Manufacturers & Distributors ARTICLE -

Split-Dollar Life Insurance Can be a Valuable Planning Tool

Target Audience: Manufacturing and Distributing Companies, M&D Industry, Private Manufacturing Company Owners

Business owners often use buy-sell agreements funded by life insurance policies to ensure an orderly transition of their companies to new owners. The problem is paying the premiums.

This can be particularly true if your designated successors are significantly younger and have significantly lower wages than you — your children, for example. Often, successors buy insurance on an owner’s life as a means of funding a buy-sell agreement. When the owner dies, they can use the insurance proceeds to buy the business.

In such cases, however, the policy premiums for coverage can be prohibitive. Split-dollar life insurance may solve the problem.

Bridge the gap

With split-dollar life insurance, your company splits the premiums for your life insurance coverage with a key employee or other successor. Both parties contribute a portion of the premiums and share in the policy’s death benefits.

In most cases, the business pays part (or all) of the premiums and receives full reimbursement from the proceeds when death benefits are paid. The successor-employee’s beneficiaries receive the remainder of the proceeds. Not only can such arrangements help guarantee a smooth succession because they ensure that the buy-sell agreement’s funding is in place, but they also can be an appealing benefit for key employees.

Split-dollar life insurance can be a versatile planning tool, but there are tax and accounting ramifications to consider. For example, neither you nor the employee can deduct the cost of the premiums. Note that, if you give the employee a bonus to help with his or her share of the premiums, the bonus will be considered taxable income to him or her. On the other hand, the bonus is a deductible business expense for you.

Regime rules

Of course, it’s a little more complicated than that because of the regime rules that govern how you handle taxes. If your company owns the policy, the employee is taxed under the economic benefit regime. If the employee owns the policy, taxes are determined by the loan regime.

Under the economic benefit regime, the employee is taxed on the value of the annual economic benefit you provide. The rules governing how you calculate this benefit are complicated, and you should consult your financial advisor for guidance.

Additionally, if the employee has current access — such as the right to borrow or withdraw from the policy — he or she is taxed on the annual increase in policy equity. Again, your financial advisor can help you determine the tax consequences.

By contrast, under the loan regime, your premium advances are treated as a series of loans to the employee. If you’re not collecting interest on the loans, the IRS considers them below market loans. In that case, the employee is taxed on the difference between the market interest rate and the interest you’re actually collecting. Not surprisingly, this rarely works out well for the employee.

Complex and beneficial

Split-dollar life insurance can be a real boon for you and your heirs or key employees, but it’s not for the fainthearted. A manufacturing accounting firm can work with you to establish split-dollar arrangements that are best for all concerned.

Find out how our M&D accountants can add value to your business. Email us or call us at 1 (888) 875-9770.

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