Neonatology Associates, P.A. v. CommissionerNeonatology Associates, P.A. v. Commissioner
Certain insurance salesmen formed two purported voluntary employees’ beneficiary associations (VEBA‘s) to generate commissions on their sales of life and other insurance products purchased through the VEBA‘s. Each employer/participant contributed to its own plan formed under the VEBA‘s, and each plan generally provided that a covered employee would receive current-year (term) life insurance on his or her life. Premiums on the underlying insurance policies were substantially greater than the cost of term life insurance because they funded both the cost of term life insurance and credits which would be applied to conversion universal life policies of the individual insureds. The credits applied to a conversion policy were “earned” on that policy evenly over 120 months, meaning that policyholders generally could withdraw any earned amount or borrow against it with no out-of-pocket expense.
Held: The corporate employer/participants (N and L) may not deduct contributions to their plans in excess of the cost of term life insurance.
Held, further, L may deduct payments made outside its plan for life insurance on two of its employees to the extent the payments funded term life insurance.
Held, further, neither M, a sole proprietorship/participant, nor N may deduct contributions to its plan to purchase life insurance for certain nonemployees.
Held, further,
Held, further, in the case of N and L, the disallowed deductions are constructive dividends to their employee/owners.
Held, further, Ps are liable for the accuracy-related penalties for negligence or intentional disregard of rules or regulations determined by R under
Held, further, no P is liable for a penalty under
Neil L. Prupis, Kevin L. Smith, and Theresa Borzelli, for petitioners.
Randall P. Andreozzi, Peter J. Gavagan, Mark A. Ericson, and Matthew I. Root, for respondent.
LARO, Judge: The docketed cases, consolidated for purposes of trial, briefing, and opinion, represent three test cases selected by the parties to resolve their disagreements as to certain voluntary employees’ beneficiary association (VEBA) plans; namely, the Southern California Medical Profession Association VEBA (SC VEBA) and the New Jersey Medical Profession Association VEBA (NJ VEBA).2 The parties in 19 other cases pending before the Court have agreed to be bound by the decisions we render herein as to these VEBA issues.
Two of the test cases involve a corporate employer and one or more employee/owners. These employer/employee groups are the Neonatology Associates, P.A. (Neonatology), group and the Lakewood Radiology, P.A. (Lakewood), group. These groups relate to two purported welfare benefit funds formed under the SC VEBA; namely, the Neonatology Employee Welfare Plan (Neonatology Plan) and the Lakewood Employee Welfare Plan (Lakewood Plan).3
The third test case involves an individual working as a sole proprietor and two of his employees. This group is the Wan B. Lo, Ph.D., D.O., d.b.a. Marlton Pain Control and Acupuncture Center (Marlton) group. The Marlton group relates to
In regard to each test case, respondent determined that the employer or sole proprietor could not deduct its or his contributions to the respective plan and, in the case of Neonatology and Lakewood, that the employee/owners had income to the extent that he or she benefited from a contribution.5 Respondent determined that each petitioner was liable for deficiencies in Federal income tax as a result of the VEBA determinations and that each petitioner was liable for a related accuracy-related penalty under
Each petitioner petitioned the Court to redetermine respondent‘s determinations. Respondent‘s notices of deficiency list the following deficiencies, addition to tax, and accuracy-related penalties:6
Neonatology Group
Neonatology, docket No. 1201-97
| Year | Deficiency | Addition to Tax | Accuracy-Related Penalty |
|---|---|---|---|
| 1992 | $1,620 | — | $324 |
| 1993 | 6,262 | — | 1,252 |
John J. and Ophelia J. Mall, docket No. 1208-97
| Year | Deficiency | Addition to Tax | Accuracy-Related Penalty |
|---|---|---|---|
| 1992 | $6,186 | — | $1,237 |
| 1993 | 7,404 | — | 1,481 |
Lakewood, docket No. 2995-97
| Year | Deficiency | Addition to Tax | Accuracy-Related Penalty |
|---|---|---|---|
| 1991 | $169,437 | — | $33,887 |
| 1991 | — | — | — |
| 1992 | 71,110 | $10,667 | 14,222 |
| 1993 | 93,111 | — | 18,622 |
Estate of Steven Sobo, Deceased, Bonnie Sobo, Executrix, and Bonnie Sobo, docket No. 2795-97
| Year | Deficiency | Addition to Tax | Accuracy-Related Penalty |
|---|---|---|---|
| 1991 | $27,729 | — | $5,546 |
| 1992 | 5,107 | — | 1,021 |
| 1993 | 3,018 | — | 604 |
Akhilesh S. and Dipti A. Desai, docket No. 2981-97
| Year | Deficiency | Addition to Tax | Accuracy-Related Penalty |
|---|---|---|---|
| 1991 | $42,047 | — | $8,409 |
| 1992 | 15,751 | — | 3,150 |
| 1993 | 25,016 | — | 5,003 |
Kevin T. and Cheryl McManus, docket No. 2985-97
| Year | Deficiency | Addition to Tax | Accuracy-Related Penalty |
|---|---|---|---|
| 1991 | $6,821 | — | $1,364 |
| 1992 | 6,146 | — | 1,229 |
| 1993 | 8,214 | — | 1,643 |
Arthur and Lois M. Hirshkowitz, docket No. 2994-97
| Year | Deficiency | Addition to Tax | Accuracy-Related Penalty |
|---|---|---|---|
| 1991 | $82,933 | — | $16,587 |
| 1992 | 45,233 | — | 9,047 |
| 1993 | 79,853 | — | 15,971 |
Marlton Group
Wan B. and Cecilia T. Lo, docket No. 4572-97
| Year | Deficiency | Addition to Tax | Accuracy-Related Penalty |
|---|---|---|---|
| 1993 | $41,807 | — | $8,361 |
| 1994 | 49,970 | — | 9,994 |
We decide the following issues:
- Whether Neonatology and Lakewood may deduct contributions to their respective plans in excess of the amounts needed to purchase current-year (term) life insurance for their covered employees. We hold they may not.
-
Whether Lakewood may deduct payments made outside of its plan to purchase additional life insurance for two of its employees. We hold it may to the extent that the payments funded term life insurance. - Whether Neonatology may deduct contributions made to its plan to purchase life insurance for John Mall (Mr. Mall), who was neither a Neonatology employee nor a person eligible to participate in the Neonatology Plan. We hold it may not.
- Whether Marlton may deduct contributions to its plan to purchase insurance for its sole proprietor, Dr. Lo, who was neither a Marlton employee nor a person eligible to participate in the Marlton Plan. We hold it may not.
- Whether
section 264(a) precludes Marlton from deducting contributions to its plan to purchase term life insurance for its two employees. We hold it does. - Whether, in the case of Lakewood and Neonatology, the disallowed contributions/payments are includable in the employee/owners’ gross income.7 We hold they are.
- Whether petitioners are liable for the accuracy-related penalties for negligence or intentional disregard of rules or regulations determined by respondent under
section 6662(a) . We hold they are.
- Whether Lakewood is liable for the addition to tax for failure to file timely determined by respondent under
section 6651(a) . We hold it is. - Whether we should grant respondent‘s motion to impose a $25,000 penalty against each petitioner under
section 6673(a)(1)(B) . We hold we shall not.
Unless otherwise indicated, section references are to the Internal Revenue Code applicable to the relevant years, Rule references are to the Tax Court Rules of Practice and Procedure, and dollar amounts are rounded to the dollar.
FINDINGS OF FACT
I. Overview of Petitioners
Neonatology is a professional medical corporation wholly owned by Ophelia J. Mall, M.D. (Dr. Mall). Its principal place of business was in New Jersey when we filed its petition. Dr.
Neonatology reports its income and expenses for Federal income tax purposes using the cash receipts and disbursements method and the calendar year. It reported the following relevant amounts on its 1992 and 1993 Federal corporate income tax returns:
| 1992 | 1993 | |
|---|---|---|
| Total income | $282,104 | $213,092 |
| Officer compensation | 250,000 | 168,000 |
| Salaries & wages | -0- | -0- |
| Pension, profit-sharing, plans | -0- | -0- |
| Employee benefit programs | 26,000 | 28,623 |
| Taxable income (loss) | (18,881) | (20,958) |
| Income tax | -0- | -0- |
| Alt. minimum tax | -0- | -0- |
Lakewood is a professional medical corporation owned equally by Arthur Hirshkowitz (Dr. Hirshkowitz), Akhilesh Desai (Dr. Desai), Kevin T. McManus (Dr. McManus), and Steven Sobo (Dr. Sobo), until his death on September 23, 1993, and by Vijay Sankhla (Dr. Sankhla) afterwards. When we filed the petitions of the various members of the Lakewood group,8 Lakewood‘s principal place of business and the residence of each individual (and his or her spouse) was in New Jersey.
