Sixth Circuit Holds Dentist's Life Insurance Plan Was a Split-Dollar Arrangement

(Parker Tax Publishing July 2025)

The Sixth Circuit affirmed a district court and held that the value of the economic benefits of a taxpayer's life insurance policy had to be included in the taxpayer's income under the split-dollar life insurance rules in Reg. Sec 1.61-22. The court further held that the taxpayer's dental practice was not allowed to claim deductions for the annual premium payments it made because they were not ordinary and necessary business expenses. McGowan v. U.S., 2025 PTC 234 (6th Cir. 2025).

Background

Peter McGowan has practiced dentistry for about three decades. He incorporated his dental practice as Peter E. McGowan DDS, Inc., a C corporation (i.e., the Company) and served as its director, president, treasurer, secretary, and sole shareholder. During the tax years at issue, the Company typically paid McGowan a weekly base salary, plus an end-of-year bonus equaling the company's otherwise taxable income.

At some point, McGowan, in his own name, purchased a whole life insurance policy from Guardian Life Insurance. While covered under that policy, McGowan learned of a tax-efficient alternative from his health insurance advisor. In broad strokes, the new plan (the Plan) involved the Company compensating McGowan with life insurance in a structure intended to replace his Guardian policy and minimize the tax burden across both parties. It operated through a document called the Benefits Trust Agreement (the Agreement), which established two subtrusts.

One subtrust, labeled the Death Benefit Trust (the DBT), bought and owned a whole-life insurance policy from Penn Mutual covering McGowan (the Policy). The Policy's terms functioned like his prior policy, save for one nuance: McGowan, despite being the insured, did not pay the premiums himself. Rather, the Company contributed $37,222 to the DBT each year, which the DBT then used to pay the Policy's base premium. The other subtrust was labeled the Restricted Property Trust (the RPT). The RPT received up to $12,778 from the Company annually, which it would transfer to the DBT. The DBT, in turn, invested the sums as "paid-up additions" to the Policy's cash value and death benefit. The DBT, in exchange, gave the RPT a security interest in the Policy's cash value.

The Plan worked in five-year increments. So long as the DBT satisfied the base premium, the Plan remained effective for a five-year term. If McGowan died during the Plan's operation, the RPT would release its security interest and Penn Mutual would pay the death benefit to the DBT. The DBT would then pay that benefit to McGowan's designated beneficiary: his wife. If the Plan expired, with the Company declining to renew it for another five-year term, the Plan would terminate and the Policy would go to McGowan. And if the Company failed to contribute the base premium to the DBT, the DBT would surrender the Policy for its cash value and transfer the cash to the RPT in satisfaction of its security interest. The RPT would then donate the proceeds to a charity chosen by McGowan - specifically, the Toledo Zoo, a longtime charitable interest of McGowan's.

McGowan purchased the Plan for $6,000 in startup fees. He chose the amount of the Policy's death benefit and, in so doing, tried to "maintain" the scope of coverage he had under Guardian. As a result, the policies' terms were comparable: the Guardian policy had a $2.5-million death benefit and $37,622.64 base premium, while the new Policy had a $2,057,613 death benefit and $37,222.22 base premium.

On his tax returns, McGowan reported neither the value of the death benefit nor the accumulated cash value of the Policy as taxable income. He did report the annual $12,778 contributions to the RPT as income, following a Code Sec. 83(b) election that was not in dispute. Meanwhile, the Company claimed deductions each year for $50,000, the sum of its annual payments to the subtrusts, as ordinary and necessary business expenses.

This arrangement continued from 2011 through 2015, at which point McGowan tried to extend the Plan. But he missed the deadline to do so. That misstep meant that, pursuant to the Plan's terms, McGowan took direct ownership of the Policy in 2016. In his return for that year, he reported that his receipt of the Policy triggered taxable income of $115,227 - the then - cash value of the Policy less the sum of the appreciated value of each year's $12,778 RPT contribution, which had already been reported as income.

The IRS determined that McGowan should have recognized the Policy's accumulation of cash value as taxable income each tax year, and that the Company should not have been taking deductions for its annual contributions to the DBT. Accordingly, the IRS assessed additional taxes and penalties for McGowan and the Company. McGowan and the Company (i.e., the taxpayers) paid the assessed taxes and penalties and sued for a refund in a district court. In McGowan v. U.S, 2023 PTC 254 (N.D. Ohio 2023), the district court granted summary judgment to the government. The taxpayers appealed to the Sixth Circuit.

Split-Dollar Life Insurance Arrangements

In a split-dollar life insurance arrangement, an employer contracts with an employee to pay some or all of the premiums on the employee's life insurance, generally in exchange for the parties sharing the policy's benefits. In this context, the "dollars" expended on premiums and received as benefits are, on paper, "split" among the company and the employee. In 2003, the IRS issued Reg. Sec. 1.61-22 (i.e., the "split dollar regulation") to address and clarify the taxation of split-dollar arrangements. The regulation addresses three types of life insurance plans: general, compensatory, and shareholder. Each triggers effectively the same tax consequences but differs in its qualifying criteria. This case concerns the compensatory provision in Reg. Sec. 1.61-22(b)(2).

