Professional Tax Research Solutions from the Founder of Kleinrock. tax and accounting research
Parker Tax Pro Library
Accounting News Tax Analysts professional tax research software Like us on Facebook Follow us on Twitter View our profile on LinkedIn Find us on Pinterest
federal tax research
Professional Tax Software
tax and accounting
Tax Research Articles Tax Research Parker's Tax Research Articles Accounting Research CPA Client Letters Tax Research Software Client Testimonials Tax Research Software Federal Tax Research tax research

Accounting Software for Accountants, CPA, Bookeepers, and Enrolled Agents

Increase in Value of Split-Dollar Insurance Policy Was a Distribution, Not Income, to S Corp Employee-Shareholder

(Parker Tax Publishing October 2018)

In a case of first impression, the Sixth Circuit reversed the Tax Court and held that the economic benefits flowing from the increase in value of a split-dollar life insurance policy to an employee-shareholder of an S corporation was a distribution in respect of stock, even though the employee-shareholder received the benefits under a compensatory split-dollar arrangement. The Sixth Circuit reasoned that Reg. Sec. 1.301-1(q) explicitly treats economic benefits provided to a shareholder under any split-dollar arrangement, including a compensatory arrangement, as a distribution of property, and rejected the IRS's argument that the tax treatment depended on whether the arrangement was a compensatory or shareholder split-dollar arrangement. Machacek v. Comm'r, 2018 PTC 347 (6th Cir. 2018).


John and Marianne Machacek, a married couple, were the sole shareholders of John J. Machacek, Inc. (Machacek, Inc.), an S corporation. Mr. Machacek was also an employee of Machacek, Inc. In 2002, the company adopted an employee benefit plan, which included a compensatory split-dollar insurance arrangement. Under the plan, Machacek, Inc. provided Mr. Machacek with a life insurance policy and paid the $100,000 annual premium. Machacek Inc. deducted the premium payment on its return. The Machaceks excluded from the income the economic benefits flowing to Mr. Machacek as a result of Machacek, Inc.'s payment of the premium.

The IRS issued a notice of deficiency determining that the Machaceks should have included in income the economic benefit from the increase in the value of the life insurance policy. The Machaceks challenged the notice in the Tax Court.

The Tax Court determined that Machacek, Inc. was not entitled to deduct the $100,000 premium payment. Because the $100,000 premium payment was not deductible, Machacek, Inc. underreported its income for that year and, due to the pass-through nature of S corporations, the increased income was passed through to the Machaceks, who were then required to pay income tax on that amount. The non-deductibility of the premium payment was not disputed, and the Machaceks conceded that they had to report the amount of the premium payment as pass-through income. However, with respect to the tax treatment of the economic benefits flowing to Mr. Machacek as a result of Machacek, Inc.'s payment of the premium, the Machaceks argued that they were not required to report as taxable income - in addition to the pass-through amount of the premium - the economic benefits flowing from the increase in value of the life insurance policy caused by the payment of the premium. The Tax Court ruled against the Machaceks and found that they were required to account for the economic benefits in their individual income.

The Tax Court held that the value of the $100,000 contribution by Machacek, Inc. was properly attributed to Mr. Machacek, as an employee of the S corporation and a nonowner of the life insurance contract. Although the Tax Court noted that this result might seem aberrational in view of the passthrough treatment generally afforded to S corporations, this result was mandated by the split-dollar life insurance regulations. According to the Tax Court, in instances other than those governed by the split-dollar life insurance regulations, the general rule of the non-taxability of the previously taxed S corporation income is unperturbed. The Machaceks appealed to the Sixth Circuit.


Reg. Sec. 1.61-22(b) describes three types of split-dollar life insurance arrangements: traditional, compensatory, and shareholder. A traditional arrangement is defined in Reg. Sec. 1.61-22(b)(1) as one between an owner and a nonowner of a life insurance contract in which either party pays the premiums and at least one of the parties paying premiums is entitled to recover all or part of the premiums from the insurance proceeds. Reg. Sec. 1.61-22(b)(2) describes compensatory and shareholder split-dollar arrangements. A compensatory split-dollar arrangement is one in which an employer is the owner of the contract and provides life insurance coverage in connection with the performance of services by an employee. In a shareholder split-dollar arrangement, the owner is a corporation, and the arrangement is entered into with an individual in their capacity as a shareholder.

Under Reg. Sec. 1.61-22(d)(1), the nonowner of a split-dollar arrangement must take into account the full value of all economic benefits flowing from the arrangement. Reg. Sec. 1.61-22(d)(1) states that, depending on the relationship between the owner and nonowner, the economic benefits may constitute a payment of compensation, a distribution under Code Sec. 301, a contribution to capital, a gift, or a transfer having a different tax character. The split-dollar regulations make no reference to Subchapter S.

