In Uncategorized on 08/29/2012 at 05:56

Very often lawyers get carried away with their own brilliance. Such is the case in the roll-out of a split-dollar life insurance arrangement (or SDLIA; I’ll explain what that means presently). The case is G. Steven Neff and Carrie J. Neff, T. C. Memo. 2012-244, filed 8/27/12, Judge Swift rolling it all out for us.

The explanation, cribbed from, of course, is as follows. The split-dollar concept is simple. It is a funding arrangement that helps one individual obtain life insurance at a cost lower than would otherwise be possible. This is achieved by sharing (splitting) the premium with another individual or entity, such as a business. The arrangement, provided by a written agreement, generally calls for the sharing of premiums in exchange for the sharing of death benefits and, in some cases, cash value. In the last-named instance, it provides a means whereby descendants can buy out ancestors.

Steve and Carrie, and business partners Bradley T. Jensen and Terri Jensen, set up a split-dollar life insurance deal to provide liquidity to buy out Steve or Brad, when they die. Steve and Brad were master builders, and needed to secure succession when each of them dies.

Steve and Brad had their business pay the premiums, but, by written agreement, should one die, or their business be sold, or if their agreement with the business be terminated for any reason, Steve and Brad must reimburse the business for the premiums paid, out of death benefit at death or out of cash surrender value if living.

Termination of a split-dollar deal is known as a roll-out. In this case, the total premiums amounted to more than $800K. Steve and Brad paid the business about $131K.

“Nothing in the SDLIA agreements and the collateral assignment agreements suggests that–upon termination of the SDLIAs for reasons other than the deaths of petitioners–reimbursement to N & J Management [the business] of the premiums it paid on the policies would be put off until the deaths of petitioners and receipt of the life insurance proceeds.” T. C. Memo. 2012-244, at p. 8.

Because of regulatory changes in 2002, Steve’s and Brad’s lawyers told them to end the SDLIAs effective at year end 2003, and they did.  But the story doesn’t end there.

“At the request of petitioners’ counsel, individuals at petitioners’ accounting firm calculated what they regarded as the ‘December 2003’ fair market value of N & J Management’s rights to be reimbursed the $842,345 premiums paid. However, apparently on advice of petitioners’ counsel, the individuals at petitioners’ accounting firm treated N & J Management’s reimbursement rights as the right to be reimbursed the $842,345 only upon the deaths of petitioners. The accounting firm applied a present value discount for the $842,345–using an assumed life expectancy for each petitioner of 85 and an interest rate of 6%. Petitioners’ advisers calculated the December 2003 present value of N & J Management’s $842,345 reimbursement rights at $131,969.” T. C. Memo. 2012-244, at pp. 10-11 (Footnote omitted).

So the business relinquished its right to be reimbursed the full $842K in exchange for the $131K payment, Brad and Steve of course being on both sides of the deal.

The lawyers either never papered the roll-out, or, if they did, the paper never got into evidence on the trial. “Apparently, no contemporaneous documentation exists (or was offered into evidence) relating to the December 2003 agreement between petitioners and N & J Management that ended or terminated the SDLIA arrangements. No written termination letter or agreement between petitioners and N & J Management with regard to the SDLIAs was offered into evidence. No written contract of any kind was offered into evidence relating to the above December 2003 agreement to end the SDLIAs. Further, no contemporaneous documentation refers to a sale by N & J Management to petitioners of ‘contract rights’. T. C. Memo. 2012-244, at p. 12.

Brad and Steve never picked up $710K of income for the remainder of the premiums paid by the business. Or the cash surrender value of the SDLIAs they got at the roll-out.

At trial, Steve’s and Brad’s lawyers tried to argue for the first time that the roll-out really happened in 2004, because that was when the checks were cashed, and that was a closed year. But Judge Swift isn’t buying: “No explanation is provided as to why petitioners’ counsel was not able to obtain and review the 2004 bank records and canceled checks before September 2011.” T. C. Memo. 2012-244, at p. 16.

You can’t ambush the IRS.

Now the rules regarding SDLIAs were confusing, and for the years that Steve and Brad had their SDLIAs, they had to pick up as income whatever premiums the business paid on account of the policies. This they never did. So they had to bail, and claim they were paying the business for its right to receive the premiums the business paid at the deaths of Steve and Brad, and really didn’t terminate the SDLIAs.

Wrong, says Judge Swift: “To the contrary, we believe it obvious that a cancellation, an unwinding, a release, or a roll-out of N & J Management’s interests in the SDLIAs occurred. The formal SDLIA agreements may not have been technically or formally terminated by a written document, but as of the end of December 2003, the SDLIA arrangements were unwound, and N & J Management was released from its obligation as employer to provide further funding on the life insurance policies. Petitioners have stipulated that after and as a result of the transaction at issue in these cases, N & J Management had no continuing interest or reimbursement rights with regard to the underlying life insurance policies.

“We find that the transaction before us constituted an effective roll-out of the SDLIAs and that the equity split-dollar life insurance arrangements were terminated during December 2003, even in the absence of a formal written termination of the SDLIA agreements.” T. C. Memo. 2012-244, at p. 19.

Paying at roll-out for the right to receive reimbursement of premiums at death doesn’t cut it.

And the income is payment for services under Section 83. It’s not cancellation of debt, which is only the medium (and not the message) for paying for Steve’s and Brad’s services.

By the way, even if Steve’s and Brad’s lawyers are right about the deal being done in 2004, a supposedly closed year, the doctrine of mitigation would still open the year for adjustment of income. See my blogpost “Mitigation and Inventory”, 4/20/11.

But since Steve and Brad relied in good faith on their lawyers, the Court denied IRS the Section 6662 penalties.

Leave a Reply

Please log in using one of these methods to post your comment: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: