Intergenerational Split Dollar Strategy Case Study

Michael C. Crawford  -  Mar 23, 2017    

Mike and Joan were recently introduced to the private split dollar concept, through which they can “advance” funds to an ILIT for premium instead of making gifts of premium. This approach can help with their gift tax situation, but they do not qualify for additional insurance. They decided that life insurance on their daughter or her husband will provide a tremendous benefit to their daughter’s children. Mike establishes an ILIT that will purchase life insurance on their daughter, Julie, with the grandchildren as beneficiaries. The insurance will be purchased through a “non-equity” private split dollar plan under the “economic benefit regime.”

The trust applies for a $10,000,000 life insurance policy on Julie’s life. The premium will be paid for on a five-pay basis. The premium is $300,000 a year. Each year, for five years, Mike and Joan will advance $300,000 to the trust for total outlay of $1,500,000 after five years. Each year the trust contributes an amount toward the policy premium equal to the annual economic benefit. Mike and Joan can make an annual exclusion gift to the trust of that amount.

Under the private split dollar agreement, Mike should be entitled to repayment of the greater of the premiums paid and the policy cash value at Julie’s death. Julie’s current life expectancy is 50 years. If they forgive the amount due at the end of the fifth year, will the value of the forgiven amount be $1,500,000 or a lesser amount? They realize that forgiving the repayment would create a gift. But what would be the value of the gift? There is no clear guidance from the IRS on this technique.

There are two schools of thought:

Possible Positive Outcome
Their accountant has suggested that since by agreement the repayment is due at Julie’s death, if an earlier repayment were to be made, the value of the repayment amount for gift tax purposes could be discounted. She suggest it should be based on the present value of $ 1,500,000 to be received at the end of 45 years (estimated remaining life expectancy for Julie in five years), discounted by the Applicable Federal Rate in effect at the time of the forgiveness. The discount could be significant and possibly result in a very small gift. The balance would be discounted to future generations.

Potential Benefits:

  • Enhanced legacy for beneficiaries
  • Significant wealth transfer
  • Little or no gift tax exposure
  • Can provide significant estate, gift and/or generation-skipping transfer (GST) tax discount over the repayment amount

Possible Negative Outcome
Their attorneys disagree. They point out that the IRS has not ruled on this approach. There are a number of issues that could be raised to eliminate a discount and trigger a tax and a penalty. Their concern: If repayment is forgiven at the end of five years and a valuation discount is taken, the discount may be disallowed and a tax penalty assessed. This is because:

  • The arrangement could be viewed as a step transaction and the premiums deemed gifts
  • IRS could treat the split dollar as loan regime instead of “non- equity” economic benefit regime plan
  • Early payment could be deemed a modification of split dollar agreement
  • IRS could attack gift tax valuation discount by ignoring limitation on modification in split dollar agreement to mutual agreement relying on IRC §2703
  • A question remains whether restrictions in agreement create additional economic benefit

Michael C. Crawford, CFP® CLU® ChFC®

Michael Crawford of Red Bank, NJ is the founder of Nationwide Wealth Management and Nationwide Valuations. He is also an active group facilitator at Tiger 21, the premier peer-to-peer learning network for ultra high net worth individuals. Michael Crawford has experience servicing Red Bank NJ, Middletown, NJ and surrounding areas. Please contact: Michael Crawford CFP, CLU, ChFC 1-888-399-5169.

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