Lakewood reports its income and expenses for Federal income tax purposes using the cash receipts and disbursements method and, but for 1991, using the calendar year; its 1991 taxable years consist of a fiscal year ended on October 31, 1991, and a short taxable year ended on December 31, 1991. It reported the following relevant amounts on its Federal corporate income tax returns for the subject years:
| 10/1991 | 12/1991 | 1992 | 1993 (As amended) | |
|---|---|---|---|---|
| Total income | $2,303,425 | $403,869 | $2,411,265 | $2,286,460 |
| Officers’ compensation | 987,554 | 350,000 | 1,171,931 | 940,895 |
| Salaries & wages | 148,750 | 29,167 | 200,565 | 303,750 |
| Pension, profit-sharing, plans | 46,907 | 25,000 | 132,428 | 169,170 |
| Employee benefit programs | -0- | -0- | -0- | -0- |
| Other deductions (VEBA contribution) | 480,901 | -0- | 209,869 | 296,056 |
| Taxable income (loss) | 3,664 | (103,857) | (23,325) | (7,796) |
| | 1,246 | -0- | -0- | -0- |
| Alt. minimum tax | -0- | -0- | -0- | 20,531 |
It filed its 1992 Federal corporate income tax return untimely on May 28, 1993.
Marlton is a sole proprietorship owned by Wan B. Lo (Dr. Lo), and he reports Marlton‘s income and expenses on his personal Schedule C, Profit or Loss from Sole-Proprietor Business, using the cash receipts and disbursements method and the calendar year. Dr. Lo reported the following amounts for Marlton on Schedules C of his joint 1993 and 1994 Federal individual income tax returns:
| 1993 | 1994 | |
|---|---|---|
| Gross income | $875,477 | $868,275 |
| Wages | 130,944 | 124,939 |
| Pension, profit-sharing, plans | 16,920 | 17,396 |
| Employee benefit programs | 100,000 | 120,000 |
| Net profit | 406,863 | 381,122 |
Dr. Lo and his wife, Cecilia (Ms. Lo) (collectively, the Los), resided in New Jersey when we filed their petition.
II. The Subject VEBA‘s
Pacific Executive Services (PES) was a California partnership formed by two insurancemen named Stephen R. Ross (Mr. Ross) and Donald S. Murphy (Mr. Murphy).9 PES devised the idea of using a speciously designed life insurance product in the setting of deviously designed VEBA‘s to prosper financially from the enactment of the Tax Reform Act of 1986 (TRA), Pub. L. 99-514, 100 Stat. 2085. PES believed that the TRA restricted the ability of closely held businesses to reduce their tax liabilities through contributions to retirement and employee benefit plans. PES believed that the TRA gave PES the opportunity to market aggressively to owners of such businesses a novel tax avoidance scheme. PES anticipated that few of the prospective investors in the scheme would be
PES united with Barry Cohen (Mr. Cohen), a longtime insurance salesman, to market the subject VEBA‘s to medical professionals primarily through the Kirwan Cos. (Kirwan). Mr. Cohen is an officer, director, and part owner of Kirwan. He is not an attorney or an accountant. Michael J. Kirwan (Mr. Kirwan) is Kirwan‘s president and other part owner. Mr. Kirwan is not an attorney or an accountant.
Kirwan represented to prospective investors during its marketing of one or both of the subject VEBA‘s that the VEBA‘s let an investor make unlimited tax-deductible contributions to his or her separate plan and that each plan would give a covered employee significant paid-up life insurance when he or she left the plan.10 PES represented to prospective investors that each of the subject VEBA‘s gave investors
the ability to park funds for several years while the funds continue to grow at interest in a tax free environment. While most people would be happy to take accumulated funds, pay the tax due at that time at ordinary rates, [sic] we have created a plan which provides for a permanent deferral of all the taxes due, either during ones [sic] lifetime or to the heirs. In summary, we create a tax deduction for the contributions to the * * * [VEBA] going in and a permanent tax deferral coming out.
* * * * * * *
Each individual employer establishes his own level of benefits and has his own trust account with a third party trustee * * *. The contribution goes into the individual trust account for each employer and the benefits provided under the plan are paid for out of the individual accounts. Each employer receives reports which apply only to his account.
The SC VEBA and the NJ VEBA were formed by the Southern California Medical Profession Association and the New Jersey Medical Profession Association, respectively. PES established, manages, and controls both of these associations, neither of which is a valid or operating professional association. PES established both associations for the sole purpose of forming the subject VEBA‘s and of furthering its VEBA scheme by misleading targeted investor/medical professionals into believing that respectable, established medical associations
The subject VEBA‘s are structured so that each participating employer establishes its own plan thereunder, executes its own plan document, and has a plan name that bears its own name. Each employer, with the aid of an insurance salesman (primarily Mr. Cohen), selects its plan administrator, the members of the committee administering its plan, and the level of benefits offered under its plan;11 the only employee benefit provided under the subject VEBA‘s is a current-year death benefit payable at a specified multiple of prior-year compensation. Each employer generally funds its plan with a limited number of group insurance policies and/or group annuities owned by its plan for the benefit of its employees. All group life insurance policies must provide explicitly that the insured individual may convert his or her policy, without medical examination, to an individual policy upon termination of eligibility for coverage.
Each employer has its own trust account maintained under its plan for its covered employees, and each plan is accounted for separately. A covered employee has no recourse for benefits other than, first, from insurance contracts on his or her life and, second, from any assets held in the employer‘s plan. Employees covered by one plan cannot reach assets of another plan, and occurrences in one plan do not affect another plan‘s operation. Each plan prepares its own separate summary plan description, each employer may amend
Independent entities serve as trustees of the respective trusts underlying the subject VEBA‘s, and each trust‘s terms are the same except for the sponsor‘s name. Under the trusts’ terms, each participating employer agrees to make the contributions required by the administrator to provide benefits under the plan, and neither the participating employer nor another employer is liable for a participating employer‘s contributions. Any benefits payable under one plan are paid solely from that plan‘s allocable share of the trust fund, and neither the participating employer, administrator, nor trustee is liable for the inadequacy of funds required to be paid. Each plan and corresponding trust account benefit exclusively the related employer‘s covered employees and their beneficiaries, and no part of that trust account may be used for, or diverted to, purposes other than the exclusive benefit of those employees.
III. The Insurance Companies
The Inter-American Insurance Co. of Illinois (Inter-American) specializes in providing to small, closely held corporations products such as qualified pension and profit sharing plans and group life insurance plans. When Inter- American was formed in the late 1970‘s, it was owned indirectly by Beaven/Inter-American Cos., Inc. (Beaven/Inter-American), the wholly owned company of Raymond G. Ankner (Mr. Ankner), who has worked in the insurance industry for more than 30 years. Inter-American liquidated on December 23, 1991, pursuant to a court order to do so, and Beaven/Inter-American changed its name to Beaven Cos., Inc. Mr. Ankner currently markets the life insurance products described herein through a company of his called CJA & Associates.
Capital Holding Agency Group, Inc. (Capital Holding), underwrites life and health insurance, annuities, and other insurance products offered for sale through certain of its affiliated insurance companies; e.g., Commonwealth Life Insurance Co. (Commonwealth) and Peoples Security Life
IV. The Life Insurance Products
Inter-American and Commonwealth both issue a virtually identical conventional group term life insurance product known as the millennium group 5 (MG-5) policy. Premiums on an MG-5 policy are generally commensurate with the life insurance risk assumed by the issuing company and do not present policyholders with asset accumulation. The MG-5 policies allow policyholders to convert their policies to 5-year level annual renewable term, universal or whole life products which do not have any accumulated value (or “conversion credits” as that term is described below).
Inter-American and Commonwealth both issue a second virtually identical innovative life insurance product known as the continuous group (C-group) product. The C-group product is a novel product designed by Inter-American (and later adopted by Commonwealth) to masquerade as a policy that provides only term life insurance benefits in order to make the product marketable to targeted investors and to allow Inter-American to make life insurance purchases from it more attractive than purchases from its larger competitors. The C-group product is actually a universal life product consisting of two related policies. The first policy, the accumulation phase of the C-group product, is a group term life insurance policy known as the C-group term policy. The second policy, the payout phase of the C-group product, is an individual universal life insurance policy known as the C-group conversion universalife (UL) policy. The C-group conversion UL policy is referenced in the C-group term contract and the C-group conversion UL contract as a “special conversion policy“.