Generally, an arrangement between an owner and a non-owner of a life insurance contract is a compensatory split-dollar arrangement if (1) it is entered into in connection with the performance of services, (2) the employer pays all or part of the premiums, and (3) either (i) the beneficiary of the death benefit is designated by the employee or (ii) the employee has any interest in the policy cash value of the life insurance contract. If the Plan met these terms, then McGowan was required to recognize the full value of the Plan's economic benefits (minus any consideration he paid to the Company for those benefits) and the Company was prohibited from claiming deductions for its premiums paid.

The taxpayers argued that because the DBT formally owned the Policy and had no independent trustee, the Company was not "an owner" of the Policy, rendering the Plan an arrangement between two nonowners. They also contended that the possibility of the DBT's cash value being donated to charity under the Plan prevented the conclusion that McGowan had designated the relevant beneficiary. In addition, the taxpayers challenged the validity of the split-dollar regulation under the Supreme Court's decision Loper Bright Enterprises v. Raimondo, 2024 PTC 237 (S. Ct. 2024), overruling Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). According to the taxpayers, the split-dollar regulation contravened Congress's statutory command in Code Sec. 61 and impermissibly forecloses deductions that the Company otherwise could have claimed.

Analysis

The Sixth Circuit affirmed the district court after finding that the taxpayers landed firmly within the split-dollar regulation.

Regarding the taxpayers' argument that the arrangement was between two nonowners, the court noted that under, Reg. Sec. 1.61-22(c)(1)(iii)(C), an employer is treated as the owner of a life insurance contract if the owner of the policy is a welfare benefit fund within the meaning of Code Sec. 419(e)(1). Code Sec. 419(e)(1) defines a welfare benefit fund as any fund (1) which is part of a plan of an employer and (2) through which the employer provides welfare benefits to employees or their beneficiaries. The court found that the DBT was just that. In fact, the taxpayers themselves referred to the DBT as a welfare benefit fund in the district court.

The court further found that McGowan had in fact designated the beneficiary. The court acknowledged that the Policy's death benefit was paid first to the DBT, which was not designated by McGowan, at which point it was transferred to his wife. In the court's view, this structuring deserved little heed. The Agreement specified that the DBT "shall distribute and pay" the death benefit to McGowan's beneficiary upon his death. The court said that in economic reality, the Plan enabled McGowan to select his wife as the ultimate beneficiary of his life insurance policy's death benefit - subtrust intermediary notwithstanding. In addition, the court found that the potential donation of the death benefit to the Toledo Zoo itself formed a "current or future right" for McGowan, since he presumably derived some intrinsic value from the money being sent to the beneficiary he selected.

Finally, the court rejected the taxpayers' Loper Bright challenge after finding that the statutory authority behind the split-dollar regulation was readily apparent. In the court's view, the expansive language of Code Sec. 61's definition of gross income is broad enough to include any economic benefit conferred on an employee as compensation, including the benefit of a split-dollar arrangement. The court also observed that Code Sec. 419(a) prohibits deductions for employer contributions to a welfare benefit fund unless "they would otherwise be deductible." But the court found that the premiums were not otherwise deductible as ordinary and necessary business expenses. The court found that, far from being commonplace among dentists or promoting the Company's inherent profit motive, the premiums served merely to advance McGowan's personal goal of leaving a beneficiary of his choice over $2 million, no strings attached, in an attempted tax-efficient vehicle.

The Fate of Machacek

In closing, the court cast doubt on the soundness of its decision in Machacek v. Comm'r, 2018 PTC 347 (6th Cir. 2018). In Machacek, the Sixth Circuit held that when a shareholder-employee receives economic benefits from a split-dollar arrangement - even those deemed compensatory - the benefits must be treated as a dividend and taxed at capital gains rates. In so holding, the Machacek court relied on Reg. Sec. 1.301-1(m), which states that "the provision by a corporation to its shareholder pursuant to a split-dollar life insurance arrangement ... is treated as a distribution of property." This meant that, despite the court's holding for the government, McGowan was entitled to $40,978 refund since the IRS had originally assessed his deficiency on the premise that the Plan triggered ordinary income.

The court in the present case observed that, by categorically holding that split-dollar life insurance plans involving shareholder-employees always concern the shareholders' stock, Machacek seemingly overlooks the possibility that such plans could relate to services or other non-stock categories. The court noted that the IRS issued a non-acquiescence letter indicating its disagreement with the holding in Machacek and that tax academics have argued that the case was wrongly decided. Most damning of all, in the court's view, was the Tax Court's decision in De Los Santos v. Comm'r, 156 T.C. 120 (2021), a published opinion joined by all 16 then-active judges, concluding that the Tax Court was "unable to embrace the reasoning or result" in Machacek.

The court said that "Machacek's sun may soon set." Observing that Machacek was decided under the principle of Chevron deference, the court suggested that a different outcome could result under the Loper Bright standard. However, since neither party in this case asked the court to reconsider Machacek, the court deferred doing so to another case.

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.

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