[Federal Register Volume 68, Number 180 (Wednesday, September 17, 2003)]
[Rules and Regulations]
[Pages 54336-54361]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-23596]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 31, and 602

[TD 9092]
RIN 1545-BA44


Split-Dollar Life Insurance Arrangements

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the 
income, employment, and gift taxation of split-dollar life insurance 
arrangements. The final regulations provide needed guidance to persons 
who enter into split-dollar life insurance arrangements.

DATES: Effective Date: These regulations are effective September 17, 
2003.
    Applicability Dates: For dates of applicability of the final 
regulations, see Sec. Sec.  1.61-22(j), 1.83-3(e), 1.83-6(a)(5)(ii), 
1.301-1(q)(4), and 1.7872-15(n).

FOR FURTHER INFORMATION CONTACT: Concerning the section 61 regulations, 
please contact Elizabeth Kaye at (202) 622-4920; concerning the section 
83 regulations, please contact Erinn Madden at (202) 622-6030; 
concerning the section 301 regulations, please contact Krishna 
Vallabhaneni at (202) 622-7550; concerning the section 7872 
regulations, please contact Rebecca Asta at (202) 622-3930; and 
concerning the application of these regulations to the Federal gift 
tax, please contact Lane Damazo at (202) 622-3090.

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under 
control number 1545-1792. The collections of information are in Sec.  
1.7872-15(d)(2) and (j)(3)(ii). Responses to these collections of 
information are required by the IRS to verify consistent treatment by 
the borrower and lender of split-dollar loans with nonrecourse or 
contingent payments. In addition, in the case of a split-dollar loan 
that provides for nonrecourse payments, the collections of information 
are voluntary and are required to obtain a benefit (that is, the 
treatment of a nonrecourse split-dollar loan as a noncontingent split-
dollar loan).
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number assigned by the Office of 
Management and Budget.
    The estimated annual burden per respondent varies from 15 minutes 
to 30 minutes, depending on individual circumstances, with an estimated 
average of 17 minutes.
    Comments concerning the accuracy of this burden estimate and 
suggestions for

[[Page 54337]]

reducing this burden should be sent to the Internal Revenue Service, 
Attn: IRS Reports Clearance Officer, W:CAR:MP:T:T:SP, Washington, DC 
20224, and to the Office of Management and Budget, Attn: Desk Officer 
for the Department of the Treasury, Office of Information and 
Regulatory Affairs, Washington, DC 20503.
    Books or records relating to this collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background and Explanation of Provisions

1. Summary of the Prior Notices of Proposed Rulemaking

    On July 9, 2002, a notice of proposed rulemaking (REG-164754-01) 
was published in the Federal Register (67 FR 45414) proposing 
comprehensive rules for the income, gift, employment, and self-
employment taxation of equity and non-equity split-dollar life 
insurance arrangements (the 2002 proposed regulations). In general, a 
split-dollar life insurance arrangement is an arrangement between two 
or more parties to allocate the policy benefits and, in some cases, the 
costs of a life insurance contract. Under an equity split-dollar life 
insurance arrangement, one party to the arrangement typically receives 
an interest in the policy cash value (or equity) of the life insurance 
contract disproportionate to that party's share of policy premiums. 
That party also typically receives the benefit of current life 
insurance protection under the arrangement. Under a non-equity split-
dollar life insurance arrangement, one party typically provides the 
other party with current life insurance protection but not any interest 
in the policy cash value.
    The 2002 proposed regulations provide two mutually exclusive 
regimes for taxation of split-dollar life insurance arrangements--a 
loan regime and an economic benefit regime. Under the loan regime 
(which is set forth in Sec.  1.7872-15 of the 2002 proposed 
regulations), the non-owner of the life insurance contract is treated 
as loaning the amount of its premium payments to the owner of the 
contract. The loan regime generally governs the taxation of collateral 
assignment arrangements. Under the economic benefit regime (which is 
set forth in Sec.  1.61-22(d) through (g) of the 2002 proposed 
regulations), the owner of the life insurance contract is treated as 
providing economic benefits to the non-owner of the contract. The 
economic benefit regime generally governs the taxation of endorsement 
arrangements. The 2002 proposed regulations reserved on the rules for 
valuing economic benefits provided to the non-owner under an equity 
split-dollar life insurance arrangement governed by the economic 
benefit regime, pending receipt of comments from interested parties.
    On May 9, 2003, a notice of proposed rulemaking (REG-164754-01) was 
published in the Federal Register (68 FR 24898) proposing rules for the 
valuation of economic benefits under an equity split-dollar life 
insurance arrangement governed by the economic benefit regime (the 2003 
proposed regulations). The 2003 proposed regulations provide that, in 
the case of an equity split-dollar life insurance arrangement, the 
value of the economic benefits provided to the non-owner under the 
arrangement for a taxable year equals the cost of any current life 
insurance protection provided to the non-owner, the amount of policy 
cash value to which the non-owner has current access (to the extent 
that such amount was not actually taken into account for a prior 
taxable year), and the value of any other economic benefits provided to 
the non-owner (to the extent not actually taken into account for a 
prior taxable year).
    A public hearing on the 2002 proposed regulations was held on 
October 23, 2002, and a public hearing on the 2003 proposed regulations 
was held on July 29, 2003. In addition, interested parties submitted 
comments on the 2002 proposed regulations and on the 2003 proposed 
regulations.

2. Overview of the Final Regulations

    These final regulations provide guidance on the taxation of split-
dollar life insurance arrangements and apply for purposes of Federal 
income, employment, self-employment, and gift taxes. After 
consideration of all comments, the 2002 and 2003 proposed regulations 
are adopted as amended by this Treasury decision. In general, the 
amendments are discussed below.
Definition of Split-Dollar Life Insurance Arrangement
    The final regulations generally define a split-dollar life 
insurance arrangement as any arrangement between an owner of a life 
insurance contract and a non-owner of the contract under which either 
party to the arrangement pays all or part of the premiums, and one of 
the parties paying the premiums is entitled to recover (either 
conditionally or unconditionally) all or any portion of those premiums 
and such recovery is to be made from, or is secured by, the proceeds of 
the contract. The definition does not cover the purchase of an 
insurance contract in which the only parties to the arrangement are the 
policy owner and the life insurance company acting only in its capacity 
as issuer of the contract.
    The final regulations also retain the special rules from the 2002 
proposed regulations that treat certain arrangements entered into 
either in connection with the performance of services or between a 
corporation and another person in that person's capacity as a 
shareholder in the corporation as split-dollar life insurance 
arrangements regardless of whether the arrangements otherwise satisfy 
the general definition of a split-dollar life insurance arrangement. 
Neither the general rule nor the special rules cover so-called ``key 
man'' life insurance arrangements under which a company purchases a 
life insurance contract to insure the life of a ``key'' employee or 
shareholder but retains all the rights and benefits of the contract 
(including the rights to all death benefits and cash value).
    The IRS and Treasury are concerned that certain arrangements may be 
inappropriately structured to avoid the application of these 
regulations (for example, by using separate life insurance contracts 
that are, in substance, one life insurance contract). The Commissioner 
will use existing authority to challenge any such transaction.
Mutually Exclusive Regimes
    The final regulations retain the approach of using two mutually 
exclusive regimes--an economic benefit regime and a loan regime--for 
determining the tax treatment of split-dollar life insurance 
arrangements. As under the 2002 proposed regulations, ownership of the 
life insurance contract determines which regime applies. Several 
commentators on both the 2002 and the 2003 proposed regulations argued 
that the use of the two mutually exclusive regimes is an artificial and 
rigid approach that fails to account adequately for the economic 
reality of a split-dollar life insurance arrangement. However, the IRS 
and Treasury believe that the final regulations, like the 2002 and 2003 
proposed regulations, properly account for the division of the costs 
and benefits of a split-dollar life insurance arrangement.
    Several commentators asked that taxpayers be permitted to elect 
which regime would apply to their split-dollar life insurance 
arrangements. However,

[[Page 54338]]

in the view of the IRS and the Treasury, taxpayers effectively have the 
ability to elect which regime will apply by designating one party or 
the other as the owner of the life insurance contract.
    One commentator asserted that there is no authority under section 
7872 to treat payments made pursuant to split-dollar life insurance 
arrangements as loans. Therefore, this commentator recommends that 
taxation of split-dollar life insurance arrangements under section 7872 
should occur only if affirmatively elected by the parties to the 
arrangement. The IRS and Treasury believe there is sufficient authority 
to require the application of section 7872 to split-dollar life 
insurance arrangements. There is no legislative history indicating that 
Congress did not intend section 7872 to apply to payments made pursuant 
to these arrangements.
    A number of commentators expressed concern about the possible 
application of section 402 of the Sarbanes-Oxley Act of 2002 (Sarbanes-
Oxley), Public Law 107-204, to all or certain split-dollar life 
insurance arrangements entered into by companies subject to Sarbanes-
Oxley. These regulations do not address this issue, as interpretation 
and administration of Sarbanes-Oxley fall within the jurisdiction of 
the Securities and Exchange Commission.
    The final regulations adopt the general rule in the 2002 proposed 
regulations for determining which regime applies to a split-dollar life 
insurance arrangement. The 2002 proposed regulations provided a special 
rule that the economic benefit regime applied to a split-dollar life 
insurance arrangement if the arrangement is entered into in connection 
with the performance of services, and the employee or service provider 
is not the owner of the life insurance contract; or the arrangement is 
entered into between a donor and a donee (for example, a life insurance 
trust) and the donee is not the owner of the life insurance contract. 
The final regulations adopt this special rule, but provide that this 
rule applies when the employer, service recipient or donor is the 
owner.
    The final regulations add a rule regarding the treatment of a 
transfer of a life insurance contract under a split-dollar life 
insurance arrangement from an owner to a non-owner when payments under 
the arrangement had been treated, prior to transfer, as split-dollar 
loans under Sec.  1.7872-15. Under this rule, the economic benefit 
regime applies to the split-dollar life insurance arrangement from the 
date of the transfer and the payments made (both before and after the 
transfer) are not treated as split-dollar loans on or after the date of 
the transfer. The transferor of the life insurance contract must fully 
take into account all economic benefits provided under the split-dollar 
life insurance arrangement.
Owners and Non-Owners
    The final regulations generally retain the rules in the 2002 
proposed regulations for determining the owner and the non-owner of the 
life insurance contract. Thus, the owner generally is the person named 
as the policy owner. If two or more persons are designated as the 
policy owners, the first-named person generally is treated as the owner 
of the entire contract.
    Several commentators argued that determining tax ownership based on 
whom the parties name as the policy owner of the life insurance 
contract represents a departure from general tax principles. 
Commentators suggested that a split-dollar life insurance arrangement 
is like any co-ownership situation in which two or more parties agree 
to share in the costs and benefits of a policy such that each party 
will be entitled to exercise certain rights with respect to the 
underlying policy and will have certain responsibilities.
    The IRS and Treasury disagree with that argument. Split-dollar life 
insurance arrangements are structured in myriad ways, some formally as 
loans to the employee (for example, collateral-assignment 
arrangements), some formally as co-ownership arrangements between the 
employer and the employee, and some as arrangements in which the 
employer is, in form, the sole owner (for example, endorsement 
arrangements). In addition, split-dollar life insurance arrangements 
ordinarily involve division of the benefits and costs of the life 
insurance contract, but the division of benefits ordinarily does not 
correspond to the division of costs. Because the division of the 
burdens and benefits of the life insurance contract vary widely in 
split-dollar life insurance arrangements, and because title ownership 
generally is a factor in determining tax ownership, it is reasonable to 
determine tax ownership based on who is the named owner of the policy. 
In addition, this rule provides a clear objective standard so that both 
taxpayers and the IRS can readily determine which regime applies under 
the final regulations.
    If two or more persons are named as policy owners of a life 
insurance contract and each person has, at all times, all the incidents 
of ownership with respect to an undivided interest in the contract, 
those persons are treated as owners of separate contracts for purposes 
of these regulations (although not for purposes of section 7702 and 
other rules for the taxation of life insurance contracts). An undivided 
interest in a life insurance contract consists of an identical 
fractional or percentage interest or share in each right, benefit, and 
obligation with respect to the contract. For example, if an employer 
and an employee own a life insurance contract and share equally in all 
rights, benefits and obligations under the contract, they are treated 
as owning two separate contracts; ordinarily neither contract would be 
treated as part of a split-dollar life insurance arrangement. However, 
if the employer and the employee agree to enter into a split-dollar 
life insurance arrangement with respect to what otherwise would have 
been treated as the employer's (or the employee's) separate contract, 
the purported undivided interests will be disregarded, and the entire 
arrangement will be treated as a split-dollar life insurance 
arrangement. The Commissioner will consider all of the facts and 
circumstances of an arrangement to determine whether the parties have 
appropriately characterized the arrangement as one involving undivided 
interests and, therefore, not subject to these regulations.
    The final regulations provide attribution rules for compensatory 
split-dollar life insurance arrangements. Under these rules, the 
employer or service recipient will be treated as the owner of the life 
insurance contract if the contract is owned by a member of the 
employer's controlled group (determined under the rules of sections 
414(b) and 414(c)), a trust described in section 402(b) (sometimes 
referred to as a ``secular trust''), a grantor trust treated as owned 
by the employer (including a rabbi trust), or a welfare benefit fund 
(within the meaning of section 419(e)(1)).
    The final regulations retain the special rule for non-equity split-
dollar life insurance arrangements. Under this special rule, non-equity 
arrangements entered into in a compensatory context or a gift context 
will be subject to the economic benefit regime. The final regulations 
provide rules for determining the tax treatment of the arrangement if 
the parties subsequently modify the arrangement so that it is no longer 
a non-equity arrangement. If, immediately after the modification, the 
employer, service recipient, or donor is the owner of the life 
insurance contract (determined without regard to the special rule for 
non-equity arrangements), the employer, service recipient, or donor 
continues to be treated as the owner of the life

[[Page 54339]]

insurance contract (such that the normal rules of the economic benefit 
regime for equity split-dollar life insurance arrangements will apply). 
If, immediately after the modification, the employer, service 
recipient, or donor is not the owner, the employer, service recipient, 
or donor is treated as having made a transfer of the contract to the 
employee, service provider, or donee as of the date of the 
modification. For purposes of these rules, the replacement of a non-
equity arrangement with a successor equity arrangement will be treated 
as a modification of the non-equity arrangement.

3. Taxation Under the Economic Benefit Regime

a. In General
    The final regulations retain the basic rules for taxation under the 
economic benefit regime that had been set forth in the 2002 and 2003 
proposed regulations. Thus, the final regulations provide that, for 
these arrangements, the owner of the life insurance contract is treated 
as providing economic benefits to the non-owner of the contract, and 
those economic benefits must be accounted for fully and consistently by 
both the owner and the non-owner. The value of the economic benefits, 
reduced by any consideration paid by the non-owner to the owner, is 
treated as provided from the owner to the non-owner.
    The tax consequences of the provision of economic benefits will 
depend on the relationship between the owner and the non-owner. Thus, 
the provision of the benefit may constitute a payment of compensation, 
a distribution under section 301, a capital contribution, a gift, or a 
transfer having a different tax character. The benefit must be taken 
into account based on its character. For example, in a split-dollar 
life insurance arrangement in which an employer provides an employee 
with economic benefits, the employee would take those economic benefits 
into account by reporting them as compensation on the employee's 
Federal income tax return for the year in which the benefits are 
provided and the employer would take the economic benefits into account 
by reporting them on the appropriate employment tax and information 
returns. In a split-dollar life insurance arrangement in which a donor 
provides economic benefits to an irrevocable life insurance trust, the 
donor would take those economic benefits into account by reporting them 
on the Federal gift tax return required to be filed by the donor; the 
trust, however, generally would not be required to take any action to 
take the benefits into account because those economic benefits would be 
excludable from gross income under section 102.
Non-Equity Split-Dollar Life Insurance Arrangements
    Under the final regulations, the tax treatment of a non-equity 
split-dollar arrangement generally follows the tax treatment of a non-
equity split-dollar arrangement under Rev. Rul. 64-328 (1964-2 C.B. 11) 
and its progeny. The proposed regulations required that the average 
death benefit for the taxable year be used to compute current life 
insurance protection. Commentators objected to the use of an 
``average'' death benefit. They explained that the computation of the 
average death benefit imposed additional administrative burdens on life 
insurance companies as well as both owners and non-owners. In addition, 
the commentators stated that the proposed regulations were not clear on 
how the average death benefit for the taxable year was to be 
determined. As an alternative, the commentators suggested that the 
death benefit as of the policy anniversary date would be an appropriate 
measure of the death benefit for purposes of determining current life 
insurance protection. In response to these commentators, the final 
regulations provide that, subject to an anti-abuse rule, current life 
insurance protection is determined on the last day of the non-owner's 
taxable year unless the parties agree to use the policy anniversary 
date. Taxpayers may change the valuation date with the consent of the 
Commissioner.
Equity Split-Dollar Life Insurance Arrangements
    The final regulations generally retain the rules set out in the 
2002 and 2003 proposed regulations for the taxation of equity split-
dollar life insurance arrangements. Therefore, the value of the 
economic benefits provided by the owner to the non-owner for a taxable 
year equals the cost of any current life insurance protection provided 
to the non-owner, the amount of policy cash value to which the non-
owner has current access (to the extent that such amount was not 
actually taken into account for a prior taxable year), and the value of 
any other economic benefits provided to the non-owner (to the extent 
not actually taken into account for a prior taxable year). The owner 
and the non-owner also must account fully and consistently for any 
right in, or benefit of, a life insurance contract provided to the non-
owner under an equity split-dollar life insurance arrangement.
    The final regulations provide that the non-owner has current access 
to any portion of the policy cash value to which the non-owner has a 
current or future right and that currently is directly or indirectly 
accessible by the non-owner, inaccessible to the owner, or inaccessible 
to the owner's general creditors. As indicated in the preamble of the 
2003 proposed regulations, the IRS and Treasury intend that the concept 
of ```access' '' be construed broadly to include any direct or indirect 
right under the arrangement allowing the non-owner to obtain, use, or 
realize potential economic value from the policy cash value. Thus, for 
example, a non-owner has access to policy cash value if the non-owner 
can directly or indirectly make a withdrawal from the policy, borrow 
from the policy, or effect a total or partial surrender of the policy. 
Similarly, for example, the non-owner has access if the non-owner can 
anticipate, assign (either at law or in equity), alienate, pledge, or 
encumber the policy cash value or if the policy cash value is available 
to the non-owner's creditors by attachment, garnishment, levy, 
execution, or other legal or equitable process. Policy cash value is 
inaccessible to the owner if the owner does not have the full rights to 
policy cash value normally held by an owner of a life insurance 
contract. Policy cash value is inaccessible to the owner's general 
creditors if, under the terms of the split-dollar life insurance 
arrangement or by operation of law or any contractual undertaking, the 
creditors cannot, for any reason, effectively reach the policy cash 
value in the event of the owner's insolvency.
    Commentators on the 2003 proposed regulations generally objected to 
the rule requiring the non-owner under an equity arrangement to include 
in income the portion of the policy cash value to which the non-owner 
has current access. Several commentators argued that section 72(e) 
specifically provides for tax-free inside build-up under a life 
insurance contract, precluding any taxation of policy cash value to the 
non-owner prior to a ``realization event'' (such as rollout of the 
policy). That argument ignores the plain language of section 72(e)(1), 
which states that the rules of section 72(e) apply only if no other 
provision of subtitle A of the Internal Revenue Code (Code) applies. In 
the case of an equity arrangement subject to the economic benefit 
regime, the relationship between the owner and the non-owner and the 
terms of the arrangement between them ordinarily make other provisions 
of subtitle A applicable, such as section 61(a)(1).
    The tax-deferred inside build-up provided by section 72(e) properly