Reg. Sec. 1.301-1, which governs the distribution of property by a corporation to its shareholders with respect to their stock, addresses the treatment of economic benefits received under a split-dollar arrangement. Reg. Sec. 1.301-1(q)(1)(i) states that the provision of economic benefits by a corporation to its shareholder under an arrangement described in Reg. Sec. 1.61-22(b)(1) or (2) is treated as a distribution of property. By its terms, the regulation applies to all split-dollar arrangements.

The Machaceks argued that, under Reg. Sec. 1.301-1(q)(1)(i), the economic benefits of the arrangement should be treated as a distribution of property by Machacek, Inc. to Mr. Machacek in his capacity as a shareholder, notwithstanding that the benefits flowed from a compensatory split-dollar arrangement. The Machaceks also argued that Subchapter S, which precludes the double taxation of dividends, overrode the split-dollar arrangement regulations.

The IRS argued that the Tax Court's decision to treat economic benefits as individual income, rather than a shareholder distribution, was correct because Mr. Machacek received life insurance as part of a compensatory arrangement. The IRS asserted that such a position would be uncontroversial if Mr. Machacek were an ordinary employee rather than a shareholder-employee of an S corporation. While recognizing that Reg. Sec. 1.301-1(q)(1)(i) applies to both compensatory and shareholder arrangements, the IRS argued that interpreting it to provide that shareholder status trumps employee status would defeat the reason for distinguishing between the different types of arrangements. The IRS also pointed out that Machacek, Inc. would get a deduction in a future year when it transferred ownership of the policy to Mr. Machacek, and argued that treating the benefits as a distribution would allow the Machaceks to escape taxation on the accumulated value and realize an additional tax advantage when Machacek, Inc. later deducted the cost of the policy.

Sixth Circuit's Decision

The Sixth Circuit noted that the application of Reg. Sec. 1.301-1(q)(1)(i) to economic benefits flowing to an S corporation shareholder-employee under a compensatory split-dollar arrangement was an issue of first impression. Because the Tax Court did not consider the impact of that regulation, the Sixth Circuit reversed the Tax Court's decision and remanded the case back to the Tax Court for further proceedings.

The Sixth Circuit agreed with the Machaceks and held the Tax Court erred by relying on the compensatory nature of the arrangement to conclude that the economic benefits were not distributions. The Sixth Circuit found that under Reg. Sec. 1.301-1(q)(1)(i), the economic benefits under the arrangement were a distribution of property, regardless of whether Mr. Machacek received them through a compensatory or shareholder split-dollar arrangement. In the court's view, Reg. Sec. 1.301-1(q)(1)(i) treats such benefits provided to a shareholder under any type of split-dollar arrangement as a distribution of property.

The Sixth Circuit noted the language in Reg. Sec. 1.301-1(c) stating that the regulation as a whole does not apply to an amount paid by a corporation to a shareholder unless the amount is paid to the shareholder in their capacity as such. However, the court found that the explicit inclusion in Reg. Sec. 1.301-1(q)(1)(i) of all arrangements described in Reg. Sec. 1.61-22(b)(2) - including compensatory arrangements - made clear that when a shareholder-employee receives economic benefits under a compensatory arrangement, the benefits are a distribution and thus are deemed to have been paid to the shareholder in their shareholder capacity. In the court's view, the IRS gave no alternative explanation for the inclusion of compensatory arrangements in Reg. Sec. 1.301-1(q)(1)(i). The court rejected the IRS's argument that the language of Reg. Sec. 1.301-1(q)(1)(i) showed that the tax treatment depended on the nature of the split-dollar arrangement, concluding that if the type of arrangement were the controlling factor, the regulation could have said so, but did not.

The Sixth Circuit found that the IRS failed to set out what it saw as the reason for distinguishing between compensatory and shareholder arrangements, and it was not clear to the court that treating all economic benefits to shareholders as distributions would undermine the purpose of the regulations. In the court's view, the structure of the split-dollar regulations implied that the regulations were intended to broaden the scope of the term. The court noted that commenters at the time the regulations were issued recognized that split-dollar arrangements were defined so broadly that arrangements not previously considered split-dollar could be swept within its scope. Further, the court noted that the split-dollar regulations apply to all situations, not just situations where the nonowner of the policy is a shareholder, and thus there were obvious reasons for distinguishing between shareholder and compensatory arrangements.

For a discussion of split-dollar life insurance arrangements, see Parker Tax ¶221,330.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

Parker Tax Pro Library - An Affordable Professional Tax Research Solution.

Professional tax research

We hope you find our professional tax research articles comprehensive and informative. Parker Tax Pro Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.

Parker Tax Research

Try Our Easy, Powerful Search Engine

A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play

Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.

Parker Tax Research Library

Dear Tax Professional,

My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.

Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.

To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.

Our product, the Parker Tax Pro Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.

Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!


James Levey

Parker Tax Pro Library - An Affordable Professional Tax Research Solution.

    ®2012-2018 Parker Tax Publishing. Use of content subject to Website Terms and Conditions.

IRS Codes and Regs
Tax Court Cases IRS guidance