The C-group term policy provides covered employees with a life insurance (death) benefit while they work and a cash
The C-group conversion UL policy was specially designed for employees converting from the C-group term policy to individual coverage, and, absent an additional expense, it is issued only to individuals who convert from the C-group term policy to individual coverage. An insured employee has the right to convert, generally without expense, from the C-group term policy to a C-group conversion policy with equal or less face value if group coverage ceases because (1) the employee ceases employment, (2) the employee leaves the class eligible for coverage, (3) the underlying contract terminates, (4) the underlying contract is amended to terminate or reduce the insurance of a class of insured employees, or (5) the underlying contract terminates as to an individual employer or plan.12 Upon conversion, conversion credits are transferred from the C-group term policy to the C-group conversion UL policy in a total amount that would approximate the cash value that would have been present if a typical universal life policy had been purchased when the C-group term policy was
developed and used tables to reference the amount of conversion credits which would accumulate under the C-group term policy and be transferred to the C-group conversion UL policy upon conversion, and the table amounts were referenced in marketing materials provided to prospective customers; no C-group term policyholder who converted to a C-group conversion UL policy ever received anything less than the appropriate amount referenced in the tables. Upon conversion, the C-group conversion UL policy is generally fully funded, and C-group conversion UL policyholders need not pay additional premiums on the C-group conversion UL policy. A converting policyholder may, if he or she desires, pay additional premiums on the C-group conversion UL policy. None of the individual petitioners chose to do so.
Mr. Ankner designed the concept of conversion credits to allow the C-group term policy to operate in tandem with the C-group conversion UL policy, while preserving the appearance and argument that the two policies were separate and distinct. Conversion credits generally work as follows. With respect to each premium paid on the C-group term policy, the portion that exceeds the applicable mortality charge (cost of insurance) is set aside in a conversion credit account bearing interest at 4.5 percent per annum for transfer to the C-group conversion UL policy upon conversion thereto. Upon conversion, the conversion credits which have accumulated up to that time (conversion credit
balance) are generally transferred to the C-group conversion UL policy in accordance with a schedule under which (1) none of the conversion credit balance is transferred to the C-group conversion UL policy if conversion occurs in the C-group term policy’s first year, (2) 47.5 percent of the conversion credit balance is transferred to the C-group conversion UL policy if conversion occurs in the C-group term policy’s second year, (3) 90.25 percent of the conversion credit balance is transferred to the C-group conversion UL policy if conversion occurs in the C-group term policy’s third year, and (4) 95 percent of the conversion credit balance is transferred to the C-group conversion UL policy if conversion occurs in the C-group term policy’s fourth or later
beginning with the month of conversion.14 C-group conversion UL policyholders may borrow against their policies up to the net loan value (i.e., cash value less any prior outstanding loans), and, after the fourth year, any loans are at the same interest rate as is credited to the conversion credit balance.
Statutory reserves are maintained for the C-group term policies in an amount that equals the greater of: (1) The minimum statutory reserve for group term life insurance, which excludes consideration of the conversion benefits, or (2) the present value of expected future payments under the policies (including both death benefits and applied conversion credits) less the present value of expected future premiums.15 Present values are calculated using best-estimate assumptions as to interest, mortality, lapses, and expenses. Inter-American and Commonwealth reinsured with a third party certain amounts of the risk associated with the C-group product.
The C-group term policy provides an annual experience refund to the policyholder. Interest of 4.5 percent per annum is credited to the conversion credit balance at or about the end of each certificate year, and, to the extent that the interest on the funds reflected in the balance actually exceeds the credited amount, the excess is returned to the policyholder as an experience refund. The experience refund
V. The Neonatology Plan
Mr. Cohen introduced Dr. Mall to the SC VEBA, and she decided on her own, without seeking the advice of an independent knowledgeable professional, to cause Neonatology to invest therein. Dr. Mall knew that term life insurance was substantially more expensive to buy through the SC VEBA than through other plans offered to her by the American Medical Association and the American Academy of Pediatrics. She believed that the SC VEBA was the best investment for Neonatology because it offered her the proffered tax benefits and accumulated value. Dr. Mall received correspondence on the SC VEBA but generally chose not to read it before investing in the SC VEBA.
Neonatology established the Neonatology Plan under the SC VEBA on January 31, 1991, effective January 1, 1991, and the Malls were the only persons covered by that plan during the relevant years. Mr. Mall was not a paid employee of Neonatology, and he was not eligible to join the plan. Dr. Mall and PES, the plan administrator, allowed Mr. Mall to join the plan, and they made him eligible to receive a death benefit in an amount commensurate with the death benefit payable under other life insurance that he had owned outside the plan. Dr. Mall falsified and backdated documents in an attempt to legitimize Mr. Mall’s participation in the Neonatology Plan and to attempt to legitimize the plan with various governmental agencies and regulatory bodies.
The Neonatology Plan’s adoption agreement provides that all employees covered by the plan will receive a death benefit equal to 6.5 times his or her prior-year “compensation” (defined by the plan to exclude nontaxable fringe benefit items). Neonatology paid Dr. Mall compensation of $240,000, $250,000, and $168,000 during 1991, 1992, and 1993, respectively. Neonatology did not pay Mr. Mall any compensation during those years.
Neonatology contributed to the Neonatology Plan during each year from 1991 through 1993 and, for each subject year, claimed a deduction for those contributions and other related amounts. In 1991, Neonatology contributed $10,000 to the
During the relevant years, the Neonatology Plan purchased three life insurance policies, two on the life of Dr. Mall and the third on the life of Mr. Mall.16 The attributes of these policies are as follows.
1. Dr. Mall’s Inter-American C-Group Term Policy
Effective March 15, 1991, Inter-American issued a $650,000 C-group term policy (certificate No. 5076202) on the life of Dr. Mall, age 45. The first-year premium was $9,906, and the cost of insuring Dr. Mall for that year was $1,689.85. The Neonatology Plan paid the first-year premium, and, at the end of that year, the conversion credit balance was $8,585.88 ($9,906 - $1,689.85 + $369.73); the $369.73 is the interest of 4.5 percent earned on the conversion credit balance (($8,585.88 - $369.73) x 4.5% = $369.73)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year. This policy lapsed on March 15, 1992.
2. Dr. Mall’s Commonwealth C-Group Term Policy
Effective March 15, 1992, Commonwealth issued a $650,000 C-group term policy (certificate No. 6007725) on the life of Dr. Mall, age 46. The first-year premium was $10,653.50, and the cost of insuring Dr. Mall for that year
The second-year premium, before any experience refund, was $10,731.50. The policy was credited with an experience refund of $106.08, and the Neonatology Plan paid the net premium of $10,625.42 ($10,731.50 - $106.08). The cost of insuring Dr. Mall for the second year was $1,814.34, and, at the end of that year, the conversion credit balance was $19,025.33 ($9,288.90 + $10,731.50 - $1,814.34 + $819.27); the $819.27 is the interest of 4.5 percent earned on the conversion credit balance (($19,025.33 - $819.27) x 4.5% = $819.27)). Of the conversion credit balance, $9,037.03 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its second year ($19,025.33 x 47.5%).
The Neonatology Plan continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective October 15, 1996, Dr. Mall converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $71,102. At the time of conversion, the C-group term policy’s conversion credit balance was $46,508.32, and $44,182.90 of that amount ($46,508.32 x 95%) was transferred to the C-group conversion UL policy for potential earning. Dr. Mall will earn these credits in 120 equal monthly installments, beginning October 1996. The conversion credit balance of $46,508.32 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before February 1, 1993, (2) female, (3) issue age 46, (4) duration of 4 years 7 months, and (5) $650,000 death benefit.
3. Mr. Mall’s Commonwealth C-Group Term Policy
Effective March 15, 1992, Commonwealth issued a $500,000 C-group term policy (certificate No. 6010423) on the life of Mr. Mall, age 47. The first-year premium was $10,290,
The second-year premium, before any experience refund, was $10,530. The policy was credited with an experience refund of $98.25, and the Neonatology Plan paid the net premium of $10,431.75 ($10,530 - $98.25). The cost of insuring Mr. Mall for the second year was $2,250.45, and, at the end of that year, the conversion credit balance was $17,643.01 ($8,603.71 + $10,530 - $2,250.45 + $759.75); the $759.75 is the interest of 4.5 percent earned on the conversion credit balance (($17,643.01 - $759.75) x 4.5% = $759.75)). Of the conversion credit balance, $8,380.43 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its second year ($17,643.01 x 47.5%).
The Neonatology Plan continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective October 15, 1996, Mr. Mall converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $67,069. At the time of conversion, the C-group term policy’s conversion credit balance was $43,304, and $41,138.80 of that amount ($43,304 x 95%) was transferred to the C-group conversion UL policy for potential earning. Mr. Mall will earn these credits in 120 equal monthly installments, beginning October 1996. The conversion credits of $41,138.80 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before February 1, 1993, (2) male, (3) issue age 47, (4) duration of 4 years 7 months, and (5) $500,000 death benefit.
