Split-dollar's two tax regimes compared side by side in plain terms

Every split-dollar arrangement entered into after September 17, 2003 is taxed under one of two sets of rules, and the two work almost like opposites. Under the economic benefit regime, the party named as owner (usually the one who pays the premiums) is treated as the owner of the policy, and the other party is taxed each year on the value of the benefits they receive. Under the loan regime, the policy owner is treated as having borrowed the premiums, and the tax question is whether interest is charged. The same policy, with the same parties and the same money, can produce very different tax results depending on which side of the line the paperwork falls.

This post sets the regimes side by side in plain terms: who pays, who owns, what is taxed each year, and what the employee or family ends up with. It builds on the overview in split-dollar life insurance and is general information, not tax advice. Split-dollar agreements are a field for tax attorneys, and the illustrations here are invented.

First, what split-dollar is

A split-dollar arrangement is an agreement between two parties to share the cost and the benefits of one permanent life insurance policy. In the typical employer version, a company pays some or all of the premium on a policy covering an executive. At death, the company is repaid its premiums, or the policy's cash value, and the executive's family receives the rest of the death benefit. In the typical family version, a parent or a family entity advances the premium on a policy owned by an irrevocable trust (an irrevocable life insurance trust), and the parent is repaid later.

The Treasury regulations define the category by its features: the arrangement is between an owner and a non-owner of the policy, either party pays all or part of the premiums, and at least one party can recover those premiums from the policy proceeds. If those features are present, the rules in Treas. Reg. section 1.61-22 and section 1.7872-15 decide the tax result, and the choice is between two regimes.

The question that picks the regime

The regulations ask who the owner of the policy is for tax purposes, and what rights the other party has. Practitioners often describe the two common designs by the way they are set up:

• Endorsement method. The employer is named as the policy owner, and the policy is endorsed so that the employee's family has the right to a defined share of the death benefit. This design falls under the economic benefit regime.
• Collateral assignment method. The employee, or a trust, is the policy owner. The employer's right to be repaid is secured by a collateral assignment of the policy. This design falls under the loan regime.

Words on a page do not settle the question. The IRS looks at substance, so a document that calls the employer the owner but gives the employee all the rights of ownership may not be treated the way the labels suggest. Which regime applies is something a tax attorney confirms from the actual agreement and the actual policy.

Side by side

Every row is a simplification. The following sections go through the questions in the order that matter to a family deciding whether an arrangement makes sense.

Who pays: usually the same, but treated differently

In both regimes, the funder, usually the employer or a parent, writes the checks. What differs is how the law characterizes the payments.

In the economic benefit regime, the payments are premiums on the funder's own policy. The funder is the owner, and the family receives a benefit, which is taxed.

In the loan regime, the payments are treated as loans to the policy owner. The funder is a lender. The policy owner owes the money back, usually from the death benefit or when the arrangement ends.

This is why the same $30,000 payment is described as a premium in one design and as a loan in the other. The money moves identically. Only the tax label differs.

Who owns: the hinge of the whole thing

The owner is the person who can name the beneficiary, borrow against the policy, surrender it and exercise other contract rights. The two regimes mirror each other:

• If the funder is the owner, the other party's benefits are taxed as they are received. The employee has less control; the employer has more. The family typically has a right to the death benefit portion, but may have little say over the policy itself.
• If the insured or the trust is the owner, the funder is a lender. The policy belongs to the family, and the funder holds only a repayment right, which usually reduces what the family eventually receives.

For families using an ILIT, ownership by the trust is the point: it keeps the death benefit out of the insured's estate, so long as the structure and the funder's rights are drafted so the funder's repayment right does not pull the policy back in. That is the reason such arrangements are drafted by estate attorneys. The irrevocable life insurance trusts guide explains the trust side.

What is taxed each year

Economic benefit

The non-owner is taxed on the value of what they receive each year. The regulations treat the benefit as consisting of three things: the cost of current life insurance protection, any cash value the non-owner can reach, and other benefits. The cost of the protection is the death benefit the non-owner can receive, multiplied by a rate. The rate comes from IRS-published tables or, in some cases, from the insurer's own published term rates. An employer typically reports this as taxable compensation. The concept is related to imputed income on group term coverage, though the rules differ.

An invented illustration. Suppose an employer funds a policy on a 50-year-old executive, and the executive's family has the right to $1,000,000 of the death benefit. If the applicable rate for that year is $1.50 per $1,000, a made-up figure and not a published rate, the cost of protection is 1,000 × $1.50 = $1,500. The executive reports $1,500 as income that year. In later years, as the insured ages, the rate rises, and the annual figure rises with it. If the executive also becomes entitled to part of the cash value, that part is added.

In the family version, when the funder is a parent and the policy owner is a trust, the same value is treated as a gift each year from the parent to the trust. Gift tax rules then apply, including the annual exclusion of $19,000 per recipient in 2026, and the lifetime exclusion, which is part of the $15,000,000 federal basic exclusion in 2026. The gift tax and life insurance premiums guide gives the background.

Loan

If the premium payments are loans, the question is the interest rate. Under the below-market loan rules in IRC section 7872, if a loan charges less than a minimum rate called the applicable federal rate, the law treats the borrower as having paid the lender the missing interest and the lender as having given the money back as compensation or a gift, depending on the relationship. In plain terms, forgone interest is treated as if it moved, and the forgone amount is taxed.

