What Is a 64/11 Split-Dollar Arrangement?

A split-dollar arrangement is a specialized financial strategy involving life insurance, primarily used by owners of closely-held businesses for estate planning. The arrangement’s name is derived from two Internal Revenue Service (IRS) publications: Revenue Ruling 64-328 and Notice 2002-8. For any arrangement established or significantly changed after September 17, 2003, the definitive rules are set by the Treasury Department’s Final Regulations.

The arrangement is most common among owners of S-corporations but is adaptable for other business structures. It allows a business to assist a key shareholder or employee in purchasing a substantial life insurance policy that might otherwise be unaffordable.

The Mechanics of a Split-Dollar Arrangement

Under the Final Regulations, the taxation of a split-dollar arrangement depends on who owns the life insurance policy. This creates two distinct regimes: the loan regime and the economic benefit regime. Generally, if the employee or their trust owns the policy, the arrangement is treated as a loan from the business. If the business owns the policy, it is typically taxed under the economic benefit regime.

However, a common estate planning structure creates an exception. In this model, an Irrevocable Life Insurance Trust (ILIT) established by the shareholder owns the policy. While this would normally place the arrangement under the loan regime, it can be structured to be taxed under the economic benefit regime. To qualify, the agreement must limit the ILIT’s interest to the pure death benefit, giving the trust no right to the policy’s cash value. The business pays the premiums and must be entitled to recover its premium payments from the policy proceeds.

This ownership structure is central to the arrangement’s estate planning goals. Because the ILIT is the owner and beneficiary of the policy, the proceeds are not considered part of the insured shareholder’s personal assets upon their death. This prevents the death benefit from being included in their gross estate, thereby shielding it from federal estate taxes.

Upon the insured shareholder’s death, the life insurance policy pays out a death benefit. The proceeds are divided according to the split-dollar agreement, with the remaining portion of the death benefit paid directly to the ILIT. The ILIT then distributes the funds to the shareholder’s heirs as specified in the trust documents.

Tax Implications for Involved Parties

Each party in a split-dollar arrangement faces distinct tax consequences. For the business, the premium payments it makes on the life insurance policy are not a deductible business expense. These payments are treated as an investment that the company is entitled to recover from the policy’s proceeds.

The shareholder must recognize taxable income each year the arrangement is in place. This is known as the “economic benefit,” which represents the value of the pure life insurance protection received. The value of this benefit is calculated using either the rates from an IRS table or, if certain conditions are met, the insurance carrier’s lower one-year term insurance rates. This imputed income is the shareholder’s cost for participating in the plan and must be reported on their personal income tax return.

For the ILIT and the ultimate heirs, the death benefit received by the trust is generally received free from both federal income and estate taxes. This tax-free transfer of wealth is the primary objective of the strategy.

Key Elements of the Split-Dollar Agreement

A formal, written split-dollar agreement is the foundational document for the arrangement. This legal document must be drafted to comply with IRS regulations and ensure the desired tax treatment.

The agreement must clearly delineate the rights and responsibilities of all parties. It formalizes the details of the arrangement, such as naming the ILIT as the policy owner and beneficiary, the business’s obligation to pay premiums, and its right to be repaid from the death benefit.