[[Page 54340]]

applies only to the taxpayer that owns the life insurance contract. If 
the owner of the contract provides any of the rights or benefits under 
the contract to another taxpayer, that provision of rights and benefits 
is subject to tax under the rules that otherwise follow from the 
relationship between the parties. For example, this result applies 
whenever an employer that owns a life insurance contract compensates an 
employee by giving the employee rights to the policy cash value. In 
that case, the employer (as the owner of the contract) enjoys tax-
deferred inside build-up under section 72(e), but the employee has 
gross income under section 61(a)(1) equal to the value of the economic 
benefit attributable to the employee's rights to the policy cash value. 
Thus, the regulations are consistent with section 72(e).
    Other commentators generally acknowledged that the 2003 proposed 
regulations properly tax the non-owner whenever the non-owner has 
``current access'' to the policy cash value in an equity arrangement 
but argued that the tax should be imposed under section 83 rather than 
under section 61. In effect, these commentators argued that the 
employee's current access to policy cash value should give rise to 
transfers of property with respect to portions of the life insurance 
contract. The commentators argued that the primary difference between 
this suggested approach and the approach set out in the 2003 proposed 
regulations would be the treatment of inside build-up on amounts 
already taxed to the non-owner. Specifically, the commentators argued 
that, under the proposed section 83 approach, inside build-up on 
amounts already taxed to the non-owner would be tax-free to the non-
owner under section 72(e); under the approach of the 2003 proposed 
regulations, the subsequent inside build-up is tax-deferred to the 
owner but not to the non-owner.
    The IRS and Treasury believe that the approach set out in the 2003 
proposed regulations remains appropriate and so have not followed the 
suggestion to adopt a section 83 approach. Section 83 applies only in 
connection with a transfer of property, but a non-owner may have 
currently includible income by reason of another rule--such as the 
doctrines of constructive receipt, cash equivalence, or economic 
benefit. It would be inappropriate to limit current taxation to 
circumstances that constitute transfers of property under section 83, 
and it would be inappropriate in this context to apply section 83 to 
circumstances that give rise to income under other Code provisions or 
judicial doctrines.
    Several commentators raised questions about the effect of state law 
limitations on access to policy cash value by the owner's creditors. 
These commentators read Example 2 in the 2003 proposed regulations as 
stating that any such state law restriction would in and of itself 
cause the non-owner to have current access to the policy cash value. 
Thus, these commentators argued, the 2003 regulations potentially 
imposed current tax on the policy cash value of any non-equity 
arrangement where state law limited the rights of the owner's creditors 
to reach the policy cash value. However, Example 2 indicated that the 
owner there had the right to receive the lesser of the policy cash 
value or total premiums; in other words, Example 2 indicated that the 
arrangement was an equity arrangement. The final regulations clarify 
that the non-owner has current access to policy cash value only if, 
under the arrangement, the non-owner has a current or future right to 
policy cash value; the non-owner will not have any such right in a true 
non-equity arrangement. If the non-owner does have such a right, any 
restriction on the owner's creditors to reach policy cash value, 
whether established by contract or by local law, results in an economic 
benefit to the non-owner.
    Several commentators objected to the rule in the 2003 proposed 
regulations that the non-owner has current access to any portion of the 
policy cash value that cannot be accessed by the owner. These 
commentators argued that as long as policy cash value can be accessed 
by the owner's creditors in the event of insolvency, the owner should 
not be viewed as providing any economic benefit to the non-owner. That 
objection, however, overlooks the economic reality of an equity split-
dollar life insurance arrangement. If the owner commits funds to a life 
insurance contract and undertakes that it will not withdraw those funds 
from the insurance contract, the amounts so committed do not remain a 
general asset of the owner. The owner of the life insurance contract in 
such an arrangement has parted with the ownership and use of the funds 
for the benefit of the non-owner. This contrasts with an irrevocable 
rabbi trust, where the employer effectively remains the tax owner of 
the assets held by the trustee and the rabbi trust assets may still be 
(and very often are) invested in the employer's business.
    In response to the suggestions of commentators, the final 
regulations provide that the policy cash value, like the amount of 
current life insurance protection, is determined as of the last day of 
the non-owner's taxable year unless the parties agree to use the policy 
anniversary date. The final regulations retain the anti-abuse rule 
preventing the parties from manipulating the policy cash value for 
purposes of determining the value of the economic benefit that the non-
owner must take into account and extend that rule to the value of the 
current life insurance protection.
    Taxpayers should note that, in certain cases, a separate tax rule 
may require a non-owner to include an amount in gross income under an 
equity split-dollar life insurance arrangement at a time earlier than 
would be required under these regulations. For example, section 457(f) 
generally requires an employee of a tax-exempt organization (other than 
a church organization under section 3121(w)(3)) or of a state or local 
government to include deferred compensation in gross income when the 
employee's rights to the deferred compensation are not subject to a 
substantial risk of forfeiture. An equity split-dollar life insurance 
arrangement governed by the economic benefit regime constitutes a 
deferred compensation arrangement. Accordingly, an employee of a tax-
exempt organization or of a state or local government may have to 
include an amount in gross income attributable to an equity split-
dollar life insurance arrangement even if the employee does not have 
current access to the policy cash value under these regulations.
Other Tax Consequences
    These final regulations retain the rule of the 2002 proposed 
regulations that the non-owner has no investment in the contract under 
section 72(e) prior to a transfer of the contract. The final 
regulations also retain the rule that any amount paid by the non-owner 
to the owner for any economic benefit is included in the owner's gross 
income.
    Several commentators objected to the rule providing no investment 
in the contract to the non-owner for amounts paid to the owner. They 
argued that section 72(e)(6) provides for such investment in the 
contract. Commentators also objected to the rule requiring that the 
owner include in gross income any amount paid by the non-owner. These 
commentators argued that the owner does not have an accession to wealth 
as a result of the non-owner's payments because such payments 
ordinarily are made to fulfill the non-owner's obligation under the 
split-dollar life insurance arrangement to pay part of the premiums of 
the life insurance contract.

[[Page 54341]]

    The regulations generally treat only one person as the owner of the 
life insurance contract. Because only the owner of a life insurance 
contract can have an investment in that contract, a non-owner employee 
cannot have basis in the contract for any of the costs of current life 
insurance protection. In addition, such costs should not be included in 
the non-owner's basis or investment in the contract if and when the 
non-owner becomes the owner of the contract because those payments were 
made for annual life insurance protection, which protection was 
exhausted prior to the non-owner's acquisition of the contract. 
Similarly, the fact that the split-dollar life insurance arrangement 
may require the non-owner to reimburse the owner for the cost of the 
death benefit protection provided to the non-owner does not mean that 
such payment is not income to the owner. In these cases, the owner is 
``renting'' out part of the benefit of the life insurance contract to 
the non-owner for consideration; such consideration constitutes income 
to the owner.
b. Taxation of Amounts Received Under the Life Insurance Contract
    The final regulations retain the rule in the 2002 proposed 
regulations that any amount received under the life insurance contract 
(other than an amount received by reason of death) and provided, 
directly or indirectly, to the non-owner is treated as though paid by 
the insurance company to the owner and then by the owner to the non-
owner. As under the 2002 proposed regulations, this rule applies to 
certain policy loans (referred to in the regulations as ``specified 
policy loans''). Although several commentators objected to this 
treatment of policy loans, the IRS and Treasury believe that the rule 
is necessary to ensure that parties to a split-dollar life insurance 
arrangement do not avoid current taxation of the non-owner with respect 
to amounts provided to the non-owner through the contract.
    The final regulations retain the rule that section 101(a) applies 
to exclude death benefit proceeds paid to a beneficiary (other than the 
owner of the life insurance policy) from the gross income of the 
beneficiary only to the extent such amount is allocable to current life 
insurance protection provided to the non-owner under the split-dollar 
life insurance arrangement, the cost of which was paid by the non-
owner, or the value of which the non-owner actually took into account 
as an economic benefit provided by the owner to the non-owner. 
Commentators objected to this rule, arguing that the section 101(a) 
exclusion extends to the entire amount of death benefit proceeds paid 
on the death of the insured. They asserted that there is no authority 
to limit the exclusion to death proceeds allocable to current life 
insurance protection provided to the non-owner pursuant to the split-
dollar life insurance arrangement, the cost of which was paid by the 
non-owner, or the value of which the non-owner actually took into 
account.
    The IRS and Treasury disagree with that argument. Under the 
regulations, the owner is treated as providing economic benefits to the 
non-owner. Although the section 101(a) exclusion extends to the entire 
amount of death benefit proceeds, the IRS and Treasury believe that 
only the amount of the death benefit proceeds attributable to the 
current life insurance protection for which the non-owner paid or which 
the non-owner took into account under these regulations is excludable 
from the income of the non-owner's estate or designated beneficiary.
    To the extent the non-owner has neither paid for nor taken into 
account the current life insurance protection, the proceeds paid to the 
estate or designated beneficiary of the non-owner is a separate 
transfer of cash that is not shielded from tax by the section 101(a) 
exclusion. Specifically, those proceeds are deemed payable to the 
owner, and are excluded from the owner's income by reason of the 
section 101(a) exclusion, and then paid by the owner to the non-owner's 
beneficiary (whether or not paid to the beneficiary directly by the 
insurance company) in a transfer to be taken into account under these 
regulations.
    The character of death benefit proceeds transferred or deemed 
transferred by the owner to the non-owner is determined by the 
relationship between the owner and the non-owner. Thus, death benefit 
proceeds received by the beneficiary of a shareholder who is a non-
owner that were paid or payable to a corporation will be treated as a 
taxable distribution to the shareholder. The same principle applies 
where death benefit proceeds under a life insurance contract subject to 
a split-dollar life insurance arrangement are payable to a beneficiary 
of a service provider who is a non-owner, except that the death benefit 
proceeds would constitute a compensation payment to the service 
provider for past services rather than a corporate distribution. This 
treatment is similar to the situation in Rev. Rul. 61-134 (1961-2 C.B. 
250) which also denied exclusion under section 101(a) to death benefits 
paid under a corporate-owned life insurance policy. In Rev. Rul. 61-
134, various shareholders were the beneficiaries of a corporate-owned 
life insurance policy by reason of their capacity as shareholders. The 
ruling concluded that the death benefit proceeds received by the 
shareholders directly from the insurer constituted a taxable 
distribution of property from the corporation to the shareholders, even 
though the proceeds would have been excludable from the corporation's 
income if they had been paid directly to the corporation.
c. Transfer of Life Insurance Contract to the Non-Owner
    The final regulations follow the 2002 proposed regulations in 
determining the tax treatment of a transfer of the life insurance 
contract from the owner to the non-owner. Consistent with the general 
rule for determining ownership, the final regulations provide that a 
transfer of a life insurance contract (or an undivided interest 
therein) underlying a split-dollar life insurance arrangement occurs on 
the date that the non-owner becomes the owner of the entire contract 
(or the undivided interest therein). Unless and until ownership of the 
contract is formally changed, the owner will continue to be treated as 
the owner for all Federal income, employment, and gift tax purposes. 
The fair market value of an undivided interest must be the 
proportionate share of the fair market value of the entire contract 
without regard to any discounts or other arrangements between the 
parties.
    After a transfer of an entire life insurance contract, the 
transferee generally becomes the owner for Federal income, employment, 
and gift tax purposes, including for purposes of these final 
regulations. Thus, if the transferor pays premiums after the transfer, 
the payment of those premiums may be includible in the transferee's 
gross income if the payments are not split-dollar loans under Sec.  
1.7872-15. Alternatively, the arrangement will be subject to the loan 
regime if the payments constitute split-dollar loans under Sec.  
1.7872-15.

4. Taxation Under the Loan Regime

a. In General
    The final regulations generally adopt the rules of the 2002 
proposed regulations for the loan regime. Under Sec.  1.7872-15, a 
payment made pursuant to a split-dollar life insurance arrangement is a 
split-dollar loan and the owner and non-owner are treated, 
respectively, as borrower and lender if (i) the payment is made either 
directly

[[Page 54342]]

or indirectly by the non-owner to the owner; (ii) the payment is a loan 
under general principles of Federal tax law or, if not a loan under 
general principles of Federal tax law, a reasonable person would expect 
the payment to be repaid in full to the non-owner (whether with or 
without interest); and (iii) the repayment is to be made from, or is 
secured by, either the policy's death benefit proceeds or its cash 
surrender value, or both.
    Commentators questioned whether the additional standard (``if not a 
loan under general principles of Federal tax law, a reasonable person 
would expect the payment to be repaid in full to the non-owner (whether 
with or without interest)'') is necessary. The IRS and Treasury 
recognize that, in the earlier years during which a split-dollar life 
insurance arrangement is in effect, policy surrender and load charges 
may significantly reduce the policy's cash surrender value, resulting 
in under-collateralization of a non-owner's right to be repaid its 
premium payments. Nevertheless, so long as a reasonable person would 
expect the payment to be repaid in full, the payment is a split-dollar 
loan under Sec.  1.7872-15, rather than a transfer under Sec.  1.61-
22(b)(5) on the date the payment is made. However, the rules in Sec.  
1.7872-15(a)(2) do not cause a payment to be treated as a loan for 
Federal tax purposes if, because of an agreement between the owner and 
non-owner, the arrangement does not provide for repayment by the owner 
to the non-owner. For example, if a non-owner makes a payment purported 
to be a split-dollar loan to an owner, and the non-owner and owner 
enter into a separate agreement providing that the non-owner will make 
a transfer to the owner in an amount sufficient to repay the purported 
split-dollar loan, Sec.  1.7872-15(a)(2) will not cause the payment to 
be treated as a loan. See Sec.  1.61-22(b)(5) for the treatment of 
payments by a non-owner that are not split-dollar loans. The final 
regulations include a new rule under Sec.  1.7872-15(a)(4) that 
disregards certain stated interest if such interest is to be paid 
directly or indirectly by the lender (or person related to the lender).
    Under Sec.  1.7872-15, each payment under a split-dollar life 
insurance arrangement is treated as a separate loan for Federal tax 
purposes. Commentators have suggested that treating each payment as a 
separate loan will be difficult to administer and overly burdensome for 
certain taxpayers and have suggested allowing an election to treat all 
payments made during a single year (or single calendar quarter) as one 
loan (made on a specified date during the year). However, the final 
regulations adopt the approach in the 2002 proposed regulations that 
each premium payment is treated as a separate loan. Treating separate 
extensions of credit as separate loans is consistent with the 1985 
proposed regulations under section 7872 and the legislative history of 
section 7872, and most accurately accounts for the benefits provided by 
the lender to the borrower when the loans are below-market.
    If a payment on a split-dollar loan is nonrecourse to the borrower 
and the loan does not otherwise provide for contingent payments, Sec.  
1.7872-15 treats the loan as a split-dollar loan that provides for 
contingent payments unless the parties to the split-dollar life 
insurance arrangement provide a written representation with respect to 
the loan. In response to a commentator, the final regulations delete 
the requirement in the proposed regulations that a nonrecourse split-
dollar loan provide for interest payable at a stated rate.
    If a split-dollar loan does not provide for sufficient interest, 
the loan is a below-market split-dollar loan subject to section 7872 
and Sec.  1.7872-15. If the split-dollar loan provides for sufficient 
interest, then, except as provided in Sec.  1.7872-15, the loan is 
subject to the general rules for debt instruments (including the rules 
for OID). In general, interest on a split-dollar loan is not deductible 
by the borrower under sections 264 and 163(h). Section 1.7872-15 
provides special rules for split-dollar loans that provide for certain 
variable rates of interest, contingent interest payments, and lender or 
borrower options. Section 1.7872-15 also provides rules for below-
market split-dollar loans with indirect participants.
    If a split-dollar loan is a below-market loan, then, in general, 
the loan is recharacterized as a loan with interest at the applicable 
Federal rate (AFR), coupled with an imputed transfer by the lender to 
the borrower. The timing, amount, and characterization of the imputed 
transfers between the lender and borrower of the loan will depend upon 
the relationship between the lender and the borrower (for example, the 
imputed transfer is generally characterized as a compensation payment 
if the lender is the borrower's employer), and whether the loan is a 
demand loan or a term loan.
b. Special Rules for Certain Term Loans
    Special rules are provided for split-dollar term loans payable upon 
the death of an individual, certain split-dollar term loans that are 
conditioned on the future performance of substantial services by an 
individual, and gift split-dollar term loans. Under Sec.  1.7872-15, 
these split-dollar loans are split-dollar term loans for purposes of 
determining whether the loan provides for sufficient interest. However, 
if the loan does not provide for sufficient interest when the loan is 
made, forgone interest is determined on the loan annually similar to a 
split-dollar demand loan. Commentators requested clarification on 
whether the rate used for purposes of imputation under Sec.  1.7872-
15(e)(5) for these split-dollar loans is the AFR for the month in which 
the loan is made (redetermined annually) or the AFR as of the month in 
which the loan is made (determined on the date the loan is made). The 
rate used to determine the amount of forgone interest each year is the 
AFR based on the term of the loan, determined on the date the split-
dollar loan is made, and the rate is not redetermined annually.
c. Split-Dollar Loans With Stated Interest That Is Subsequently Waived, 
Cancelled or Forgiven
    If a split-dollar loan provides for stated interest that is 
subsequently waived, cancelled or forgiven, appropriate adjustments are 
required to be made by the parties to reflect the difference between 
the interest payable at the stated rate and the interest actually paid 
by the borrower at that time. Further, the final regulations provide 
that, if stated interest is subsequently waived, cancelled or forgiven, 
an amount is treated as retransferred from the lender to the borrower. 
The final regulations add a new rule under which this amount generally 
is increased by a deferral charge. The final regulations provide a new 
rule that a payment by the lender to the borrower that, in substance, 
is a waiver, cancellation or forgiveness is treated as a waiver, 
cancellation, or forgiveness under the final regulations. The final 
regulations also provide a new rule that, if a split-dollar loan is 
nonrecourse and the parties to the split-dollar life insurance 
arrangement had made the representation under Sec.  1.7872-15(d)(2), 
although adjustments are required to be made by the parties if the 
interest paid on the split-dollar loan is less than the interest 
payments required under the split-dollar loan if all payments were 
made, a deferral charge is not imposed.
d. Payment Ordering Rules
    Payments made by a borrower to a lender pursuant to a split-dollar 
life insurance arrangement are applied in the following order: To 
accrued but

[[Page 54343]]

unpaid interest (including any OID) on all outstanding split-dollar 
loans in the order the interest accrued; to principal on the 
outstanding split-dollar loans in the order in which the loans were 
made; to payments of amounts previously paid by the lender pursuant to 
the split-dollar life insurance arrangement that were not reasonably 
expected to be repaid; and to any other payment with respect to a 
split-dollar life insurance arrangement. One commentator suggested 
limiting the payments to which the payment ordering rule applies to 
those that are made to or for the benefit of the lender. The final 
regulations adopt this suggestion in the payment ordering rule in Sec.  
1.7872-15(k).
e. Employment Taxes and Self-Employment Tax
    An imputed transfer under Sec.  1.7872-15 that is treated as an 
imputed transfer of compensation will have consequences for the Federal 
Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act 
(FUTA) if the adjustment represents wages to the borrower. In response 
to questions regarding the consequences of an imputed transfer for 
employment and self-employment tax purposes, the regulations under 
sections 1402(a), 3121(a), 3231(e), and 3306(b) were clarified to 
reference Sec.  1.7872-15 as well as Sec.  1.61-22.

5. Gift Tax Treatment of Split-Dollar Life Insurance Arrangements

    The final regulations apply for gift tax purposes, including 
private split-dollar life insurance arrangements. Thus, if an 
irrevocable life insurance trust is the owner of the life insurance 
contract underlying the split-dollar life insurance arrangement, and a 
reasonable person would expect that the donor, or the donor's estate, 
will recover an amount equal to the donor's premium payments, those 
premium payments are treated as loans made by the donor to the trust 
and are subject to Sec.  1.7872-15. In such a case, payment of a 
premium by the donor is treated as a split-dollar loan to the trust in 
the amount of the premium payment. If the loan is repayable upon the 
death of the donor, the term of the loan is the donor's life expectancy 
determined under the appropriate table under Sec.  1.72-9 as of the 
date of the payment and the value of the gift is the amount of the 
premium payment less the present value (determined under section 7872 
and Sec.  1.7872-15) of the donor's right to receive repayment. If, 
however, the donor makes premium payments that are not split-dollar 
loans, then the premium payments are governed by general gift tax 
principles. In such a case, with each premium payment, the donor is 
treated as making a gift to the trust equal to the amount of that 
payment.
    Different rules apply, however, if the donor is treated under Sec.  
1.61-22(c) as the owner of the life insurance contract underlying the 
split-dollar life insurance arrangement. Under these circumstances, the 
donor is treated as making a gift to the trust. The value of the gift 
is the value of the economic benefits provided to the trust, less the 
amount of any premium paid by the trustee. For example, assume that 
under the terms of the split-dollar life insurance arrangement, on 
termination of the arrangement or the donor's death, the donor or 
donor's estate is entitled to receive an amount equal to the greater of 
the aggregate premiums paid by the donor or the cash surrender value of 
the contract. In this case, the donor makes a gift to the trust equal 
to the cost of the current life insurance protection provided to the 
trust less any premium amount paid by the trustee. (Thus, a payment by 
the donor will not constitute a gift if the trust pays the portion of 
the premium equal to the cost of the current life insurance protection 
and the donor pays the balance of the premium.) On the other hand, if 
the donor or the donor's estate is entitled to receive an amount equal 
to the lesser of the aggregate premiums paid by the donor, or the cash 
surrender value of the contract, the amount of the economic benefits 
provided to the trust by the donor equals the cost of any current life 
insurance protection provided to the trust, the amount of policy cash 
value to which the trust has current access (to the extent that such 
amount was not actually taken into account for a prior taxable year), 
and the value of any other economic benefits provided to the trust (to 
the extent not actually taken into account for a prior taxable year). 
The value of the donor's gift of economic benefits equals the value of 
those economic benefits provided to the trust for the year minus the 
amount of premiums paid by the trustee.
    As discussed earlier, the final regulations treat the donor as the 
owner of a life insurance contract where the donee is named as the 
policy owner if, under the split-dollar life insurance arrangement, the 
only economic benefit provided to the donee by the donor under the 
arrangement is the value of current life insurance protection. Any 
amount paid by a donee, directly or indirectly, to the donor for such 
current life insurance protection would generally be included in the 
donor's gross income.
    Where the donor is the owner of the life insurance contract that is 
part of the split-dollar life insurance arrangement, amounts received 
by the irrevocable insurance trust (either directly or indirectly) 
under the contract (for example, as a policy owner dividend or proceeds 
of a specified policy loan) are treated as gifts by the donor to the 
irrevocable insurance trust as provided in Sec.  1.61-22(e). The donor 
must also treat as a gift to the trust the amount set forth in Sec.  
1.61-22(g) upon the transfer of the life insurance contract (or 
undivided interest therein) from the donor to the trust.
    The gift tax consequences of the transfer of an interest in a life 
insurance contract to a third party will continue to be determined 
under established gift tax principles notwithstanding who is treated as 
the owner of the life insurance contract under the final regulations. 
See, for example, Rev. Rul. 81-198 (1981-2 C.B. 188). Similarly, for 
estate tax purposes, regardless of who is treated as the owner of a 
life insurance contract under the final regulations, the inclusion of 
the policy proceeds in a decedent's gross estate will continue to be 
determined under section 2042. Thus, the policy proceeds will be 
included in the decedent's gross estate under section 2042(1) if 
receivable by the decedent's executor, or under section 2042(2) if the 
policy proceeds are receivable by a beneficiary other than the 
decedent's estate and the decedent possessed any incidents of ownership 
with respect to the policy. One commentator requested that these 
regulations address the extent to which a decedent's interest in a co-
owned policy is included in that decedent's gross estate under section 
2042, but the IRS and Treasury believe that issue is beyond the scope 
of these regulations and may be addressed in future guidance.

