This Tax-Deferral Arrangement Is Too Good To Be True

I was approached by a life insurance salesman regarding a proposed investment that sounds too good to be true. This salesman recommended that my corporation take out a leveraged split-dollar life insurance policy on me. Under this program, the corporation would purchase this policy on me, with a portion of the premiums to be paid by the corporation, and the remaining portion to be paid by me. Following the purchases, the corporation would borrow $100,000 from the life insurance company and make

Charles Blair, DDS and

John McGill, MBA, CPA, JD

Question:

I was approached by a life insurance salesman regarding a proposed investment that sounds too good to be true. This salesman recommended that my corporation take out a leveraged split-dollar life insurance policy on me. Under this program, the corporation would purchase this policy on me, with a portion of the premiums to be paid by the corporation, and the remaining portion to be paid by me. Following the purchases, the corporation would borrow $100,000 from the life insurance company and make an unscheduled premium deposit into the policy. The corporation would then pay back interest only on the loan at a high rate (14-15 percent) to the insurance company, the vast majority of which (13-14 percent) would be credited as interest under the policy. Accordingly, most of the money going into the policy would be funded through tax-deductible interest payments made by the corporation, while the inside build-up of the policy would grow on a tax-deferred basis. What do you think of this arrangement?

Answer:

We would be very skeptical that the tax benefits sought through this arrangement would be realized. In a recent Tax Court case, Young vs. Commissioner, the IRS attacked this arrangement and sought to tax the benefits as a dividend to the doctors individually. The Tax Court upheld this treatment, resulting in disastrous double taxation to the doctors and their professional corporation.

While the facts of this case were extremely weak for the doctors involved, the IRS is aggressively pursuing these types of cases for future litigation. In addition, Congress is proposing legislation that would severely curtail or eliminate the tax benefits associated with corporate-owned life insurance policies. For these reasons you should stay away from this type of arrangement.

Question:

I have been in practice for about 30 years and have made only a small amount of progress in putting away money for my retirement. I first set up a profit-sharing plan only four years ago and was funding it at a relatively high level until last year. When the new tax law kicked in, my contribution percentage went way down, while the amount I was forced to contribute for my younger staff members went up considerably. As a result, I was getting less than 60 percent of the benefits under the plan and my accountant advised me to stop funding this plan. I can afford to put away about $30,000 for myself and no more than $40,000 total. What type of other retirement savings vehicle would you suggest in my situation?

Answer:

The 1993 Tax Act included a provision that reduced the amount of doctor`s compensation that can be taken into account for purposes of computing retirement- plan contributions to a maximum of $150,000. As a result, the amount of money allocated to a doctor under conventional retirement plans has been significantly reduced. Doctors maintaining similar contribution levels during calendar year 1994, when this provision went into effect, found that their contribution allocation was decreased substantially while the staff allocation increased. As a result, many doctors have significantly curtailed, or eliminated, contributions to their retirement plans.

In your particular situation, you should take advantage of a retirement plan that takes your age, as well as compensation, into account for purposes of allocating contributions. Traditionally, these age-based plans have included age-weighted, profit-sharing plans, target-benefit pension plans and defined-benefit pension plans. Recently, the IRS has allowed another plan type, known as a cross-tested, profit-sharing plan. This plan takes age, as well as compensation, into account, and compares allocations between the staff members as a whole, and the doctor, in order to determine if the discrimination tests under the Internal Revenue Code are passed.

In many cases, doctors have found that through switching to a cross-tested, profit-sharing plan, they can receive the maximum annual allocation of $30,000, while significantly reducing staff- funding costs. In addition, most doctors have determined that they can receive these benefits while having to operate only one plan, rather than the two plans that many doctors have been forced to use. For additional free information regarding these retirement plans, send a self-addressed, stamped ($.52) business envelope to Blair/McGill & Company, 4601 CharlottePark Drive, Suite 230, Charlotte, NC 28217, and request "Cross-Tested Retirement Plans."

Question:

Some time ago, I set up a sideline business that I own 50-50 with another partner. I expect each of us to make at least $75,000 from it in 1996. I have a retirement plan in my practice and am funding it at the maximum rate each year. Can I set up a separate retirement plan for the new business and make tax-deductible contributions to it, or am I limited to my practice retirement plan?

Answer:

While the Internal Revenue Code provides specific rules requiring that all commonly-controlled businesses be aggregated in determining qualification under the retirement-plan rules, your situation is an exception. Since you own a 50 percent interest, you are not in a controlling position, and this business is not part of a commonly-controlled group.

As a result, you will be allowed to establish one or more qualified retirement plans for this new business and fund them at the maximum permissible level, in addition to the funding currently allowed under your dental practice retirement plan.

Dr. Blair is a nationally-known consultant and lecturer. McGill is a tax attorney and MBA. They are the editors of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes and protect assets. The newsletter ($130 a year) and consulting information are available from Blair/McGill and Company, 4601 CharlottePark Drive, Suite 230, Charlotte, NC 28217, phone (704) 523-5882.

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