Revenue Ruling 79-55 and Split-Dollar Arrangements

Revenue Ruling 79-55 is a directive from the Internal Revenue Service that provides guidance on the tax treatment of a specific type of split-dollar life insurance arrangement. The ruling establishes that when a corporation provides life insurance protection to a shareholder under such a plan, the value of that protection is considered a taxable economic benefit. This benefit is treated for tax purposes as a dividend distribution from the corporation.

The Split-Dollar Arrangement Addressed

Revenue Ruling 79-55 addresses an arrangement involving a corporation and its principal shareholder. In this scenario, the corporation agrees to purchase a whole life insurance policy on the shareholder’s life. The corporation is responsible for paying a significant portion, or all, of the annual policy premiums.

The “split” in the arrangement refers to the division of policy rights and benefits. Upon the death of the insured shareholder, the corporation is entitled to receive a portion of the death benefit proceeds. This reimbursement is structured to be an amount equal to the total premiums the corporation has paid or the policy’s cash surrender value at the time of death. The cash surrender value represents the accumulated savings component within the whole life policy.

The remaining portion of the death benefit, which is the total payout minus the amount reimbursed to the corporation, is paid directly to the beneficiary designated by the shareholder. This structure allows the shareholder to provide a substantial life insurance benefit to their heirs, with the corporation effectively financing the underlying cost of the policy’s cash value growth.

Calculating the Taxable Economic Benefit

The life insurance protection provided to the shareholder is a quantifiable economic benefit that must be reported as income. The value of this benefit is not the full premium paid by the corporation, but the value of the pure death benefit protection the shareholder receives for the year. This is calculated by measuring the cost of one-year term insurance for the shareholder’s age.

Initially, Revenue Ruling 79-55 required that this value be calculated using the government’s “P.S. 58” rates. These were standardized rates published by the IRS to value such benefits but were later recognized as being high compared to the actual cost of term insurance.

In subsequent guidance, specifically Notice 2002-8, the IRS permitted the use of a new table, “Table 2001,” which features lower rates. To calculate the taxable amount, one would find the shareholder’s age, look up the corresponding rate per $1,000 of coverage in Table 2001, and multiply that rate by the net death benefit. For example, if a 50-year-old shareholder has a $1 million net death benefit, and the Table 2001 rate is $2.00 per thousand, the annual taxable economic benefit would be $2,000.

Tax Consequences for Shareholder and Corporation

The annual economic benefit has distinct tax consequences for both the shareholder and the corporation. For the shareholder-employee, this value is characterized as a dividend distribution. The shareholder must report the calculated amount as dividend income on their personal income tax return, Form 1040, and pay taxes on it at applicable dividend tax rates. It is not considered salary or wages, so it is not subject to payroll taxes.

From the corporation’s perspective, the premium payments it makes on the life insurance policy are not tax-deductible business expenses. The corporation is a beneficiary of the policy, which precludes a deduction under tax law. The economic benefit amount that the shareholder reports as a dividend cannot be deducted by the corporation as a compensation expense, as the payment is treated as a distribution of profits.

Current Applicability of the Ruling

The principles in Revenue Ruling 79-55 have been largely superseded for new arrangements. The IRS issued Revenue Ruling 2003-105, which declared the old ruling obsolete for any split-dollar life insurance arrangements entered into or materially modified after September 17, 2003. Consequently, its direct application is now limited to older, “grandfathered” plans.

For arrangements established after September 17, 2003, a more comprehensive set of final regulations applies. These new rules require split-dollar plans to be taxed under one of two distinct regimes: the “loan regime” or the “economic benefit regime.” Under the loan regime, the corporation’s premium payments are treated as loans to the shareholder, and imputed interest rules apply. Under the economic benefit regime, the policy is treated as being owned by the corporation, and the shareholder is taxed annually on the economic benefits they receive.

This shift in regulation means that while the historical context of Revenue Ruling 79-55 is important, its direct use is confined to a shrinking pool of legacy arrangements. Taxpayers with modern split-dollar plans must navigate the more complex framework established by the 2003 final regulations.