6. Effective Date and Obsolescence of Prior Guidance

    These final regulations apply to any split-dollar life insurance 
arrangement entered into after September 17, 2003. Additionally, these 
final regulations apply to any split-dollar life insurance arrangement 
entered into on or before September 17, 2003 if the arrangement is 
materially modified after September 17, 2003. However, a split-dollar 
life insurance arrangement that is otherwise described in Section IV, 
Paragraph 4 of Notice 2002-8 (2002-1 C.B. 398) will not be treated as 
materially modified for these purposes if the change in the split-
dollar life insurance arrangement is

[[Page 54344]]

made solely to comply with Section IV, Paragraph 4 of Notice 2002-8.
    These final regulations provide a non-exclusive list of changes 
that will not result in a material modification for purposes of the 
effective date. For example, the final regulations provide that a 
change solely in the mode of premium payment or a change solely in the 
interest rate payable on a policy loan under the life insurance 
contract will not be treated as a material modification.
    The 2002 and 2003 proposed regulations provided rules under which 
taxpayers were permitted to rely on the 2002 and 2003 proposed 
regulations for arrangements entered into on or before September 17, 
2003. This reliance also was intended to be available in circumstances 
under which taxpayers relied on the proposed regulations to determine 
that the arrangement would not be subject to the proposed regulations 
(for example, if the arrangement does not fall with the definition of a 
split-dollar life insurance arrangement).
    Concurrent with the publication of these final regulations in the 
Federal Register, the IRS and Treasury are issuing Rev. Rul. 2003-105 
(2003-40 I.R.B.) to obsolete certain revenue rulings with respect to 
split-dollar life insurance arrangements entered into or materially 
modified after September 17, 2003.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory flexibility assessment is not required. It is 
hereby certified that the collection of information requirements in 
these regulations will not have a significant economic impact on a 
substantial number of small entities. This certification is based on 
the fact that the regulations merely require a taxpayer to prepare a 
written representation that contains minimal information (if the loan 
provides for nonrecourse payments) or a projected payment schedule (if 
the loan provides for contingent payments). In addition, the 
preparation of these documents should take no more than .28 hours per 
taxpayer. Therefore, a Regulatory Flexibility Analysis under the 
Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. 
Pursuant to section 7805(f) of the Code, the notice of proposed 
rulemaking preceding this regulation was submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business. The Chief Counsel for Advocacy did not submit 
any comments on the regulations.

Drafting Information

    The principal authors of these final regulations are Rebecca Asta 
of the Office of Associate Chief Counsel (Financial Institutions and 
Products), Lane Damazo of the Office of Associate Chief Counsel 
(Passthroughs and Special Industries), Elizabeth Kaye of the Office of 
Associate Chief Counsel (Income Tax and Accounting), Erinn Madden of 
the Office of Associate Chief Counsel (Tax-Exempt and Governmental 
Entities), and Krishna Vallabhaneni of the Office of Associate Chief 
Counsel (Corporate). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 31

    Employment taxes, Income taxes, Penalties, Pensions, Railroad 
retirement, Reporting and recordkeeping requirements, Social security, 
Unemployment compensation.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

0
Accordingly, 26 CFR parts 1, 31, and 602 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.7872-15 also issued under 26 U.S.C. 1275 and 7872. * * 
*


0
Par. 2. Section 1.61-2 is amended by:
0
1. Redesignating paragraphs (d)(2)(ii)(a) and (b) as paragraphs 
(d)(2)(ii)(A) and (B), respectively.
0
2. Adding two sentences immediately following the second sentence in 
newly designated paragraph (d)(2)(ii)(A).
    The additions read as follows:


Sec.  1.61-2  Compensation for services, including fees, commissions, 
and similar items.

* * * * *
    (d) * * *
    (2) * * *
    (ii)(A) Cost of life insurance on the life of the employee. * * * 
For example, if an employee or independent contractor is the owner (as 
defined in Sec.  1.61-22(c)(1)) of a life insurance contract and the 
payments with regard to such contract are not split-dollar loans under 
Sec.  1.7872-15(b)(1), the employee or independent contractor must 
include in income the amount of any such payments by the employer or 
service recipient with respect to such contract during any year to the 
extent that the employee's or independent contractor's rights to the 
life insurance contract are substantially vested (within the meaning of 
Sec.  1.83-3(b)). This result is the same regardless of whether the 
employee or independent contractor has at all times been the owner of 
the life insurance contract or the contract previously has been owned 
by the employer or service recipient as part of a split-dollar life 
insurance arrangement (as defined in Sec.  1.61-22(b)(1) or (2)) and 
was transferred by the employer or service recipient to the employee or 
independent contractor under Sec.  1.61-22(g). * * *
* * * * *

0
Par. 3. Section 1.61-22 is added to read as follows:


Sec.  1.61-22  Taxation of split-dollar life insurance arrangements.

    (a) Scope--(1) In general. This section provides rules for the 
taxation of a split-dollar life insurance arrangement for purposes of 
the income tax, the gift tax, the Federal Insurance Contributions Act 
(FICA), the Federal Unemployment Tax Act (FUTA), the Railroad 
Retirement Tax Act (RRTA), and the Self-Employment Contributions Act of 
1954 (SECA). For the Collection of Income Tax at Source on Wages, this 
section also provides rules for the taxation of a split-dollar life 
insurance arrangement, other than a payment under a split-dollar life 
insurance arrangement that is a split-dollar loan under Sec.  1.7872-
15(b)(1). A split-dollar life insurance arrangement (as defined in 
paragraph (b) of this section) is subject to the rules of paragraphs 
(d) through (g) of this section, Sec.  1.7872-15, or general tax rules. 
For rules to determine which rules apply to a split-dollar life 
insurance arrangement, see paragraph (b)(3) of this section.
    (2) Overview. Paragraph (b) of this section defines a split-dollar 
life insurance arrangement and provides rules to determine whether an 
arrangement is subject to the rules of paragraphs (d) through (g) of 
this section, Sec.  1.7872-15, or general tax rules. Paragraph (c) of 
this section defines certain other terms. Paragraph (d) of this section 
sets forth rules for the taxation of economic benefits provided under a 
split-dollar life insurance

[[Page 54345]]

arrangement. Paragraph (e) of this section sets forth rules for the 
taxation of amounts received under a life insurance contract that is 
part of a split-dollar life insurance arrangement. Paragraph (f) of 
this section provides rules for additional tax consequences of a split-
dollar life insurance arrangement, including the treatment of death 
benefit proceeds. Paragraph (g) of this section provides rules for the 
transfer of a life insurance contract (or an undivided interest in the 
contract) that is part of a split-dollar life insurance arrangement. 
Paragraph (h) of this section provides examples illustrating the 
application of this section. Paragraph (j) of this section provides the 
effective date of this section.
    (b) Split-dollar life insurance arrangement--(1) In general. A 
split-dollar life insurance arrangement is any arrangement between an 
owner and a non-owner of a life insurance contract that satisfies the 
following criteria--
    (i) Either party to the arrangement pays, directly or indirectly, 
all or any portion of the premiums on the life insurance contract, 
including a payment by means of a loan to the other party that is 
secured by the life insurance contract;
    (ii) At least one of the parties to the arrangement paying premiums 
under paragraph (b)(1)(i) of this section is entitled to recover 
(either conditionally or unconditionally) all or any portion of those 
premiums and such recovery is to be made from, or is secured by, the 
proceeds of the life insurance contract; and
    (iii) The arrangement is not part of a group-term life insurance 
plan described in section 79 unless the group-term life insurance plan 
provides permanent benefits to employees (as defined in Sec.  1.79-0).
    (2) Special rule--(i) In general. Any arrangement between an owner 
and a non-owner of a life insurance contract is treated as a split-
dollar life insurance arrangement (regardless of whether the criteria 
of paragraph (b)(1) of this section are satisfied) if the arrangement 
is described in paragraph (b)(2)(ii) or (iii) of this section.
    (ii) Compensatory arrangements. An arrangement is described in this 
paragraph (b)(2)(ii) if the following criteria are satisfied--
    (A) The arrangement is entered into in connection with the 
performance of services and is not part of a group-term life insurance 
plan described in section 79;
    (B) The employer or service recipient pays, directly or indirectly, 
all or any portion of the premiums; and
    (C) Either--
    (1) The beneficiary of all or any portion of the death benefit is 
designated by the employee or service provider or is any person whom 
the employee or service provider would reasonably be expected to 
designate as the beneficiary; or
    (2) The employee or service provider has any interest in the policy 
cash value of the life insurance contract.
    (iii) Shareholder arrangements. An arrangement is described in this 
paragraph (b)(2)(iii) if the following criteria are satisfied--
    (A) The arrangement is entered into between a corporation and 
another person in that person's capacity as a shareholder in the 
corporation;
    (B) The corporation pays, directly or indirectly, all or any 
portion of the premiums; and
    (C) Either--
    (1) The beneficiary of all or any portion of the death benefit is 
designated by the shareholder or is any person whom the shareholder 
would reasonably be expected to designate as the beneficiary; or
    (2) The shareholder has any interest in the policy cash value of 
the life insurance contract.
    (3) Determination of whether this section or Sec.  1.7872-15 
applies to a split-dollar life insurance arrangement--(i) Split-dollar 
life insurance arrangements involving split-dollar loans under Sec.  
1.7872-15. Except as provided in paragraph (b)(3)(ii) of this section, 
paragraphs (d) through (g) of this section do not apply to any split-
dollar loan as defined in Sec.  1.7872-15(b)(1). Section 1.7872-15 
applies to any such loan. See paragraph (b)(5) of this section for the 
treatment of a payment made by a non-owner under a split-dollar life 
insurance arrangement if the payment is not a split-dollar loan.
    (ii) Exceptions. Paragraphs (d) through (g) of this section apply 
(and Sec.  1.7872-15 does not apply) to any split-dollar life insurance 
arrangement if--
    (A) The arrangement is entered into in connection with the 
performance of services, and the employer or service recipient is the 
owner of the life insurance contract (or is treated as the owner of the 
contract under paragraph (c)(1)(ii)(A)(1) of this section); or
    (B) The arrangement is entered into between a donor and a donee 
(for example, a life insurance trust) and the donor is the owner of the 
life insurance contract (or is treated as the owner of the contract 
under paragraph (c)(1)(ii)(A)(2) of this section).
    (4) Consistency requirement. A split-dollar life insurance 
arrangement described in paragraph (b)(1) or (2) of this section must 
be treated in the same manner by the owner and the non-owner of the 
life insurance contract under either the rules of this section or Sec.  
1.7872-15. In addition, the owner and non-owner must fully account for 
all amounts under the arrangement under paragraph (b)(5) of this 
section, paragraphs (d) through (g) of this section, or Sec.  1.7872-
15.
    (5) Non-owner payments that are not split-dollar loans. If a non-
owner of a life insurance contract makes premium payments (directly or 
indirectly) under a split-dollar life insurance arrangement, and the 
payments are neither split-dollar loans nor consideration for economic 
benefits described in paragraph (d) of this section, then neither the 
rules of paragraphs (d) through (g) of this section nor the rules in 
Sec.  1.7872-15 apply to such payments. Instead, general income tax, 
employment tax, self-employment tax, and gift tax principles apply to 
the premium payments. See, for example, Sec.  1.61-2(d)(2)(ii)(A).
    (6) Waiver, cancellation, or forgiveness. If a repayment obligation 
described in Sec.  1.7872-15(a)(2) is waived, cancelled, or forgiven at 
any time, then the parties must take the amount waived, cancelled, or 
forgiven into account in accordance with the relationships between the 
parties (for example, as compensation in the case of an employee-
employer relationship).
    (7) Change in the owner. If payments made by a non-owner to an 
owner were treated as split-dollar loans under Sec.  1.7872-15 and the 
split-dollar life insurance arrangement is modified such that, after 
the modification, the non-owner is the owner (within the meaning of 
paragraph (c)(1) of this section) of the life insurance contract under 
the arrangement, paragraphs (d) through (g) of this section apply to 
the split-dollar life insurance arrangement from the date of the 
modification. The payments made (both before and after the 
modification) are not treated as split-dollar loans under Sec.  1.7872-
15 on or after the date of the modification. The non-owner of the life 
insurance contract under the modified split-dollar life insurance 
arrangement must fully take into account all economic benefits provided 
under the arrangement under paragraph (d) of this section on or after 
the date of the modification. For the treatment of a transfer of the 
contract when the unmodified arrangement is governed by paragraphs (d) 
through (g) of this section, see paragraph (g) of this section.
    (c) Definitions. The following definitions apply for purposes of 
this section:

[[Page 54346]]

    (1) Owner--(i) In general. With respect to a life insurance 
contract, the person named as the policy owner of such contract 
generally is the owner of such contract. If two or more persons are 
named as policy owners of a life insurance contract and each person 
has, at all times, all the incidents of ownership with respect to an 
undivided interest in the contract, each person is treated as the owner 
of a separate contract to the extent of such person's undivided 
interest. If two or more persons are named as policy owners of a life 
insurance contract but each person does not have, at all times, all the 
incidents of ownership with respect to an undivided interest in the 
contract, the person who is the first-named policy owner is treated as 
the owner of the entire contract.
    (ii) Special rule for certain arrangements--(A) In general. 
Notwithstanding paragraph (c)(1)(i) of this section--
    (1) An employer or service recipient is treated as the owner of a 
life insurance contract under a split-dollar life insurance arrangement 
that is entered into in connection with the performance of services if, 
at all times, the only economic benefit that will be provided under the 
arrangement is current life insurance protection as described in 
paragraph (d)(3) of this section; and
    (2) A donor is treated as the owner of a life insurance contract 
under a split-dollar life insurance arrangement that is entered into 
between a donor and a donee (for example, a life insurance trust) if, 
at all times, the only economic benefit that will be provided under the 
arrangement is current life insurance protection as described in 
paragraph (d)(3) of this section.
    (B) Modifications. If an arrangement described in paragraph 
(c)(1)(ii)(A) of this section is modified such that the arrangement is 
no longer described in paragraph (c)(1)(ii)(A) of this section, the 
following rules apply:
    (1) If, immediately after such modification, the employer, service 
recipient, or donor is the owner of the life insurance contract under 
the split-dollar life insurance arrangement (determined without regard 
to paragraph (c)(1)(ii)(A) of this section), the employer, service 
recipient, or donor continues to be treated as the owner of the life 
insurance contract.
    (2) If, immediately after such modification, the employer, service 
recipient, or donor is not the owner of the life insurance contract 
under the split-dollar life insurance arrangement (determined without 
regard to paragraph (c)(1)(ii)(A) of this section), the employer, 
service recipient, or donor is treated as having made a transfer of the 
entire life insurance contract to the employee, service provider, or 
donee under the rules of paragraph (g) of this section as of the date 
of such modification.
    (3) For purposes of this paragraph (c)(1)(ii)(B), entering into a 
successor split-dollar life insurance arrangement that has the effect 
of providing any economic benefit in addition to that described in 
paragraph (d)(3) of this section is treated as a modification of the 
prior split-dollar life insurance arrangement.

    (iii) Attribution rules for compensatory arrangements. For purposes 
of this section, if a split-dollar life insurance arrangement is 
entered into in connection with the performance of services, the 
employer or service recipient is treated as the owner of the life 
insurance contract if the owner (within the meaning of paragraph 
(c)(1)(i) of this section) of the life insurance contract under the 
split-dollar life insurance arrangement is--
    (A) A trust described in section 402(b);
    (B) A trust that is treated as owned (within the meaning of 
sections 671 through 677) by the employer or the service recipient;
    (C) A welfare benefit fund within the meaning of section 419(e)(1); 
or
    (D) A member of the employer or service recipient's controlled 
group (within the meaning of section 414(b)) or a trade or business 
that is under common control with the employer or service recipient 
(within the meaning of section 414(c)).
    (iv) Life insurance contracts owned by partnerships. [Reserved]
    (2) Non-owner--(i) Definition. With respect to a life insurance 
contract, a non-owner is any person (other than the owner of such 
contract under paragraph (c)(1) of this section) that has any direct or 
indirect interest in such contract (but not including a life insurance 
company acting only in its capacity as the issuer of a life insurance 
contract).
    (ii) Example. The following example illustrates the provisions of 
this paragraph (c)(2):

    Example.  (i) On January 1, 2009, Employer R and Trust T, an 
irrevocable life insurance trust that is not treated under sections 
671 through 677 as owned by a grantor or other person, enter into a 
split-dollar life insurance arrangement in connection with the 
performance of services under which R will pay all the premiums on 
the life insurance contract until the termination of the arrangement 
or the death of E, an employee of R. C, the beneficiary of T, is E's 
child. R is the owner of the contract under paragraph (c)(1)(i) of 
this section. E is the insured under the life insurance contract. 
Upon termination of the arrangement or E's death, R is entitled to 
receive the lesser of the aggregate premiums or the policy cash 
value of the contract and T will be entitled to receive any 
remaining amounts. Under the terms of the arrangement and applicable 
state law, the policy cash value is fully accessible by R and R's 
creditors but T has the right to borrow or withdraw at any time the 
portion of the policy cash value exceeding the amount payable to R.

    (ii) Because E and T each have an indirect interest in the life 
insurance contract that is part of the split-dollar life insurance 
arrangement, each is a non-owner under paragraph (c)(2)(i) of this 
section. E and T each are provided economic benefits described in 
paragraph (d)(2) of this section pursuant to the split-dollar life 
insurance arrangement. Economic benefits are provided by owner R to 
E as a payment of compensation, and separately provided by E to T as 
a gift.

