(This article is part of a periodic series of guest columns written by innovators in the nonprofit sector.)
by William Whitehurst
Will the Internal Revenue Service close the loop on retirement plans sponsored by tax-exempt employers for their key executives? The relevant question appears to be not "whether" but "when." At least that's the perception after recent IRS attacks on other established executive compensation techniques used by tax-exempts and the enlarged scope of its field agent training program.
Take split-dollar life insurance, for example. "Split-dollar," as it is commonly known, is a technique for dividing (or "splitting") the various elements of a life insurance contract (premiums, cash value, death benefit, etc.) between an employer and an executive to provide retirement and death benefits. Different variations on this technique have been a standard part of the executive compensation packages provided by tax-exempts for many years, and especially since the extension of nondiscrimination rules to employer-wide plans in 1989.
Perhaps concerned that modern insurance policies didn't fit within its established precedent, and that split dollar was being widely used to circumvent the nondiscrimination rules applicable to employer-wide plans, the IRS in 1996 released its infamous Technical Advice Memorandum 9604001 (now known in the trade simply as "the TAM"). The TAM held that the annual increase in the cash value of a life insurance policy owned by an executive but for which premiums were paid by the employer, was taxable each year to the executive. Although the TAM only represented the view of the IRS's National Office on the particular case at hand, it was widely regarded at the time of its release as the death knell of the most popular form of split dollar.
Over the ensuing years, however, the IRS, under enormous insurance industry pressure to rescind the TAM, said little publicly about split dollar and the insurance industry, seemingly emboldened by the IRS's silence, resumed promoting split dollar. Then, in January of this year, the IRS, with no advance notice, released an official notice (Notice 2001-10), essentially reaffirming the position it took in the TAM. As a result, most new collateral assignment split dollar programs were immediately put on hold and the split dollar insurance industry screeched to a halt.
With that circumstance in mind, I accepted an invitation to attend the IRS's annual training course for field agents auditing tax-exempt employers held in April this year. For the first time, I was told, the training session would cover retirement programs for executives as well as the more traditional programs covering all employees (such as tax sheltered annuity programs). The invitation was to come sit down face to face with the agents who conduct audits in this area and share with them my knowledge of what was happening out in the real world regarding executive benefits. Since I worked extensively in the area, and had seen most of the techniques then in use, wouldn't I come and share my experiences with the field agents?
I readily agreed to participate, but with a secondary purpose in mind. The timing of this expansion in the audit training program was alarming. The Service has just effectively closed what it perceived as the split-dollar life insurance loophole. Now the Service was turning its attention to executive retirement plans, the remaining area of perceived abuse by tax-exempts. The training session offered an opportunity for a unique look into the inner workings of the Service's eyes and ears - it's field agents - and how they might be approaching the review of tax-exempts' executive compensation programs.
As expected, I found at the training session a room full of agents from around the country who were dedicated to the proper enforcement of the tax laws. While abusive executive compensation packages clearly are an issue for their leadership in Washington, however, the agents' focus seemed to remain on proper compliance with the rules applicable to broad-based retirement programs. I left the training session relieved by the knowledge that the IRS apparently is not about to start a full frontal assault on executive retirement programs. Still, it's clear that, probably sooner rather than later, the IRS will begin scrutinizing those programs on a wholesale basis. Hopefully, the Service will be pragmatic in dealing with what has evolved in the marketplace during the Service's long period of neglect.
ABOUT THE AUTHOR:
William H. Whitehurst is a partner with the law firm of Womble Carlyle Sandridge and Rice, PLLC in Winston-Salem, North Carolina. His concentration is in employee benefits and executive compensation.
Whitehurst is experienced in helping health care and educational institutions address the special rules applicable to benefits for executives and staff of not-for-profit employers. In addition, Whitehurst's formal business training allows him to understand the practical business considerations commonly faced by both for-profit and not-for-profit sponsors of employee benefit programs. He uses his knowledge in this area to advise both plan sponsors and their outside consultants.
