Law Professor Submits Comments on Proposed Split-Dollar Regs

[1] I write to comment on the indication in Notice 2002-59 that the government anticipates no longer applying uniform rates in connection with the valuation of benefits under some split-dollar life insurance arrangements. I believe that this very significant departure from prior published guidance -- as well as from the constitutionally required principle that valuation be made on an objective basis and without regard to the identity of the transferor or the transferee -- should not be included in the final regulations. My comment is prompted by the recent submission by the members of the American Bar Association Task Force with respect to the proposed split-dollar regulations, in which they recommend that the final valuation table for term insurance rates for split-dollar plans be applied on a uniform basis.

[2] A fundamental rule of transfer taxation requires that fair market value be established based on the price that a hypothetical buyer and seller would agree upon as appropriate. See Treas. Reg. 20.2031-1(b); 25.2512-1. Thus, the actual identity and circumstances of the donor and the donee must be disregarded, making irrelevant the nature or quality of the transferor's interest before the transfer or the transferee's interest afterwards.

[3] For example, if A makes a gift of property X to B, the value for transfer tax purposes must be established without regard to A's or B's identity, their ownership of other interests or their other circumstances. And if B were instead to make the gift of property X to A, the value would necessarily be identical.

[4] Indeed, as the Fifth Circuit has suggested in Estate of Bright v. United States, 658 F.2d 999 (5th Cir. 1981), this rule goes to the core of the constitutional underpinning for the transfer tax system: If the tax were based on the subjective circumstances or other ownership interests of the donor or donee, rather than the objective value determined under the hypothetical -- buyer-seller formulation, the tax would be transformed from one on transfers to an impermissible (unconstitutional) direct tax on the property itself. The Service, as well as the courts, has fully embraced this valuation methodology. See Rev. Rul. 93-12, 1993-1 C.B. 202 (revoking a prior ruling that had rejected the Fifth Circuit's decision in Estate of Bright). In short, once the property that is the subject of the transfer has been identified, valuation of that property interest must be objectively established.

[5] For two additional, separate reasons (i.e., in addition to the constitutional deficiency identified by the court in Bright), the courts would be loathe to embrace an interpretation of the Code at variance with this principle. First, the courts are required to avoid any interpretation that would raise constitutional questions. See, e.g., I.N.S. v. St. Cyr, 533 U.S. 289 (2001). Thus, given the constitutional necessity for objective valuation, as suggested by the court in Bright, any argument that the Code contemplates a different value for insurance protection depending on the identity of the transferor or transferee could not be sustained. Second, a well- ingrained interpretation that has gained wide acceptance cannot be set aside in the absence of an unambiguous indication from Congress mandating that a new approach be taken. See, e.g., Mitchell v. Commissioner, 292 F.3d 800 (D.C. Cir. 2002).

[6] In sum, if the government should mandate an approach under which the value of insurance protection for transfer tax purposes would depend on the identity of the transferor or the transferee, it is very unlikely that it would be sustained by the courts.