    (3) Transfer of entire contract or undivided interest therein. A 
transfer of the ownership of a life insurance contract (or an undivided 
interest in such contract) that is part of a split-dollar life 
insurance arrangement occurs on the date that a non-owner becomes the 
owner (within the meaning of paragraph (c)(1) of this section) of the 
entire contract or of an undivided interest in the contract.
    (4) Undivided interest. An undivided interest in a life insurance 
contract consists of an identical fractional or percentage interest or 
share in each right, benefit, and obligation with respect to the 
contract. In the case of any arrangement purporting to create undivided 
interests where, in substance, the rights, benefits or obligations are 
shared to any extent among the holders of such interests, the 
arrangement will be treated as a split-dollar life insurance 
arrangement.
    (5) Employment tax. The term employment tax means any tax imposed 
by, or collected under, the Federal Insurance Contributions Act (FICA), 
the Federal Unemployment Tax Act (FUTA), the Railroad Retirement Tax 
Act (RRTA), and the Collection of Income Tax at Source on Wages.
    (6) Self-employment tax. The term self-employment tax means the tax 
imposed by the Self-Employment Contributions Act of 1954 (SECA).
    (d) Economic benefits provided under a split-dollar life insurance 
arrangement--(1) In general. In the case of a split-dollar life 
insurance arrangement subject to the rules of paragraphs (d) through 
(g) of this section, economic benefits are treated as being provided to 
the non-owner of the life insurance contract. The non-owner

[[Page 54347]]

(and the owner for gift and employment tax purposes) must take into 
account the full value of all economic benefits described in paragraph 
(d)(2) of this section, reduced by the consideration paid directly or 
indirectly by the non-owner to the owner for those economic benefits. 
Depending on the relationship between the owner and the non-owner, the 
economic benefits may constitute a payment of compensation, a 
distribution under section 301, a contribution to capital, a gift, or a 
transfer having a different tax character. Further, depending on the 
relationship between or among a non-owner and one or more other persons 
(including a non-owner or non-owners), the economic benefits may be 
treated as provided from the owner to the non-owner and as separately 
provided from the non-owner to such other person or persons (for 
example, as a payment of compensation from an employer to an employee 
and as a gift from the employee to the employee's child).
    (2) Value of economic benefits. The value of the economic benefits 
provided to a non-owner for a taxable year under the arrangement 
equals--
    (i) The cost of current life insurance protection provided to the 
non-owner as determined under paragraph (d)(3) of this section;
    (ii) The amount of policy cash value to which the non-owner has 
current access within the meaning of paragraph (d)(4)(ii) of this 
section (to the extent that such amount was not actually taken into 
account for a prior taxable year); and
    (iii) The value of any economic benefits not described in paragraph 
(d)(2)(i) or (ii) of this section provided to the non-owner (to the 
extent not actually taken into account for a prior taxable year).
    (3) Current life insurance protection--(i) Amount of current life 
insurance protection. In the case of a split-dollar life insurance 
arrangement described in paragraph (d)(1) of this section, the amount 
of the current life insurance protection provided to the non-owner for 
a taxable year (or any portion thereof in the case of the first year or 
the last year of the arrangement) equals the excess of the death 
benefit of the life insurance contract (including paid-up additions 
thereto) over the total amount payable to the owner (including any 
outstanding policy loans that offset amounts otherwise payable to the 
owner) under the split-dollar life insurance arrangement, less the 
portion of the policy cash value actually taken into account under 
paragraph (d)(1) of this section or paid for by the non-owner under 
paragraph (d)(1) for the current taxable year or any prior taxable 
year.
    (ii) Cost of current life insurance protection. The cost of current 
life insurance protection provided to the non-owner for any year (or 
any portion thereof in the case of the first year or the last year of 
the arrangement) equals the amount of the current life insurance 
protection provided to the non-owner (determined under paragraph 
(d)(3)(i) of this section) multiplied by the life insurance premium 
factor designated or permitted in guidance published in the Internal 
Revenue Bulletin (see Sec.  601.601(d)(2)(ii) of this chapter).
    (4) Policy cash value--(i) In general. For purposes of this 
paragraph (d), policy cash value is determined disregarding surrender 
charges or other similar charges or reductions. Policy cash value 
includes policy cash value attributable to paid-up additions.
    (ii) Current access. For purposes of this paragraph (d), a non-
owner has current access to that portion of the policy cash value--
    (A) To which, under the arrangement, the non-owner has a current or 
future right and;
    (B) That currently is directly or indirectly accessible by the non-
owner, inaccessible to the owner, or inaccessible to the owner's 
general creditors.
    (5) Valuation date--(i) General rules. For purposes of this 
paragraph (d), the amount of the current life insurance protection and 
the policy cash value shall be determined on the same valuation date. 
The valuation date is the last day of the non-owner's taxable year, 
unless the owner and non-owner agree to instead use the policy 
anniversary date as the valuation date. Notwithstanding the previous 
sentence, if the split-dollar life insurance arrangement terminates 
during the taxable year of the non-owner, the value of such economic 
benefits is determined on the day that the arrangement terminates.
    (ii) Consistency requirement. The owner and non-owner of the split-
dollar arrangement must use the same valuation date. In addition, the 
same valuation date must be used for all years prior to termination of 
the split-dollar life insurance arrangement unless the parties receive 
consent of the Commissioner to change the valuation date.
    (iii) Artifice or device. Notwithstanding paragraph (d)(5)(i) of 
this section, if any artifice or device is used to understate the 
amount of any economic benefit on the valuation date in paragraph 
(d)(5)(i) of this section, then, for purposes of this paragraph (d), 
the date on which the amount of the economic benefit is determined is 
the date on which the amount of the economic benefit is greatest during 
that taxable year.
    (iv) Special rule for certain taxes. For purposes of employment tax 
(as defined in paragraph (c)(5) of this section), self-employment tax 
(as defined in paragraph (c)(6) of this section), and sections 6654 and 
6655 (relating to the failure to pay estimated income tax), the 
portions of the current life insurance protection and the policy cash 
value that are treated as provided by the owner to the non-owner shall 
be treated as so provided on the last day of the taxable year of the 
non-owner. Notwithstanding the previous sentence, if the split-dollar 
life insurance arrangement terminates during the taxable year of the 
non-owner, such portions of the current life insurance protection and 
the policy cash value shall be treated as so provided on the day that 
the arrangement terminates.
    (6) Examples. The following examples illustrate the rules of this 
paragraph (d). Except as otherwise provided, both examples assume the 
following facts: employer (R) is the owner (as defined in paragraph 
(c)(1)(i) of this section) and employee (E) is the non-owner (as 
defined in paragraph (c)(2)(i) of this section) of a life insurance 
contract that is part of a split-dollar life insurance arrangement that 
is subject to the provisions of paragraphs (d) through (g) of this 
section; the contract is a life insurance contract as defined in 
section 7702 and not a modified endowment contract as defined in 
section 7702A; R does not withdraw or obtain a loan of any portion of 
the policy cash value and does not surrender any portion of the life 
insurance contract; the compensation paid to E is reasonable; E is not 
provided any economic benefits described in paragraph (d)(2)(iii) of 
this section; E does not make any premium payments; E's taxable year is 
the calendar year; the value of the economic benefits is determined on 
the last day of E's taxable year; and E reports on E's Federal income 
tax return for each year that the split-dollar life insurance 
arrangement is in effect the amount of income required to be reported 
under paragraph (d) of this section. The examples are as follows:

    Example 1.  (i) Facts. On January 1 of year 1, R and E enter 
into the split-dollar life insurance arrangement. Under the 
arrangement, R pays all of the premiums on the life insurance 
contract until the termination of the arrangement or E's death. The 
arrangement provides that upon termination of the arrangement or E's 
death, R is entitled to receive the lesser of the

[[Page 54348]]

aggregate premiums paid or the policy cash value of the contract and 
E is entitled to receive any remaining amounts. Under the terms of 
the arrangement and applicable state law, the policy cash value is 
fully accessible by R and R's creditors but E has the right to 
borrow or withdraw at any time the portion of the policy cash value 
exceeding the amount payable to R. To fund the arrangement, R 
purchases a life insurance contract with constant death benefit 
protection equal to $1,500,000. R makes premium payments on the life 
insurance contract of $60,000 in each of years 1, 2, and 3. The 
policy cash value equals $55,000 as of December 31 of year 1, 
$140,000 as of December 31 of year 2, and $240,000 as of December 31 
of year 3.
    (ii) Analysis. Under the terms of the split-dollar life 
insurance arrangement, E has the right for year 1 and all subsequent 
years to borrow or withdraw the portion of the policy cash value 
exceeding the amount payable to R. Thus, under paragraph (d)(4)(ii) 
of this section, E has current access to such portion of the policy 
cash value for each year that the arrangement is in effect. In 
addition, because R pays all of the premiums on the life insurance 
contract, R provides to E all of the economic benefits that E 
receives under the arrangement. Therefore, under paragraph (d)(1) of 
this section, E includes in gross income the value of all economic 
benefits described in paragraphs (d)(2)(i) and (ii) of this section 
provided to E under the arrangement.
    (iii) Results for year 1. For year 1, E is provided, under 
paragraph (d)(2)(ii) of this section, $0 of policy cash value 
(excess of $55,000 policy cash value determined as of December 31 of 
year 1 over $55,000 payable to R). For year 1, E is also provided, 
under paragraph (d)(2)(i) of this section, current life insurance 
protection of $1,445,000 ($1,500,000 minus $55,000 payable to R). 
Thus, E includes in gross income for year 1 the cost of $1,445,000 
of current life insurance protection.
    (iv) Results for year 2. For year 2, E is provided, under 
paragraph (d)(2)(ii) of this section, $20,000 of policy cash value 
($140,000 policy cash value determined as of December 31 of year 2 
minus $120,000 payable to R). For year 2, E is also provided, under 
paragraph (d)(2)(i) of this section, current life insurance 
protection of $1,360,000 ($1,500,000 minus the sum of $120,000 
payable to R and the aggregate of $20,000 of policy cash value that 
E actually includes in income on E's year 1 and year 2 federal 
income tax returns). Thus, E includes in gross income for year 2 the 
sum of $20,000 of policy cash value and the cost of $1,360,000 of 
current life insurance protection.
    (v) Results for year 3. For year 3, E is provided, under 
paragraph (d)(2)(ii) of this section, $40,000 of policy cash value 
($240,000 policy cash value determined as of December 31 of year 3 
minus the sum of $180,000 payable to R and $20,000 of aggregate 
policy cash value that E actually included in gross income on E's 
year 1 and year 2 federal income tax returns). For year 3, E is also 
provided, under paragraph (d)(2)(i) of this section, current life 
insurance protection of $1,260,000 ($1,500,000 minus the sum of 
$180,000 payable to R and $60,000 of aggregate policy cash value 
that E actually includes in gross income on E's year 1, year 2, and 
year 3 federal income tax returns). Thus, E includes in gross income 
for year 3 the sum of $40,000 of policy cash value and the cost of 
$1,260,000 of current life insurance protection.
    Example 2.  (i) Facts. The facts are the same as in Example 1 
except that E cannot directly or indirectly access any portion of 
the policy cash value, but the terms of the split-dollar life 
insurance arrangement or applicable state law provide that the 
policy cash value in excess of the amount payable to R is 
inaccessible to R's general creditors.
    (ii) Analysis. Under the terms of the split-dollar life 
insurance arrangement or applicable state law, the portion of the 
policy cash value exceeding the amount payable to R is inaccessible 
to R's general creditors and E has a current or future right to that 
portion of the cash value. Thus, under paragraph (d)(4)(ii) of this 
section, E has current access to such portion of the policy cash 
value for each year that the arrangement is in effect. In addition, 
because R pays all of the premiums on the life insurance contract, R 
provides to E all of the economic benefits that E receives under the 
arrangement. Therefore, under paragraph (d)(1) of this section, E 
includes in gross income the value of all economic benefits 
described in paragraphs (d)(2)(i) and (ii) of this section provided 
to E under the arrangement.
    (iii) Results for years 1, 2 and 3. The results for this example 
are the same as the results in Example 1.
    (e) Amounts received under the contract--(1) In general. Except as 
otherwise provided in paragraph (f)(3) of this section, any amount 
received under a life insurance contract that is part of a split-dollar 
life insurance arrangement subject to the rules of paragraphs (d) 
through (g) of this section (including, but not limited to, a policy 
owner dividend, proceeds of a specified policy loan described in 
paragraph (e)(2) of this section, or the proceeds of a withdrawal from 
or partial surrender of the life insurance contract) is treated, to the 
extent provided directly or indirectly to a non-owner of the life 
insurance contract, as though such amount had been paid to the owner of 
the life insurance contract and then paid by the owner to the non-
owner. The amount received is taxable to the owner in accordance with 
the rules of section 72. The non-owner (and the owner for gift tax and 
employment tax purposes) must take the amount described in paragraph 
(e)(3) of this section into account as a payment of compensation, a 
distribution under section 301, a contribution to capital, a gift, or 
other transfer depending on the relationship between the owner and the 
non-owner.
    (2) Specified policy loan. A policy loan is a specified policy loan 
to the extent--
    (i) The proceeds of the loan are distributed directly from the 
insurance company to the non-owner;
    (ii) A reasonable person would not expect that the loan will be 
repaid by the non-owner; or
    (iii) The non-owner's obligation to repay the loan to the owner is 
satisfied or is capable of being satisfied upon repayment by either 
party to the insurance company.
    (3) Amount required to be taken into account. With respect to a 
non-owner (and the owner for gift tax and employment tax purposes), the 
amount described in this paragraph (e)(3) is equal to the excess of--
    (i) The amount treated as received by the owner under paragraph 
(e)(1) of this section; over
    (ii) The amount of all economic benefits described in paragraphs 
(d)(2)(ii) and (iii) of this section actually taken into account by the 
non-owner (and the owner for gift tax and employment tax purposes) plus 
any consideration described in paragraph (d)(1) of this section paid by 
the non-owner for such economic benefits described in paragraphs 
(d)(2)(ii) and (iii) of this section. The amount determined under the 
preceding sentence applies only to the extent that neither this 
paragraph (e)(3)(ii) nor paragraph (g)(1)(ii) of this section 
previously has applied to such economic benefits.
    (f) Other tax consequences--(1) Introduction. In the case of a 
split-dollar life insurance arrangement subject to the rules of 
paragraphs (d) through (g) of this section, this paragraph (f) sets 
forth other tax consequences to the owner and non-owner of a life 
insurance contract that is part of the arrangement for the period prior 
to the transfer (as defined in paragraph (c)(3) of this section) of the 
contract (or an undivided interest therein) from the owner to the non-
owner. See paragraph (g) of this section and Sec.  1.83-6(a)(5) for tax 
consequences upon the transfer of the contract (or an undivided 
interest therein).
    (2) Investment in the contract--(i) To the non-owner. A non-owner 
does not receive any investment in the contract under section 72(e)(6) 
with respect to a life insurance contract that is part of a split-
dollar life insurance arrangement subject to the rules of paragraphs 
(d) through (g) of this section.
    (ii) To owner. Any premium paid by an owner under a split-dollar 
life insurance arrangement subject to the rules of paragraphs (d) 
through (g) of this section is included in the owner's investment in 
the contract under section 72(e)(6). No premium or amount

[[Page 54349]]

described in paragraph (d) of this section is deductible by the owner 
(except as otherwise provided in Sec.  1.83-6(a)(5)). Any amount paid 
by a non-owner, directly or indirectly, to the owner of the life 
insurance contract for current life insurance protection or for any 
other economic benefit under the life insurance contract is included in 
the owner's gross income and is included in the owner's investment in 
the life insurance contract for purposes of section 72(e)(6) (but only 
to the extent not otherwise so included by reason of having been paid 
by the owner as a premium or other consideration for the contract).
    (3) Treatment of death benefit proceeds--(i) Death benefit proceeds 
to beneficiary (other than the owner). Any amount paid to a beneficiary 
(other than the owner) by reason of the death of the insured is 
excluded from gross income by such beneficiary under section 101(a) as 
an amount received under a life insurance contract to the extent such 
amount is allocable to current life insurance protection provided to 
the non-owner pursuant to the split-dollar life insurance arrangement, 
the cost of which was paid by the non-owner, or the value of which the 
non-owner actually took into account pursuant to paragraph (d)(1) of 
this section.
    (ii) Death benefit proceeds to owner as beneficiary. Any amount 
paid or payable to an owner in its capacity as a beneficiary by reason 
of the death of the insured is excluded from gross income of the owner 
under section 101(a) as an amount received under a life insurance 
contract to the extent such amount is not allocable to current life 
insurance protection provided to the non-owner pursuant to the split-
dollar life insurance arrangement, the cost of which was paid by the 
non-owner, or the value of which the non-owner actually took into 
account pursuant to paragraph (d)(1) of this section.
    (iii) Transfers of death benefit proceeds. Death benefit proceeds 
paid to a party to a split-dollar life insurance arrangement (or the 
estate or beneficiary of that party) that are not excludable from that 
party's income under section 101(a) to the extent provided in paragraph 
(f)(3)(i) or (ii) of this section, are treated as transferred to that 
party in a separate transaction. The death benefit proceeds treated as 
so transferred will be taxed in a manner similar to other transfers. 
For example, if death benefit proceeds paid to an employee, the 
employee's estate, or the employee's beneficiary are not excludable 
from the employee's gross income under section 101(a) to the extent 
provided in paragraph (f)(3)(i) of this section, then such payment is 
treated as a payment of compensation by the employer to the employee.
    (g) Transfer of entire contract or undivided interest therein--(1) 
In general. Upon a transfer within the meaning of paragraph (c)(3) of 
this section of a life insurance contract (or an undivided interest 
therein) to a non-owner (transferee), the transferee (and the owner 
(transferor) for gift tax and employment tax purposes) takes into 
account the excess of the fair market value of the life insurance 
contract (or the undivided interest therein) transferred to the 
transferee at that time over the sum of--
    (i) The amount the transferee pays to the transferor to obtain the 
contract (or the undivided interest therein); and
    (ii) The amount of all economic benefits described in paragraph 
(d)(2)(ii) and (iii) of this section actually taken into account by the 
transferee (and the transferor for gift tax and employment tax 
purposes), plus any consideration described in paragraph (d)(1) of this 
section paid by the transferee for such economic benefits described in 
paragraphs (d)(2)(ii) and (iii) of this section. The amount determined 
under the preceding sentence applies only to the extent that neither 
this paragraph (g)(1)(ii) nor paragraph (e)(3)(ii) of this section 
previously has applied to such economic benefits.
    (2) Determination of fair market value. For purposes of paragraph 
(g)(1) of this section, the fair market value of a life insurance 
contract is the policy cash value and the value of all other rights 
under such contract (including any supplemental agreements thereto and 
whether or not guaranteed), other than the value of current life 
insurance protection. Notwithstanding the preceding sentence, the fair 
market value of a life insurance contract for gift tax purposes is 
determined under Sec.  25.2512-6(a) of this chapter.
    (3) Exception for certain transfers in connection with the 
performance of services. To the extent the ownership of a life 
insurance contract (or undivided interest in such contract) is 
transferred in connection with the performance of services, paragraph 
(g)(1) of this section does not apply until such contract (or undivided 
interest in such contract) is taxable under section 83. For purposes of 
paragraph (g)(1) of this section, fair market value is determined 
disregarding any lapse restrictions and at the time the transfer of 
such contract (or undivided interest in such contract) is taxable under 
section 83.
    (4) Treatment of non-owner after transfer--(i) In general. After a 
transfer of an entire life insurance contract (except when such 
transfer is in connection with the performance of services and the 
transfer is not yet taxable under section 83), the person who 
previously had been the non-owner is treated as the owner of such 
contract for all purposes, including for purposes of paragraph (b) of 
this section and for purposes of Sec.  1.61-2(d)(2)(ii)(A). After the 
transfer of an undivided interest in a life insurance contract (or, if 
later, at the time such transfer is taxable under section 83), the 
person who previously had been the non-owner is treated as the owner of 
a separate contract consisting of that interest for all purposes, 
including for purposes of paragraph (b) of this section and for 
purposes of Sec.  1.61-2(d)(2)(ii)(A).
    (ii) Investment in the contract after transfer--(A) In general. The 
amount treated as consideration paid to acquire the contract under 
section 72(g)(1), in order to determine the aggregate premiums paid by 
the transferee for purposes of section 72(e)(6)(A) after the transfer 
(or, if later, at the time such transfer is taxable under section 83), 
equals the greater of the fair market value of the contract or the sum 
of the amounts determined under paragraphs (g)(1)(i) and (ii) of this 
section.
    (B) Transfers between a donor and a donee. In the case of a 
transfer of a contract between a donor and a donee, the amount treated 
as consideration paid by the transferee to acquire the contract under 
section 72(g)(1), in order to determine the aggregate premiums paid by 
the transferee for purposes of section 72(e)(6)(A) after the transfer, 
equals the sum of the amounts determined under paragraphs (g)(1)(i) and 
(ii) of this section except that--
    (1) The amount determined under paragraph (g)(1)(i) of this section 
includes the aggregate of premiums or other consideration paid or 
deemed to have been paid by the transferor; and
    (2) The amount of all economic benefits determined under paragraph 
(g)(1)(ii) of this section actually taken into account by the 
transferee does not include such benefits to the extent such benefits 
were excludable from the transferee's gross income at the time of 
receipt.
    (C) Transfers of an undivided interest in a contract. If a portion 
of a contract is transferred to the transferee, then the amount to be 
included as consideration paid to acquire the contract is determined by 
multiplying the amount determined under paragraph (g)(4)(ii)(A) of this 
section (as modified by paragraph (g)(4)(ii)(B) of this section, if the 
transfer is between a donor and a donee) by a fraction, the numerator 
of which is the fair market value of the

[[Page 54350]]

portion transferred and the denominator of which is the fair market 
value of the entire contract.
    (D) Example. The following example illustrates the rules of this 
paragraph (g)(4)(ii):

    Example. (i) In year 1, donor D and donee E enter into a split-
dollar life insurance arrangement as defined in paragraph (b)(1) of 
this section. D is the owner of the life insurance contract under 
paragraph (c)(1) of this section. The life insurance contract is not 
a modified endowment contract as defined in section 7702A. In year 
5, D gratuitously transfers the contract, within the meaning of 
paragraph (c)(3) of this section, to E. At the time of the transfer, 
the fair market value of the contract is $200,000 and D had paid 
$50,000 in premiums under the arrangement. In addition, by the time 
of the transfer, E had current access to $80,000 of policy cash 
value which was excludable from E's gross income under section 102.
    (ii) E's investment in the contract is $50,000, consisting of 
the $50,000 of premiums paid by D. The $80,000 of policy cash value 
to which E had current access is not included in E's investment in 
the contract because such amount was excludable from E's gross 
income when E had current access to that policy cash value.

