Tax code

Two-Dollar Life Insurance Plans and the Tax Code | law of the free man

A recent Tax Court decision in De Los Santos v. Commissioner illustrates the complexity of shared dollar life insurance arrangements. Taxpayers who participate in these types of life insurance arrangements or other types of life insurance arrangements should consult with a competent tax advisor to ensure that the arrangement is properly reported on all tax returns. applicable income.

In 2003, the Treasury Department issued final regulations regarding the taxation of two-dollar life insurance agreements. Two-dollar life insurance arrangements such as those at issue in this case fall into one of two categories: “compensatory arrangements” or “shareholder arrangements”. Reg. § 1.61-22(b)(2)(ii), (iii). In both types, the “owner” of the life insurance policy pays the premiums, and the “non-owner” has a current interest in the policy.

In the case of a shared dollar arrangement, “the economic benefits are treated as being provided to the non-holder of the life insurance contract”, and the non-holder “must account for the full value of all benefits economic”, minus any consideration paid for this purpose. Reg. § 1.61-22(d)(1). “Depending on the relationship between the owner and the non-owner, the economic benefits may constitute an offset payment, a Section 301 distribution,” or a transfer of some other tax nature. Identifier. This means that the economic benefits under a “compensatory arrangement” will generally constitute the payment of compensation to the service provider, and the economic benefits under a “shareholder arrangement” will generally constitute a distribution to the ‘shareholder. Our Country Home Between., Inc. vs. Comm’r145 TC 1, 51 (2015).

Indeed, the regulations provide that “[t]a supply by a corporation to its shareholder under a shared dollar life insurance contract. . . economic benefits. . . is treated as a distribution of property. Reg. § 1.301-1(q)(1)(i).

Readers will find the details and factual framework of the From Los Santos case below:

DeLos Santos v. Comm’r, 156 TC No. 9 | April 12, 2021 | Lauber, J. | Dekt. No. 5458-16

Short summary: Taxpayer-husband is a doctor. In 2011 and 2012 (“Matter Years”), he was the sole shareholder of Dr. Ruben De Los Santos MD, PA, a Texas organized S Corporation (“S Corp.”). The S Corp. employed a taxpayer-husband and a taxpayer-wife, the latter being the office manager for the medical office. Four other employees also worked for S Corp.

Before the years in question, the S corp. had adopted a benefits plan to provide its employees with life insurance and other benefits. Under this plan, the taxpayers were entitled to a death benefit of $12.5 million, and the four junior employees were entitled to a death benefit of $10,000 and certain flexible benefits. To fund the promised death benefits, the S Corp. used the Legacy Employee Welfare Benefit Trust (“Trust”), which purchased a life insurance policy insuring the taxpayers’ lives. The policy was a “flexible premium variable universal life policy” with accumulation values ​​based on the investment experience of a segregated fund.

During the period 2006-2010, S Corp. contributed $1,862,349 to the Trust and treated these contributions as tax-deductible medical practice expenses. From 2007 to 2012, the Trust paid aggregate premiums of $884,534 on the policy. As a result of these premium payments and the resulting investment gains, the “accumulation value” of the policy was $640,358 at year end 2011 and $744,460 at year end. year 2012.

The taxpayers filed joint federal income tax returns for 2011 and 2012 in a timely manner. They reported no income on those returns related to their participation in the plan. On December 4, 2015, the IRS issued the taxpayers a Notice of Deficiency, determining that the economic benefits they received under the plan were currently taxable to them as ordinary income. The taxpayers filed a petition in the United States Tax Court challenging the decision.

After the parties filed counter-motions for partial summary judgment, the Tax Court ruled that the plan constituted a two-dollar compensatory life insurance contract and that the economic benefits enjoyed by the taxpayers generated income. current taxable. View From Los Santos, Memo TC. 2018-155. Subsequently, the taxpayers filed a second motion for summary judgment arguing that the characterization of the payments should be treated as a distribution under section 301 of the Code.

Key issues: Whether the compensatory two-dollar life insurance arrangement resulted in ordinary income for the taxpayers or distributions under Section 301 of the Code.

Main holdings: Since the compensatory split-dollar life insurance arrangement provided benefits to the taxpayer husband as an employee of Corporation S, those benefits cannot be characterized as a distribution by a corporation to a shareholder with respect to relates to his actions. In addition, for the purposes of taxation of employee benefits, the taxpayer-spouse is treated as a partner in a partnership and the economic benefits realized by him are therefore taxable under section 707 ( c) as secured payments, that is to sayordinary income.

