deal of detail. He ended about 8 minutes early. Although the
outline is not as long as many, he covered it in whole.
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