    (iii) No investment in the contract for current life insurance 
protection. Except as provided in paragraph (g)(4)(ii)(B) of this 
section, no amount allocable to current life insurance protection 
provided to the transferee (the cost of which was paid by the 
transferee or the value of which was provided to the transferee) is 
treated as consideration paid to acquire the contract under section 
72(g)(1) to determine the aggregate premiums paid by the transferee for 
purposes of determining the transferee's investment in the contract 
under section 72(e) after the transfer.
    (h) Examples. The following examples illustrate the rules of this 
section. Except as otherwise provided, each of the examples assumes 
that the employer (R) is the owner (as defined in paragraph (c)(1) of 
this section) of a life insurance contract that is part of a split-
dollar life insurance arrangement subject to the rules of paragraphs 
(d) through (g) of this section, that the employee (E) is not provided 
any economic benefits described in paragraph (d)(2)(iii) of this 
section, that the life insurance contract is not a modified endowment 
contract under section 7702A, that the compensation paid to E is 
reasonable, and that E makes no premium payments. The examples are as 
follows:

    Example 1. (i) In year 1, R purchases a life insurance contract 
on the life of E. R is named as the policy owner of the contract. R 
and E enter into an arrangement under which R will pay all the 
premiums on the life insurance contract until the termination of the 
arrangement or E's death. Upon termination of the arrangement or E's 
death, R is entitled to receive the greater of the aggregate 
premiums or the policy cash value of the contract. The balance of 
the death benefit will be paid to a beneficiary designated by E.
    (ii) Because R is designated as the policy owner of the 
contract, R is the owner of the contract under paragraph (c)(1)(i) 
of this section. In addition, R would be treated as the owner of the 
contract regardless of whether of R were designated as the policy 
owner under paragraph (c)(1)(i) of this section because the split-
dollar life insurance arrangement is described in paragraph 
(c)(1)(ii)(A)(1) of this section. E is a non-owner of the contract. 
Under the arrangement between R and E, a portion of the death 
benefit is payable to a beneficiary designated by E. The arrangement 
is a split-dollar life insurance arrangement under paragraph (b)(1) 
or (2) of this section. Because R pays all the premiums on the life 
insurance contract, R provides to E the entire amount of the current 
life insurance protection E receives under the arrangement. 
Therefore, for each year that the split-dollar life insurance 
arrangement is in effect, E must include in gross income under 
paragraph (d)(1) of this section the value of current life insurance 
protection described in paragraph (d)(2)(i) of this section provided 
to E in each year.
    Example 2. (i) The facts are the same as in Example 1 except 
that, upon termination of the arrangement or E's death, R is 
entitled to receive the lesser of the aggregate premiums or the 
policy cash value of the contract. Under the terms of the 
arrangement and applicable state law, the policy cash value is fully 
accessible by R and R's creditors but E has the right to borrow or 
withdraw at any time the portion of the policy cash value exceeding 
the amount payable to R.
    (ii) Because R is designated as the policy owner, R is the owner 
of the contract under paragraph (c)(1)(i) of this section. E is a 
non-owner of the contract. For each year that the split-dollar life 
insurance arrangement is in effect, E has the right to borrow or 
withdraw at any time the portion of the policy cash value exceeding 
the amount payable to R. Thus, under paragraph (d)(4)(ii) of this 
section, E has current access to such portion of the policy cash 
value for each year that the arrangement is in effect. In addition, 
because R pays all the premiums on the life insurance contract, R 
provides to E all the economic benefits that E receives under the 
arrangement. Therefore, for each year that the split-dollar life 
insurance arrangement is in effect, E must include in gross income 
under paragraph (d)(1) of this section, the value of all economic 
benefits described in paragraph (d)(2)(i) and (ii) of this section 
provided to E in each year.
    Example 3. (i) The facts are the same as in Example 1 except 
that in year 5, R and E modify the split-dollar life insurance 
arrangement to provide that, upon termination of the arrangement or 
E's death, R is entitled to receive the greater of the aggregate 
premiums or one-half the policy cash value of the contract. Under 
the terms of the modified arrangement and applicable state law, the 
policy cash value is fully accessible by R and R's creditors but E 
has the right to borrow or withdraw at any time the portion of the 
policy cash value exceeding the amount payable to R.
    (ii) For each year that the split-dollar life insurance arrangement 
is in effect, E must include in gross income under paragraph (d)(1) of 
this section the value of the economic benefits described in paragraph 
(d)(2)(i) of this section provided to E under the arrangement during 
that year. In year 5 (and subsequent years), E has the right to borrow 
or withdraw at any time the portion of the policy cash value exceeding 
the amount payable to R. Thus, under paragraph (d)(4)(ii) of this 
section, E has current access to such portion of the policy cash value. 
Thus, in year 5 (and each subsequent year), E must also include in 
gross income under paragraph (d)(1) of this section the value of the 
economic benefits described in paragraph (d)(2)(ii) of this section 
provided to E in each year.
    (iii) The arrangement is not described in paragraph 
(c)(1)(ii)(A)(1) of this section after it is modified in year 5. 
Because R is the designated owner of the life insurance contract, R 
continues to be treated as the owner of the contract under paragraph 
(c)(1)(ii)(B)(1) of this section after the arrangement is modified. 
In addition, because the modification made by R and E in year 5 does 
not involve the transfer (within the meaning of paragraph (c)(3) of 
this section) of an undivided interest in the life insurance 
contract from R to E, the modification is not a transfer for 
purposes of paragraph (g) of this section.
    Example 4. (i) The facts are the same as in Example 2 except 
that in year 7, R and E modify the split-dollar life insurance 
arrangement to provide that, upon termination of the arrangement or 
E's death, R will be paid the lesser of 80 percent of the aggregate 
premiums or the policy cash value of the contract. Under the terms 
of the modified arrangement and applicable state law, the policy 
cash value is fully accessible by R and R's creditors but E has the 
right to borrow or withdraw at any time the portion of the policy 
cash value exceeding the lesser of 80 percent of the aggregate 
premiums paid by R or the policy cash value of the contract.
    (ii) Commencing in year 7 (and in each subsequent year), E must 
include in gross income the economic benefits described in paragraph 
(d)(2)(ii) of this section as provided in this Example 4(ii) rather 
than as provided in Example 2(ii). Thus, in year 7 (and in each 
subsequent year) E must include in gross income under paragraph (d) 
of this section, the excess of the policy cash value over the lesser 
of 80 percent of the aggregate premiums paid by R or the policy cash 
value of the contract (to the extent E did not actually include such 
amounts in gross income for a prior taxable year). In addition, in 
year 7 (and each subsequent year) E must also include in gross 
income the value of the

[[Page 54351]]

economic benefits described in paragraph (d)(2)(i) of this section 
provided to E under the arrangement during in each such year.
    Example 5. (i) The facts are the same as in Example 3 except 
that in year 7, E is designated as the policy owner. At that time, 
E's rights to the contract are substantially vested as defined in 
Sec.  1.83-3(b).
    (ii) In year 7, R is treated as having made a transfer (within 
the meaning of paragraph (c)(3) of this section) of the life 
insurance contract to E. E must include in gross income the amount 
determined under paragraph (g)(1) of this section.
    (iii) After the transfer of the contract to E, E is the owner of 
the contract and any premium payments by R will be included in E's 
income under paragraph (b)(5) of this section and Sec.  1.61-
2(d)(2)(ii)(A) (unless R's payments are split-dollar loans as 
defined in Sec.  1.7872-15(b)(1)).
    Example 6. (i) In year 1, E and R enter into a split-dollar life 
insurance arrangement as defined in paragraph (b)(2) of this 
section. Under the arrangement, R is required to make annual premium 
payments of $10,000 and E is required to make annual premium 
payments of $500. In year 5, a $500 policy owner dividend payable to 
E is declared by the insurance company. E directs the insurance 
company to use the $500 as E's premium payment for year 5.
    (ii) For each year the arrangement is in effect, E must include 
in gross income the value of the economic benefits provided during 
the year, as required by paragraph (d)(2) of this section, over the 
$500 premium payments paid by E. In year 5, E must also include in 
gross income as compensation the excess, if any, of the $500 
distributed to E from the proceeds of the policy owner dividend over 
the amount determined under paragraph (e)(3)(ii) of this section.
    (iii) R must include in income the premiums paid by E during the 
years the split-dollar life insurance arrangement is in effect, 
including the $500 of the premium E paid in year 5 with proceeds of 
the policy owner dividend. R's investment in the contract is 
increased in an amount equal to the premiums paid by E, including 
the $500 of the premium paid by E in year 5 from the proceeds of the 
policy owner dividend. In year 5, R is treated as receiving a $500 
distribution under the contract, which is taxed pursuant to section 
72.
    Example 7. (i) The facts are the same as in Example 2 except 
that in year 10, E withdraws $100,000 from the cash value of the 
contract.
    (ii) In year 10, R is treated as receiving a $100,000 
distribution from the insurance company. This amount is treated as 
an amount received by R under the contract and taxed pursuant to 
section 72. This amount reduces R's investment in the contract under 
section 72(e). R is treated as paying the $100,000 to E as cash 
compensation, and E must include that amount in gross income less 
any amounts determined under paragraph (e)(3)(ii) of this section.
    Example 8. (i) The facts are the same as in Example 7 except E 
receives the proceeds of a $100,000 specified policy loan directly 
from the insurance company.
    (ii) The transfer of the proceeds of the specified policy loan 
to E is treated as a loan by the insurance company to R. Under the 
rules of section 72(e), the $100,000 loan is not included in R's 
income and does not reduce R's investment in the contract. R is 
treated as paying the $100,000 of loan proceeds to E as cash 
compensation. E must include that amount in gross income less any 
amounts determined under paragraph (e)(3)(ii) of this section.

    (i) [Reserved]
    (j) Effective date--(1) General rule--(i) In general. This section 
applies to any split-dollar life insurance arrangement (as defined in 
paragraph (b)(1) or (2) of this section) entered into after September 
17, 2003.
    (ii) Determination of when an arrangement is entered into. For 
purposes of paragraph (j) of this section, a split-dollar life 
insurance arrangement is entered into on the latest of the following 
dates:
    (A) The date on which the life insurance contract under the 
arrangement is issued;
    (B) The effective date of the life insurance contract under the 
arrangement;
    (C) The date on which the first premium on the life insurance 
contract under the arrangement is paid;
    (D) The date on which the parties to the arrangement enter into an 
agreement with regard to the policy; or
    (E) The date on which the arrangement satisfies the definition of a 
split-dollar life insurance arrangement (as defined in paragraph (b)(1) 
or (2) of this section).
    (2) Modified arrangements treated as new arrangements--(i) In 
general. For purposes of paragraph (j)(1) of this section, if an 
arrangement entered into on or before September 17, 2003 is materially 
modified after September 17, 2003, the arrangement is treated as a new 
arrangement entered into on the date of the modification.
    (ii) Non-material modifications. The following is a non-exclusive 
list of changes that are not material modifications under paragraph 
(j)(2)(i) of this section (either alone or in conjunction with other 
changes listed in paragraphs (j)(2)(ii)(A) through (I) of this 
section)--
    (A) A change solely in the mode of premium payment (for example, a 
change from monthly to quarterly premiums);
    (B) A change solely in the beneficiary of the life insurance 
contract, unless the beneficiary is a party to the arrangement;
    (C) A change solely in the interest rate payable under the life 
insurance contract on a policy loan;
    (D) A change solely necessary to preserve the status of the life 
insurance contract under section 7702;
    (E) A change solely to the ministerial provisions of the life 
insurance contract (for example, a change in the address to send 
payment);
    (F) A change made solely under the terms of any agreement (other 
than the life insurance contract) that is a part of the split-dollar 
life insurance arrangement if the change is non-discretionary by the 
parties and is made pursuant to a binding commitment (whether set forth 
in the agreement or otherwise) in effect on or before September 17, 
2003;
    (G) A change solely in the owner of the life insurance contract as 
a result of a transaction to which section 381(a) applies and in which 
substantially all of the former owner's assets are transferred to the 
new owner of the policy;
    (H) A change to the policy solely if such change is required by a 
court or a state insurance commissioner as a result of the insolvency 
of the insurance company that issued the policy; or
    (I) A change solely in the insurance company that administers the 
policy as a result of an assumption reinsurance transaction between the 
issuing insurance company and the new insurance company to which the 
owner and the non-owner were not a party.
    (iii) Delegation to Commissioner. The Commissioner, in revenue 
rulings, notices, and other guidance published in the Internal Revenue 
Bulletin, may provide additional guidance with respect to other 
modifications that are not material for purposes of paragraph (j)(2)(i) 
of this section. See Sec.  601.601(d)(2)(ii) of this chapter.

0
Par. 4. Section 1.83-1 is amended by:
0
1. Removing the second sentence of paragraph (a)(2).
0
2. Adding a sentence at the end of paragraph (a)(2).
    The addition reads as follows:


Sec.  1.83-1  Property transferred in connection with the performance 
of services.

    (a) * * *
    (2) Life insurance. * * * For the taxation of life insurance 
protection under a split-dollar life insurance arrangement (as defined 
in Sec.  1.61-22(b)(1) or (2)), see Sec.  1.61-22.
* * * * *

0
Par. 5. Section 1.83-3 is amended by:
0
1. Adding a sentence at the end of paragraph (a)(1).
0
2. Adding a sentence immediately prior to the last sentence in 
paragraph (e).
    The additions read as follows:


Sec.  1.83-3  Meaning and use of certain terms.

    (a) * * * (1) * * * For special rules applying to the transfer of a 
life

[[Page 54352]]

insurance contract (or an undivided interest therein) that is part of a 
split-dollar life insurance arrangement (as defined in Sec.  1.61-
22(b)(1) or (2)), see Sec.  1.61-22(g).
* * * * *
    (e) * * * Notwithstanding the previous sentence, in the case of a 
transfer of a life insurance contract, retirement income contract, 
endowment contract, or other contract providing life insurance 
protection, or any undivided interest therein, that is part of a split-
dollar life insurance arrangement (as defined in Sec.  1.61-22(b)(1) or 
(2)) that is entered into, or materially modified (within the meaning 
of Sec.  1.61-22(j)(2)), after September 17, 2003, the policy cash 
value and all other rights under such contract (including any 
supplemental agreements thereto and whether or not guaranteed), other 
than current life insurance protection, are treated as property for 
purposes of this section. * * *
* * * * *

0
Par. 6. Section 1.83-6 is amended as follows:
0
1. Redesignating paragraph (a)(5) as paragraph (a)(6).
0
2. Adding a new paragraph (a)(5).
    The addition reads as follows:


Sec.  1.83-6  Deduction by employer.

    (a) * * *
    (5) Transfer of life insurance contract (or an undivided interest 
therein)--(i) General rule. In the case of a transfer of a life 
insurance contract (or an undivided interest therein) described in 
Sec.  1.61-22(c)(3) in connection with the performance of services, a 
deduction is allowable under paragraph (a)(1) of this section to the 
person for whom the services were performed. The amount of the 
deduction, if allowable, is equal to the sum of the amount included as 
compensation in the gross income of the service provider under Sec.  
1.61-22(g)(1) and the amount determined under Sec.  1.61-22(g)(1)(ii).
    (ii) Effective date--(A) General rule--Paragraph (a)(5)(i) of this 
section applies to any split-dollar life insurance arrangement (as 
defined in Sec.  1.61-22(b)(1) or (2)) entered into after September 17, 
2003. For purposes of this paragraph (a)(5), an arrangement is entered 
into as determined under Sec.  1.61-22(j)(1)(ii).
    (B) Modified arrangements treated as new arrangements. If an 
arrangement entered into on or before September 17, 2003 is materially 
modified (within the meaning of Sec.  1.61-22(j)(2)) after September 
17, 2003, the arrangement is treated as a new arrangement entered into 
on the date of the modification.
* * * * *

0
Par. 7. In Sec.  1.301-1, paragraph (q) is added to read as follows:


Sec.  1.301-1  Rules applicable with respect to distributions of money 
and other property.

* * * * *
    (q) Split-dollar and other life insurance arrangements--(1) Split-
dollar life insurance arrangements--(i) Distribution of economic 
benefits. The provision by a corporation to its shareholder pursuant to 
a split-dollar life insurance arrangement, as defined in Sec.  1.61-
22(b)(1) or (2), of economic benefits described in Sec.  1.61-22(d) or 
of amounts described in Sec.  1.61-22(e) is treated as a distribution 
of property, the amount of which is determined under Sec.  1.61-22(d) 
and (e), respectively.
    (ii) Distribution of entire contract or undivided interest therein. 
A transfer (within the meaning of Sec.  1.61-22(c)(3)) of the ownership 
of a life insurance contract (or an undivided interest therein) that is 
part of a split-dollar life insurance arrangement is a distribution of 
property, the amount of which is determined pursuant to Sec.  1.61-
22(g)(1) and (2).
    (2) Other life insurance arrangements. A payment by a corporation 
on behalf of a shareholder of premiums on a life insurance contract or 
an undivided interest therein that is owned by the shareholder 
constitutes a distribution of property, even if such payment is not 
part of a split-dollar life insurance arrangement under Sec.  1.61-
22(b).
    (3) When distribution is made--(i) In general. Except as provided 
in paragraph (q)(3)(ii) of this section, paragraph (b) of this section 
shall apply to determine when a distribution described in paragraph 
(q)(1) or (2) of this section is taken into account by a shareholder.
    (ii) Exception. Notwithstanding paragraph (b) of this section, a 
distribution described in paragraph (q)(1)(ii) of this section shall be 
treated as made by a corporation to its shareholder at the time that 
the life insurance contract, or an undivided interest therein, is 
transferred (within the meaning of Sec.  1.61-22(c)(3)) to the 
shareholder.
    (4) Effective date--(i) General rule. This paragraph (q) applies to 
split-dollar and other life insurance arrangements entered into after 
September 17, 2003. For purposes of this paragraph (q)(4), a split-
dollar life insurance arrangement is entered into as determined under 
Sec.  1.61-22(j)(1)(ii).
    (ii) Modified arrangements treated as new arrangements. If a split-
dollar life insurance arrangement entered into on or before September 
17, 2003 is materially modified (within the meaning of Sec.  1.61-
22(j)(2)) after September 17, 2003, the arrangement is treated as a new 
arrangement entered into on the date of the modification.

0
Par. 8. Section 1.1402(a)-18 is added to read as follows:


Sec.  1.1402(a)-18  Split-dollar life insurance arrangements.

    See Sec. Sec.  1.61-22 and 1.7872-15 for rules relating to the 
treatment of split-dollar life insurance arrangements.
0
Par. 9. Section 1.7872-15 is added to read as follows:


Sec.  1.7872-15  Split-dollar loans.

    (a) General rules--(1) Introduction. This section applies to split-
dollar loans as defined in paragraph (b)(1) of this section. If a 
split-dollar loan is not a below-market loan, then, except as provided 
in this section, the loan is governed by the general rules for debt 
instruments (including the rules for original issue discount (OID) 
under sections 1271 through 1275 and the regulations thereunder). If a 
split-dollar loan is a below-market loan, then, except as provided in 
this section, the loan is governed by section 7872. The timing, amount, 
and characterization of the imputed transfers between the lender and 
borrower of a below-market split-dollar loan depend upon the 
relationship between the parties and upon whether the loan is a demand 
loan or a term loan. For additional rules relating to the treatment of 
split-dollar life insurance arrangements, see Sec.  1.61-22.
    (2) Loan treatment--(i) General rule. A payment made pursuant to a 
split-dollar life insurance arrangement is treated as a loan for 
Federal tax purposes, and the owner and non-owner are treated, 
respectively, as the borrower and the lender, if--
    (A) The payment is made either directly or indirectly by the non-
owner to the owner (including a premium payment made by the non-owner 
directly or indirectly to the insurance company with respect to the 
policy held by the owner);
    (B) The payment is a loan under general principles of Federal tax 
law or, if it is not a loan under general principles of Federal tax law 
(for example, because of the nonrecourse nature of the obligation or 
otherwise), a reasonable person nevertheless would expect the payment 
to be repaid in full to the non-owner (whether with or without 
interest); and
    (C) The repayment is to be made from, or is secured by, the 
policy's death

[[Page 54353]]

benefit proceeds, the policy's cash surrender value, or both.
    (ii) Payments that are only partially repayable. For purposes of 
Sec.  1.61-22 and this section, if a non-owner makes a payment pursuant 
to a split-dollar life insurance arrangement and the non-owner is 
entitled to repayment of some but not all of the payment, the payment 
is treated as two payments: One that is repayable and one that is not. 
Thus, paragraph (a)(2)(i) of this section refers to the repayable 
payment.
    (iii) Treatment of payments that are not split-dollar loans. See 
Sec.  1.61-22(b)(5) for the treatment of payments by a non-owner that 
are not split-dollar loans.
    (iv) Examples. The provisions of this paragraph (a)(2) are 
illustrated by the following examples:

    Example 1. Assume an employee owns a life insurance policy under 
a split-dollar life insurance arrangement, the employer makes 
premium payments on this policy, there is a reasonable expectation 
that the payments will be repaid, and the repayments are secured by 
the policy. Under paragraph (a)(2)(i) of this section, each premium 
payment is a loan for Federal tax purposes.
    Example 2. (i) Assume an employee owns a life insurance policy 
under a split-dollar life insurance arrangement and the employer 
makes premium payments on this policy. The employer is entitled to 
be repaid 80 percent of each premium payment, and the repayments are 
secured by the policy. Under paragraph (a)(2)(ii) of this section, 
the taxation of 20 percent of each premium payment is governed by 
Sec.  1.61-22(b)(5). If there is a reasonable expectation that the 
remaining 80 percent of a payment will be repaid in full, then, 
under paragraph (a)(2)(i) of this section, the 80 percent is a loan 
for Federal tax purposes.
    (ii) If less than 80 percent of a premium payment is reasonably 
expected to be repaid, then this paragraph (a)(2) does not cause any 
of the payment to be a loan for Federal tax purposes. If the payment 
is not a loan under general principles of Federal tax law, the 
taxation of the entire premium payment is governed by Sec.  1.61-
22(b)(5).

