When Wally Bonesteele, the founder of Cascade Warehouse Company in Salem, Ore., died in his 60s in 1995, it came as a shock to his heirs and successors. The succession plan for this $15 million forest products transportation and warehousing concern was already mostly in place. But the family soon realized that estate taxes would make the transfer to the next generation much more expensive than they’d expected. To help the next generation avoid the same problem, Cascade’s managers are now investigating an obscure tool called “split-dollar insurance” to help offset the controlling family’s future estate taxes.
Split-dollar life insurance—so named because the company and the employee each owns a share of the policies’ benefits, “splitting” the dollars—may help provide funding for the next-generation owners. “It’s not so much tax avoidance as it is helping the next generation offset some of the costs they will have to make sure the business succeeds from one generation to the next,” says Scott Cantonwine, president and CEO of Cascade Warehouse and son-in-law of the founder. Although Cantonwine is only 45, he’s in a bit of a rush: He aims to invest in a split-dollar insurance plan in 2003, before the new regulations are finalized by the IRS—a move that is expected to eliminate many tax breaks for such plans as of next January.
Split-dollar insurance policies are, frankly, confusing to most lay people. That’s too bad—because even with the new IRS regulations, these policies are still a pretty good bet for family businesses eager to retain key employees or to offset estate costs by providing cash for the next generation.
In the typical split-dollar employee compensation plan, the employer owns the policy, is the first beneficiary and pays the premium. The insured employee usually has the right to buy the policy back, should he leave the company. In exchange, the employee receives a substantial, sometimes cost-free death benefit. The employer is repaid for the premiums when the policy has built up its cash value or when the employee dies. The remaining death benefit and cash value then belong to the employee or the employee’s heirs.
“This is very popular with C corporations as well as many public companies because it’s a neat way to provide another fringe benefit program to a key employee,“ says David Lurie, an independent life insurance broker with Transamerica Financial Advisors in Houston. “The primary idea is to beef up the life insurance holdings of the employee. Whereas the employee might only be able to afford a $100,000 policy, this allows them to get a $250,000 or $500,000 policy with a substantial death benefit, depending on the cash value.”
Lurie says these plans are a good way to show appreciation for top employees and motivate them to stay with the business. Since the employer owns the policy, if the employee leaves or is fired, the policy stays with the business. In 2004, after the new IRS rules go into effect, plans purchased for employees must be claimed as a series of loans, terminated or cashed out, effectively closing the tax loophole on these plans.
More commonly, however, split-dollar insurance is used in family businesses to offset wealth transfer costs and provide a means of funding the next generation’s investment. For Cascade Warehouse, for example, the policy would be used to pay estate taxes, should Scott Cantonwine or another family principal die. In such cases, Lurie says, “the business isn’t operating on all its cylinders and the heirs aren’t in the best financial position. This is just a way to ensure the value of the business.“
In a wealth transfer situation, the owning family sets up an irrevocable life insurance trust. The trust pays the insurance premium. Under current regulations, the cash value of the plan isn’t taxed as long as the plan remains in place. Starting in 2004, however, the tax rates on this equity will be substantially higher. But anyone who sets up such a trust now will still enjoy three options—borrowing from the plan, terminating it or cashing out (if it has built up equity)—that can be exercised if the new IRS regulations prove onerous. Since final IRS regulations haven’t been released yet, there may be some advantage to creating a plan now and then calling a financial planner later this year to crunch some numbers and see which option works best.
Either way, the window of opportunity on split-dollar tax breaks will close at the end of 2003. Experts recommend family business owners make a decision before the IRS cements its policy. Cascade’s Scott Cantonwine hopes the IRS doesn’t eliminate any more benefits to the plans. “If people want to carry on a family business, there should be some tools in place to help them do that,” he says.
Kawa-Jump is a writer who lives in Fort Wayne, Ind.