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Taxpayer and dentist Peter McGowan ran a dental practice formed as a C corporation. When purchasing a whole life insurance policy, he made an arrangement with the company to pay the premiums.
In a plan recommended by his health insurance advisor and insurance agent, Peter established two trusts. One trust, the death benefit trust (DBT), bought the policy. The company made payments to the DBT, which then paid the premiums. The company also made contributions to a second trust, the restricted property trust (RPT), which then transferred funds to the DBT to purchase paid-up additions to the cash value and death benefit, in return for a security interest in the policy’s cash value. The plan arrangements were effective for five years, at which time it was subject to renewal.
If Peter died during the term, the benefits would be paid to the DBT. The DBT was directed to pay the death benefit to Peter’s wife, the beneficiary he had designated. If the plan expired (because its five-year term wasn’t renewed), the insurance policy would be transferred to Peter. If the company failed to make the payments to the DBT, then the policy would be surrendered for its cash surrender value, which would be transferred to the RPT, and the RPT was directed to pay the amounts received to the Toledo Zoo, a charitable organization.
Five years later, Peter failed to renew and extend the plan. The Internal Revenue Service audited Peter and his company and determined that each year, Peter should have recognized the accumulation of cash value as taxable income. In addition, it found that the company’s deductions of its annual contributions to the DBT weren’t proper. The taxpayers paid the required tax and penalties and then appealed.
The district court held for the IRS, and in McGowan v. United States (Sixth Circuit, July 9, 2025), the U.S. Court of Appeals for the Sixth Circuit affirmed. The IRS had determined that this was a compensatory split-dollar arrangement between an owner and a non-owner of the life insurance in connection with the performance of services. In that case, when the employer pays premiums and the employee designates the beneficiary, the employee is supposed to recognize the full value of the economic benefits, and the company is prohibited from taking deductions for the premiums.
Peter argued that because the arrangement was between him and the company, while the owner of the insurance was the DBT, the plan wasn’t an arrangement between an owner and a non-owner. The court wasn’t convinced and confirmed that this fell squarely within the split-dollar regime in which Peter designated his wife as the beneficiary of the death benefit, and the Zoo as the beneficiary of the cash value.
The court held that the use of the DBT as an intermediary between the company and the employee didn’t change the substance of the agreement: the company would pay the premiums, and Peter designated the beneficiary. As a result, the usual reporting rules held. Peter recognized income each year in the amount of the accumulated cash value, and the company wasn’t permitted to deduct the payments to the DBT.
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