The Neonatology Plan paid no benefits during the relevant years, and the 1992 and 1993 Forms W-2, Wage and Tax Statements, that Neonatology issued to Dr. Mall did not report any life insurance benefits provided to her under the plan. On their joint 1992 and 1993 Federal individual income
During the subject years, Commonwealth paid the following commissions on the C-group products issued on the Malls’ lives:
| Period Beginning | Kirwan | Mr. Ankner1 | Mr. Murphy |
|---|---|---|---|
| 3/92 | $8,922.94 | $709.34 | $2,498.67 |
| 3/93 | 852.82 | 136.88 | 273.74 |
1These commissions were paid to Mr. Ankner either indirectly through one of his companies or directly.
Kirwan also received, in or about 1996, commissions equal to 5 percent of the conversion credit balances, both earned and unearned, which were applied to the Malls’ C-group conversion UL policies. These commissions totaled $4,266.09 (($44,182.90 x 5%) + ($41,138.80 x 5%)).
Respondent determined that Neonatology could not deduct its excess contributions to the Neonatology Plan and increased Neonatology’s income by $23,646 in 1992 and $19,969 in 1993 to reflect the following adjustments:
| 1992 | 1993 | |
|---|---|---|
| Contributions to the Neonatology Plan | $20,000 | $22,623 |
| Administrator’s fees | 1,000 | 1,000 |
| 1991 NOL from plan contributions | 4,272 | — |
| Subtotal | 25,272 | 23,623 |
| Less: P.S. 58 costs included in income | 1,626 | 3,654 |
| Adjustment | 23,646 | 19,969 |
Respondent determined primarily that the disallowed contributions were not deductible under
provide current-year life insurance protection.18 Respondent determined alternatively that the excess contributions were not deductible under
As to the Malls, respondent determined they had “other income” of $19,374 in 1992 (Neonatology’s adjustment of $23,646 less the 1991 NOL of $4,272) and $19,969 in 1993. Respondent determined that the other income was either constructive dividend income under
VI. The Lakewood Plan
Mr. Cohen introduced Drs. Hirshkowitz and Desai to the SC VEBA in 1990. Drs. Hirshkowitz and Desai both knew that the premiums paid on the C-group product were more expensive than the cost of term life insurance. They caused Lakewood to invest in the SC VEBA anyway because, as they understood it, the SC VEBA ultimately allowed Lakewood’s principals to withdraw the excess premiums from the plan tax free by way of policy loans. All of Lakewood’s principals are physicians, and Dr. Hirshkowitz, on the basis of his conversations with Mr. Cohen, understood that the SC VEBA allowed policyholders to convert their C-group term policies
Lakewood established the Lakewood Plan under the SC VEBA on December 28, 1990, effective January 1, 1990. The only employees covered by the plan during the subject years were Drs. Hirshkowitz, Desai, Sobo, McManus, and Sankhla.19 During the respective years from 1990 through 1993, Lakewood paid Dr. Desai compensation of $318,020, $308,279, $297,452, and $275,270, it paid Dr. Sobo compensation of $330,030 $354,277, $329,185, and $203,640, it paid Dr. McManus compensation of $218,821, $368,708, $340,376, and $333,204, and it paid Dr. Sankhla compensation of $50,000, $127,500, $142,500, and $147,500. During the respective years from 1990 through 1992, Lakewood paid Dr. Hirshkowitz compensation of $327,691, $181,994, and $204,918.
Under the terms of the Lakewood Plan, as in effect through December 31, 1992, a covered employee received a death benefit equal to 2.5 times his or her prior-year compensation. Lakewood amended its plan as of January 1, 1993, effective January 1, 1990, to increase the death benefit to 8.15 times prior-year compensation. Drs. Hirshkowitz, Desai, and McManus each elected on January 1, 1993, not to accept this additional coverage.
No Lakewood employee covered by the Lakewood Plan, if he or she had died, would ever have received a death benefit equal to 2.5 times or 8.15 times his or her prior-year compensation. Each of Lakewood’s employee/owners decided the amount that Lakewood would contribute to the SC VEBA on his or her behalf, and Lakewood wrote separate checks for
On its Federal corporate income tax return for its taxable year ended October 31, 1991, Lakewood claimed a $480,901.49 deduction for VEBA contributions made to the Lakewood Plan for the following persons’ benefits:
Trustee’s fees........ $1,000.00
Dr. Hirshkowitz.......254,051.49
Dr. Desai.............122,750.00
Dr. Sobo.............. 83,100.00
Dr. McManus........... 20,000.00
480,901.49
On its 1992 Federal corporate income tax return, Lakewood claimed a $209,869.03 deduction for VEBA contributions made for the following persons’ benefits:
Dr. Hirshkowitz......$136,678.43
Dr. Desai............ 42,056.44
Dr. Sobo............. 13,213.52
Dr. McManus.......... 17,920.64
209,869.03
This deduction consists of contributions to the Lakewood Plan and $70,000 that Lakewood paid directly to Peoples Security for C-group term policies purchased outside of the Lakewood Plan for Drs. Hirshkowitz and Desai. Of the $70,000 paid to Peoples Security, $50,000 was attributable to the coverage of Dr. Hirshkowitz, and $20,000 was attributable to the coverage of Dr. Desai.
On its 1993 Federal corporate income tax return, Lakewood claimed a $296,055.90 deduction for VEBA contributions made for the following persons’ benefits:
Trustee’s fees........ $1,000.00
Dr. Hirshkowitz.......211,119.90
Dr. Desai............. 55,000.00
Dr. Sobo.............. 15,000.00
Dr. Sankhla........... 5,750.00
Dr. McManus........... 18,186.00
296,055.90
1The Lakewood Plan returned this $5,000 to Lakewood in October 1993.
This
During the relevant years, the Lakewood Plan purchased 12 insurance policies on the lives of Lakewood’s principals. The attributes of these policies are as follows.
1. Dr. Hirshkowitz’ Inter-American C-Group Term Policy
Effective December 31, 1990, Inter-American issued a $1 million C-group term policy (certificate No. 5076058) on the life of Dr. Hirshkowitz, age 57. The first-year premium was $48,680, and the cost of insuring Dr. Hirshkowitz for that year was $9,475.15. The Lakewood Plan paid the first-year premium, and, at the end of that year, the conversion credit balance was $40,969.07 ($48,680 - $9,475.15 + $1,764.22); the $1,764.22 is the interest of 4.5 percent earned on the conversion credit balance (($40,969.07 - $1,764.22) x 4.5% = $1,764.22)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year. This policy lapsed on December 31, 1991.
2. Dr. Desai’s Inter-American C-Group Term Policy
Effective December 31, 1990, Inter-American issued a $1 million C-group term policy (certificate No. 5076059) on the life of Dr. Desai, age 45. The first-year premium was $17,390, and the cost of insuring Dr. Desai for that year was $3,419.48. The Lakewood Plan paid the first-year premium, and, at the end of that year, the conversion credit balance
3. Dr. Sobo’s Inter-American C-Group Term Policy
Effective December 31, 1990, Inter-American issued a $1 million C-group term policy (certificate No. 5076057) on the life of Dr. Sobo, age 38. The first-year premium was $10,800, and the cost of insuring Dr. Sobo for that year was $2,374.08. The Lakewood Plan paid the first-year premium, and, at the end of that year, the conversion credit balance was $8,805.09 ($10,800 - $2,374.08 + $379.17); the $379.17 is the interest of 4.5 percent earned on the conversion credit balance (($8,805.09 - $379.17) x 4.5% = $379.17)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year. This policy lapsed on December 31, 1991.
4. Dr. Hirshkowitz’ Commonwealth C-Group Term Policy
Effective October 31, 1991, Commonwealth issued a $150,000 C-group term policy (certificate No. 6000972) on the life of Dr. Hirshkowitz, age 58. The first-year premium was $7,540.50, and the cost of insuring Dr. Hirshkowitz for that year was $1,572.75. The Lakewood Plan paid the first-year premium, and, at the end of that year, the conversion credit balance was $6,236.30 ($7,540.50 - $1,572.75 + $268.55); the $268.55 is the interest of 4.5 percent earned on the conversion credit balance (($6,236.30 - $268.55) x 4.5% = $268.55)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year.
