Introduction
For government contractors, particularly small business owners looking to retain key personnel or manage executive compensation, understanding complex financial arrangements is essential. A split-dollar agreement is a sophisticated arrangement between an employer and an employee—or a business and its owner—to share the costs and the benefits of a life insurance policy. While these agreements are primarily private financial instruments, they intersect with federal contracting compliance when they impact overhead rates, executive compensation caps, and allowable costs under the Federal Acquisition Regulation (FAR).
Definition
A split-dollar agreement is a contractual arrangement where two parties (typically an employer and an employee) agree to share the premium costs, cash value, and death benefits of a permanent life insurance policy. In the context of a government contractor, the company usually pays the premiums, and the employee receives the death benefit protection. The "split" refers to how the policy's economic benefits are divided, often structured as either an "endorsement" method (where the employer owns the policy) or a "collateral assignment" method (where the employee owns the policy).
Examples
- Executive Retention: A prime contractor uses a split-dollar agreement to provide a high-value life insurance benefit to a Chief Technology Officer. The company pays the premiums, and the agreement stipulates that the company will be reimbursed for those premiums from the policy's cash value upon the executive's retirement or death.
- Business Succession: In a closely-held small business, a split-dollar agreement may be used to fund a buy-sell arrangement, ensuring that the business has the liquidity to purchase an owner's shares upon their passing.
Frequently Asked Questions
Are premiums paid under a split-dollar agreement allowable costs under FAR?
Generally, no. Under FAR 31.205-46, costs for life insurance on officers or employees are only allowable if they are part of a reasonable compensation package and the contractor is not the beneficiary. If the contractor is a beneficiary—which is common in split-dollar arrangements—the costs are typically unallowable for government contract billing purposes.
How does this impact my DCAA audit?
During a Defense Contract Audit Agency (DCAA) audit, auditors will scrutinize executive compensation. If a split-dollar agreement is deemed excessive or is improperly categorized as an overhead expense, it may be questioned. Using platforms like SamSearch can help contractors stay updated on how current cost accounting standards (CAS) apply to executive benefits.
Can I use a split-dollar agreement to lower my tax liability?
Yes, but it must be structured correctly to avoid being classified as a taxable "loan" under IRS regulations. Contractors should consult with a tax attorney to ensure the agreement complies with both IRS rules and the cost principles outlined in the FAR.
Conclusion
While a split-dollar agreement is a powerful tool for executive compensation and retention, it carries significant compliance risks for government contractors. Because these arrangements often involve the company paying premiums for policies where they have a financial interest, they are frequently flagged as unallowable costs in government audits. Before implementing such an agreement, contractors must conduct a thorough cost-benefit analysis and ensure their accounting practices align with FAR Part 31. For ongoing guidance on navigating complex regulatory environments, contractors rely on SamSearch to maintain compliance and competitive advantage.
