Electing Loan Treatment for Equity SDAs
It is unclear how parties to an existing Equity SDA can elect loan treatment under Section 7872 if desired. Paragraph A.1(ii) of the Interim Guidance requires that the parties must consistently follow the same characterization from the inception of an Equity SDA when reporting taxable income. This rule would appear to disqualify most, if not all, Equity SDAs from electing loan treatment absent special relief, as most employees have only reported the term portion of annual premium payments as compensation income consistent with Rev. Rul. 64-328.
If a decision is made not to provide grandfather protection for Equity SDAs as discussed in Section II below, we suggest that the IRS consider how taxpayers desiring loan treatment prospectively might qualify under the consistency requirement in the Notice. One approach is to terminate the Equity SDA and have the employee repay the employer its premium payments, possibly out of the policy itself. A new Equity SDA could then be established for the existing policy. This approach is cumbersome, expensive, and problematic in the absence of additional guidance, as the Notice suggests that policy equity would be taxable on termination of the Equity SDA.
Alternatively, it has been suggested informally by Treasury officials that taxpayers could elect loan treatment retroactively by reporting imputed income under Section 7872 for all years remaining open under the statute of limitations. How and when this could be done has not been addressed. In addition, taxpayers will be reluctant to amend their tax returns to obtain loan treatment without assurance that such action is consistent with change in accounting rules under Section 446 of the Code.