By Payroll and Entitlements Editorial Staff
Death benefits that an S corporation provided to its sole shareholder under a split-dollar life insurance arrangement were employee compensation rather than a corporate distribution. In reaching this decision, the Tax Court firmly rejected the contrary conclusion reached by the Sixth Circuit Court of Appeals in J.J. Machcek, CA-6, 2018-2 U.S.T.C. 50,447.
Sole shareholder’s split-dollar life insurance benefits. The taxpayers were a medical doctor and his wife. The doctor was the sole owner of his practice, which was organized as an S corporation that employed him and his wife. The taxpayers received wages from the S corporation, as well as fringe benefits from an employee welfare benefit plan.
The fringe benefits included death benefits that the Tax Court had previously concluded were provided under a compensatory split-dollar life insurance program (R. De Los Santos, Dec. 61.270). However. the taxpayers responded by seeking summary judgment that the economic benefits provided by the program actually constituted a corporate distribution.
Tax court rejects “Machcek”. The Machacek court relied on Reg. §1.301-1(q), which states that economic benefits that a corporation provides to a shareholder under a split-dollar life insurance policy are treated as distributions of property. The regulation cross references Reg. §1.61-22(b) which meant that it applied to both compensatory and noncompensatory split-dollar arrangements.
The Tax Court rejected this analysis. Instead, Code Sec. 301 clearly requires distributions to be made to a shareholder in the shareholder’s capacity as a shareholder. Thus, it did not apply to compensatory benefits.
Split-dollar benefits were S corporation fringe benefits. The benefits also were fringe benefits paid by an S corporation under Code Sec. 1372. As such, they were treated as guaranteed partnership payments that were ordinary income, and not a corporate distribution. Following Our Country Home Enterprises, Inc.,, Dec. 60,344. (R. De Los Santos, 156 TC -, No. 9., Dec. 61,851).
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