n-08-42.pdf

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Part III - Administrative, Procedural, and Miscellaneous

Modifications of split-dollar life insurance arrangements

Notice 2008-42
SECTION 1. PURPOSE
This notice provides guidance regarding the application of §§ 101(j) and 264(f) of
the Internal Revenue Code (Code) to life insurance contracts that are subject to split-
dollar life insurance arrangements. Specifically, this notice provides that a modification
of a split-dollar life insurance arrangement that does not entail any change to the life
insurance contract underlying the arrangement will not be treated as a material change
in the life insurance contract for purposes of §§ 101(j) and 264(f).
SECTION 2. BACKGROUND
Split dollar life insurance arrangements

In general, a split-dollar life insurance arrangement is an arrangement between
two or more parties to allocate the policy benefits and, in some cases, the costs of a life
insurance contract. Sections 1.61-22, 1.301-1(q), and 1.7872-15 of the Income Tax
Regulations provide rules for the taxation of participants in a split-dollar life insurance
arrangement. Those regulations generally apply to any split-dollar life insurance
arrangement entered into after September 17, 2003. For this purpose, if an
arrangement entered into on or before September 17, 2003, is materially modified after

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September 17, 2003, the arrangement is treated as a new arrangement entered into on
the date of the modification. Section 1.61-22(j)(2)(ii) sets forth a non-exclusive list of
changes that are not treated as material modifications for this purpose.
Section 101(j)

Section 101(j) was added to the Code by § 863(a) of the Pension Protection Act
of 2006, Public Law 109-280. Section 101(j)(1) generally provides that in the case of an
employer-owned life insurance contract, the amount of death benefits excluded from
gross income of an applicable policyholder under § 101(a)(1) shall not exceed an
amount equal to the sum of the premiums and other amounts paid by the policyholder
for the contract. For this purpose, an employer-owned life insurance contract is a life
insurance contract that (i) is owned by a person engaged in a trade or business and
under which such person is directly or indirectly a beneficiary under the contract, and (ii)
covers the life of an insured who is an employee with respect to the trade or business
on the date the contract is issued. An applicable policyholder is generally a person who
owns an employer-owned life insurance contract, or a related person as described in
§ 101(j)(3).
Section 101(j)(2) provides exceptions to the general rule of § 101(j)(1) in the case
of certain employer-owned life insurance contracts with respect to which certain notice
and consent requirements are met. Those exceptions are based either on (i) the
insured's status as an employee within 12 months of death or as a director, a highly
compensated employee or a highly compensated individual; or (ii) the extent to which
death benefits are paid to a family member, trust, or estate of the insured employee, or

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are used to purchase an equity interest in the applicable policyholder from a family
member, trust or estate.
Section 101(j) applies to life insurance contracts issued after August 17, 2006,
except for a contract issued after that date pursuant to a § 1035 exchange for a contract
issued on or before that date. For this purpose, a material increase in the death benefit
or other material change generally causes the contract to be treated as a new contract.
Other than as described above, contracts issued on or before August 17, 2006, are
grandfathered and not subject to the requirements of § 101(j). See
Pub. L. No.
109-280, § 863(d).
Section 264(f)
Section 264(f) was added to the Code by § 1084(c) of the Taxpayer Relief Act of
1997, Pub. L. No. 105-34. Section 264(f)(1) provides that "[n]o deduction shall be
allowed for that portion of the taxpayer's interest expense which is allocable to
unborrowed policy cash value" with respect to a life insurance policy or an annuity or
endowment contract. Section 264(f)(4) identifies those policies and contracts that are
excepted from the rule of § 264(f)(1).
Section 264(f) applies to contracts issued after June 8, 1997, in taxable years
ending after such date; any material increase in the death benefit or other material
change in the contract is treated as a new contract for this purpose. Other than as
described above, contracts issued on or before June 8, 1997, are grandfathered and not
subject to the requirements of § 264(f). See
Pub. L. No. 105-34, § 1084(d) (as
amended by Pub. L. No. 105-206, § 6010).

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SECTION 3. APPLICATION OF SECTIONS 101(j) AND 264(f) TO CONTRACTS THAT
ARE SUBJECT TO SPLIT-DOLLAR LIFE INSURANCE ARRANGEMENTS
Both §§ 101(j) and 264(f) apply to "life insurance contracts," which are defined in
§ 7702 for all purposes of the Internal Revenue Code as any contract that is a life
insurance contract under the applicable law, but only if such a contract either meets the
cash value accumulation test of § 7702(b), or both meets the guideline premium
requirements of § 7702(c) and falls within the cash value corridor of § 7702(d). Under
§ 7702, the term "life insurance contract" generally does not encompass the terms of an
arrangement, such as a split-dollar arrangement, of which the contract is a part.
Accordingly, if the parties to a split-dollar life insurance arrangement modify the terms of
the arrangement but do not modify the terms of the life insurance contract underlying
the arrangement, the modification will not be treated as a material change in the life
insurance contract for purposes of §§ 101(j) and 264(f), even if the modification is
treated as a material modification of the split-dollar arrangement for purposes of
§ 1.61-22(j).
DRAFTING INFORMATION
The principal author of this notice is Linda K. Boyd of the Office of Associate
Chief Counsel (Financial Institutions and Products). For further information regarding
this notice, contact Ms. Boyd at (202) 622-3970 (not a toll-free call).