Main points of law:

  • The purpose of summary judgment is to expedite litigation and avoid costly, unnecessary, and time-consuming trials. See FPL Grp., Inc. & Subs. v. Comm’r, 116 TC 73, 74 (2001). The Tax Court can grant summary judgment on a matter in respect of which there is no real dispute of material fact and a decision can be made as a matter of law. rule 121(b); Arts, Inc. & Subs. v. Comm’r118 TC 226, 238 (2002).
  • In 2003, the Treasury Department issued final regulations regarding the taxation of two-dollar life insurance agreements. Two-dollar life insurance arrangements such as those at issue in this case fall into one of two categories: “compensatory arrangements” or “shareholder arrangements”. Reg. § 1.61-22(b)(2)(ii), (iii). In both types, the “owner” of the life insurance policy pays the premiums, and the “non-owner” has a current interest in the policy.
  • In a “compensatory arrangement”, the arrangement “is made in the course of providing services” by a service provider for a service recipient. Reg. § 1.61-22(b)(2)(ii)(A). In a ‘shareholder arrangement’, the arrangement ‘is made between a company and another person in his or her capacity as a shareholder of the company’. Treasures. Reg. § 1.61-22(b)(2)(iii)(A).
  • In the case of a shared dollar arrangement, “the economic benefits are treated as being provided to the non-holder of the life insurance contract”, and the non-holder “must account for the full value of all benefits economic”, minus any consideration paid for this purpose. Reg. § 1.61-22(d)(1). “Depending on the relationship between the owner and the non-owner, the economic benefits may constitute an offset payment, a Section 301 distribution,” or a transfer of some other tax nature. Identifier. This means that the economic benefits under a “compensatory arrangement” will generally constitute the payment of compensation to the service provider, and the economic benefits under a “shareholder arrangement” will generally constitute a distribution to the ‘shareholder. Our Country Home Between., Inc. vs. Comm’r145 TC 1, 51 (2015).
  • Section 301 governs distributions of property by a corporation to its shareholders. However, not all payments from a corporation to a shareholder constitute “distributions” within the meaning of Section 301. Rather, Section 301(a) requires that the transfer be made “by a corporation to a shareholder regarding his actions”. The phrase “in respect of its shares” means that the distributor must receive payment in its capacity as a shareholder.” “Section 301 does not apply to an amount paid by a corporation to a shareholder unless this amount is paid to the shareholder in his capacity as shareholder Reg § 1.301-1(c).
  • Thus, a payment is not a “distribution” if the shareholder receives it in his capacity as a creditor of the company. Loftin & Woodard, Inc. c. United States577 F.2d 1206, 1242 (5and 1978). Nor is the payment of a “distribution” if the shareholder receives it in his capacity as an employee of the company. Haber v. Comm’r52 TC 255, 268 (1969), aff’d by curiam422 F.2d 198 (5and Cir. 1970). “These transfers are not made in respect of shares because, except for the obvious reason that the shareholder’s status as a shareholder is incidental, the corporation receives equal value in return. . .”
  • “The supply by a corporation to its shareholder under a shared dollar life insurance contract. . . economic benefits. . . is treated as a distribution of property. Reg. § 1.301-1(q)(1)(i).
  • The Split Dollar Regulations govern the taxation of such arrangements, not only for income and gift tax purposes, but also for employment tax purposes. Reg. § 1.61-22(a)(1). And it’s well established that an S corporation “cannot avoid federal employment taxes by characterizing compensation.” . . as distributions of the net income of the company. Veterinary Surgical Consultants, PC c. Comm’r117 TC 141, 145-46 (2001).
  • Subchapter S governs the tax treatment of S corporations and their shareholders. Article 1372 provides that “for the application of the provisions of this subtitle. . . that relate to employee benefits – (1) S Corporation should be treated as a partnership, and (2) any 2% shareholder of S Corporation should be treated as a partner in that partnership. A “2% shareholder” is defined to include “any person who owns . . . more than 2% of the outstanding shares of that company. » 1372(b).
  • The term “benefits” generally refers to “any form of employee compensation provided in addition to salary or base salary, in the form of pension, insurance coverage, vacation, etc. “. Webster’s New World Collegiate Dictionary 568 (4and 2010). Although the term “benefits” is not defined in the Code, all available evidence suggests that Congress intended to adopt the common understanding of the term, that is to saythat a “benefit” includes any employer-provided benefit that supplements an employee’s salary, including life insurance benefits.

Insight: the From Los Santos The decision shows the complexity that arises when taxpayers engage in two-dollar life insurance arrangements. Taxpayers who participate in these types of life insurance arrangements or other types of life insurance should consult with a qualified tax advisor to ensure that these arrangements are properly reported on all applicable tax returns.

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