BIG Def Comp Solutions | Hospitals, Colleges & Non-Profit Org Leaders

September 22, 2022

4 minute read – Administrators are finding the Sec. 4960 of the IRC now make it possible to recruit high-end key-people who require salaries and earnings over $1 million. Thus, bringing the benefits of split-dollar life insurance to the forefront.

On June 11, 2020, the Treasury Department and the IRS released detailed proposed rules (the “Proposed Regulations”) interpreting §4960 of the IRC. The Proposed Regulations provide additional detail about the tax penalties on tax-exempt employers and entities treated as related to those organization paying certain employees remuneration in excess of $1 million or excess payments contingent upon an employer’s separation from employment.

The most helpful parts of the proposed regulations is in defining who is, or is not, a covered employee, which included a number of exemptions, what is or is not an Applicable Tax Exempt Organization and what is and is not considered remuneration subject to the excise tax.

The Proposed Regulations touched upon the use split-dollar arrangements as it pertains to the §4960 excise tax. The regulations provide that imputed interest on a below-market split-dollar loan (where the insurance arrangement is structured using the loan approach) is treated as remuneration under these rules, even though there is no federal tax withholding on the interest. Final regulations under §4960 were issued in January 2021 and are largely unchanged from the Proposed Regulations discussed.

I mentioned hospitals and healthcare systems. It’s difficult to get ahold of who’s paying what to whom here. However, as college sports now allows student-athletes to play-for-pay the coaches are stepping up, saying what about me?!  At colleges and universities, the need to pay head coaches of major football and basketball programs salaries far in excess of $1 million makes incorporating split-dollar into compensation programs attractive. Here is the growing list of schools and coaches who have entered split-dollar arrangements as part of recent pay packages:

  • Jim Harbaugh, University of Michigan: $4 million premium loan in 2016 and $2 million a year for each of the next five years.
  • Dabo Swinney, Clemson: $1 million premium loan in 2019.
  • Ed Orgeron, LSU: $2.5 million premium loan in 2020 and another $2.5 million premium loan in 2021.
  • James Franklin, Penn State: Starting in 2021, $1 million premium loan a year for 10 years.
  • Dawn Staley, South Carolina: Starting in 2018, $300,000 premium loan a year for five years.

This is a version of a non-qualified deferred compensation plan using life insurance: Split dollar is a strategy that allows the disproportionate sharing of the cost and benefits of a permanent life insurance policy. The premium loans made to the employee accumulate cash value in a policy which can later be accessed in retirement tax-free as withdrawals and/or loans from the policy. The tax-exempt employer recovers its loans, plus any accrued interest, from the death benefit and any remaining death benefit proceeds are paid to the employee’s beneficiaries.

When it comes to avoiding the excise tax, the use of split-dollar arrangements is not limited to universities and coaches. Applicable tax-exempt organizations are those which are exempt under §501(a) as well as §501(c)(3), including not only colleges and universities but also hospitals. Health maintenance organizations and other social welfare organizations exempt under §501(c)(4) and agricultural [§501(c)(5)], chambers of commerce, real estate boards and professional sports leagues [§501(c)(6)] also apply.

Recently a client said, “so I never heard of this life insurance company policy.”  Remember, this is not an insurance company, it’s a tax beneficial design which needs the chassis  (framework) which the life insurance policy provides. Same is true with other non-qualified deferred compensation plans.

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