How to report the payment of the cash surrender value of a split dollar arrangement

[Guest cstrong]

Under a split dollar arrangement, if the cash value of the policy is paid to an employee (who at the time has terminated employment), is it reported on a 1099 or W-2? I'd appreciate any thoughs.

[Guest Harry O]

Not enough info to determine whether anything is reportable at all. What kind of split dollar - collateral assignment or endorsement? Did the parties report income under the "loan" method or economic benefit - PS 58 method? Do the parties believe that no equity needs to be reported at all under the old classic split dollar interpretation . . . The normal rule (if anything is reportable) is that this amount would be reportable on a W-2 not a 1099.

[Guest cstrong]

It is a collateral assignment split dollar arrangement, and it is set up as a loan (rather than the economic benefit method). The parties agree that the cash surrender value needs to be reported but can't agree whether it should be reported on a W-2 or a 1099.

[Guest Harry O]

If it is set up as a loan, no cash value is reportable. That is the reason to set it up that way. As long as the imputed interest was correctly reported in prior years, no CSV is taxable at rollout.

[Kirk Maldonado]

If the individual was an employee at any time during the year, issue a Form W-2. If the individual was not employee at any time during the year, issue a Form 1099. Rev. Rul. 71-52.

[Guest Harry O]

Rev. Rul. 71-52 is obsolete. See Notice 2001-14.

In this split dollar situation, the transfer of equity at rollout would likely be considered "wages" attributable to prior employment for employment tax purposes. These amounts would be subject to FIT and FICA. Thus, these amounts should not be reported on a Form 1099 (where there is no means to report FICA wages and withholdings) but on Form W-2.

However, there still should be no income to report at rollout if the arrangement has been properly accounted for as a "loan."

[Kirk Maldonado]

Harry O:

While it is true that Rev. Rul. 71-52 is technically obsolete, that is for reasons other than the rule contained therein regarding the form on which the income is to be reported. There was no discussion of why that rule would not still apply in Notice 2001-14.

My prediction is that if somebody did some research, they would find a definitive answer to this question and that it would be consistent with the position espoused in Rev. Rul. 71-52 because it is logical and I'm not aware of any statutory changes that would mandate a different result. I want to emphasize that I'm not saying that there having been any such changes, I'm just saying that I'm not aware of any.

I agree with your position that it should be reported on a Form W-2 if the income is attributable to a year during which the individual was an employee of the business (at some time during the year.

But what if the income is attributable to a subsequent year? For example, assume that the employee unexpectedly quit on December 31, 2005 and the rollout didn't occur until during 2006? Would you still report the income on a Form W-2, even though the individual was not an employee during 2006?

That doesn't seem to make sense to me, but I will confess that I've never researched the issue further after finding the guidance in Rev. Rul. 71-52.

[Guest Harry O]

The key issue is not whether someone was an employee part of the year or not. The issue is whether the payment to the individual is "wages" or not. In Rev. Rul. 71-52, the gain from the disqualifying disposition was expressly held not to be wages. If the income is not wages, employment taxes do not apply. Non-wage payments can properly be reported on a Form 1099.

There are many cases where payments are made after the tax year in which an employee terminates and they are properly reportable on a Form W-2 because they are wages. For example, stock option exercises by former employees years after termination of employment are wages and reportable on Form W-2. I've had occasion to research this issue. Employers would love to treat these types of post-employment payments (e.g., severance, stock option exercises, etc.) as 1099 reportable rather than W-2 to avoid FICA tax on such payments.

In your split dollar example I would report the rollout as wages on Form W-2. The income is attributable to the year services were performed not the year it was paid. Whether a payment is wages is determined not by when the payment is received but rather whether such payments are remuneration from employment. Imagine the FICA loophole if all payments were delayed to the taxable year following termination of employment.

[Kirk Maldonado]

Harry O:

If the amounts involved in Rev. Rul 71-52 were not wages, why did the IRS say to report them on the Form W-2 if the person was an employee in the year of the transaction?

[Guest Harry O]

You can report non-wage payments on a W-2 but you cannot report wage payments on a 1099. Again the form is a bit of a red herring. The first step is to figure out if you are making a payment of "wages" or not. If it is not wages, you can pick your form without worry as long as the IRS is somehow notified of the income; if it is wages, you can only use a W-2.

[Kirk Maldonado]

Harry O:

Your post illustrates the fact that we were focusing on different aspects of the issue. I was focused upon which form should be used to report the incone. You were focused upon whether the income was properly designated as "wages."

Are you saying then, that if the amounts (1) constitute wages but (2) they are not payable until after the year in which the person's employment is terminated, then (3) you would still report it on a Form W-2?

It seems odd to me to report amounts on a Form W-2 for a person who isn't employed by that entity that year, and might even be an employee of another entity at that time.

[Guest EXB 1]

If it is treated as a loan arrangement, and imputed interest was reported annually, the cash value should not be reported as taxable income. This is the entire reason for setting it up as a loan arrangement to begin with.