was in excess of $5 million. The doctors’ primary interest was twofold— first, to provide additional tax-advantaged retirement capital in addition to supplementing their qualified plans. Second, it was to provide a death benefit for their families. The doctors’ children will have fully paid policies when they turn 21, all funded with excess cash flow from the medical practice. If advisers need more information/expertise about split dollar plans, which type of expert should they contact?
About the Authors
Tim Voorhees, JD, MBA, is a principal partner at Matsen Voorhees Mintz LLP in Costa Mesa, CA. With more than 35 years of experience as an attorney and business planning adviser, Tim has helped clients save millions of dollars in taxes while transferring their legacy to their families and favorite charities. His book on tax-efficient planning is described at www. ZeroTaxCounsel.com. Feel free to email Tim at tim@vfos.com.
Voorhees: Split dollar planning is a team sport. The clients need to include their CPA, their attorney and a qualified insurance specialist who knows how to establish a leveraged plan. A more traditional split dollar program requires a high level of expertise, and the leveraged version requires additional modeling of details regarding the loan.
Using the Corporation to Fund Life Insurance for the Highly Compensated Key Takeaways • Split dollar plans are a unique way for corporations to pay for life insurance for a key employee or company owner. • A split dollar plan can be used to finance estate taxes, buy-sell arrangements, or meaningful supplemental retirement benefits for executives and their heirs.
• Advisers who take the time to understand the complex split dollar concept love it—and so do their clients. But learning its nuances requires a commitment.
Guy Baker, MBA, MSFS, MSM, was recently recognized as one of Worth Magazines’ top 250 advisers. Established in Orange County in 1970, Guy has built a financial service company serving the needs of business owners who are looking to have a trustworthy relationship to help them manage their Three Circles ofWealth.
What advisers need to know about the power of split dollar plans. Make the commitment to understanding them or finding an expert who does. Interview with Guy Baker, BMI Consulting, and Tim Voorhees Tim, in a nutshell, what is a “split dollar” plan? Voorhees: There are two forms of split dollar plans—the loan regime (formerly collateral assignment split dollar) and the endorsement split dollar. In both cases, the corporation pays the premium on a life insurance policy for the selected participant and his or her beneficiary. With the endorsement method, the corporation owns the policy and the cash value but endorses the death benefit to the named beneficiary. With the loan method, participants or their designees (a trust or partnership, for instance) own the policy and the cash value but must repay the loan or pay tax on the loan amount at some point in the future. The participant names the beneficiary, but the corporation owns part of the death benefit (hence the name split dollar) equal to the loan. Guy, what is the primary objective of using the split dollar arrangement? Baker: Split dollar is a unique way for the corporation to pay for life insurance for the benefit of a key employee or the owner of the company. The premium is paid from the corporation’s pocketbook. The plan is both legal and economic.
Comparison of Benefits
Matsen Voorhees Mintz LLP 695 Town Center Drive, 7th Floor, Costa Mesa, CA 92626 Phone: 800-447-7090 or 949-878-9400 • Fax: 866-447-7090 Email: info@MVMLawyers.com
Inheritance to Heirs in Year 15
$3,500,000
$4,800,000
Estste Tax in Year 15
$3,500,000
$2,000,000
Total 15 Year After-Tax Retirement Income
$1,479,000
$2,867,835
Increased Inheritance to Heirs Decreased Estate Taxes Increased Retirement Income
Readers of this document should consult with independent advisers regarding the tax, accounting and legal implications of the proposed strategies before any strategy is implemented. Nothing in this presentation is intended to offer securities or investment advice. Above numbers are based on a hypothetical fact pattern. Tax and regulatory rules affecting strategies in this document may change often and have varying interpretations. To ensure compliance with requirements imposed by the IRS under Circular 230, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or for promoting, marketing or recommending to another party any matters addressed herein. This draft is dated 4/3/2014. The final published version may differ.
Increase to Charity
$1,3000,000 $500,000 $1,388,835 $0
If the company chooses to fund the loan regime split dollar, the imputed interest cost for the loan is determined by a special table provided by the IRS. Currently, these rates are very low. So the cost is negligible.
How long have split dollar plans been around?
A very cost-effective way to implement split dollar is for the corporation to borrow the premium instead of financing it from working capital.
