ABATax Comment Concerning IRS Notice 2001-10

Section of Taxation
Submission to the Federal Executive Branch

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Comments Concerning IRS Notice 2001–10
April 2001

I.  Characterizing Equity SDAs

  1. Section 83
     
    1. Employer as Beneficial Owner of Property

      The legal form of ownership is significant when determining which party—the employer or the employee—is the beneficial owner of property for purposes of Section 83 and Section 7872. Rev. Rul. 64-328 provides that the income tax treatment to the employee is the same under an SDA whether it is structured using the collateral assignment method or endorsement method, at least insofar as treatment of the annual value of the insurance coverage received by the employee. Extending the position of Rev. Rul. 64-328 regarding uniformity of tax treatment to other tax issues, such as the taxation of the inside policy build-up under an Equity SDA or the appropriate tax treatment to the employer, is much less compelling

      Our preliminary analysis suggests that it is difficult to view collateral assignment Equity SDAs as providing the employer with beneficial ownership of the policy and its benefits in most situations. The employer merely has a right to receive repayment of its funds, which is not a property right under the policy. The collateral assignment simply secures repayment of the employer's contract right. The split-dollar documentation and state law both provide that the employee is the owner of a policy, albeit subject to a security interest in favor of the employer.

      On the other hand, it appears that Equity SDAs structured using the endorsement method should result in the employer being treated as the policy owner. The employer may use the endorsement method to gain greater control over the policy and its benefits. 4 The employer's creditors may assert rights to all policy cash value notwithstanding the endorsement to the employee. The endorsement may be viewed under state law in some circumstances as only providing the employee rights as a creditor against the employer. We note that treating the employer as beneficial owner of policies subject to an endorsement method Equity SDA would be consistent with previous private letter rulings issued by the IRS. See PLRs 8310027 and 7916029 (finding the rollout of an SDA structured using the endorsement method resulted in taxation under Section 83).

      The payment of premiums by the employer does not mean, ipso facto, that the employer is the beneficial owner of the policy. The legal ownership structure of Equity SDAs has significant non-tax consequences. Rights to policy assignment, designation of beneficiaries and investment of cash value (for variable contracts) are affected by legal ownership of the policy. The employer is not entitled to a transfer of the policy and all the incidents of policy ownership in satisfaction of its premium recovery rights; rather, the employer is entitled only to the repayment of its cash expenditure. We also note that payment of premiums is not probative of who has "incidents of ownership" in a life insurance context for purposes of the estate tax.

      We suggest that consideration be given to a rule providing that beneficial ownership be presumed to follow legal ownership. That is, if the collateral assignment method is used to structure the Equity SDA, the employee would be presumptively considered the beneficial owner of the policy absent unusual circumstances, resulting in tax treatment under Section 7872. The endorsement method would result in the employer being presumed to be the beneficial owner of the policy, resulting in tax treatment under Section 83. This approach reflects practical realities, facilitates certainty in structuring transactions, and allows the IRS discretion to invoke substance over form principles for abusive situations when the parties do not act consistently with the legal ownership selected for the transaction.


4 Other non-tax reasons may exist as well for using the endorsement method. The parties may desire to avoid any appearance of there being a loan transaction between the employer and employee. This may be pertinent in states that prohibit corporations from making loans to officers and shareholders, or where the employer has a lending agreement in place that restricts loans from the corporation to an employee. The endorsement method facilitates use of the policy funds to finance on an informal basis a non-qualified retirement program.


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