Rev. Rul. 79-50

ISSUE

Whether, for federal income tax purposes, a certain life insurance arrangement should be treated as a "split-dollar" arrangement similar to that described in Rev. Rul. 64-328, 1964-2 C.B. 11, as amplified by Rev. Rul. 66-110, 1966-1 C.B. 12, and Rev. Rul. 67-154, 1967-1 C.B. 11?

FACTS

A corporation entered into an arrangement with the taxpayer, one of its principal stockholders, to purchase a life insurance contract, in which there is a substantial investment element. Under the arrangement the corporation provides the funds to pay part of the annual premium to the extent of the increase in the cash surrender value each year. The taxpayer provides the balance, if any, of the premiums. The taxpayer is the owner of the policy. Upon death of the taxpayer, the corporation is entitled to receive, out of the proceeds of the policy, an amount equal to the cash surrender value of the policy, or at least an amount equal to the funds it provided for premium payments. The taxpayer has the right to name the beneficiary of the balance of the insurance proceeds.

LAW AND ANALYSIS

Section 61 of the Internal Revenue Code of 1954 provides that gross income means all income from whatever source derived. Section 1.61-1 of the Income Tax Regulations provides that gross income includes income realized in any form.

Section 301(a) of the Code provides that a distribution of any property made by a corporation to a shareholder with respect to its stock shall be treated as provided in section 301(c). Section 301(c) provides that the portion of the distribution that is a dividend shall be included in gross income.

Section 316(a) defines "dividend" as any distribution of property made by a corporation to its shareholders out of earnings and profits accumulated after February 28, 1913 or out of earnings and profits of the taxable year.

Under a typical "split-dollar" arrangement, an employer and an employee join in purchasing an insurance contract, in which there is a substantial investment element, on the life of the employee. Generally, the employer provides the funds to pay part of the annual premium to the extent of the increase in the cash surrender value each year, and the employee pays the balance of the annual premium. The employer is entitled to receive, out of the proceeds of the policy, an amount equal to the cash surrender value, or at least a part thereof sufficient to equal the funds it has provided for premium payments. The employee has the right to name the beneficiary of the balance of any proceeds payable by reason of the employee's death. Although the employee must pay a substantial part of the first premium, after the first year the employee's share of the premium decreases rapidly, and in some cases it even becomes zero after a relatively few years. The employee thus can obtain valuable insurance protection for many years (decreasing each year, but still substantial in amount) with a relatively small outlay for premiums in the early years, and at little or no cost to the employee in later years. The effect of the arrangement is that the earnings on the investment element, which at arm's length would go to the employer, are applied to provide current life insurance protection to the employee at either no cost to the employee or at a cost less than the employee would pay absent the arrangement. The employee receives an economic benefit represented by the amount of the annual premium cost that the employee is relieved of paying and would otherwise have to bear absent the arrangement.

Rev. Rul. 64-328 holds that when there is a "split-dollar" arrangement, in which the employer pays the portion of the premiums equal to the increases in the cash surrender value and the employee pays the balance, if any, of the premiums, and in which, from the proceeds payable upon the employee's death, the employer receives at least an amount equal to the funds it has provided, with the beneficiary receiving the balance, the value of the insurance protection in excess of the premiums paid by the employee must be included in the employee's income. Rev. Rul. 64-328 further states that the same income tax result follows if the transaction is cast in some other form that results in a similar benefit to the employee.

In the situation presented here, the arrangement between the corporation and the taxpayer arose from the corporation-shareholder relationship. The taxpayer is relieved by the corporation from paying premiums that the taxpayer would otherwise have to pay to carry the insurance policy in effect. Thus, the taxpayer is receiving an economic benefit under the arrangement. Although the owner of the policy, as well as the life insured, is a shareholder rather than an employee, the arrangement is similar to the type contemplated by Rev. Rul. 64-328. Here, the benefit flowing from the corporation to the taxpayer is a distribution within the meaning of section 301(a) of the Code made by the corporation to a shareholder with respect to its stock and must be treated in accordance with section 301(c). Section 301(c) provides that the portion of the distribution that is a dividend is included in gross income. Section 316 determines what part of a distribution is treated as a dividend.

HOLDING

The life insurance arrangement, as described herein, should be treated for federal income tax purposes as a corporate distribution from the corporation to its shareholder. The taxpayer must include in income the value of the insurance protection in excess of the premiums paid by the taxpayer, and treat this amount as provided in section 301(c) of the Code.