Comments Concerning IRS Notice 2001–10
I. Characterizing Equity SDAs
The Notice allows taxpayers to characterize a payment by an employer under an Equity SDA as either a "below-market loan" under Section 7872(e)(1) of the Code, an employer investment in a life insurance policy under Section 83 of the Code, or a payment of compensation to the employee under Section 61 of the Code. 1 The parties' characterization will "generally" be accepted if (i) the characterization is not "clearly inconsistent" with the substance of the transaction, (ii) the parties have "consistently followed" the characterization from the commencement of the Equity SDA, and (iii) all benefits are "fully accounted for" consistent with the characterization elected by the parties.
We commend Treasury and the IRS on its decision to provide taxpayers latitude in characterizing Equity SDAs. Currently, there are no rules for determining when the employer or the employee should be treated as the beneficial owner of an insurance policy for tax purposes. Ensuring predictability as to both the identity of the policy owner for tax purposes and tax treatment of the transaction is essential.
Unfortunately, the characterization election has generated considerable concern and confusion regarding Equity SDAs. The Notice raises but does not answer several important questions regarding how Code Sections 83 and 7872 might apply to Equity SDAs. This ambiguity is exacerbated by the Notice's requirement that any election to characterize an Equity SDA at this time is irrevocable. We are concerned that requiring parties to characterize a transaction without clear tax rules will cause employers to abandon legitimate Equity SDAs that are used to attract and retain employees.
1 This comment refers to the parties under the SDA as the employer and the employee. Similar principles should apply to SDAs in other contexts, except that Section 83 does not apply to private split-dollar life insurance arrangements.