Split-Dollar Anti-Abuse Considerations: Documentation and Substantiation to Withstand Scrutiny

High-net-worth (HNW) estate plans frequently use split-dollar life insurance to preserve family wealth, provide executive benefits, or fund buy-sell obligations. But split-dollar arrangements attract tax and fiduciary scrutiny—especially in major U.S. financial centers such as New York City, Los Angeles, Chicago, and Houston—unless carefully documented and substantiated. This article explains the documentary, valuation, and procedural steps advisors and families should implement to withstand IRS, state tax, and ERISA review.

Why documentation matters (and what government examiners look for)

Auditors focus on whether the parties treated the arrangement consistent with the intended tax regime (economic benefit, loan, or constructive receipt) and whether premium payments, interest, and benefits were reported correctly. Key legal and tax risks include:

• Misclassification between the economic benefit and loan regimes
• Inadequate evidence of loans or repayments (triggering imputed income under IRC §7872)
• Failure to report imputed compensation or interest (Form 1099, W-2, or employer tax filings)
• Transfer-for-value or post-termination events that create unintended income or estate tax exposure
• ERISA or state premium tax compliance issues for employer-owned plans

Relevant statutory and technical guidance includes the IRS Applicable Federal Rates for loan pricing and rules under IRC §7872 for below-market loans:

• IRS Applicable Federal Rates: https://www.irs.gov/applicable-federal-rates
• IRC §7872 (below-market loans): https://www.law.cornell.edu/uscode/text/26/7872

Core documents every split-dollar file must include

Maintain an organized file that proves the economics, governance, and intent of the arrangement. Minimum documents:

• Fully executed split-dollar agreement — signed, dated, and referencing the governing law and repayment triggers
• Board minutes / corporate resolutions authorizing premium payments and collateral assignments
• Policy contract, illustrations, and carrier-side underwriting file
• Premium payment records (checks, wire confirmations, corporate ledger entries)
• Loan amortization schedule where applicable (showing AFR use and compounding method)
• Valuation reports (actuarial opinion of the economic benefit or policy cash value)
• Employee communications or offer letters (for executive arrangements)
• Tax reporting copies: payroll entries, Form W-2 or 1099s, and corporate tax filings reflecting interest or imputed income
• Post-termination / unwind documents describing policy transfer, repayment, or netting calculation

Also include collateral documentation (e.g., collateral assignment forms), proof of sufficiency of security, and correspondence with the life insurer.

Substantiation methods: how to calculate and defend tax consequences

Accurate, supportable calculations are essential. Two common substantiation paths:

1. Economic benefit regime — quantify the taxable economic benefit using either:

   • The carrier’s term cost or
   • An actuarial calculation based on insured age, mortality tables, and policy values

2. Loan regime — establish a bona fide loan with:

   • Promissory note, stated interest rate consistent with the IRS AFRs, amortization schedule, and payment history
   • Evidence that funds were fungible and that repayment was expected and enforced

Illustrative example (for modeling purposes only):

Use the IRS AFR tables for actual computations to avoid challenge. For loan regimes, provide the promissory note, corporate minutes approving the loan, and bank statements showing payments.

Documentation intensity vs. audit risk: a quick reference

Price ranges reflect U.S. markets in major metro areas and typical advisor fees—actual quotes vary by firm and complexity.

Common audit triggers and red flags

• Large premium payments by an employer or family member without clear corporate authority
• Missing or incomplete promissory note when the arrangement purports to be a loan
• Using inconsistent interest rates (below AFR) or not reporting imputed interest under IRC §7872
• Post-termination transfers or cash-outs that produce unexpected gain or transfer-for-value issues
• Executive arrangements lacking clear compensation intent or documented nondiscrimination (for employer policies)
• Policy ownership changes without documented repayment or explicit agreement language

If you operate in fiduciary-sensitive states like New York or California, expect closer scrutiny on corporate governance and ERISA compliance.

Practical best practices for HNW families and advisors

• Use a standardized checklist that includes all documents listed above and store copies both digitally and in hard copy.
• For loan regimes, fix the interest rate to the relevant monthly AFR and document that the rate was selected to comply with IRC §7872.
• Obtain an actuarial opinion whenever the economic benefit is material to taxable income or estate valuation.
• Ensure board resolutions/LLC member consents explicitly authorize premium payments and collateral assignments.
• Coordinate taxable reporting with payroll and tax counsel: imputed income for executives should be reflected on W-2s; nonemployee compensation on Form 1099 where appropriate.
• Plan for unwinding: include explicit termination mechanics, reimbursement priority, and transfer-for-value protections in the original split-dollar agreement.

Relevant internal resources:

• Economic Benefit vs Loan Regime: How the IRS Treats Split-Dollar Arrangements Today
• Employer-Owned Policies and Split-Dollar: Compliance, ERISA Issues, and Best Practices
• Drafting Split-Dollar Agreements: Protecting Interests, Valuation, and Repayment Terms

Vendors and service-cost considerations in the U.S. market

When assembling a team, consider:

• Law firms (specialized estate and tax counsel): typical transaction drafting fees $3k–$15k
• Actuaries/valuation firms: $2.5k–$10k per opinion (Aon, Willis Towers Watson, Mercer; independent actuaries also available)
• Carriers commonly used for HNW estate work: New York Life, MassMutual, Northwestern Mutual, Prudential — pricing varies materially by age, underwriting class, and product type. As an illustration, a survivorship universal life policy for a 60/60 couple with $5M face may require initial premium ranges commonly in the $150,000–$400,000 first-year band depending on underwriting and product design. (Obtain carrier-specific illustrations for underwriting accuracy.)
• Ongoing administration: trustee or third-party administrator fees typically $1,500–$10,000/yr.

Always obtain multiple carrier illustrations and verify assumptions (cost of insurance, borrowing assumptions, MDRT credits, and policy fees).

Actionable checklist (ready to use)

• Execute a written split-dollar agreement with clear regime selection and termination terms
• Approve arrangement via board/owner resolution and retain minutes
• Obtain and retain carrier policy contract, illustration, and underwriting file
• If a loan regime, execute a promissory note at AFR and maintain amortization schedule
• If economic benefit regime, secure an actuarial valuation and preserve methodology
• Record all premium payments and any repayments; reconcile annually
• Coordinate tax reporting with payroll/tax counsel—issue W-2/1099 as appropriate
• Plan for post-termination events and include protective clauses addressing transfer-for-value

Conclusion

For HNW families and their advisors in the U.S., split-dollar life insurance can be a powerful estate-planning tool—but only when documentation, valuation, and corporate governance align with the chosen tax regime. Meticulous records, AFR-based loan documentation, actuarial support, and clear governance are the keys to surviving IRS and fiduciary scrutiny.