Voorhees: Split dollar was put into the Internal Revenue Code in the 1950s. For decades, it was a mainstay for many corporate benefit plans for selected top executives. Split dollar plans were a simple way for the executives to benefit from the corporate pocketbook for a nominal cost. Unfortunately, the Sarbanes-Oxley Act made split dollar impossible for public corporations because of the loan prohibition. Nonetheless, the plans are still a powerful tool for closely held entities. So, what happened after Sarbox? Baker: In 2005, the IRS changed the rules on split dollar, which actually brought clearer definition to the benefit. The IRS defined the arrangement (IRC 7872) between the executive and the corporation as a loan. This meant that interest had to be imputed to the transaction. The executive could either pay the interest or pay tax on the interest. This clarity gave significant confidence to tax planners who questioned the validity of the split dollar concept. How many types of split dollar arrangements are there? (Corporate, family, capital gain, etc.) Voorhees: Besides the two different forms (endorsement and loan regime), a split dollar plan can be used to finance estate taxes, to fund a buy-sell arrangement, or to provide a meaningful supplemental retirement benefit for the executive or his or her heirs.
Advisers who have taken the time to understand the split dollar concept love it and so do their clients. But it requires a significant commitment to learn how to do this type of transaction.
A very cost-effective way to implement split dollar is for the corporation to borrow the premium instead of financing it from working capital. The company can borrow the premium and pay the interest on the loan. This interest will be higher than the cost to the executive. The resulting arbitrage provides an added benefit to the owner of the company. The owner is able to borrow the premium and have it grow in the policy until he or she needs to access it. The low cost of the imputed interest versus the higher cost of the loan provides a unique way to transfer wealth from the corporation to the executive/owner. This method, called Capital Split Dollar (CSD), was developed by Stan Mountford in the mid-1980s. Why don’t more advisers recommend this technique? Baker: Split dollar is a complex transaction requiring a careful balancing of the interests of the corporation (which wants enough ownership and control to justify the tax deduction) and the insurance carrier and lender (which want enough rights to the collateral to secure the loan). Obviously, the employees’ rights must be protected too. All of the legal documents and loan agreements must comply with banking, insurance and tax regulations. Advisers who have taken the time to understand the split dollar concept love it and so do their clients. But it requires a significant commitment to learn how to do this type of transaction. What are the biggest risks (or IRS red flags) inherent in split dollar arrangements?
Capital Split Dollar
Climbing the Pyramid Enhances Tax Efficiency
Initial Structure SMITH DISTRIBUTORS
OUTSIDE LENDER
Taxes on Employee Withdrawals
Taxes on Contributions Minimal Tax on Contributions
6) Advanced Tax Efficient Lifetime Income Solutions Capital Split Dollar Charitable LLC Family Retirement Account
Moderate Tax on Contributions
Moderate Withdrawal Taxes
Moderate Tax on Contributions
3) Non-Qualified Deffered Comp SERPS 409(A) Plans Traditional Deferred Comp
Heavy Current Income Tax
1) Traditional Compensation Heavily taxed with payroll taxes going in and ordinary income coming out
Loan
THOMAS AND VIRGINIA SMITH
Borrow from Smith Distributors, then use the proceeds to pay the premium on a life insurance policy owned by an ILIT
SMITH DISTRIBUTORS
4) Specialized Plans with Pre-Tax Funding Partially Taxes Withdrawals Charitable Remainder Trust Gift Annuities Pooled Income Fund
2) Qualified Plans Profit Sharing Defined Benefit 401(K)
Borrow from outside lender, then loan the same amount to Thomas and Virginia
Uses the proceeds to purchase a life insurance policy. The large initial premium substantially increases the Smiths’ retirement benefits
Moderate Withdrawal Taxes
Heavy Deferred Income Tax
Loan
Minimal Withdrawal Taxes
5) Specialized Plans with Tax Efficient Funding and Tax Free Withdrawals Super Clat Section 79 Plan Section 162 Plan
Moderate Tax on Contributions
Makes loan to Smith Distributors, secured by collateral assignment on the life insurance policy
Heavy Withdrawal Taxes
Heavy Withdrawal Taxes
Heavy Withdrawal Taxes
Voorhees: An opinion letter that was written to cover this transaction explains how the corporation can deduct the interest on the loan. This causes some advisers to question the validity of the transaction, because normally interest on financed insurance is NOT deductible. This unique feature only enhances the arbitrage economics. Nonetheless, the financed insurance arrangement is viable even if the interest is not deducted. A poorly constructed copy of Capital Split Dollar could cause significant tax issues for the corporation and the participant. So it is imperative the transaction have a Private Letter Ruling or Circular 230 opinion letter. Guy, do you have any case studies or client examples you can share? Baker: Sure. A recent case was written on a successful group of doctors. They put CSD on themselves, their wives and their children. The combined value
How long have split dollar plans been around?