The second-year premium, before any experience refund, was $7,720. The policy was credited with an experience refund of $115.21, and the Lakewood Plan paid the net premium of $7,604.79 ($7,720 - $115.21). The cost of insuring
The third-year premium, before any experience refund, was $7,972.50. The policy was credited with an experience refund of $176.01, and the Lakewood Plan paid the net premium of $7,796.49 ($7,972.50 - $176.01). The cost of insuring Dr. Hirshkowitz for the third year was $1,798.22, and, at the end of that year, the conversion credit balance was $19,874.34 ($12,844.23 + $7,972.50 - $1,798.22 + $855.83); the $855.86 is the interest of 4.5 percent earned on the conversion credit balance (($19,874.34 - $855.83) x 4.5% = $855.83)). Of the conversion credit balance, $17,935.59 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its third year ($19,874.34 x 90.25%).
The Lakewood Plan continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective October 31, 1996, Dr. Hirshkowitz converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $44,653. At the time of conversion, the balance in the C-group term policy’s conversion credit account was $35,400, and $33,630 of that amount ($35,400 x 95%) was transferred to the C-group conversion UL policy for potential earning. Mr. Hirshkowitz will earn these credits in 120 equal monthly installments, beginning October 1996. The conversion credit balance of $33,630 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before February 1, 1993, (2) male, (3) issue age 58, (4) duration of 5 years, and (5) $150,000 death benefit.
5. Dr. Desai’s Commonwealth C-Group Term Policy
Effective October 31, 1991, Commonwealth issued a $150,000 C-group term policy (certificate No. 6000973) on the
The second-year premium, before any experience refund, was $2,890.50. The policy was credited with an experience refund of $44.06, and the Lakewood Plan paid the net premium of $2,846.44 ($2,890.50 - $44.06). The cost of insuring Dr. Desai for the second year was $607.89, and, at the end of that year, the conversion credit balance was $4,865.74 ($2,373.60 + $2,890.50 - $607.89 + $209.53); the $209.53 is the interest of 4.5 percent earned on the conversion credit balance (($4,865.74 - $209.53) x 4.5% = $209.53)). Of the conversion credit balance, $2,311.23 could have been transferred at this time to the C-group
conversion UL policy, upon conversion thereto, because the C-group term policy was in its second year ($4,865.74 x 47.5%).
The third-year premium, before any experience refund, was $2,962.50. The policy was credited with an experience refund of $66.69, and the Lakewood Plan paid the net premium of $2,895.81 ($2,962.50 - $66.69). The cost of insuring Dr. Desai for the third year was $665.36, and, at the end of that year, the conversion credit balance was $7,485.21 ($4,865.74 + $2,962.50 - $665.36 + $322.33); the $322.33 is the interest of 4.5 percent earned on the conversion credit balance (($7,485.21 - $322.33) x 4.5% = $322.33)). Of the conversion credit balance, $6,755.40 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its third year ($7,485.21 x 90.25%).
The Lakewood Plan continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective October 31, 1996, Dr. Desai converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $22,916. At the time of conversion,
6. Dr. Sobo’s $150,000 Commonwealth C-Group Term Policy
Effective October 31, 1991, Commonwealth issued a $150,000 C-group term policy (certificate No. 6000971) on the life of Dr. Sobo, age 38. The first-year premium was $1,620, and the cost of insuring Dr. Sobo for that year was $356.11. The Lakewood Plan paid the first-year premium, and, at the end of that year, the conversion credit balance was $1,320.76 ($1,620 - $356.11 + $56.87); the $56.87 is the interest of 4.5 percent earned on the conversion credit balance (($1,320.76 - $56.87) x 4.5% = $56.87)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year.
The second-year premium, before any experience refund, was $1,638. The policy was credited with an experience refund of $24.48, and the Lakewood Plan paid the net premium of $1,613.52 ($1,638 - $24.48). The cost of insuring Dr. Sobo for the second year was $370.54.Dr. Sobo died on September 23, 1993. On December 14, 1993, the Lakewood Plan paid $150,000 to Bonnie W. Sobo (Ms. Sobo) as the beneficiary of this policy.
7. Dr. McManus’ Commonwealth C-Group Term Policy
Effective October 31, 1991, Commonwealth issued a $2.1 million C-group term policy (certificate No. 6001004) on the life of Dr. McManus, age 34. The first-year premium was $18,186, and the cost of insuring Dr. McManus for that year was $4,496.72. The Lakewood Plan paid the first-year premium, and, at the end of that year, the conversion credit balance
The second-year premium, before any experience refund, was $18,186. The policy was credited with an experience refund of $265.36, and the Lakewood Plan paid the net premium of $17,920.64 ($18,186 - $265.36). The cost of insuring Dr. McManus for the second year was $4,465.82, and, at the end of that year, the conversion credit balance was $29,286.63 ($14,305.30 + $18,186 - $4,465.82 + $1,261.15); the $1,261.15 is the interest of 4.5 percent earned on the conversion credit balance (($29,286.63 -$1,261.15) x 4.5% = $1,261.15)). Of the conversion credit balance, $13,911.15 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its second year ($29,286.63 x 47.5%).
The third-year premium, before any experience refund, was $18,186. The policy was credited with an experience refund of $401.32, and the Lakewood Plan paid the net premium of $17,784.68 ($18,186 - $401.32). The cost of insuring Dr. McManus for the third year was $4,433.46, and, at the end of that year, the conversion credit balance was $44,975.93 ($29,286.63 + $18,186 - $4,433.46 + $1,936.76); the $1,936.76 is the interest of 4.5 percent earned on the conversion credit balance (($44,975.93 - $1,936.76) x 4.5% = $1,936.76)). Of the conversion credit balance, $40,590.78 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its third year ($44,975.93 x 90.25%).
The Lakewood Plan continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective October 1, 1996, Dr. McManus converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $187,827. At the time of conversion, the C-group term policy’s conversion credit balance was $78,672.63, and$74,739 of that amount ($78,672.63 x 95%) was transferred to the C-group conversion UL policy for
8. Dr. Hirshkowitz’ Commonwealth C-Group Term Policy
Effective December 31, 1991, Commonwealth issued a $1 million C-group term policy (certificate No. 6004482) on the life of Dr. Hirshkowitz, age 58. The premium for the 10-month period from December 31, 1991, through October 30, 1992, was $41,891.67, and the cost of insuring Dr. Hirshkowitz for the 10-month period was $8,814.60. The Lakewood Plan paid the 10-month premium, and, at the end of that 10-month period, the conversion credit balance was $34,317.46 ($41,891.67 - $8,814.60 + $1,240.39); the $1,240.39 is the interest of 4.5 percent earned on the conversion credit balance (($34,317.46 - $1,240.39) x 4.5% x 10/12 = $1,240.39)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year.
The premium for the next 12-month period, before any experience refund, was $51,470. The policy was credited with an experience refund of $200, and the Lakewood Plan paid the net premium of $51,270 ($51,470 - $200). The cost of insuring Dr. Hirshkowitz for the second year was $11,189.96, and, at the end of that year, the conversion credit balance was $77,954.39 ($34,317.46 + $51,470 - $11,189.96 + $3,356.89); the $3,356.89 is the interest of 4.5 percent earned on the conversion credit balance (($77,954.39 - $3,356.89) x 4.5% = $3,356.89)). Of the conversion credit balance, $37,028.34 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its second year ($77,954.39 x 47.5%).
The third-year premium for the next 12-month period, before any experience refund, was $53,150. The policy was credited with an experience refund of $1,321.18, and the
The Lakewood Plan continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective October 31, 1996, Dr. Hirshkowitz converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $296,937. At the time of conversion, the C-group term policy’s conversion credit balance was $227,084.21, and $215,730 of that amount ($227,084.21 x 95%) was transferred to the C-group conversion UL policy for potential earning. Dr. Hirshkowitz will earn these credits in 120 equal monthly installments, beginning October 1996. The conversion credit balance of $215,730 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before February 1, 1993, (2) male, (3) issue age 58, (4) duration of 4 years 10 months, and (5) $1 million death benefit.
9. Dr. Desai’s Commonwealth C-Group Term Policy
Effective December 31, 1991, Commonwealth issued a $1 million C-group term policy (certificate No. 6004483) on the life of Dr. Desai, age 46. The premium for the 10-month period from December 31, 1991, through October 30, 1992, was $15,758.33, and the cost of insuring Dr. Desai for this 10-month period was $3,149.57. The Lakewood Plan paid the 10-month premium, and, atthe end of that 10-month period, the conversion credit balance was $13,081.59 ($15,758.33 - $3,149.57 + $472.83); the $472.83 is the interest of 4.5 percent earned on the conversion credit balance (($13,081.59 - $472.83) x 4.5% x 10/12 = $472.83)). None of the conversion credit balance could have been transferred at this time to the
The premium for the next 12-month period, before any experience refund, was $19,270. The policy was credited with an experience refund of $60, and the Lakewood Plan paid the net premium of $19,210 ($19,270 - $60). The cost of insuring Dr. Desai for the second year was $4,064.12, and, at the end of that year, the conversion credit balance was $29,560.40 ($13,081.59 + $19,270 - $4,064.12 + $1,272.93); the $1,272.93 is the interest of 4.5 percent earned on the conversion credit balance (($29,560.40 - $1,272.93) x 4.5% = $1,272.93)). Of the conversion credit balance, $14,041.19 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its second year ($29,560.40 x 47.5%).
