The IRS has issued a notice (Notice 2001-10) regarding the tax treatment of split-dollar life insurance arrangements. This notice clarifies prior rulings regarding split-dollar arrangements, provides taxpayers with interim guidance on the tax treatment of split-dollar arrangements pending publication of further guidance, and requests taxpayer comments on the interim guidance and on other unresolved issues. 

Notice 2001-10 primarily deals with arrangements between employers and employees, but the IRS believes the same principles generally govern the Federal tax treatment of split-dollar arrangements in other contexts, including arrangements that provide compensation to non-employees and economic benefits to corporate shareholders, and arrangements involving gifts.

In a traditional split-dollar life insurance arrangement, an employer and employee join in the purchase of a life insurance contract on the life of the employee. Typically, the employer is responsible for the portion of the annual premium equal to the annual increase in the cash surrender value (CSV), while the employee pays the balance of the premium, which frequently drops to nothing within the first few years. In return for paying its portion, the employer receives part of the policy's cash value at the employee's death or when the plan is terminated.

Prior to the recent Notice, the tax treatment of such arrangements was set forth in various Revenue Rulings. But these rulings did not deal with another type of split-dollar arrangement that has become increasingly popular in recent years and is known as an "equity split-dollar arrangement."

In an equity split-dollar arrangement, the amount of the employer's reimbursement is limited to no more than the amount of the premiums paid. Any excess CSV belongs to the employee, so he or she retains an "equity" interest.

Notice 2001-10 sets forth guidelines for the tax treatment of all types of split-dollar arrangements. In general, the IRS concludes that any payment made by an employer under a split-dollar arrangement must be accounted for:

1. As a loan,
2. As an investment in the contract for the employer's own account, or
3. As a payment of compensation.