Intergenerational Split-Dollar Planning

Take-Away: An estate planning technique that is getting a lot more attention these days, as 2026 and the reduced applicable exemption amount fast approaches, and estate illiquidity is a genuine concern, is the use of an intergenerational split-dollar arrangement.

Split-dollar: Split-dollar is not a form of life insurance. Rather, it is an arrangement where the proceeds or cash value in a life insurance contract is split, divided, or shared at death. In some cases, it may also provide for a split of the cost of the premiums paid to sustain the life insurance policy. When a family is involved, usually the terminology of private split-dollar is used. In a private split-dollar insurance arrangement, two trusts or persons purchase life insurance on the life of a family member. Typically, when a split-dollar arrangement is used in an estate plan, an ILIT is the owner of the life insurance policy. The premiums for the insurance policy involved are often paid by the settlor of the trust, or a proxy for the settlor.

Court Decisions: In a recent successful split-dollar court decision, the payor of the policy premiums was the settlor-lender’s revocable trust. A recently successful split-dollar decision was issued by the Tax Court in Estate of Marion Levine v. Commissioner, 158 Tax Court, No. 2 (February 28, 2022.) Earlier Tax Court decisions with regard to split-dollar arrangements that were not so successful were Estate of Cahill v. Commissioner, Tax Court Memo, 2018-84 and Estate of Morrissette v. Commissioner, Tax Court Memo 2021-60 (May 13, 2021) which were covered in missives a year or so ago. The Levine decision will be periodically referenced in the following summary.

Two Types of Split-Dollar: The parties to a split-dollar arrangement can agree to allocate the policy costs and benefits between them in a variety of ways. There are two types of split-dollar arrangements recognized by the Tax Code:

Economic Benefit Regime: The Economic Benefit regime. [Regulation 1.61-22] In this type of arrangement, the ILIT generally pays only the term cost of the life insurance, which is not all that large in the early years of the arrangement. Another party, such as a family member (often the insured) or a family trust, e.g. a funded lifetime QTIP trust or a dynasty-type of trust, pays the remaining portion of the annual policy premium. All three of the reported Tax Court decisions dealt with this type of split-dollar arrangement.
Loan Regime: The Loan regime. [Regulation 1.7872-15.] This type of arrangement is often between an employee and his/her employer. The employee borrows funds from their employer to pay the insurance premium. The employee pledges the insurance policy as collateral security for the unpaid loan from the employer. The excess death benefit over the outstanding loan owed to the employer is directed to the employee’s designated beneficiary under the policy. The employee is currently taxed on the imputed interest income of the loan. If the loan is forgiven by the employer on the employee’s death, the outstanding loan balance is taxed to the employee (or his/her estate.)

Estate Planning Objectives of a Split-Dollar Arrangement: The reasons why split-dollar arrangements attract the attention of sophisticated estate planners can be summarized by the following three perceived benefits:

Purchase More Life Insurance: The advancement of funds to pay the premium on the policy can reduce the required current gifts of the donor, which enables the ILIT to purchase the desired amount of life insurance to meet future perceived liquidity needs. Absent a split-dollar arrangement, or an existing heavily funded irrevocable trust, the insured would have to make large dollar gifts to the ILIT to support the purchase of a large life insurance policy. If those gifts exceed the donor-insured’s annual exclusion gifts, or his/her available applicable exemption amount, then a simple gift-funding arrangement will be insufficient to purchase the desired or necessary amount of life insurance. If the donor-insured has his/her revocable trust advance funds pursuant to an economic benefit split-dollar arrangement, then the loan transfers do not constitute taxable or reportable gifts. Consequently, with loans involved the gift tax implications of normal ILIT funding sources is avoided.
Death Benefit Not Subject to Estate Taxes: Having the ILIT own the life insurance involved means that the settlor-insured does not retain any ‘incidence of ownership’ over the ILIT owned policies, thus assuring that the life insurance proceeds will be excluded from the settlor-insured’s taxable estate. [IRC 2042.] This arrangement works even better when in an intergenerational split-dollar plan where the settlor is not the insured. For example, in the successful Levine case, Mrs. Levine’s children were the insureds under the life insurance policies involved and owned by the ILIT. In addition, in Levine, the insurance policies were purchased from inception by the ILIT; therefore, Mrs. Levine never possessed any incidence of ownership in the policies.
Valuation Discount on the Receivable Held by the Lender: The value of the note receivable due to the lender, which is equal to the greater of the premiums paid or the cash value of the policy owned by the ILIT (in Mrs. Levine’s case her revocable trust) might be valued at substantially less than the face value of the money advanced to the insurance trust.

