Characterizing Equity SDAs as Loans under Section 7872
Section 7872 and its proposed regulations suggest that characterization as either a demand loan or a term loan depends upon the specific terms of the SDA. Section 7872(f)(5) defines a "demand loan" as any loan payable in full whenever the lender demands repayment. In addition, a demand loan includes a nontransferable loan that conditions the benefits of the interest arrangement on the future performance of substantial services as defined under Section 83. Section 7872(f)(6) provides that any loan that is not a demand loan is a "term loan." Proposed regulations clarify that a "term loan" is repayable at an ascertainable time, including a time that may be determined actuarially.
Taxpayers need guidance as to whether amounts extended by an employer under Equity SDAs will be treated as "demand loans" or "term loans." A typical Equity SDA provides that the employer may recover its premium payments on the employee's death or, if earlier, the employee's termination of employment. It is unclear whether this arrangement would qualify as a "demand loan" or a "term loan". The employee's life expectancy can be calculated actuarially, so the premium recovery right attributable to the employee's death suggests a term loan. However, a recovery of premiums at employment termination may convert the arrangement into a demand loan under Section 7872(f)(5), as the benefits of interest free loan treatment continue only for as long as the employee remains employed. On the other hand, this provision presumably will not convert the arrangement to a demand loan where, as is normally the case, the Equity SDA is transferable to a third person, such as a trust.