A very cost-effective way to implement split dollar is for the corporation to borrow the premium instead of financing it from working capital.
Voorhees: Split dollar was put into the Internal Revenue Code in the 1950s. For decades, it was a mainstay for many corporate benefit plans for selected top executives. Split dollar plans were a simple way for the executives to benefit from the corporate pocketbook for a nominal cost. Unfortunately, the Sarbanes-Oxley Act made split dollar impossible for public corporations because of the loan prohibition. Nonetheless, the plans are still a powerful tool for closely held entities. So, what happened after Sarbox? Baker: In 2005, the IRS changed the rules on split dollar, which actually brought clearer definition to the benefit. The IRS defined the arrangement (IRC 7872) between the executive and the corporation as a loan. This meant that interest had to be imputed to the transaction. The executive could either pay the interest or pay tax on the interest. This clarity gave significant confidence to tax planners who questioned the validity of the split dollar concept. How many types of split dollar arrangements are there? (Corporate, family, capital gain, etc.) Voorhees: Besides the two different forms (endorsement and loan regime), a split dollar plan can be used to finance estate taxes, to fund a buy-sell arrangement, or to provide a meaningful supplemental retirement benefit for the executive or his or her heirs.
Advisers who have taken the time to understand the split dollar concept love it and so do their clients. But it requires a significant commitment to learn how to do this type of transaction.
A very cost-effective way to implement split dollar is for the corporation to borrow the premium instead of financing it from working capital. The company can borrow the premium and pay the interest on the loan. This interest will be higher than the cost to the executive. The resulting arbitrage provides an added benefit to the owner of the company. The owner is able to borrow the premium and have it grow in the policy until he or she needs to access it. The low cost of the imputed interest versus the higher cost of the loan provides a unique way to transfer wealth from the corporation to the executive/owner. This method, called Capital Split Dollar (CSD), was developed by Stan Mountford in the mid-1980s. Why don’t more advisers recommend this technique? Baker: Split dollar is a complex transaction requiring a careful balancing of the interests of the corporation (which wants enough ownership and control to justify the tax deduction) and the insurance carrier and lender (which want enough rights to the collateral to secure the loan). Obviously, the employees’ rights must be protected too. All of the legal documents and loan agreements must comply with banking, insurance and tax regulations. Advisers who have taken the time to understand the split dollar concept love it and so do their clients. But it requires a significant commitment to learn how to do this type of transaction. What are the biggest risks (or IRS red flags) inherent in split dollar arrangements?
Capital Split Dollar
Climbing the Pyramid Enhances Tax Efficiency
Initial Structure SMITH DISTRIBUTORS
OUTSIDE LENDER
Taxes on Employee Withdrawals
Taxes on Contributions Minimal Tax on Contributions
6) Advanced Tax Efficient Lifetime Income Solutions Capital Split Dollar Charitable LLC Family Retirement Account
Moderate Tax on Contributions
Moderate Withdrawal Taxes
Moderate Tax on Contributions
3) Non-Qualified Deffered Comp SERPS 409(A) Plans Traditional Deferred Comp
Heavy Current Income Tax
1) Traditional Compensation Heavily taxed with payroll taxes going in and ordinary income coming out
Loan
THOMAS AND VIRGINIA SMITH
Borrow from Smith Distributors, then use the proceeds to pay the premium on a life insurance policy owned by an ILIT
SMITH DISTRIBUTORS
4) Specialized Plans with Pre-Tax Funding Partially Taxes Withdrawals Charitable Remainder Trust Gift Annuities Pooled Income Fund
2) Qualified Plans Profit Sharing Defined Benefit 401(K)
Borrow from outside lender, then loan the same amount to Thomas and Virginia
Uses the proceeds to purchase a life insurance policy. The large initial premium substantially increases the Smiths’ retirement benefits
Moderate Withdrawal Taxes
Heavy Deferred Income Tax
Loan
Minimal Withdrawal Taxes
5) Specialized Plans with Tax Efficient Funding and Tax Free Withdrawals Super Clat Section 79 Plan Section 162 Plan
Moderate Tax on Contributions
Makes loan to Smith Distributors, secured by collateral assignment on the life insurance policy
Heavy Withdrawal Taxes
Heavy Withdrawal Taxes
Heavy Withdrawal Taxes
Voorhees: An opinion letter that was written to cover this transaction explains how the corporation can deduct the interest on the loan. This causes some advisers to question the validity of the transaction, because normally interest on financed insurance is NOT deductible. This unique feature only enhances the arbitrage economics. Nonetheless, the financed insurance arrangement is viable even if the interest is not deducted. A poorly constructed copy of Capital Split Dollar could cause significant tax issues for the corporation and the participant. So it is imperative the transaction have a Private Letter Ruling or Circular 230 opinion letter. Guy, do you have any case studies or client examples you can share? Baker: Sure. A recent case was written on a successful group of doctors. They put CSD on themselves, their wives and their children. The combined value
was in excess of $5 million. The doctors’ primary interest was twofold— first, to provide additional tax-advantaged retirement capital in addition to supplementing their qualified plans. Second, it was to provide a death benefit for their families. The doctors’ children will have fully paid policies when they turn 21, all funded with excess cash flow from the medical practice. If advisers need more information/expertise about split dollar plans, which type of expert should they contact?