The third-year premium for the next 12-month period, before any experience refund, was $19,750. The policy was credited with an experience refund of $474.65, and the Lakewood Plan paid the net premium of $19,275.35 ($19,750 - $474.65). The cost ofinsuring Dr. Desai for the third year was $4,449.23, and, at the end of that year, the conversion credit balance was $46,879.92 ($29,560.40 + $19,750 - $4,449.23 + $2,018.75); the $2,018.75 is the interest of 4.5 percent earned on the conversion credit balance (($46,879.92 - $2,018.75) x 4.5% = $2,018.75)). Of the conversion credit balance, $42,309.13 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its third year ($46,879.92 x 90.25%).
The Lakewood Plan continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective October 1, 1996, Dr. Desai converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $151,656. At the time of conversion, the C-group term policy’s conversion credit balance was $84,397.58, and $80,177.70 of that amount ($84,397.58 x 95%) was transferred to the C-group conversion UL policy for potential earning. Dr. Desai will earn these credits in 120 equal monthly installments, beginning October 1996. The conversion credit balance of $80,177.70 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before
10. Dr. Sobo’s Commonwealth C-Group Term Policy
Effective December 31, 1991, Commonwealth issued a $1 million C-group term policy (certificate No. 6004474) on the life of Dr. Sobo, age 39. The premium for the 10-month period from December 31, 1991, through October 30, 1992, was $9,583.33, and the cost of insuring Dr. Sobo for this 10-month period was $2,079.88. The Lakewood Plan paid the 10-month premium, and, at the end of that 10-month period, the conversion credit balance was $7,784.83 ($9,583.33 - $2,079.88 + $281.38); the $281.38 is the interest of 4.5 percent earned on the conversion credit balance (($9,583.33 - $281.38) x 4.5% x 10/12 = $281.38)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year.
The premium for the next 12-month period, before any experience refund, was $11,620. The policy was credited with an experience refund of $20, and the Lakewood Plan paid the net premium of $11,600 ($11,620 - $20). The cost of insuring Dr. Sobo for the second year was $2,588.77.
On February 3, 1994, the Lakewood Plan paid Ms. Sobo $1 million as the beneficiary of this policy. Pursuant to the plan, Dr. Sobo’s death benefit should have been $2,682,858 (prior-year compensation of $329,185 multiplied by 8.15). The Lakewood Plan had assets from which it could have paid Ms. Sobo more than the$1,150,000 that it did (the $1 million on this policy and the $150,000 on certificate No. 6000971). The Lakewood Plan retained those assets for the remaining covered employees.
11. Dr. Sankhla’s Commonwealth MG-5 Policy
Effective December 31, 1991, Commonwealth issued a $150,000 MG-5 policy on the life of Dr. Sankhla, age 38, for a 1-year premium of $397.50. The policy was renewed for a second year at a premium of $397.50, and for a third year at a premium of $397.50. The Lakewood Plan paid all three of these premiums.
Effective December 31, 1993, Commonwealth issued a $100,000 C-group term policy (certificate No. 6022354) on the life of Dr. Hirshkowitz, age 60. The premium for the 10-month period from December 31, 1993, through October 30, 1994, was $4,496.67, and the cost of insuring Dr. Hirshkowitz for that 10-month period was $1,107.84. The Lakewood Plan paid the 10-month premium, and, at the end thereof, the conversion credit balance was $3,515.91 ($4,496.67 - $1,107.84 + $127.08); the $127.08 is the interest of 4.5 percent earned on the conversion credit balance (($3,515.91 - $127.08) x 4.5% x 10/12 = $127.08)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year.
In addition to its purchase of these 12 life insurance policies, the Lakewood Plan, during the subject years, purchased three group annuities designated for certain Lakewood employees. None of these annuities funded the life insurance provided under the plan. The Lakewood Plan generally purchased these annuities to accumulate wealth to pay future premiums on the C-group term policies. The attributes of these annuities are as follows.
1. Plus II Group Annuity
Effective December 31, 1990, Inter-American issued to the Lakewood Plan a Plus II group annuity (#C15518/C91063). The Lakewood Plan deposited $78,240 into the annuity on the day it was effective and $92,700 in 1991. The Lakewood Plan closed the annuity in April 1997, withdrawing $230,169.02. The $59,229.02 difference between the total deposits ($170,940) and the amount withdrawn ($230,169.02) represents interest.
2. Commonwealth Sygnet 24 Group Annuity Effective in 1991
Effective October 31, 1991, Commonwealth issued to the Lakewood Plan a Sygnet 24 group annuity (#D10120/D90039). This annuity is designed for asset accumulation over a long period of time and has surrender charges that grade off over 6 years. The Lakewood Plan deposited $242
3. Commonwealth Sygnet 24 Group Annuity Effective in 1993
Effective December 30, 1993, Commonwealth issued to the Lakewood Plan a second Sygnet 24 group annuity (#D11794/D90214). The Lakewood Plan deposited $75,551.50 into the annuity on the day it was effective and closed the annuity on November 25, 1996, withdrawing $65,078.20. The Lakewood Plan paid a $15,865.68 charge on its deposit and a $3,436.85 surrender charge on its withdrawal. The $7,042.45 difference between the (1) deposit ($75,551.50) and (2) sum of the charge ($3,436.85) plus withdrawal ($65,078.20) represents interest.
Beginning in 1992, Lakewood purchased outside of the SC VEBA three Peoples Security C-group term policies. Lakewood owned these policies and deducted the underlying premiums as VEBA contributions. The attributes of these policies are as follows.
1. Dr. Desai’s Peoples Security C-Group Term Policy
Effective August 15, 1992, Peoples Security issued a $1,005,000 C-group term policy (certificate No. 7003612) on thelife of Dr. Desai, age 46. The first-year premium was $19,004.55, and the cost of insuring Dr. Desai for that year was $3,786.22. Lakewood paid this premium, and, at the end of that year, the conversion credit balance was $15,903.15 ($19,004.55 - $3,786.22 + $684.82); the $684.82 is the interest of 4.5 percent earned on the conversion credit balance (($15,903.15 - $684.82) x 4.5% = $684.82)). None of the conversion credit balance could have been transferred at this
The second-year premium, before any experience refund, was $19,366.35. The policy was credited with an experience refund of $145.33, and Lakewood paid the net premium of $19,221.02 ($19,366.35 - $145.33). The cost of insuring Dr. Desai for the second year was $4,072.87, and, at the end of that year, the conversion credit balance was $32,600.48 ($15,903.15 + $19,366.35 - $4,072.87 + $1,403.85); the $1,403.85 is the interest of 4.5 percent earned on the conversion credit balance (($32,600.48 - $1,403.85) x 4.5% = $1,403.85)). Of the conversion credit balance, $15,485.23 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its second year ($32,600.48 x 47.5%).
Lakewood continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective February 15, 1996, Dr. Desai converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $106,353. At the time of conversion, the C-group term policy’s conversion credit balance was $58,141.90, and $55,234.80 of that amount ($58,141.90 x 95%) was transferred to the C-group conversion UL policy for potential earning. Dr. Desai will earn these credits in 120 equal monthly installments, beginning February 1996. The conversion credit balance of $55,234.80 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before February 1, 1993, (2) male, (3) issue age 46, (4) duration of 3 years 6 months, and (5) $1,005,000 death benefit.
2. Dr. Hirshkowitz’ Peoples Security C-Group Term Policy
Effective August 15, 1992, Peoples Security issued a $940,000 C-group term policy (certificate No. 7002550) on the life of Dr. Hirshkowitz, age 59. The first-year premium was $48,861.20, and the cost of insuring Dr. Hirshkowitz for that year was $10,907.54. Lakewood paid this premium, and, at the end of that year, the conversion credit balance was $39,661.57 ($48,861.20 - $10,907.54 + $1,707.91); the $1,707.91 is the interest of 4.5 percent earned on the
The second-year premium, before any experience refund, was $50,440.40. The policy was credited with an experience refund of $362.35, and Lakewood paid the net premium of $50,078.05 ($50,440.40 - $362.35). The cost of insuring Dr. Hirshkowitz for the second year was $11,830.58, and, at the end of that year, the conversion credit balance was $81,793.61 ($39,661.58 + $50,440.40 - $11,830.58 + $3,522.21); the $3,522.21 is the interest of 4.5 percent earned on the conversion credit balance (($81,793.61 - $3,522.21) x 4.5% = $3,522.21)). Of the conversion credit balance, $38,851.96 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its second year ($81,793.61 x 47.5%).
