Identifying the Transfer of Property in an Equity SDA
We have considerable difficulty identifying what event or events, if any, constitute the "transfer of property" with Equity SDAs before rollout. Assuming arguendo that the employer is the beneficial owner of the policy (under the analysis set forth in Part 2 above), it is difficult to understand how and under what circumstances increases in CSV during the term of the Equity SDA can be transfers of property. As noted above, a "transfer of property" requires a transfer of a life insurance policy with CSV. An employer does not transfer a life insurance policy when retaining ownership. The employer retains ownership of the entire policy even after CSV exceeds the employer's premium recovery amount. We are not aware of any authority under which a life insurance policy can be segregated into multiple pieces of "property" for purposes of Section 83.
We note that an employer's promise to convey equity increases to the employee at some later date is quite similar to a promise to pay deferred compensation under an unfunded arrangement. The employer's promise to the employee would not ordinarily be binding upon the insurer. The employer's promise to pay is set forth in the SDA contract, to which the insurer is not a party. Until the employer transfers cash or an interest in the policy to the employee, the employee's taxable income should be limited to the annual value of the insurance protection the employee receives each year.
The practical realities of plan administration suggest that taxing increases in CSV during the term of Equity SDAs would result in a significant increase in tax compliance expense. Employers and administrators undoubtedly would need to develop sophisticated programming to track changes in CSV. The tracking would need to be quite complicated. Timing rules would also need to be developed to define precisely when CSV would be taxable to the employee. CSV taxed to the employee would presumably generate basis, with future CSV attributable to basis representing tax-deferred earnings. In addition, death benefit coverage attributable the employee portion of CSV would need to be segregated, as it presumably would be tax-free to the employee.
In addition, special rules would need to be made for contracts with fluctuating values. Modern variable life insurance contracts may result in decreases in CSV. Decreases may also result if the Equity SDA allows for the employer to take a premium holiday and use CSV to fund death benefit coverage. These contingencies would require guidance regarding how decreases in CSV should be allocated between the taxable and tax deferred portions of the policy CSV. If a decrease in CSV is allocated to the employee owned portion of the CSV, it would be helpful to have guidance addressing whether this reduction would be a deductible loss.
The only event that appears to result in an unequivocal "transfer of property," assuming the employer has beneficial policy ownership, is rollout of the employer's interest in the policy. A rollout occurs when the employer is repaid its premium advances in a single payment, and the SDA is terminated. 5 Treating rollout as the "transfer of property" is consistent with PLRs 8310027 and 7916029, avoids the complicated tracking and allocation issues noted above, and allows for an objective and simple rule to administer.