Split-Dollar Life Insurance for Tax-Exempt Entities

It has been a long time (2007) since I have written on split-dollar life insurance arrangements, as the use of this compensation vehicle has declined over the years. And I generally don’t write about compensation issues for tax-exempt organizations. However, I recently noticed a blog post, “Tax Reform Elevates Split Dollar Arrangements As Incentive Plan,” pointing to a likely resurgence in the use of split-dollar arrangements, at least by tax-exempt entities, in light of the 21 percent excise tax imposed on compensation in excess of $1 million by new Code Section 4960, added by the Tax Cuts and Jobs Act of 2017. Following is an excerpt from the blog:

Now the potential exists to use split dollar plans to mitigate the significant additional expense of the new 21 percent excise tax, making it even more favorable as a part of an executive compensation package. The remuneration subject to the new tax in Section 4960 includes deferred compensation benefits that are includible in income (some exceptions apply). Split dollar plans are considered loans pursuant to Section 7872 and, therefore, are not included in remuneration.

The most publicized plan is, of course, Jim Harbaugh’s arrangement with University of Michigan. In 2016, it was reported that his split dollar policy will receive six annual installments of $2M with an estimated $75M death benefit.

Including split dollar as a component of a compensation package provides benefits to the employer and employee. Employees benefit from a design providing tax free death benefit and future tax free income* with minimal out of pocket costs.

Universities, credit unions and other not for profit organizations benefit from incenting and motivating the employee to stay, flexibility and control over the plan design and funding depending on performance and best of all recovery of advanced contributions and loan interest—which is why we are increasingly seeing it used.

*under current tax law withdrawals and loans from life insurance can be received free of income tax