    (3) No de minimis exceptions. For purposes of this section, section 
7872 is applied to a split-dollar loan without regard to the de minimis 
exceptions in section 7872(c)(2) and (3).
    (4) Certain interest provisions disregarded--(i) In general. If a 
split-dollar loan provides for the payment of interest and all or a 
portion of the interest is to be paid directly or indirectly by the 
lender (or a person related to the lender), then the requirement to pay 
the interest (or portion thereof) is disregarded for purposes of this 
section. All of the facts and circumstances determine whether a payment 
to be made by the lender (or a person related to the lender) is 
sufficiently independent from the split-dollar loan for the payment to 
not be an indirect payment of the interest (or a portion thereof) by 
the lender (or a person related to the lender).
    (ii) Examples. The provisions of this paragraph (a)(4) are 
illustrated by the following examples:

    Example 1-- (i) On January 1, 2009, Employee B issues a split-
dollar term loan to Employer Y. The split-dollar term loan provides 
for five percent interest, compounded annually. Interest and 
principal on the split-dollar term loan are due at maturity. On 
January 1, 2009, B and Y also enter into a fully vested non-
qualified deferred compensation arrangement that will provide a 
payment to B in an amount equal to the accrued but unpaid interest 
due at the maturity of the split-dollar term loan.
    (ii) Under paragraph (a)(4)(i) of this section, B's requirement 
to pay interest on the split-dollar term loan is disregarded for 
purposes of this section, and the split-dollar term loan is treated 
as a loan that does not provide for interest for purposes of this 
section.
    Example 2-- (i) On January 1, 2004, Employee B and Employer Y 
enter into a fully vested non-qualified deferred compensation 
arrangement that will provide a payment to B equal to B's salary in 
the three years preceding the retirement of B. On January 1, 2009, B 
and Y enter into a split-dollar life insurance arrangement and, 
under the arrangement, B issues a split-dollar term loan to Y on 
that date. The split-dollar term loan provides for five percent 
interest, compounded annually. Interest and principal on the split-
dollar term loan are due at maturity. Over the period in which the 
non-qualified deferred compensation arrangement is effective, the 
terms and conditions of B's non-qualified deferred compensation 
arrangement do not change in a way that indicates that the payment 
of the non-qualified deferred compensation is related to B's 
requirement to pay interest on the split-dollar term loan. No other 
facts and circumstances exist to indicate that the payment of the 
non-qualified deferred compensation is related to B's requirement to 
pay interest on the split-dollar term loan.
    (ii) The facts and circumstances indicate that the payment by Y 
of non-qualified deferred compensation is independent from B's 
requirement to pay interest under the split-dollar term loan. Under 
paragraph (a)(4)(i) of this section, the fully vested non-qualified 
deferred compensation does not cause B's requirement to pay interest 
on the split-dollar term loan to be disregarded for purposes of this 
section. For purposes of this section, the split-dollar term loan is 
treated as a loan that provides for stated interest of five percent, 
compounded annually.

    (b) Definitions. For purposes of this section, the terms split-
dollar life insurance arrangement, owner, and non-owner have the same 
meanings as provided in Sec.  1.61-22(b) and (c). In addition, the 
following definitions apply for purposes of this section:
    (1) A split-dollar loan is a loan described in paragraph (a)(2)(i) 
of this section.
    (2) A split-dollar demand loan is any split-dollar loan that is 
payable in full at any time on the demand of the lender (or within a 
reasonable time after the lender's demand).
    (3) A split-dollar term loan is any split-dollar loan other than a 
split-dollar demand loan. See paragraph (e)(5) of this section for 
special rules regarding certain split-dollar term loans payable on the 
death of an individual, certain split-dollar term loans conditioned on 
the future performance of substantial services by an individual, and 
gift split-dollar term loans.
    (c) Interest deductions for split-dollar loans. The borrower may 
not deduct any qualified stated interest, OID, or imputed interest on a 
split-dollar loan. See sections 163(h) and 264(a). In certain 
circumstances, an indirect participant may be allowed to deduct 
qualified stated interest, OID, or imputed interest on a deemed loan. 
See paragraph (e)(2)(iii) of this section (relating to indirect loans).
    (d) Treatment of split-dollar loans providing for nonrecourse 
payments--(1) In general. Except as provided in paragraph (d)(2) of 
this section, if a payment on a split-dollar loan is nonrecourse to the 
borrower, the payment is a contingent payment for purposes of this 
section. See paragraph (j) of this section for the treatment of a 
split-dollar loan that provides for one or more contingent payments.
    (2) Exception for certain loans with respect to which the parties 
to the split-dollar life insurance arrangement make a representation--
(i) Requirement. An otherwise noncontingent payment on a split-dollar 
loan that is nonrecourse to the borrower is not a contingent payment 
under this section if the parties to the split-dollar life insurance 
arrangement represent in writing that a reasonable person would expect 
that all payments under the loan will be made.
    (ii) Time and manner for providing written representation. The 
Commissioner may prescribe the time and manner for providing the 
written representation required by paragraph (d)(2)(i) of this section. 
Until the Commissioner prescribes otherwise, the written representation 
that is required by paragraph (d)(2)(i) of this section must meet the 
requirements of this paragraph (d)(2)(ii). Both the borrower and the 
lender must sign the representation not later than the last day 
(including extensions) for filing the Federal income tax return of the 
borrower or lender, whichever is earlier, for the taxable year in which 
the lender

[[Page 54354]]

makes the first split-dollar loan under the split-dollar life insurance 
arrangement. This representation must include the names, addresses, and 
taxpayer identification numbers of the borrower, lender, and any 
indirect participants. Unless otherwise stated therein, this 
representation applies to all subsequent split-dollar loans made 
pursuant to the split-dollar life insurance arrangement. Each party 
should retain an original of the representation as part of its books 
and records and should attach a copy of this representation to its 
Federal income tax return for any taxable year in which the lender 
makes a loan to which the representation applies.
    (e) Below-market split-dollar loans--(1) Scope--(i) In general. 
This paragraph (e) applies to below-market split-dollar loans 
enumerated under section 7872(c)(1), which include gift loans, 
compensation-related loans, and corporation-shareholder loans. The 
characterization of a split-dollar loan under section 7872(c)(1) and of 
the imputed transfers under section 7872(a)(1) and (b)(1) depends upon 
the relationship between the lender and the borrower or the lender, 
borrower, and any indirect participant. For example, if the lender is 
the borrower's employer, the split-dollar loan is generally a 
compensation-related loan, and any imputed transfer from the lender to 
the borrower is generally a payment of compensation. The loans covered 
by this paragraph (e) include indirect loans between the parties. See 
paragraph (e)(2) of this section for the treatment of certain indirect 
split-dollar loans. See paragraph (f) of this section for the treatment 
of any stated interest or OID on split-dollar loans. See paragraph (j) 
of this section for additional rules that apply to a split-dollar loan 
that provides for one or more contingent payments.
    (ii) Significant-effect split-dollar loans. If a direct or indirect 
below-market split-dollar loan is not enumerated in section 
7872(c)(1)(A), (B), or (C), the loan is a significant-effect loan under 
section 7872(c)(1)(E).
    (2) Indirect split-dollar loans--(i) In general. If, based on all 
the facts and circumstances, including the relationship between the 
borrower or lender and some third person (the indirect participant), 
the effect of a below-market split-dollar loan is to transfer value 
from the lender to the indirect participant and from the indirect 
participant to the borrower, then the below-market split-dollar loan is 
restructured as two or more successive below-market loans (the deemed 
loans) as provided in this paragraph (e)(2). The transfers of value 
described in the preceding sentence include (but are not limited to) a 
gift, compensation, a capital contribution, and a distribution under 
section 301 (or, in the case of an S corporation, under section 1368). 
The deemed loans are--
    (A) A deemed below-market split-dollar loan made by the lender to 
the indirect participant; and
    (B) A deemed below-market split-dollar loan made by the indirect 
participant to the borrower.
    (ii) Application. Each deemed loan is treated as having the same 
provisions as the original loan between the lender and borrower, and 
section 7872 is applied to each deemed loan. Thus, for example, if, 
under a split-dollar life insurance arrangement, an employer (lender) 
makes an interest-free split-dollar loan to an employee's child 
(borrower), the loan is restructured as a deemed compensation-related 
below-market split-dollar loan from the lender to the employee (the 
indirect participant) and a second deemed gift below-market split-
dollar loan from the employee to the employee's child. In appropriate 
circumstances, section 7872(d)(1) may limit the interest that accrues 
on a deemed loan for Federal income tax purposes. For loan arrangements 
between husband and wife, see section 7872(f)(7).
    (iii) Limitations on investment interest for purposes of section 
163(d). For purposes of section 163(d), the imputed interest from the 
indirect participant to the lender that is taken into account by the 
indirect participant under this paragraph (e)(2) is not investment 
interest to the extent of the excess, if any, of--
    (A) The imputed interest from the indirect participant to the 
lender that is taken into account by the indirect participant; over
    (B) The imputed interest to the indirect participant from the 
borrower that is recognized by the indirect participant.
    (iv) Examples. The provisions of this paragraph (e)(2) are 
illustrated by the following examples:

    Example 1. (i) On January 1, 2009, Employer X and Individual A 
enter into a split-dollar life insurance arrangement under which A 
is named as the policy owner. A is the child of B, an employee of X. 
On January 1, 2009, X makes a $30,000 premium payment, repayable 
upon demand without interest. Repayment of the premium payment is 
fully recourse to A. The payment is a below-market split-dollar 
demand loan. A's net investment income for 2009 is $1,100, and there 
are no other outstanding loans between A and B. Assume that the 
blended annual rate for 2009 is 5 percent, compounded annually.
    (ii) Based on the relationships among the parties, the effect of 
the below-market split-dollar loan from X to A is to transfer value 
from X to B and then to transfer value from B to A. Under paragraph 
(e)(2) of this section, the below-market split-dollar loan from X to 
A is restructured as two deemed below-market split-dollar demand 
loans: a compensation-related below-market split-dollar loan between 
X and B and a gift below-market split-dollar loan between B and A. 
Each of the deemed loans has the same terms and conditions as the 
original loan.
    (iii) Under paragraph (e)(3) of this section, the amount of 
forgone interest deemed paid to B by A in 2009 is $1,500 ([$30,000 x 
0.05]--0). Under section 7872(d)(1), however, the amount of forgone 
interest deemed paid to B by A is limited to $1,100 (A's net 
investment income for the year). Under paragraph (e)(2)(iii) of this 
section, B's deduction under section 163(d) in 2009 for interest 
deemed paid on B's deemed loan from X is limited to $1,100 (the 
interest deemed received from A).

    Example 2. (i) The facts are the same as the facts in Example 1, 
except that T, an irrevocable life insurance trust established for 
the benefit of A (B's child), is named as the policy owner. T is not 
a grantor trust.
    (ii) Based on the relationships among the parties, the effect of 
the below-market split-dollar loan from X to T is to transfer value 
from X to B and then to transfer value from B to T. Under paragraph 
(e)(2) of this section, the below-market split-dollar loan from X to 
T is restructured as two deemed below-market split-dollar demand 
loans: a compensation-related below-market split-dollar loan between 
X and B and a gift below-market split-dollar loan between B and T. 
Each of the deemed loans has the same terms and conditions as the 
original loan.
    (iii) Under paragraph (e)(3) of this section, the amount of 
forgone interest deemed paid to B by T in 2009 is $1,500 ([$30,000 x 
0.05]--0). Section 7872(d)(1) does not apply because T is not an 
individual. The amount of forgone interest deemed paid to B by T is 
$1,500. Under paragraph (e)(2)(iii) of this section, B's deduction 
under section 163(d) in 2009 for interest deemed paid on B's deemed 
loan from X is $1,500 (the interest deemed received from T).

    (3) Split-dollar demand loans--(i) In general. This paragraph 
(e)(3) provides rules for testing split-dollar demand loans for 
sufficient interest, and, if the loans do not provide for sufficient 
interest, rules for the calculation and treatment of forgone interest 
on these loans. See paragraph (g) of this section for additional rules 
that apply to a split-dollar loan providing for certain variable rates 
of interest.
    (ii) Testing for sufficient interest. Each calendar year that a 
split-dollar demand loan is outstanding, the loan is tested to 
determine if the loan provides for sufficient interest. A split-dollar 
demand loan provides for sufficient interest for the calendar year if 
the rate (based on annual compounding) at

[[Page 54355]]

which interest accrues on the loan's adjusted issue price during the 
year is no lower than the blended annual rate for the year. (The 
Internal Revenue Service publishes the blended annual rate in the 
Internal Revenue Bulletin in July of each year (see Sec.  
601.601(d)(2)(ii) of this chapter).) If the loan does not provide for 
sufficient interest, the loan is a below-market split-dollar demand 
loan for that calendar year. See paragraph (e)(3)(iii) of this section 
to determine the amount and treatment of forgone interest for each 
calendar year the loan is below-market.
    (iii) Imputations--(A) Amount of forgone interest. For each 
calendar year, the amount of forgone interest on a split-dollar demand 
loan is treated as transferred by the lender to the borrower and as 
retransferred as interest by the borrower to the lender. This amount is 
the excess of--
    (1) The amount of interest that would have been payable on the loan 
for the calendar year if interest accrued on the loan's adjusted issue 
price at the blended annual rate (determined in paragraph (e)(3)(ii) of 
this section) and were payable annually on the day referred to in 
paragraph (e)(3)(iii)(B) of this section; over
    (2) Any interest that accrues on the loan during the year.
    (B) Timing of transfers of forgone interest--(1) In general. Except 
as provided in paragraphs (e)(3)(iii)(B)(2) and (3) of this section, 
the forgone interest (as determined under paragraph (e)(3)(iii)(A) of 
this section) that is attributable to a calendar year is treated as 
transferred by the lender to the borrower (and retransferred as 
interest by the borrower to the lender) on the last day of the calendar 
year and is accounted for by each party to the split-dollar loan in a 
manner consistent with that party's method of accounting.
    (2) Exception for death, liquidation, or termination of the 
borrower. In the taxable year in which the borrower dies (in the case 
of a borrower who is a natural person) or is liquidated or otherwise 
terminated (in the case of a borrower other than a natural person), any 
forgone interest is treated, for both the lender and the borrower, as 
transferred and retransferred on the last day of the borrower's final 
taxable year.
    (3) Exception for repayment of below-market split-dollar loan. Any 
forgone interest is treated, for both the lender and the borrower, as 
transferred and retransferred on the day the split-dollar loan is 
repaid in full.
    (4) Split-dollar term loans--(i) In general. Except as provided in 
paragraph (e)(5) of this section, this paragraph (e)(4) provides rules 
for testing split-dollar term loans for sufficient interest and, if the 
loans do not provide for sufficient interest, rules for imputing 
payments on these loans. See paragraph (g) of this section for 
additional rules that apply to a split-dollar loan providing for 
certain variable rates of interest.
    (ii) Testing a split-dollar term loan for sufficient interest. A 
split-dollar term loan is tested on the day the loan is made to 
determine if the loan provides for sufficient interest. A split-dollar 
term loan provides for sufficient interest if the imputed loan amount 
equals or exceeds the amount loaned. The imputed loan amount is the 
present value of all payments due under the loan, determined as of the 
date the loan is made, using a discount rate equal to the AFR in effect 
on that date. The AFR used for purposes of the preceding sentence must 
be appropriate for the loan's term (short-term, mid-term, or long-term) 
and for the compounding period used in computing the present value. See 
section 1274(d)(1). If the split-dollar loan does not provide for 
sufficient interest, the loan is a below-market split-dollar term loan 
subject to paragraph (e)(4)(iv) of this section.
    (iii) Determining loan term. This paragraph (e)(4)(iii) provides 
rules to determine the term of a split-dollar term loan for purposes of 
paragraph (e)(4)(ii) of this section. The term of the loan determined 
under this paragraph (e)(4)(iii) (other than paragraph (e)(4)(iii)(C) 
of this section) applies to determine the split-dollar loan's term, 
payment schedule, and yield for all purposes of this section.
    (A) In general. Except as provided in paragraph (e)(4)(iii)(B), 
(C), (D) or (E) of this section, the term of a split-dollar term loan 
is based on the period from the date the loan is made until the loan's 
stated maturity date.
    (B) Special rules for certain options--(1) Payment schedule that 
minimizes yield. If a split-dollar term loan is subject to one or more 
unconditional options that are exercisable at one or more times during 
the term of the loan and that, if exercised, require payments to be 
made on the split-dollar loan on an alternative payment schedule (for 
example, an option to extend or an option to call a split-dollar loan), 
then the rules of this paragraph (e)(4)(iii)(B)(1) determine the term 
of the loan. However, this paragraph (e)(4)(iii)(B)(1) applies only if 
the timing and amounts of the payments that comprise each payment 
schedule are known as of the issue date. For purposes of determining a 
split-dollar loan's term, the borrower is projected to exercise or not 
exercise an option or combination of options in a manner that minimizes 
the loan's overall yield. Similarly, the lender is projected to 
exercise or not exercise an option or combination of options in a 
manner that minimizes the loan's overall yield. If different projected 
patterns of exercise or non-exercise produce the same minimum yield, 
the parties are projected to exercise or not exercise an option or 
combination of options in a manner that produces the longest term.
    (2) Change in circumstances. If the borrower (or lender) does or 
does not exercise the option as projected under paragraph 
(e)(4)(iii)(B)(1) of this section, the split-dollar loan is treated for 
purposes of this section as retired and reissued on the date the option 
is or is not exercised for an amount of cash equal to the loan's 
adjusted issue price on that date. The reissued loan must be retested 
using the appropriate AFR in effect on the date of reissuance to 
determine whether it is a below-market loan.
    (3) Examples. The following examples illustrate the rules of this 
paragraph (e)(4)(iii)(B):

    Example 1. Employee B issues a 10-year split-dollar term loan to 
Employer Y. B has the right to prepay the loan at the end of year 5. 
Interest is payable on the split-dollar loan at 1 percent for the 
first 5 years and at 10 percent for the remaining 5 years. Under 
paragraph (e)(4)(iii)(B)(1) of this section, this arrangement is 
treated as a 5-year split-dollar term loan from Y to B, with 
interest payable at 1 percent.
    Example 2. The facts are the same as the facts in Example 1, 
except that B does not in fact prepay the split-dollar loan at the 
end of year 5. Under paragraph (e)(4)(iii)(B)(2) of this section, 
the first loan is treated as retired at the end of year 5 and a new 
5-year split-dollar term loan is issued at that time, with interest 
payable at 10 percent.
    Example 3. Employee A issues a 10-year split-dollar term loan on 
which the lender, Employer X, has the right to demand payment at the 
end of year 2. Interest is payable on the split-dollar loan at 7 
percent each year that the loan is outstanding. Under paragraph 
(e)(4)(iii)(B)(1) of this section, this arrangement is treated as a 
10-year split-dollar term loan because the exercise of X's put 
option would not reduce the yield of the loan (the yield of the loan 
is 7 percent, compounded annually, whether or not X demands 
payment).