An invented illustration. Say an employer has advanced $90,000 over three years of $30,000 each. If the loan is charged interest at an illustrative 4 percent, a made-up rate and not a current one, a year of interest on the $90,000 balance is $90,000 × 0.04 = $3,600. If the agreement charges no interest, or charges less than the applicable federal rate, the difference between $3,600 and what was charged is treated as income or a gift. Real rates depend on the loan's term and the month in which it was made, and the details are in the regulations.

Whether the interest has to be paid in cash each year or accrues until the end depends on the loan terms. Accrued interest increases the amount that must be repaid, which can eat into what the family receives.

What the employee or family ends up with

This is the question that most people actually care about.

Economic benefit. If the executive dies while the arrangement is in force, the employer receives the amount the agreement gives it, often the premiums paid or the cash value, and the family receives the rest of the death benefit. In the example of a $1,000,000 death benefit where the employer has paid $300,000 in premiums and is repaid that amount, the family receives $1,000,000 − $300,000 = $700,000. If the executive leaves or retires while living, the agreement typically says whether the executive may buy the policy, and at what price. Taking a policy out of the arrangement can be a taxable event: the value above what the executive pays may be taxed as compensation. Quite often the plan is to leave the arrangement in place until death.

Loan. If the executive dies while the loan is outstanding, the employer is repaid the loan and accrued interest from the proceeds, and the family receives what is left. With $300,000 of loans and, say, $60,000 of accrued interest, the repayment is $360,000, and the family receives $1,000,000 − $360,000 = $640,000. If the executive lives, the loan can be repaid from other funds or from the policy's cash value, leaving the executive as the clear owner of the policy. The owner keeps any growth in cash value above the debt, which is the main attraction of the loan design for people who want ownership, but the interest cost is real.

The numbers are invented to show the arithmetic. In practice the policy's death benefit, the cash value and the interest depend on the contract, and a policy that underperforms may not have enough value to repay the funder.

Where each regime tends to fit

Neither is better in the abstract. A few patterns help show the trade-offs.

• Executive retention. Employers often prefer the economic benefit design because they stay the owner and can keep the policy as an incentive. Public companies may avoid loan arrangements with executives because of restrictions in the Sarbanes-Oxley Act on loans to directors and executive officers.
• Executive who wants ownership. The loan design hands over the policy, subject to repayment, which some executives prefer. It requires charging interest at the required rate or accepting the below-market loan tax result.
• Estate planning with a trust. Families with large estates sometimes use the loan design so that the trust owns the policy and the parent's gifts are limited to the forgone interest, rather than the full premium. The value of the structure depends on the policy, interest rates, the size of the estate and the estate tax rules. With a federal basic exclusion of $15,000,000 per person in 2026, many families have no federal estate tax problem to solve, though some states tax smaller estates; see state estate and inheritance taxes and life insurance.
• Business owners. A company funding coverage on a shareholder-employee may overlap with buy-sell and key person uses. See funding a buy-sell agreement with life insurance.

Rules that apply on top of either regime

• Employer-owned policies. When an employer owns a policy on an employee, the notice and consent rules of IRC section 101(j) affect the tax-free status of the death benefit; see section 101(j) notice and consent and the checklist in the notice and consent checklist for employer-owned life insurance.
• Deferred compensation. If the arrangement promises benefits in the future, IRC section 409A may apply. See life insurance in nonqualified deferred compensation.
• Premium deductions. Under IRC section 264(a)(1), an employer generally cannot deduct premiums when it is a beneficiary of the policy.
• Policy design. The policy must meet the definition in IRC section 7702, and overfunded policies can become modified endowment contracts, which are taxed differently on withdrawals and loans.
• Substance over form. Both regimes come with detailed documentation and reporting duties.

A simpler alternative to compare

Because split-dollar is complex, it is worth looking at simpler ways to reach the same goal. A section 162 executive bonus plans pays the executive a bonus and lets them own the policy outright. The tax is higher in the year of the bonus, but the structure is easy to understand. A plain term or permanent policy owned by the executive or their family needs no agreement at all. If a trust is in the plan, annual gifts within the exclusion may fund it without a loan. Ask the adviser to run the comparison, with the after-tax numbers, before choosing split-dollar.

Questions to ask before signing

1. Under which regime does the agreement place us, and where in the document does it say so?
2. Who is the owner of the policy, and what exactly can each party do with it?
3. What is taxed each year, to whom, and how will it be reported?
4. If a loan, what interest rate, and is the interest paid or accrued?
5. What happens at the executive's death, retirement or departure, and at the funder's sale or bankruptcy?
6. What if the policy underperforms and cannot repay the funder?
7. How is the arrangement unwound, and what tax would unwinding trigger?
8. Which professional drafted the agreement, and is the insurer's sample form being used unchanged?

Key takeaways

• Split-dollar arrangements entered after September 17, 2003 are taxed under either the economic benefit regime or the loan regime, and the two are mutually exclusive.
• Under economic benefit, the funder is the owner and the other party is taxed each year on the value of the benefit received; under the loan regime, the policy owner is treated as borrowing and the question is interest.
• The same $30,000 premium payment is a premium in one design and a loan in the other, and the result at death differs: in the example, $700,000 to the family under economic benefit and $640,000 under the loan with accrued interest.
• Family arrangements with a trust are taxed through gifts, and the 2026 annual exclusion is $19,000 per recipient.
• The documents decide the outcome, so have a tax attorney draft them and compare the arrangement with simpler options first.