Lakewood continued to pay the premiums on this policy, net of the applicable experience refund, through 1995. Effective October 15, 1995, Dr. Hirshkowitz converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $164,406. At the time of conversion, the C-group term policy’s conversion credit balance was $129,411.70, and $122,941.12 of that amount ($129,411.70 x 95%) wastransferred to the C-group conversion UL policy for potential earning. Dr. Hirshkowitz will earn these credits in 120 equal monthly installments, beginning October 1995. The conversion credit balance of $122,941.12 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before February 1, 1993, (2) male, (3) issue age 59, (4) duration of 3 years 2 months, and (5) $940,000 death benefit.
3. Dr. Sankhla’s Peoples Security C-Group Term Policy
Effective January 31, 1993, Peoples Security issued a $500,000 C-group term policy (certificate No. 7003453) on the life of Dr. Sankhla, age 39. The first-year premium was $5,750, and the cost of insuring Dr. Sankhla for that year was $1,245.51. Lakewood paid this premium, and, at the end
During the relevant years, Commonwealth, Inter-American, and Peoples Security paid Kirwan, Mr. Murphy, and Mr. Ankner (either indirectly through one of his companies or directly) commissionsof $90,503.82, $6,681.23, and $20,960, respectively, on the C-group products and Sygnet group annuities sold to the Lakewood Plan. Kirwan also received, in or about 1996, commissions equal to 5 percent of the conversion credits, both earned and unearned, which were applied to the C-group conversion UL policies of Drs. Hirshkowitz, Desai, and McManus. These commissions totaled $29,746.93 (($33,630 x 5%) + ($12,486 x 5%) + ($74,739 x 5%) + ($215,730 x 5%) + ($80,177.70) + ($55,234.80) + ($122,941.12 x 5%).
The 1991, 1992, and 1993 Forms W-2 issued by Lakewood to Drs. Hirshkowitz, Desai, Sobo, McManus, and Sankhla did not report any taxable life insurance benefits provided to them under the Lakewood Plan. Dr. Hirshkowitz reported $4,590, $4,590, and $13,338 as P.S. 58 income on his joint 1991, 1992, and 1993 Federal individual income tax returns, respectively. Drs. Desai, Sobo, McManus, and Sankhla did not report on their 1991, 1992, or 1993 Federal individual income tax returns any income from the life insurance benefits provided to them by Lakewood.
Respondent determined that Lakewood could not deduct the amounts claimed as contributions to the Lakewood Plan in its October 31, 1991, and its 1992 and 1993 taxable years and disallowed the related claimed deductions of $480,901, $209,869, and $296,056, respectively. In contrast with the Neonatology adjustments, respondent’s Lakewood adjustments do not reflect thefact that an employee/owner (Dr. Hirshkowitz) reported P.S. 58 income as to the benefits that he received from the Lakewood Plan. Consistent with the Neonatology determination, respondent determined primarily that Lakewood’s contributions to its plan were not deductible under
As to the petitioning individuals of the Lakewood group, respondent determined that each group of petitioning individuals had “additional income” in the following amounts for the respective years from 1991 through 1993: Dr. and Ms. Hirshkowitz-–$254,051, $136,678, and $211,120; Dr. and Ms. Desai-–$122,750, $42,056, and $55,000; Dr. and Ms. McManus-–$20,000, $17,921, and $18,186; and the Estate of Steven Sobo, Deceased,and Ms. Sobo-–$83,100, $13,214, and $5,000.20 Respondent determined that the additional income was either constructive dividend income under
VII. The Marlton Plan
Marlton established the Marlton Plan under the NJ VEBA on December 31, 1993, effective January 1, 1993. Marlton
Lo deducted on his joint 1993 Federal individual income tax return.
The Marlton Plan provides in relevant part that: (1) Each person covered by the plan is entitled to a death benefit equal to eight times his or her prior-year compensation, (2) an employee‘s spouse may not join the plan, and (3) a proprietor may join the plan only if 90 percent or more of the plan‘s total participants are employees of Marlton on 1 day of each quarter of the plan year. The only persons covered by the Marlton Plan are Dr. Lo, Ms. Lo, and Edward Lo,21 and, during 1994, the Marlton Plan purchased a separate insurance policy on the life of each of these persons. None of these persons, had he or she died, would have received a death benefit under the plan equal to eight times his or her prior-year compensation. Ms. Lo was a Marlton employee during 1994, and it paid her, ostensibly as employee compensation, $46,800, $51,600, and $54,000 during the respective years from 1992 to 1994. Edward Lo was an employee of Marlton during 1994, and it paid him, ostensibly as employee compensation, $39,930, $39,358, and $37,918 during the years 1992 through 1994. Dr. Lo was never a Marlton employee, and he was not eligible to participate in the plan during any of the relevant years. Dr Lo‘s participation in the plan was inconsistent with the terms thereof.
On April 28, 1994, the Marlton Plan purchased from Southland Life Insurance Co. (Southland) a $3.2 million flexible premium adjustable life insurance policy (certificate No. 0600008928) on the life of Dr. Lo, age 52, and it paid Southland a $158,859 premium on the policy during that year.22 Dr. Lo‘s death beneficiary was an irrevocable trust by and between him and Ms. Lo, as grantors, and Edward Lo as trustee. The policy‘s cash value (i.e., its accumulation value23 less surrender charges) could be obtained by
Also during 1994, the Marlton Plan purchased from the First Colony Life Insurance Co. (First Colony) a $412,800 graded premium policy on the life of Ms. Lo, age 44, and a $264,008 graded premium policy on the life of Edward Lo, age 45. The Marlton Plan paid First Colony a $584.26 annual premium on Ms. Lo‘s policy and a $556.34 annual premium on Edward Lo‘s policy. The beneficiary of both policies was the Marlton plan trustee. The annual premium on these two policies remained constant for the first 10 years and then increased substantially unless the policyholder provided evidence of insurability to begin another 10-year period of reduced, level premiums.
The Marlton Plan paid no benefits during the subject years. On their joint 1993 Federal individual income tax return, the Los reported no P.S. 58 income. They reported P.S. 58 income of $4,288 on their joint 1994 Federal individual income tax return.
Respondent determined that Marlton could not deduct its contributions to the Marlton Plan and increased the Los’ income by $102,500 in 1993 and $116,212 in 1994 to reflect the following adjustments:
| 1993 | 1994 | |
| Contributions to the Marlton Plan | $100,000 | $120,000 |
| Administrator‘s fees | 2,500 | 500 |
| Subtotal | 102,500 | 120,500 |
| Less: P.S. 58 costs included in income | -0- | 4,288 |
| | 102,500 | 116,212 |
Respondent determined primarily that the contributions were not deductible under
OPINION
We must determine the tax consequences flowing from the subject VEBA‘s, which, petitioners claim, are “10-or-more employer plans” entitled to the favorable tax treatment set forth in
Before turning to the issues at hand, we pause to pass on our perception of the trial witnesses. We observe the candor, sincerity, and demeanor of each witness in order to evaluate his or her testimony and assign it weight for the primary purpose of finding disputed facts. We determine the credibility of each witness, weigh each piece of evidence, draw appropriate inferences, and choose between conflicting inferences in finding the facts of a case. The mere fact that one party presents unopposed testimony on his or her behalf does not necessarily mean that the elicited testimony will result in a finding of fact in that party‘s favor. We will not accept the testimony of witnesses at face value if we find that the outward appearance of the facts in their totality conveys an impression contrary to the spoken word. See Boehm v. Commissioner, 326 U.S. 287, 293 (1945); Wilmington Trust Co. v. Helvering, 316 U.S. 164, 167-168 (1942); see also Gallick v. Baltimore & O. R. Co., 372 U.S. 108, 114-115 (1963); Diamond Bros. Co. v. Commissioner, 322 F.2d 725, 730-731 (3d Cir. 1963), affg. T.C. Memo. 1962-132.
Petitioners called eight fact witnesses and one expert witness. Petitioners’ fact witnesses were Drs. Desai,
Respondent called two fact witnesses and one expert witness. Respondent‘s fact witnesses were Mr. Cohen and Vincent Maressa, the latter of whom is the executive director and general counsel of the Medical Society of New Jersey. Respondent‘s expert witness was Charles DeWeese, F.S.A., M.A.A.A. (Mr. DeWeese). Mr. DeWeese is an independent consulting actuary, and we recognized him as an expert on, among other things, the difference between group term insurance and universal life insurance. Mr. DeWeese generally testified that the C-group term policy and the C-group conversion UL policy were one insurance product; i.e., both policies were parts of a single life insurance product.