    (C) Split-dollar term loans providing for certain variable rates of 
interest. If a split-dollar term loan is subject to paragraph (g) of 
this section (a split-dollar loan that provides for certain variable 
rates of interest), the term of the loan for purposes of paragraph 
(e)(4)(ii) of this section is determined under paragraph (g)(3)(ii) of 
this section.
    (D) Split-dollar loans payable upon the death of an individual. If 
a split-

[[Page 54356]]

dollar term loan is described in paragraph (e)(5)(ii)(A) or (v)(A) of 
this section, the term of the loan for purposes of paragraph (e)(4)(ii) 
of this section is determined under paragraph (e)(5)(ii)(C) or 
(v)(B)(2) of this section, whichever is applicable.
    (E) Split-dollar loans conditioned on the future performance of 
substantial services by an individual. If a split-dollar term loan is 
described in paragraph (e)(5)(iii)(A)(1) or (v)(A) of this section, the 
term of the loan for purposes of paragraph (e)(4)(ii) of this section 
is determined under paragraph (e)(5)(iii)(C) or (v)(B)(2) of this 
section, whichever is applicable.
    (iv) Timing and amount of imputed transfer in connection with 
below-market split-dollar term loans. If a split-dollar term loan is a 
below-market loan, then the rules applicable to below-market term loans 
under section 7872 apply. In general, the loan is recharacterized as 
consisting of two portions: an imputed loan amount (as defined in 
paragraph (e)(4)(ii) of this section) and an imputed transfer from the 
lender to the borrower. The imputed transfer occurs at the time the 
loan is made (for example, when the lender makes a premium payment on a 
life insurance policy) and is equal to the excess of the amount loaned 
over the imputed loan amount.
    (v) Amount treated as OID. In the case of any below-market split-
dollar term loan described in this paragraph (e)(4), for purposes of 
applying sections 1271 through 1275 and the regulations thereunder, the 
issue price of the loan is the amount determined under Sec.  1.1273-2, 
reduced by the amount of the imputed transfer described in paragraph 
(e)(4)(iv) of this section. Thus, the loan is generally treated as 
having OID in an amount equal to the amount of the imputed transfer 
described in paragraph (e)(4)(iv) of this section, in addition to any 
other OID on the loan (determined without regard to section 
7872(b)(2)(A) or this paragraph (e)(4)).
    (vi) Example. The provisions of this paragraph (e)(4) are 
illustrated by the following example:

    Example. (i) On July 1, 2009, Corporation Z and Shareholder A 
enter into a split-dollar life insurance arrangement under which A 
is named as the policy owner. On July 1, 2009, Z makes a $100,000 
premium payment, repayable without interest in 15 years. Repayment 
of the premium payment is fully recourse to A. The premium payment 
is a split-dollar term loan. Assume the long-term AFR (based on 
annual compounding) at the time the loan is made is 7 percent.
    (ii) Based on a 15-year term and a discount rate of 7 percent, 
compounded annually (the long-term AFR), the present value of the 
payments under the loan is $36,244.60, determined as follows: 
$100,000/[1+(0.07/1)] \15\. This loan is a below-market split-dollar 
term loan because the imputed loan amount of $36,244.60 (the present 
value of the amount required to be repaid to Z) is less than the 
amount loaned ($100,000).
    (iii) In accordance with section 7872(b)(1) and paragraph 
(e)(4)(iv) of this section, on the date that the loan is made, Z is 
treated as transferring to A $63,755.40 (the excess of $100,000 
(amount loaned) over $36,244.60 (imputed loan amount)). Under 
section 7872 and paragraph (e)(1)(i) of this section, Z is treated 
as making a section 301 distribution to A on July 1, 2009, of 
$63,755.40. Z must take into account as OID an amount equal to the 
imputed transfer. See Sec.  1.1272-1 for the treatment of OID.

    (5) Special rules for certain split-dollar term loans--(i) In 
general. This paragraph (e)(5) provides rules for split-dollar loans 
payable on the death of an individual, split-dollar loans conditioned 
on the future performance of substantial services by an individual, and 
gift term loans. These split-dollar loans are split-dollar term loans 
for purposes of determining whether the loan provides for sufficient 
interest. If, however, the loan is a below-market split-dollar loan, 
then, except as provided in paragraph (e)(5)(v) of this section, 
forgone interest is determined annually, similar to a demand loan, but 
using an AFR that is appropriate for the loan's term and that is 
determined when the loan is issued.
    (ii) Split-dollar loans payable not later than the death of an 
individual--(A) Applicability. This paragraph (e)(5)(ii) applies to a 
split-dollar term loan payable not later than the death of an 
individual.
    (B) Treatment of loan. A split-dollar loan described in paragraph 
(e)(5)(ii)(A) of this section is tested under paragraph (e)(4)(ii) of 
this section to determine if the loan provides for sufficient interest. 
If the loan provides for sufficient interest, then section 7872 does 
not apply to the loan, and the interest on the loan is taken into 
account under paragraph (f) of this section. If the loan does not 
provide for sufficient interest, then section 7872 applies to the loan, 
and the loan is treated as a below-market demand loan subject to 
paragraph (e)(3)(iii) of this section. For each year that the loan is 
outstanding, however, the rate used in the determination of forgone 
interest under paragraph (e)(3)(iii) of this section is not the blended 
annual rate but rather is the AFR (based on annual compounding) 
appropriate for the loan's term as of the month in which the loan is 
made. See paragraph (e)(5)(ii)(C) of this section to determine the 
loan's term.
    (C) Term of loan. For purposes of paragraph (e)(5)(ii)(B) of this 
section, the term of a split-dollar loan payable on the death of an 
individual (including the death of the last survivor of a group of 
individuals) is the individual's life expectancy as determined under 
the appropriate table in Sec.  1.72-9 on the day the loan is made. If a 
split-dollar loan is payable on the earlier of the individual's death 
or another term determined under paragraph (e)(4)(iii) of this section, 
the term of the loan is whichever term is shorter.
    (D) Retirement and reissuance of loan. If a split-dollar loan 
described in paragraph (e)(5)(ii)(A) of this section remains 
outstanding longer than the term determined under paragraph 
(e)(5)(ii)(C) of this section because the individual outlived his or 
her life expectancy, the split-dollar loan is treated for purposes of 
this section as retired and reissued as a split-dollar demand loan at 
that time for an amount of cash equal to the loan's adjusted issue 
price on that date. However, the loan is not retested at that time to 
determine whether the loan provides for sufficient interest. For 
purposes of determining forgone interest under paragraph (e)(5)(ii)(B) 
of this section, the appropriate AFR for the reissued loan is the AFR 
determined under paragraph (e)(5)(ii)(B) of this section on the day the 
loan was originally made.
    (iii) Split-dollar loans conditioned on the future performance of 
substantial services by an individual--(A) Applicability--(1) In 
general. This paragraph (e)(5)(iii) applies to a split-dollar term loan 
if the benefits of the interest arrangements of the loan are not 
transferable and are conditioned on the future performance of 
substantial services (within the meaning of section 83) by an 
individual.
    (2) Exception. Notwithstanding paragraph (e)(5)(iii)(A)(1) of this 
section, this paragraph (e)(5)(iii) does not apply to a split-dollar 
loan described in paragraph (e)(5)(v)(A) of this section (regarding a 
split-dollar loan that is payable on the later of a term certain and 
the date on which the condition to perform substantial future services 
by an individual ends).
    (B) Treatment of loan. A split-dollar loan described in paragraph 
(e)(5)(iii)(A)(1) of this section is tested under paragraph (e)(4)(ii) 
of this section to determine if the loan provides for sufficient 
interest. Except as provided in paragraph (e)(5)(iii)(D) of this 
section, if the loan provides for sufficient interest, then section 
7872 does not apply to the loan and the interest on the loan is taken 
into account under paragraph (f) of this section. If the loan does not

[[Page 54357]]

provide for sufficient interest, then section 7872 applies to the loan 
and the loan is treated as a below-market demand loan subject to 
paragraph (e)(3)(iii) of this section. For each year that the loan is 
outstanding, however, the rate used in the determination of forgone 
interest under paragraph (e)(3)(iii) of this section is not the blended 
annual rate but rather is the AFR (based on annual compounding) 
appropriate for the loan's term as of the month in which the loan is 
made. See paragraph (e)(5)(iii)(C) of this section to determine the 
loan's term.
    (C) Term of loan. The term of a split-dollar loan described in 
paragraph (e)(5)(iii)(A)(1) of this section is based on the period from 
the date the loan is made until the loan's stated maturity date. 
However, if a split-dollar loan described in paragraph 
(e)(5)(iii)(A)(1) of this section does not have a stated maturity date, 
the term of the loan is presumed to be seven years.
    (D) Retirement and reissuance of loan. If a split-dollar loan 
described in paragraph (e)(5)(iii)(A)(1) of this section remains 
outstanding longer than the term determined under paragraph 
(e)(5)(iii)(C) of this section because of the continued performance of 
substantial services, the split-dollar loan is treated for purposes of 
this section as retired and reissued as a split-dollar demand loan at 
that time for an amount of cash equal to the loan's adjusted issue 
price on that date. The loan is retested at that time to determine 
whether the loan provides for sufficient interest.
    (iv) Gift split-dollar term loans--(A) Applicability. This 
paragraph (e)(5)(iv) applies to gift split-dollar term loans.
    (B) Treatment of loan. A split-dollar loan described in paragraph 
(e)(5)(iv)(A) of this section is tested under paragraph (e)(4)(ii) of 
this section to determine if the loan provides for sufficient interest. 
If the loan provides for sufficient interest, then section 7872 does 
not apply to the loan and the interest on the loan is taken into 
account under paragraph (f) of this section. If the loan does not 
provide for sufficient interest, then section 7872 applies to the loan 
and the loan is treated as a below-market demand loan subject to 
paragraph (e)(3)(iii) of this section. For each year that the loan is 
outstanding, however, the rate used in the determination of forgone 
interest under paragraph (e)(3)(iii) of this section is not the blended 
annual rate but rather is the AFR (based on annual compounding) 
appropriate for the loan's term as of the month in which the loan is 
made. See paragraph (e)(5)(iv)(C) of this section to determine the 
loan's term.
    (C) Term of loan. For purposes of paragraph (e)(5)(iv)(B) of this 
section, the term of a gift split-dollar term loan is the term 
determined under paragraph (e)(4)(iii) of this section.
    (D) Limited application for gift split-dollar term loans. The rules 
of paragraph (e)(5)(iv)(B) of this section apply to a gift split-dollar 
term loan only for Federal income tax purposes. For purposes of Chapter 
12 of the Internal Revenue Code (relating to the gift tax), gift below-
market split-dollar term loans are treated as term loans under section 
7872(b) and paragraph (e)(4) of this section. See section 7872(d)(2).
    (v) Split-dollar loans payable on the later of a term certain and 
another specified date--(A) Applicability. This paragraph (e)(5)(v) 
applies to any split-dollar term loan payable upon the later of a term 
certain or--
    (1) The death of an individual; or
    (2) For a loan described in paragraph (e)(5)(iii)(A)(1) of this 
section, the date on which the condition to perform substantial future 
services by an individual ends.
    (B) Treatment of loan--(1) In general. A split-dollar loan 
described in paragraph (e)(5)(v)(A) of this section is a split-dollar 
term loan, subject to paragraph (e)(4) of this section.
    (2) Term of the loan. The term of a split-dollar loan described in 
paragraph (e)(5)(v)(A) of this section is the term certain.
    (3) Appropriate AFR. The appropriate AFR for a split-dollar loan 
described in paragraph (e)(5)(v)(A) of this section is based on a term 
of the longer of the term certain or the loan's expected term as 
determined under either paragraph (e)(5) (ii) or (iii) of this section, 
whichever is applicable.
    (C) Retirement and reissuance. If a split-dollar loan described in 
paragraph (e)(5)(v)(A) of this section remains outstanding longer than 
the term certain, the split-dollar loan is treated for purposes of this 
section as retired and reissued at the end of the term certain for an 
amount of cash equal to the loan's adjusted issue price on that date. 
The reissued loan is subject to paragraph (e)(5) (ii) or (iii) of this 
section, whichever is applicable. However, the loan is not retested at 
that time to determine whether the loan provides for sufficient 
interest. For purposes of paragraph (e)(3)(iii) of this section, the 
appropriate AFR for the reissued loan is the AFR determined under 
paragraph (e)(5)(v)(B)(3) of this section on the day the loan was 
originally made.
    (vi) Example. The provisions of this paragraph (e)(5) are 
illustrated by the following example:

    Example. (i) On January 1, 2009, Corporation Y and Shareholder 
B, a 65 year-old male, enter into a split-dollar life insurance 
arrangement under which B is named as the policy owner. On January 
1, 2009, Y makes a $100,000 premium payment, repayable, without 
interest, from the death benefits of the underlying contract upon 
B's death. The premium payment is a split-dollar term loan. 
Repayment of the premium payment is fully recourse to B. Assume the 
long-term AFR (based on annual compounding) at the time of the loan 
is 7 percent. Both Y and B use the calendar year as their taxable 
years.
    (ii) Based on Table 1 in Sec.  1.72-9, the expected term of the 
loan is 15 years. Under paragraph (e)(5)(ii)(C) of this section, the 
long-term AFR (based on annual compounding) is the appropriate test 
rate. Based on a 15-year term and a discount rate of 7 percent, 
compounded annually (the long-term AFR), the present value of the 
payments under the loan is $36,244.60, determined as follows: 
$100,000/[1+(0.07/1)]\15\. Under paragraph (e)(5)(ii)(B) of this 
section, this loan is a below-market split-dollar term loan because 
the imputed loan amount of $36,244.60 (the present value of the 
amount required to be repaid to Y) is less than the amount loaned 
($100,000).
    (iii) Under paragraph (e)(5)(ii)(B) of this section, the amount 
of forgone interest for 2009 (and each subsequent full calendar year 
that the loan remains outstanding) is $7,000, which is the amount of 
interest that would have been payable on the loan for the calendar 
year if interest accrued on the loan's adjusted issue price 
($100,000) at the long-term AFR (7 percent, compounded annually). 
Under section 7872 and paragraph (e)(1)(i) of this section, on 
December 31, 2009, Y is treated as making a section 301 distribution 
to B of $7,000. In addition, Y has $7,000 of imputed interest income 
for 2009.

    (f) Treatment of stated interest and OID for split-dollar loans--
(1) In general. If a split-dollar loan provides for stated interest or 
OID, the loan is subject to this paragraph (f), regardless of whether 
the split-dollar loan has sufficient interest. Except as otherwise 
provided in this section, split-dollar loans are subject to the same 
Internal Revenue Code and regulatory provisions for stated interest and 
OID as other loans. For example, the lender of a split-dollar loan that 
provides for stated interest must account for any qualified stated 
interest (as defined in Sec.  1.1273-1(c)) under its regular method of 
accounting (for example, an accrual method or the cash receipts and 
disbursements method). See Sec.  1.446-2 to determine the amount of 
qualified stated interest that accrues during an accrual period. In 
addition, the lender must account under Sec.  1.1272-1 for any OID on a 
split-dollar loan. However,

[[Page 54358]]

Sec.  1.1272-1(c) does not apply to any split-dollar loan. See 
paragraph (h) of this section for a subsequent waiver, cancellation, or 
forgiveness of stated interest on a split-dollar loan.
    (2) Term, payment schedule, and yield. The term of a split-dollar 
term loan determined under paragraph (e)(4)(iii) of this section (other 
than paragraph (e)(4)(iii)(C) of this section) applies to determine the 
split-dollar loan's term, payment schedule, and yield for all purposes 
of this section.
    (g) Certain variable rates of interest--(1) In general. This 
paragraph (g) provides rules for a split-dollar loan that provides for 
certain variable rates of interest. If this paragraph (g) does not 
apply to a variable rate split-dollar loan, the loan is subject to the 
rules in paragraph (j) of this section for split-dollar loans that 
provide for one or more contingent payments.
    (2) Applicability--(i) In general. Except as provided in paragraph 
(g)(2)(ii) of this section, this paragraph (g) applies to a split-
dollar loan that is a variable rate debt instrument (within the meaning 
of Sec.  1.1275-5) and that provides for stated interest at a qualified 
floating rate (or rates).
    (ii) Interest rate restrictions. This paragraph (g) does not apply 
to a split-dollar loan if, as a result of interest rate restrictions 
(such as an interest rate cap), the expected yield of the loan taking 
the restrictions into account is significantly less than the expected 
yield of the loan without regard to the restrictions. Conversely, if 
reasonably symmetric interest rate caps and floors or reasonably 
symmetric governors are fixed throughout the term of the loan, these 
restrictions generally do not prevent this paragraph (g) from applying 
to the loan.
    (3) Testing for sufficient interest--(i) Demand loan. For purposes 
of paragraph (e)(3)(ii) of this section (regarding testing a split-
dollar demand loan for sufficient interest), a split-dollar demand loan 
is treated as if it provided for a fixed rate of interest for each 
accrual period to which a qualified floating rate applies. The 
projected fixed rate for each accrual period is the value of the 
qualified floating rate as of the beginning of the calendar year that 
contains the last day of the accrual period.
    (ii) Term loan. For purposes of paragraph (e)(4)(ii) of this 
section (regarding testing a split-dollar term loan for sufficient 
interest), a split-dollar term loan subject to this paragraph (g) is 
treated as if it provided for a fixed rate of interest for each accrual 
period to which a qualified floating rate applies. The projected fixed 
rate for each accrual period is the value of the qualified floating 
rate on the date the split-dollar term loan is made. The term of a 
split-dollar loan that is subject to this paragraph (g)(3)(ii) is 
determined using the rules in Sec.  1.1274-4(c)(2). For example, if the 
loan provides for interest at a qualified floating rate that adjusts at 
varying intervals, the term of the loan is determined by reference to 
the longest interval between interest adjustment dates. See paragraph 
(e)(5) of this section for special rules relating to certain split-
dollar term loans, such as a split-dollar term loan payable not later 
than the death of an individual.
    (4) Interest accruals and imputed transfers. For purposes of 
paragraphs (e) and (f) of this section, the projected fixed rate or 
rates determined under paragraph (g)(3) of this section are used for 
purposes of determining the accrual of interest each period and the 
amount of any imputed transfers. Appropriate adjustments are made to 
the interest accruals and any imputed transfers to take into account 
any difference between the projected fixed rate and the actual rate.
    (5) Example. The provisions of this paragraph (g) are illustrated 
by the following example:

     Example. (i) On January 1, 2010, Employer V and Employee F 
enter into a split-dollar life insurance arrangement under which F 
is named as the policy owner. On January 1, 2010, V makes a $100,000 
premium payment, repayable in 15 years. The premium payment is a 
split-dollar term loan. Under the arrangement between the parties, 
interest is payable on the split-dollar loan each year on January 1, 
starting January 1, 2011, at a rate equal to the value of 1-year 
LIBOR as of the payment date. The short-term AFR (based on annual 
compounding) at the time of the loan is 7 percent. Repayment of both 
the premium payment and the interest due thereon is nonrecourse to 
F. However, the parties made a representation under paragraph (d)(2) 
of this section. Assume that the value of 1-year LIBOR on January 1, 
2010, is 8 percent, compounded annually.
    (ii) The loan is subject to this paragraph (g) because the loan 
is a variable rate debt instrument that bears interest at a 
qualified floating rate. Because the interest rate is reset each 
year, under paragraph (g)(3)(ii) of this section, the short-term AFR 
(based on annual compounding) is the appropriate test rate used to 
determine whether the loan provides for sufficient interest. 
Moreover, under paragraph (g)(3)(ii) of this section, to determine 
whether the loan provides for sufficient interest, the loan is 
treated as if it provided for a fixed rate of interest equal to 8 
percent, compounded annually. Based on a discount rate of 7 percent, 
compounded annually (the short-term AFR), the present value of the 
payments under the loan is $109,107.91. The loan provides for 
sufficient interest because the loan's imputed loan amount of 
$109,107.91 (the present value of the payments) is more than the 
amount loaned of $100,000. Therefore, the loan is not a below-market 
split-dollar term loan, and interest on the loan is taken into 
account under paragraph (f) of this section.

