Focusing on the Big Picture

The "big picture" has two parts. In part 1, Congress loves qualified retirement plans and has bestowed on them more benefits, while the IRS distrusts non-qualified plans and has persistently sought to curtail them. Part 2 is called "Enron fallout." Among Enron's many schemes, several involved flagrant abuses of non-qualified plans to heap rewards on the top executives at the center of the scandal. Details on specific financial arrangements are only now emerging, so the fallout continues.

The best way to help companies in your market address specific concerns about these plans is to team up with an expert, such as a benefits consultant or tax attorney. The summary below is meant to help you discuss developments with this type of expert, or probe for needs that a specialist can help your prospects or clients address.

COLI

The major threat to COLI has come from the IRS, which has successfully prosecuted several lawsuits against companies that created questionable plans. Typically, these companies bought life insurance coverage on large groups of employees, often without their knowledge. These policies featured large amounts of premiums and cash value build-up along with attractive loan provisions. Soon after funding such policies, companies would borrow millions of dollars from cash value (to fund more premiums) and claim large tax deductions for interest expense. In three prominent 2002 cases involving American Electric Power, Winn-Dixie Stores, and Camelot Music, the IRS won court decisions disallowing millions of dollars in claimed interest deductions. The IRS revealed in court filings that it is currently investigating 50 similar corporate plans and expects to challenge them, also. In two official announcements (2002-96 and 2002-97), the IRS offered to settle with corporate taxpayers who voluntarily terminated abusive COLI plans and paid taxes and penalties, prior to litigation.

Interpretation: COLI has been used by responsible companies for more than 60 years. Ironically, it played an important role in helping some companies at Ground Zero recover from the shattering effects of 9/11 and the deaths of employees. The IRS is specifically targeting companies that claim large interest deductions or engage in "basis shifting" techniques. COLI programs designed to emphasize death benefit protection do not appear in jeopardy. It is possible that future regulations will require disclosure to employees that the company owns life insurance in which they are insured. Also, in the current environment of IRS scrutiny and litigation, all companies are looking at COLI more cautiously and with greater compliance concern.

Split-Dollar Plans – Here, the IRS is wearing the "white hat." Two clouds hovered over split-dollar in 2002, one created by the IRS and another by Congress. In a revenue ruling, the IRS had cast doubt over the tax consequences of "equity" split-dollar arrangements in which the employer pays premiums on a policy owned by an employee. Then, in response to Enron and other corporate scandals, Congress passed the Sarbanes-Oxley Corporate Responsibility Act of 2002. Among its provisions was a controversial Section 402, which prohibited public companies (under threat of criminal sanctions) from issuing loans to directors or executive officers. This created confusion regarding whether split-dollar arrangements would be considered loans between public companies and their directors or executives.

In January of this year, the IRS provided some relief by issuing Notice 2002-8. This ruling clarified that split-dollar may be deemed a loan only if the employee owns the policy. Also, it determined to what extent premium payments made by the company, on policies owned by the company, may generate currently taxable income for the executive.

Interpretation: Split dollar has been in existence for 35 years and is among the most popular programs benefiting key executives. Clearly, there are concerns raised by Sarbanes-Oxley for public companies that establish these programs for directors or officers. Currently, the Securities and Exchange Commission is considering amendments that would require companies to disclose these arrangements in public filings (8-Ks), even if they do not constitute prohibited loans under Sarbanes-Oxley. For other companies and arrangements, the IRS has now provided a road map for how split-dollar plans should be structured. In general, the life insurance industry is satisfied with this outcome.

Nonqualified Deferred Compensation and SERPs – The threat to non-qualified executive compensation programs is coming mainly from two sources: 1) bills proposed in Congress; and 2) possible reaction to the unfolding Enron saga, which is expected to reveal flagrant use of these programs to generate huge rewards for scoundrels. The bills considered by Congress during 2002 include S.1971, which would give the U.S. Treasury more authority to set rules for taxing benefits from these programs, and H.R.5095, which would specifically target favorable tax treatment in the "Rabbi Trusts" that are often used to fund these arrangements. Until now, these trusts have been considered one of the safest ways to fund non-qualified benefits, because of clear guidance from prior rulings.

Interpretation: The composition and mood of Congress will determine whether and how tax treatment of these programs is changed. If voters demand that tax laws stop favoring top executives who grant themselves NQDCs and SERPs, Congress may respond with new provisions. Ironically, the recent trend in these programs has been to push them down into middle managers ranks, helping non-wealthy people pursue financially security. The life insurance industry is working hard to make sure Congress understands that point, but the outcome is uncertain.

One of the best places online to stay up-to-date on these developments is the Web site of the Association for Advanced Life Underwriting (AALU), a life insurance organization active in lobbying and public education. Go to www.aalu.org. Then click "Public" and "Issues and Positions." Also, stay abreast of Pension Round-Up at FreeERISA.com for monthly updates on specific regulations and technical issues.