About the Authors
Tim Voorhees, JD, MBA, is a principal partner at Matsen Voorhees Mintz LLP in Costa Mesa, CA. With more than 35 years of experience as an attorney and business planning adviser, Tim has helped clients save millions of dollars in taxes while transferring their legacy to their families and favorite charities. His book on tax-efficient planning is described at www. ZeroTaxCounsel.com. Feel free to email Tim at tim@vfos.com.
Voorhees: Split dollar planning is a team sport. The clients need to include their CPA, their attorney and a qualified insurance specialist who knows how to establish a leveraged plan. A more traditional split dollar program requires a high level of expertise, and the leveraged version requires additional modeling of details regarding the loan.
Using the Corporation to Fund Life Insurance for the Highly Compensated Key Takeaways • Split dollar plans are a unique way for corporations to pay for life insurance for a key employee or company owner. • A split dollar plan can be used to finance estate taxes, buy-sell arrangements, or meaningful supplemental retirement benefits for executives and their heirs.
• Advisers who take the time to understand the complex split dollar concept love it—and so do their clients. But learning its nuances requires a commitment.
Guy Baker, MBA, MSFS, MSM, was recently recognized as one of Worth Magazines’ top 250 advisers. Established in Orange County in 1970, Guy has built a financial service company serving the needs of business owners who are looking to have a trustworthy relationship to help them manage their Three Circles ofWealth.
What advisers need to know about the power of split dollar plans. Make the commitment to understanding them or finding an expert who does. Interview with Guy Baker, BMI Consulting, and Tim Voorhees Tim, in a nutshell, what is a “split dollar” plan? Voorhees: There are two forms of split dollar plans—the loan regime (formerly collateral assignment split dollar) and the endorsement split dollar. In both cases, the corporation pays the premium on a life insurance policy for the selected participant and his or her beneficiary. With the endorsement method, the corporation owns the policy and the cash value but endorses the death benefit to the named beneficiary. With the loan method, participants or their designees (a trust or partnership, for instance) own the policy and the cash value but must repay the loan or pay tax on the loan amount at some point in the future. The participant names the beneficiary, but the corporation owns part of the death benefit (hence the name split dollar) equal to the loan. Guy, what is the primary objective of using the split dollar arrangement? Baker: Split dollar is a unique way for the corporation to pay for life insurance for the benefit of a key employee or the owner of the company. The premium is paid from the corporation’s pocketbook. The plan is both legal and economic.
Comparison of Benefits
Matsen Voorhees Mintz LLP 695 Town Center Drive, 7th Floor, Costa Mesa, CA 92626 Phone: 800-447-7090 or 949-878-9400 • Fax: 866-447-7090 Email: info@MVMLawyers.com
Inheritance to Heirs in Year 15
$3,500,000
$4,800,000
Estste Tax in Year 15
$3,500,000
$2,000,000
Total 15 Year After-Tax Retirement Income
$1,479,000
$2,867,835
Increased Inheritance to Heirs Decreased Estate Taxes Increased Retirement Income
Readers of this document should consult with independent advisers regarding the tax, accounting and legal implications of the proposed strategies before any strategy is implemented. Nothing in this presentation is intended to offer securities or investment advice. Above numbers are based on a hypothetical fact pattern. Tax and regulatory rules affecting strategies in this document may change often and have varying interpretations. To ensure compliance with requirements imposed by the IRS under Circular 230, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or for promoting, marketing or recommending to another party any matters addressed herein. This draft is dated 4/3/2014. The final published version may differ.
Increase to Charity
$1,3000,000 $500,000 $1,388,835 $0
If the company chooses to fund the loan regime split dollar, the imputed interest cost for the loan is determined by a special table provided by the IRS. Currently, these rates are very low. So the cost is negligible.