    (h) Adjustments for interest paid at less than the stated rate--(1) 
Application--(i) In general. To the extent required by this paragraph 
(h), if accrued but unpaid interest on a split-dollar loan is 
subsequently waived, cancelled, or forgiven by the lender, then the 
waiver, cancellation, or forgiveness is treated as if, on that date, 
the interest had in fact been paid to the lender and retransferred by 
the lender to the borrower. The amount deemed transferred and 
retransferred is determined under paragraph (h) (2) or (3) of this 
section. Except as provided in paragraph (h)(1)(iv) of this section, 
the amount treated as retransferred by the lender to the borrower under 
paragraph (h) (2) or (3) of this section is increased by the deferral 
charge determined under paragraph (h)(4) of this section. To determine 
the character of any retransferred amount, see paragraph (e)(1)(i) of 
this section. See Sec.  1.61-22(b)(6) for the treatment of amounts 
other than interest on a split-dollar loan that are waived, cancelled, 
or forgiven by the lender.
    (ii) Certain split-dollar term loans. For purposes of this 
paragraph (h), a split-dollar term loan described in paragraph (e)(5) 
of this section (for example, a split-dollar term loan payable not 
later than the death of an individual) is subject to the rules of 
paragraph (h)(3) of this section.
    (iii) Payments treated as a waiver, cancellation, or forgiveness. 
For purposes of this paragraph (h), if a payment by the lender (or a 
person related to the lender) to the borrower is, in substance, a 
waiver, cancellation, or forgiveness of accrued but unpaid interest, 
the payment by the lender (or person related to the lender) is treated 
as an amount retransferred to the borrower by the lender under this 
paragraph (h) and is subject to the deferral charge in paragraph (h)(4) 
of this section to the extent that the payment is, in substance, a 
waiver, cancellation, or forgiveness of accrued but unpaid interest.
    (iv) Treatment of certain nonrecourse split-dollar loans. For 
purposes of this paragraph (h), if the parties to a split-dollar life 
insurance arrangement make the representation described in paragraph 
(d)(2) of this section and the interest actually paid on the split-
dollar loan is less than the interest required to be accrued on the 
split-dollar loan, the excess of the interest required to be accrued 
over the interest actually paid

[[Page 54359]]

is treated as waived, cancelled, or forgiven by the lender under this 
paragraph (h). However, the amount treated as retransferred under 
paragraph (h)(1)(i) of this section is not increased by the deferral 
charge in paragraph (h)(4) of this section.
    (2) Split-dollar term loans. In the case of a split-dollar term 
loan, the amount of interest deemed transferred and retransferred for 
purposes of paragraph (h)(1) of this section is determined as follows:
    (i) If the loan's stated rate is less than or equal to the 
appropriate AFR (the AFR used to test the loan for sufficient interest 
under paragraph (e) of this section), the amount of interest deemed 
transferred and retransferred pursuant to this paragraph (h) is the 
excess of the amount of interest payable at the stated rate over the 
interest actually paid.
    (ii) If the loan's stated rate is greater than the appropriate AFR 
(the AFR used to test the loan for sufficient interest under paragraph 
(e) of this section), the amount of interest deemed transferred and 
retransferred pursuant to this paragraph (h) is the excess, if any, of 
the amount of interest payable at the AFR over the interest actually 
paid.
    (3) Split-dollar demand loans. In the case of a split-dollar demand 
loan, the amount of interest deemed transferred and retransferred for 
purposes of paragraph (h)(1) of this section is equal to the aggregate 
of--
    (i) For each year that the split-dollar demand loan was outstanding 
in which the loan was a below-market split-dollar demand loan, the 
excess of the amount of interest payable at the stated rate over the 
interest actually paid allocable to that year; plus
    (ii) For each year that the split-dollar demand loan was 
outstanding in which the loan was not a below-market split-dollar 
demand loan, the excess, if any, of the amount of interest payable at 
the appropriate rate used for purposes of imputation for that year over 
the interest actually paid allocable to that year.
    (4) Deferral charge. The Commissioner may prescribe the method for 
determining the deferral charge treated as retransferred by the lender 
to the borrower under paragraph (h)(1) of this section. Until the 
Commissioner prescribes otherwise, the deferral charge is determined 
under paragraph (h)(4)(i) of this section for a split-dollar term loan 
subject to paragraph (h)(2) of this section and under paragraph 
(h)(4)(ii) of this section for a split-dollar demand loan subject to 
paragraph (h)(3) of this section.
    (i) Split-dollar term loan. The deferral charge for a split-dollar 
term loan subject to paragraph (h)(2) of this section is determined by 
multiplying the hypothetical underpayment by the applicable 
underpayment rate, compounded daily, for the period from the date the 
split-dollar loan was made to the date the interest is waived, 
cancelled, or forgiven. The hypothetical underpayment is equal to the 
amount determined under paragraph (h)(2) of this section, multiplied by 
the highest rate of income tax applicable to the borrower (for example, 
the highest rate in effect under section 1 for individuals) for the 
taxable year in which the split-dollar term loan was made. The 
applicable underpayment rate is the average of the quarterly 
underpayment rates in effect under section 6621(a)(2) for the period 
from the date the split-dollar loan was made to the date the interest 
is waived, cancelled, or forgiven.
    (ii) Split-dollar demand loan. The deferral charge for a split-
dollar demand loan subject to paragraph (h)(3) of this section is the 
sum of the following amounts determined for each year the loan was 
outstanding (other than the year in which the waiver, cancellation, or 
forgiveness occurs): For each year the loan was outstanding, multiply 
the hypothetical underpayment for the year by the applicable 
underpayment rate, compounded daily, for the applicable period. The 
hypothetical underpayment is equal to the amount determined under 
paragraph (h)(3) of this section for each year, multiplied by the 
highest rate of income tax applicable to the borrower for that year 
(for example, the highest rate in effect under section 1 for 
individuals). The applicable underpayment rate is the average of the 
quarterly underpayment rates in effect under section 6621(a)(2) for the 
applicable period. The applicable period for a year is the period of 
time from the last day of that year until the date the interest is 
waived, cancelled, or forgiven.
    (5) Examples. The provisions of this paragraph (h) are illustrated 
by the following examples:

    Example 1. (i) On January 1, 2009, Employer Y and Employee B 
entered into a split-dollar life insurance arrangement under which B 
is named as the policy owner. On January 1, 2009, Y made a $100,000 
premium payment, repayable on December 31, 2011, with interest of 5 
percent, compounded annually. The premium payment is a split-dollar 
term loan. Assume the short-term AFR (based on annual compounding) 
at the time the loan was made was 5 percent. Repayment of both the 
premium payment and the interest due thereon was fully recourse to 
B. On December 31, 2011, Y is repaid $100,000 but Y waives the 
remainder due on the loan ($15,762.50). Both Y and B use the 
calendar year as their taxable years.
    (ii) When the split-dollar term loan was made, the loan was not 
a below-market loan under paragraph (e)(4)(ii) of this section. 
Under paragraph (f) of this section, Y was required to accrue 
compound interest of 5 percent each year the loan remained 
outstanding. B, however, was not entitled to any deduction for this 
interest under paragraph (c) of this section.
    (iii) Under paragraph (h)(1) of this section, the waived amount 
is treated as if, on December 31, 2011, it had in fact been paid to 
Y and was then retransferred by Y to B. The amount deemed 
transferred to Y and retransferred to B equals the excess of the 
amount of interest payable at the stated rate ($15,762.50) over the 
interest actually paid ($0), or $15,762.50. In addition, the amount 
deemed retransferred to B is increased by the deferral charge 
determined under paragraph (h)(4) of this section. Because of the 
employment relationship between Y and B, the total retransferred 
amount is treated as compensation paid by Y to B.

    Example 2. (i) On January 1, 2009, Employer Y and Employee B 
entered into a split-dollar life insurance arrangement under which B 
is named as the policy owner. On January 1, 2009, Y made a $100,000 
premium payment, repayable on the demand of Y, with interest of 7 
percent, compounded annually. The premium payment is a split-dollar 
demand loan. Assume the blended annual rate (based on annual 
compounding) in 2009 was 5 percent and in 2010 was 6 percent. 
Repayment of both the premium payment and the interest due thereon 
was fully recourse to B. On December 31, 2010, Y demands repayment 
and is repaid its $100,000 premium payment in full; however, Y 
waives all interest due on the loan. Both Y and B use the calendar 
year as their taxable years.
    (ii) For each year that the split-dollar demand loan was 
outstanding, the loan was not a below-market loan under paragraph 
(e)(3)(ii) of this section. Under paragraph (f) of this section, Y 
was required to accrue compound interest of 7 percent each year the 
loan remained outstanding. B, however, was not entitled to any 
deduction for this interest under paragraph (c) of this section.
    (iii) Under paragraph (h)(1) of this section, a portion of the 
waived interest is treated as if, on December 31, 2010, it had in 
fact been paid to Y and was then retransferred by Y to B. The amount 
of interest deemed transferred to Y and retransferred to B equals 
the excess, if any, of the amount of interest payable at the blended 
annual rate for each year the loan is outstanding over the interest 
actually paid with respect to that year. For 2009, the interest 
payable at the blended annual rate is $5,000 ($100,000 x 0.05). For 
2010, the interest payable at the blended annual rate is $6,000 
($100,000 x 0.06). Therefore, the amount of interest deemed 
transferred to Y and retransferred to B equals $11,000. In addition, 
the amount deemed retransferred to B is increased by the deferral 
charge determined under paragraph (h)(4) of this section. Because of 
the employment relationship between Y and B, the total retransferred 
amount is treated as compensation paid by Y to B.

    (i) [Reserved]

[[Page 54360]]

    (j) Split-dollar loans that provide for contingent payments--(1) In 
general. Except as provided in paragraph (j)(2) of this section, this 
paragraph (j) provides rules for a split-dollar loan that provides for 
one or more contingent payments. This paragraph (j), rather than Sec.  
1.1275-4, applies to split-dollar loans that provide for one or more 
contingent payments.
    (2) Exceptions--(i) Certain contingencies. For purposes of this 
section, a split-dollar loan does not provide for contingent payments 
merely because--
    (A) The loan provides for options described in paragraph 
(e)(4)(iii)(B) of this section (for example, certain call options, put 
options, and options to extend); or
    (B) The loan is described in paragraph (e)(5) of this section 
(relating to certain split-dollar term loans, such as a split-dollar 
term loan payable not later than the death of an individual).
    (ii) Insolvency and default. For purposes of this section, a 
payment is not contingent merely because of the possibility of 
impairment by insolvency, default, or similar circumstances. However, 
if any payment on a split-dollar loan is nonrecourse to the borrower, 
the payment is a contingent payment for purposes of this paragraph (j) 
unless the parties to the arrangement make the written representation 
provided for in paragraph (d)(2) of this section.
    (iii) Remote and incidental contingencies. For purposes of this 
section, a payment is not a contingent payment merely because of a 
contingency that, as of the date the split-dollar loan is made, is 
either remote or incidental (within the meaning of Sec.  1.1275-2(h)).
    (iv) Exceptions for certain split-dollar loans. This paragraph (j) 
does not apply to a split-dollar loan described in Sec.  1.1272-1(d) 
(certain debt instruments that provide for a fixed yield) or a split-
dollar loan described in paragraph (g) of this section (relating to 
split-dollar loans providing for certain variable rates of interest).
    (3) Contingent split-dollar method--(i) In general. If a split-
dollar loan provides for one or more contingent payments, then the 
parties account for the loan under the contingent split-dollar method. 
In general, except as provided in this paragraph (j), this method is 
the same as the noncontingent bond method described in Sec.  1.1275-
4(b).
    (ii) Projected payment schedule--(A) Determination of schedule. No 
comparable yield is required to be determined. The projected payment 
schedule for the loan includes all noncontingent payments and a 
projected payment for each contingent payment. The projected payment 
for a contingent payment is the lowest possible value of the payment. 
The projected payment schedule, however, must produce a yield that is 
not less than zero. If the projected payment schedule produces a 
negative yield, the schedule must be reasonably adjusted to produce a 
yield of zero.
    (B) Split-dollar term loans payable upon the death of an 
individual. If a split-dollar term loan described in paragraph 
(e)(5)(ii)(A) or (v)(A)(1) of this section provides for one or more 
contingent payments, the projected payment schedule is determined based 
on the term of the loan as determined under paragraph (e)(5)(ii)(C) or 
(v)(B)(2) of this section, whichever is applicable.
    (C) Certain split-dollar term loans conditioned on the future 
performance of substantial services by an individual. If a split-dollar 
term loan described in paragraph (e)(5)(iii)(A)(1) or (v)(A)(2) of this 
section provides for one or more contingent payments, the projected 
payment schedule is determined based on the term of the loan as 
determined under paragraph (e)(5)(iii)(C) or (v)(B)(2) of this section, 
whichever is applicable.
    (D) Demand loans. If a split-dollar demand loan provides for one or 
more contingent payments, the projected payment schedule is determined 
based on a reasonable assumption as to when the lender will demand 
repayment.
    (E) Borrower/lender consistency. Contrary to Sec.  1.1275-
4(b)(4)(iv), the lender rather than the borrower is required to 
determine the projected payment schedule and to provide the schedule to 
the borrower and to any indirect participant as described in paragraph 
(e)(2) of this section. The lender's projected payment schedule is used 
by the lender, the borrower, and any indirect participant to compute 
interest accruals and adjustments.
    (iii) Negative adjustments. If the issuer of a split-dollar loan is 
not allowed to deduct interest or OID (for example, because of section 
163(h) or 264), then the issuer is not required to include in income 
any negative adjustment carryforward determined under Sec.  1.1275-
4(b)(6)(iii)(C) on the loan, except to the extent that at maturity the 
total payments made over the life of the loan are less than the issue 
price of the loan.
    (4) Application of section 7872--(i) Determination of below-market 
status. The yield based on the projected payment schedule determined 
under paragraph (j)(3) of this section is used to determine whether the 
loan is a below-market split-dollar loan under paragraph (e) of this 
section.
    (ii) Adjustment upon the resolution of a contingent payment. To the 
extent that interest has accrued under section 7872 on a split-dollar 
loan and the interest would not have accrued under this paragraph (j) 
in the absence of section 7872, the lender is not required to recognize 
income under Sec.  1.1275-4(b) for a positive adjustment and the 
borrower is not treated as having interest expense for a positive 
adjustment. To the same extent, there is a reversal of the tax 
consequences imposed under paragraph (e) of this section for the prior 
imputed transfer from the lender to the borrower. This reversal is 
taken into account in determining adjusted gross income.
    (5) Examples. The following examples illustrate the rules of this 
paragraph (j). For purposes of this paragraph (j)(5), assume that the 
contingent payments are neither remote nor incidental. The examples are 
as follows:

    Example 1. (i) On January 1, 2010, Employer T and Employee G 
enter into a split-dollar life insurance arrangement under which G 
is named as the policy owner. On January 1, 2010, T makes a $100,000 
premium payment. On December 31, 2013, T will be repaid an amount 
equal to the premium payment plus an amount based on the increase, 
if any, in the price of a specified commodity for the period the 
loan is outstanding. The premium payment is a split-dollar term 
loan. Repayment of both the premium payment and the interest due 
thereon is recourse to G. Assume that the appropriate AFR for this 
loan, based on annual compounding, is 7 percent. Both T and G use 
the calendar year as their taxable years.
    (ii) Under this paragraph (j), the split-dollar term loan 
between T and G provides for a contingent payment. Therefore, the 
loan is subject to the contingent split-dollar method. Under this 
method, the projected payment schedule for the loan provides for a 
noncontingent payment of $100,000 and a projected payment of $0 for 
the contingent payment (because it is the lowest possible value of 
the payment) on December 31, 2013.
    (iii) Based on the projected payment schedule and a discount 
rate of 7 percent, compounded annually (the appropriate AFR), the 
present value of the payments under the loan is $76,289.52. Under 
paragraphs (e)(4) and (j)(4)(i) of this section, the loan does not 
provide for sufficient interest because the loan's imputed loan 
amount of $76,289.52 (the present value of the payments) is less 
than the amount loaned of $100,000. Therefore, the loan is a below-
market split-dollar term loan and the loan is recharacterized as 
consisting of two portions: an imputed loan amount of $76,289.52 and 
an imputed transfer of $23,710.48 (amount loaned of $100,000 minus 
the imputed loan amount of $76,289.52).
    (iv) In accordance with section 7872(b)(1) and paragraph 
(e)(4)(iv) of this section, on the

[[Page 54361]]

date the loan is made, T is treated as transferring to G $23,710.48 
(the imputed transfer) as compensation. In addition, T must take 
into account as OID an amount equal to the imputed transfer. See 
Sec.  1.1272-1 for the treatment of OID.
    Example 2. (i) Assume, in addition to the facts in Example 1, 
that on December 31, 2013, T receives $115,000 (its premium payment 
of $100,000 plus $15,000).
    (ii) Under the contingent split-dollar method, when the loan is 
repaid, there is a $15,000 positive adjustment ($15,000 actual 
payment minus $0 projected payment). Under paragraph (j)(4) of this 
section, because T accrued imputed interest under section 7872 on 
this split-dollar loan to G and this interest would not have accrued 
in the absence of section 7872, T is not required to include the 
positive adjustment in income, and G is not treated as having 
interest expense for the positive adjustment. To the same extent, T 
must include in income, and G is entitled to deduct, $15,000 to 
reverse their respective prior tax consequences imposed under 
paragraph (e) of this section (T's prior deduction for imputed 
compensation deemed paid to G and G's prior inclusion of this 
amount). G takes the reversal into account in determining adjusted 
gross income. That is, the $15,000 is an ``above-the-line'' 
deduction, whether or not G itemizes deductions.
    Example 3. (i) Assume the same facts as in Example 2, except 
that on December 31, 2013, T receives $127,000 (its premium payment 
of $100,000 plus $27,000).
    (ii) Under the contingent split-dollar method, when the loan is 
repaid, there is a $27,000 positive adjustment ($27,000 actual 
payment minus $0 projected payment). Under paragraph (j)(4) of this 
section, because T accrued imputed interest of $23,710.48 under 
section 7872 on this split-dollar loan to G and this interest would 
not have accrued in the absence of section 7872, T is not required 
to include $23,710.48 of the positive adjustment in income, and G is 
not treated as having interest expense for the positive adjustment. 
To the same extent, in 2013, T must include in income, and G is 
entitled to deduct, $23,710.48 to reverse their respective prior tax 
consequences imposed under paragraph (e) of this section (T's prior 
deduction for imputed compensation deemed paid to G and G's prior 
inclusion of this amount). G and T take these reversals into account 
in determining adjusted gross income. Under the contingent split-
dollar method, T must include in income $3,289.52 upon resolution of 
the contingency ($27,000 positive adjustment minus $23,710.48).

    (k) Payment ordering rule. For purposes of this section, a payment 
made by the borrower to or for the benefit of the lender pursuant to a 
split-dollar life insurance arrangement is applied to all direct and 
indirect split-dollar loans in the following order--
    (1) A payment of interest to the extent of accrued but unpaid 
interest (including any OID) on all outstanding split-dollar loans in 
the order the interest accrued;
    (2) A payment of principal on the outstanding split-dollar loans in 
the order in which the loans were made;
    (3) A payment of amounts previously paid by a non-owner pursuant to 
a split-dollar life insurance arrangement that were not reasonably 
expected to be repaid by the owner; and
    (4) Any other payment with respect to a split-dollar life insurance 
arrangement, other than a payment taken into account under paragraphs 
(k)(1), (2), and (3) of this section.
    (l) [Reserved]
    (m) Repayments received by a lender. Any amount received by a 
lender under a life insurance contract that is part of a split-dollar 
life insurance arrangement is treated as though the amount had been 
paid to the borrower and then paid by the borrower to the lender. Any 
amount treated as received by the borrower under this paragraph (m) is 
subject to other provisions of the Internal Revenue Code as applicable 
(for example, sections 72 and 101(a)). The lender must take the amount 
into account as a payment received with respect to a split-dollar loan, 
in accordance with paragraph (k) of this section. No amount received by 
a lender with respect to a split-dollar loan is treated as an amount 
received by reason of the death of the insured.
    (n) Effective date--(1) General rule. This section applies to any 
split-dollar life insurance arrangement entered into after September 
17, 2003. For purposes of this section, an arrangement is entered into 
as determined under Sec.  1.61-22(j)(1)(ii).
    (2) Modified arrangements treated as new arrangements. If an 
arrangement entered into on or before September 17, 2003 is materially 
modified (within the meaning of Sec.  1.61-22(j)(2)) after September 
17, 2003, the arrangement is treated as a new arrangement entered into 
on the date of the modification.

PART 31--EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT SOURCE

0
Par. 10. The authority citation for part 31 continues to read in part 
as follows:

    Authority: 26 U.S.C. 7805. * * *

0
Par. 11. In Sec.  31.3121(a)-1, paragraph (k) is added to read as 
follows:


Sec.  31.3121(a)-1  Wages.

* * * * *
    (k) Split-dollar life insurance arrangements. Except as otherwise 
provided under section 3121(v), see Sec. Sec.  1.61-22 and 1.7872-15 of 
this chapter for rules relating to the treatment of split-dollar life 
insurance arrangements.
0
Par. 12. In Sec.  31.3231(e)-1, paragraph (a)(6) is added to read as 
follows:


Sec.  31.3231(e)-1  Compensation.

    (a) * * *
    (6) Split-dollar life insurance arrangements. See Sec. Sec.  1.61-
22 and 1.7872-15 of this chapter for rules relating to the treatment of 
split-dollar life insurance arrangements.
* * * * *
0
Par. 13. In Sec.  31.3306(b)-1, paragraph (l) is added to read as 
follows:


Sec.  31.3306(b)--1  Wages.

* * * * *
    (l) Split-dollar life insurance arrangements. Except as otherwise 
provided under section 3306(r), see Sec. Sec.  1.61-22 and 1.7872-15 of 
this chapter for rules relating to the treatment of split-dollar life 
insurance arrangements.
0
Par. 14. In Sec.  31.3401(a)-1, paragraph (b)(15) is added to read as 
follows:


Sec.  31.3401(a)-1  Wages.

* * * * *
    (b) * * *
    (15) Split-dollar life insurance arrangements. See Sec.  1.61-22 of 
this chapter for rules relating to the treatment of split-dollar life 
insurance arrangements.
* * * * *

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

0
Par. 15. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805. * * *

0
Par. 16. In section 602.101, paragraph (b) is amended by adding an 
entry in numerical order for Sec.  1.7872-15 to read as follows:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                            Current OMB
   CFR part or section where identified and described       control No.
------------------------------------------------------------------------
 
                                * * * * *
1.7872-15...............................................       1545-1792
 
                                * * * * *
------------------------------------------------------------------------


Robert E. Wenzel,
Deputy Commissioner for Services and Enforcement.
    Approved: September 11, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-23596 Filed 9-11-03; 4:13 pm]
BILLING CODE 4830-01-P