A common problem found in estate planning for owners of successful closely-held businesses is the need for large amounts of liquidity to meet the inevitable Federal Estate Taxes. Even if the business owner has sufficient resources to pay premiums for life insurance to meet this need, it is generally desirable to have the insurance policy outside of the taxable estate. This will prevent the death benefit of the insurance from being added to the other estate assets for tax purposes. The most common arrangement is to have the insurance policy owned by an irrevocable trust, with the insured making gifts of cash to the trust for the purpose of making premium payments. Often, the amount of the premium exceeds the amount that the ensured can give, without triggering gift taxes. (Under existing rules, annual gifts in excess of $10,000 to any beneficiary are subject to Federal Gift Taxes.) In some cases, a prior plan of gifting has already been instituted, and even the $10,000 annual exclusion is not available.

To provide the necessary death benefit and resolve these gift tax concerns, some business owners should look at an arrangement known as a SPLIT DOLLAR. Under this arrangement, the business and the irrevocable trust enter into a premium sharing arrangement. The trustee of the irrevocable trust pays out a small portion of the annual insurance premium, while the business agrees to pay the balance of the premium due. In exchange for its premium advances, the business retains the cash value of the policy as an asset on its balance sheet. Since virtually all surety carriers consider insurance cash values as an equivalent to cash for bonding purposes, this arrangement strengthens the business for credit purposes. At some moment in the future, the total policy cash values will exceed the sum of the business cash advances. When this moment is reached, the SPLIT DOLLAR arrangement is terminated, and the business is reimbursed in cash from the policy cash values.

By properly structuring the SPLIT DOLLAR arrangement, the business (which is frequently the largest asset of the estate and responsible for the greatest portion of the tax) can solve the estate tax liquidity problem while avoiding the gift tax problems attributable to large premiums. In addition, by having the policy owned by an irrevocable trust, the death proceeds can escape taxation in the business owners' estate.