Economic Benefit vs Loan Regime: How the IRS Treats Split-Dollar Arrangements Today

Split‑dollar life insurance arrangements remain a powerful tool in high‑net‑worth (HNW) estate planning for wealth transfer, executive compensation, and business succession. But after decades of IRS guidance and litigation, the tax treatment today hinges on which “regime” governs the arrangement: the economic benefit regime or the loan regime. This article explains the current IRS posture, practical tax consequences, key planning choices for HNW families and closely held businesses (with U.S. state considerations), and implementation costs and vendors commonly used by advisors in New York, California, and Texas.

Table of Contents

Quick summary (what you need to know)

The IRS treats split‑dollar either as an economic benefit (imputed income to the insured for the cost of protection) or as a loan (premium payments treated as loans, with imputed interest rules under Section 7872 and related code sections).
Choice of regime affects annual taxable income, basis/cost recovery, and termination consequences (e.g., transfer‑for‑value or constructive receipt issues).
For HNW planning (PPLI, corporate‑owned life insurance), implementation and administrative costs can be material — typical PPLI minimums are $1M–$5M and yearly trustee/admin fees often run from $5,000 to $25,000 depending on provider and complexity.
Always structure documentation, repayment mechanics, and collateralization to withstand IRS scrutiny and avoid unintended taxable events.

Regulatory background — why the regimes exist

Key statutory touchpoints: Section 61 (gross income), Section 83 (property transferred in connection with performance), Section 101(a) (life insurance proceeds), and Section 7872 (below‑market loans).
The IRS issued targeted guidance on split‑dollar arrangements in Notice 2002‑8 (a foundational document for modern split‑dollar practice). That guidance and subsequent positions (and related case law) laid out practical tests for determining whether a benefit is an economic benefit to the insured or a loan from the employer/owner.

Sources:

IRS Notice 2002‑8 — https://www.irs.gov/pub/irs-drop/n-02-08.pdf
Private placement life insurance overview (cost & PPLI market context) — Forbes Advisor (see “Private placement life insurance”)

Economic Benefit Regime: What it is and tax mechanics

Under the economic benefit regime, the insured (usually an employee or executive) is treated as receiving the economic benefit of an employer‑paid life insurance policy. The result:

The insured must include in income an imputed income amount equal to the cost of current life insurance protection — traditionally measured by mortality cost tables (the IRS Table I cost of pure protection) or other accepted actuarial cost measures.
The employer’s payment of premiums is not treated as a loan (for the years covered) — instead the value of the protection is treated as compensation income to the employee.
At death, the death benefit may still be income tax‑free under Section 101(a) if the transfer‑for‑value rules are not implicated; however, if the insured or beneficiaries are not the original insured’s estate/trust as required, transfer‑for‑value concerns can convert proceeds to taxable income.

Practical point: Economic‑benefit imputed income tends to be front‑loaded for younger insureds because mortality cost for a large face amount is often larger as protection cost. For HNW families considering an ILIT vs employer‑owned policy, this regime can create annual taxable income that reduces the attractiveness of employer funding unless structured carefully.

Loan Regime: How tax rules apply

When the loan regime governs:

The employer’s premium payments are treated as loans to the insured or to a trust/other payee.
Tax consequences are determined under the below‑market loan rules (Section 7872) and general imputed interest principles: the borrower (insuree) recognizes imputed interest income to the lender/owner if the loan carries a below‑market interest rate.
If the loan is genuine, documented, and repaid (or collateralized in a way that makes the employer a creditor), the insured generally does not recognize annual compensation equal to the mortality cost; instead the tax cost is the imputed interest differential — typically lower for large face amounts if applicable federal rates (AFRs) are used or if the parties charge a market rate.

Key operational items:

Proper loan documentation (fixed schedule, stated interest rate, security, and repayment mechanics) is essential.
The IRS scrutinizes “substance over form”: if the loan is not bona fide (e.g., no repayment required, no default consequences, or the employer effectively retains ownership rights), the IRS may recharacterize the arrangement as economic benefit or compensation.