Example: In Levine, $6.5 million was advanced by Mrs. Levine to the ILIT. On her death, the $6.5 million advanced was valued at about one-third of that amount as of the time of her death, effectively eliminating about 2/3rds of that value from Mrs. Levine’s taxable estate. To reach this valuation result, the Tax Court concluded that Mrs. Levine had no incidents of ownership over the policies owned by the trust , and she held no legal right to accelerate the termination of the existing split-dollar agreement, thus justifying valuation discounting of the unpaid loan.

Intergenerational Split-Dollar: This arrangement builds off of the basic split-dollar arrangement. The following factors are normally found with an intergenerational split-dollar arrangement:

The individual who funds the insurance purchase is old, like more than 80 years old, thus with a relatively short life expectancy;
The individual who funds the life insurance may, but not always, borrows money from a lender, i.e. they borrow from a bank if they do not have enough available financial resources of their own;
The insurance policy is paid for with a single premium, or the premiums paid over a relatively short period of time, like three to five years;
The insured under the life insurance policy is an adult child of the individual who advances the funds to acquire the life insurance policy; usually the insured-child’s age ranges between 50 and 60 years.
The individual who advances the funds, dies within a relatively short period of time after the split-dollar arrangement is created. The ‘lender’s’ estate values the unpaid advance/loan at a substantial discount from its face value, using a discounted cash flow analysis that takes into account the probability of the insured (the child) dying in each year, the proceeds that would be paid in each year and the cash value for each year. The rationale for the steep valuation discount is that the lender’s estate is entitled to its repayment when the insured child dies, albeit years into the future. Therefore, the present value of that repayment may be significantly less than what might ultimately be paid to the lender, or his/her estate.

Observation: One interesting argument that was raised in Levine, was an often overlooked Tax Code ‘trap,’ IRC 2703(a). This Tax Code provision says: “ …the value of any property shall be determined without regard to- (1) any option, agreement, or other right to acquire or use the property at a price less than the fair market value of the property (without regard to such option, agreement, or right) or (2) any restriction on the right to sell or use such property.” The IRS argued that when Mrs. Levine, acting through her attorneys-in-fact, entered into the split-dollar arrangement, she placed a restriction on her right to control the $6.5 million that she advanced and the life insurance policies. It argued that the restriction on Mrs. Levine’s right to unilaterally access the funds transferred to the insurance companies for the benefit of the ILIT is what should be disregarded when determining the value of the property, i.e. her loan, under IRC 2703(a)(2). In response, Mrs. Levine’s estate argued that IRC 2703 applies only to property owned by the decedent at the time of her death, not to property that she had disposed of before, or to property like the life insurance policies that she never owned at all. The Tax Court agreed with the estate’s interpretation of IRC 2703, which may be reason enough why it is best to have the ILIT initially purchase the life insurance policies as opposed to the lender acquiring the policy and then transferring the policy to the ILIT.

Conclusion: As wealthy clients begin to consider the possibility that their federal gift and estate tax applicable exemption amount may, in fact, be cut back to $5.0 million starting in 2026 [3 years from now] planning to avoid, or pay for, federal estate taxes will take precedence in their estate planning. The Levine case provides a helpful ‘roadmap’ of ‘do’s and don’ts’ to follow if an intergenerational split-dollar arrangement seems to address the concerns of future estate illiquidity.