Questions a Financial Service Professional Should Ask When Proposing or Reviewing Split-Dollar Life Insurance Loans as Alternatives to Section 457(f) Deferred Compensation Plans
Split-dollar life insurance is enjoying a renewed interest from applicable tax-exempt organizations (ATEOs).
This is because ATEOs must now pay a 21 percent excise tax on compensation paid to covered employees in excess of $1 million. Covered employees include all those who have been classified at any time as the top five highest-earning employees. Compensation includes currently earned and paid as well as deferred compensation whose substantial risk of forfeiture no longer applies. This may not sound like something that would affect many tax-exempt organizations, yet because of the unique way covered employees must recognize deferred-compensation income, it has greatly increased the tax-exempt organizational motivation to find alternative reward programs for high earners. Split-dollar life insurance has been presented by many practitioners as a suitable alternative. The question financial service professionals should ask is, “Are their claims justified?”
The questions a financial service professional should then ask when proposing or reviewing split-dollar insurance loan agreements to or for ATEOs should include:
1. Have the parties executed a promissory note, or, in the case of a series of split-dollar loans, a series of promissory notes?
2. Are “monetary” repayments required pursuant to a specified repayment schedule?
3. Do pre- and post-transaction discussions indicate the intention of the parties to adhere to and comply with all interest and principal payments?
4. Does the employee provide adequate security for the loan or series of loans?
5. Does the lender have recourse against the borrower in the event the terms of the loan(s) are not fulfilled?