Comparison: Economic Benefit vs Loan Regime

Feature	Economic Benefit Regime	Loan Regime
How income is determined	Imputed cost of death benefit (mortality tables / cost of protection)	Imputed interest under Section 7872 / AFR / stated interest
Typical annual taxable amount	Often higher for younger insureds (mortality cost)	Often lower if loan carries market interest or borrower repays
Documentation requirement	Formal compensation/benefit documentation recommended	Strict loan documentation: note, security, repayment schedule
Termination risk	Transfer‑for‑value or change in ownership can cause taxable proceeds	Loan forgiveness may generate income; uncollected loan treated as compensation
Best used when	Employer wants to provide a benefit and treat cost as compensation	Parties want to treat funding as a bona fide loan to limit annual taxable income

Hypothetical example (rounded, illustrative)

Employer pays $100,000 annual premium on a $5,000,000 corporate‑owned UL policy on a 45‑year‑old executive.
Economic benefit regime: imputed income (cost of protection) might be $30,000–$70,000 depending on Table I cost for the coverage — that whole amount is taxable to the employee annually.
Loan regime: employer treats $100,000 as a loan. If AFR is 4.0%, imputed interest on an outstanding $100,000 loan is $4,000 — the taxable annual imputed interest is much lower than the economic benefit number.

(These numbers are hypothetical; use a qualified actuary and tax advisor to compute precise imputed income and loan interest.)

Implementation considerations for HNW families and business owners (NY, CA, TX focus)

States matter for estate tax and premium tax considerations: New York and California have high state estate tax and regulatory frameworks that influence product availability and cost; Texas (no state income tax) may be preferable for certain trust domiciles.
Private Placement Life Insurance (PPLI) is a common vehicle for HNW split‑dollar planning. Typical market facts:
- PPLI minimum premium: commonly $1,000,000–$5,000,000 (varies by carrier and investment strategy).
- Administration/trust setup: initial trustee/attorney fees $10,000–$50,000+; ongoing trustee/admin fees often $5,000–$25,000/year.
- Carriers frequently used: Lincoln Financial, Prudential, and Delaware Life for PPLI/large COLI applications; banks and family office managers provide wrap/asset management.
Example vendor pricing (market ranges):
- Trustee & setup (New York/San Francisco): $10k–$40k initial legal/trust setup
- Ongoing administration: $5k–$25k/year (trustee + compliance + annual actuarial)
- Investment management: 0.5%–1.5% AUM
- Note: Pricing varies widely with carrier, policy size, and investment complexity — get written quotes from carriers (Lincoln, Prudential, Delaware Life) and trustees.

Common traps and termination risks

Transfer‑for‑value rules: an inadvertent sale or transfer of a policy can convert tax‑free death proceeds into taxable income.
Unwinding risks: when a split‑dollar arrangement ends, outstanding loans, pledged collateral, and the cash value versus the employer’s economic interest can create immediate taxable events if not properly documented. See Unwinding Split‑Dollar: Tax Traps, Transfer‑for‑Value, and Post‑Termination Risks.
Documentation and substantiation: lack of contemporaneous written split‑dollar agreement and loan documents is one of the IRS’s strongest grounds for recharacterization. See Drafting Split‑Dollar Agreements: Protecting Interests, Valuation, and Repayment Terms.

Best practices for advisors and HNW clients

Decide the objective (executive comp vs estate liquidity vs wealth transfer) first — the optimal regime often follows the objective.
Use professional valuation/actuarial analysis to quantify imputed income under the economic benefit regime and compute AFR/imputed interest for the loan regime.
Document everything: split‑dollar agreement, loan note, payment schedules, collateral assignments, trustee minutes, and annual accounting.
Coordinate with estate planning (ILITs, buy‑sell agreements) and corporate counsel; see Designing Split‑Dollar with Trusts and Buy‑Sell Agreements for Business Owners.
Revisit arrangements annually — changes in applicable federal rates (AFRs), policy cash values, and company goals can change the preferred characterization.

Conclusion

For HNW families and closely held business owners in the U.S. (notably in major hubs such as New York, San Francisco, and Dallas/Houston), split‑dollar remains a flexible technique but one demanding precise legal and tax work. The choice between the economic benefit and loan regimes materially affects annual taxable income, termination tax consequences, and the policy’s utility for estate planning. Work with life insurance carriers (e.g., Lincoln Financial, Prudential, Delaware Life), experienced trust banks, and tax counsel to price and document an arrangement that meets business, wealth transfer, and compliance goals.