We have broad discretion to evaluate the cogency of an expert‘s analysis. Sometimes, an expert will help us decide a case. See, e.g., Booth v. Commissioner, supra at 573; Trans City Life Ins. Co. v. Commissioner, 106 T.C. 274, 302 (1996); see also M.I.C. Ltd. v. Commissioner, T.C. Memo. 1997-96; Proios v. Commissioner, T.C. Memo. 1994-442. Other times, he or she will not. See, e.g., Estate of Scanlan v. Commissioner, T.C. Memo. 1996-331, affd. without published opinion 116 F.3d 1476 (5th Cir. 1997); Mandelbaum v. Commissioner, T.C. Memo. 1995-255, affd. without published opinion 91 F.3d 124 (3d Cir. 1996). We weigh an expert‘s testimony in light of his or her qualifications and with due regard to all other credible evidence in the record. See Estate of Kaufman v. Commissioner, T.C. Memo. 1999-119. We may embrace or reject an expert‘s opinion in toto, or we may pick and choose the portions of the opinion we choose to adopt. See Helvering v. National Grocery Co., 304 U.S. 282, 294-295 (1938); Silverman v. Commissioner, 538 F.2d 927, 933 (2d Cir. 1976),
Mr. DeWeese is no stranger to this Court. He testified in Booth v. Commissioner, 108 T.C. 524 (1997), as an expert on multiple employer plans. We find him to be reliable, relevant, and helpful. We credit his opinion as set forth in his report and as clarified at trial. We rely on his opinion in making our findings of fact and reaching the conclusions we draw therefrom.
Mr. Jaffe helped us minimally.25 He admitted at trial that he works with Commonwealth in its everyday business operation, including helping it develop an innovative term life insurance product and rendering critical advice to it on an unrelated litigation matter. An expert witness loses his or her impartiality when he or she is too closely connected with one of the parties. See, e.g., Estate of Kaufman v. Commissioner, supra (the Commissioner‘s expert was inherently biased because he was the Commissioner‘s employee). An expert witness also is unhelpful when he or she is merely a biased spokesman for the advancement of his or her client‘s litigating position. When we see and hear an expert who displays an unyielding allegiance to the party who is paying his or her bill, we need not and generally will not hesitate to disregard that testimony as untrustworthy. See Estate of Halas v. Commissioner, 94 T.C. 570, 577 (1990); Laureys v. Commissioner, 92 T.C. 101, 129 (1989); see also Jacobson v. Commissioner, T.C. Memo. 1989-606 (when experts act as advocates, “the experts can be viewed only as hired guns of the side that retained them, and this not only disparages their professional status but precludes their assistance to the Court in reaching a proper and reasonably accurate conclusion“).
We also do not find the testimony of most of the fact witnesses to be helpful as to the critical facts underlying the issues at hand. Drs. Desai, Hirshkowitz, and Mall and Messrs. Ankner, Mall, and Ross testified incredibly with regard to material aspects of this case. They all seemed coached and frequently displayed during cross-examination (or in response to questions asked by the Court) a loss of memory or hesitation with respect to their testimony.26 Each of them (with the exception of Dr. Desai and Mr. Mall) also acknowledged that he or she had on prior occasions consciously misrepresented material facts in order to achieve a personal goal. Their testimony, as well as the testimony of Mr. Cohen, was for the most part self-serving, vague, elusive, uncorroborated, and/or inconsistent with documentary or other reliable evidence. Under circumstances such as these, we are not required to, and we do not, rely on the bald or otherwise unreliable testimony of these named fact witnesses to support our decision herein. See Diamond Bros. Co. v. Commissioner, 322 F.2d 725 at 730-731; see also Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). We rely mainly on the testimony of Mr. DeWeese and the voluminous record built by the parties through their stipulation of approximately 2,167 facts and approximately 1,691 exhibits.
We turn to the nine issues for decision and address each of these issues seriatim.
1. Contributions to the Neonatology and Lakewood Plans
We decide first the question of whether
Petitioners argue that Neonatology and Lakewood meet all five requirements with respect to their contributions to their plans, and, hence, petitioners assert, those contributions are fully deductible under
Respondent argues that
We agree with respondent that the excess contributions which Neonatology and Lakewood made to their plans are nondeductible distributions of cash for the benefit of their employee/owners and do not constitute ordinary or necessary
The Neonatology Plan and the Lakewood Plan are primarily vehicles which were designed and serve in operation to distribute surplus cash surreptitiously (in the form of excess contributions) from the corporations for the employee/owners’ ultimate use and benefit. Although the plans did provide term life insurance to the employee/owners, the excess contributions simply were not attributable to that current-year protection. The excess contributions, which represent the lion‘s share of the contributions, were paid to Inter-American, Commonwealth, or Peoples Security, as the case may be, to be set aside in an interest-bearing account for credit to the C-group conversion UL policy, upon conversion thereto, and it was the holders of these policies (namely, the employee/owners) who benefited from those excess contributions by way of their ability to participate in the C-group products.28 We find incredible petitioners’ assertion that the employee/owners of Neonatology and Lakewood, each of whom is an educated physician, would have caused their respective corporations to overpay substantially for term life insurance with no promise or expectation of receiving the excess contributions back. The premiums paid for the C-group term policy exceeded by a wide margin the cost of term life insurance.
We recognize that the conversion credit balance in a C-group term policy would be forfeited completely were the policy to lapse and not be converted. Such was the case, for example, when Neonatology let Dr. Mall‘s Inter-American C-group term policy lapse on March 15, 1992;29 in that case, Dr. Mall forfeited the conversion credit balance of $8,585.88. Petitioners focus on the possibility and actual occurrence of such a forfeiture and conclude therefrom that the premiums are all attributable to current life insurance protection. We disagree with this conclusion. The mere fact that a C-group term policyholder may forfeit the conversion credit balance does not mean, as petitioners would have it, that the balance
with commercial interest does not recharacterize the deposited funds as the cost of term insurance simply because Neonatology ultimately decided to abandon the funds. Although it is true that Neonatology and the insurancemen represented in form that Neonatology paid the entire $9,906 to Inter-American as a premium on term life insurance, the fact of the matter is that neither Neonatology nor Inter-American actually considered the excess premium to fund the cost of term life insurance. The substance of the purported premium payment outweighs its form, and, after closely scrutinizing the facts and circumstances of this case, including especially the interrelationship between the two policies underlying the C-group product and the expectations and understandings of the parties to the contracts underlying that product, we are left without any doubt that the amount credited to the conversion account balance was neither charged nor paid as the cost of current life insurance protection. The parties to those contracts have always expected and understood that the conversion credit balance would be returned to the insured in the future by way of no-cost policy loans.
We also recognize that the conversion credit balance would not be paid in addition to the underlying policy‘s face value when the insured died, and, if the insured had borrowed from the balance, that the death benefit would be reduced by the amount of any outstanding loan. In the case of Dr. Sobo, for example, his beneficiary, Ms. Sobo, received upon his death only the face value of the two C-group term policies which were then outstanding on his life. Neither she nor anyone else was entitled to, or actually received, the conversion credit balance on either policy. For the reasons stated immediately above, we do not believe that this “forfeiture” provision changes the fact that the amount credited to the conversion credit balance was simply a deposit that could either grow with interest, or, in the case of Dr. Sobo, dissipate,
We conclude that the excess contributions are disguised (constructive) distributions to the petitioning employee/owners of Neonatology and Lakewood, see Mazzocchi Bus Co., Inc. v. Commissioner, 14 F.3d 923, 927-928 (3d Cir. 1994), affg. T.C. Memo. 1993-43; Commissioner v. Makransky, 321 F.2d 598, 601-603 (3d Cir. 1963), affg. 36 T.C. 446 (1961); Truesdell v. Commissioner, 89 T.C. 1280 (1989); see also Old Colony Trust Co. v. Commissioner, 279 U.S. 716 (1929) (individual taxpayer constructively received income to the extent corporate employer agreed to pay his tax bill), which means, in turn, that the distributing corporations cannot deduct those payments.31 The fact that neither Lakewood nor Neonatology formally declared these excess contributions as cash distributions does not foreclose our finding that the excess contributions were distributions-in-fact. See Commissioner v. Makransky, supra at 601; Truesdell v. Commissioner, supra at 1295; see also Loftin & Woodard, Inc. v. United States, 577 F.2d 1206, 1214 (5th Cir. 1978); Crosby v. United States, 496 F.2d 1384, 1388 (5th Cir. 1974); Noble v. Commissioner, 368 F.2d 439, 442 (9th Cir. 1966), affg. T.C. Memo. 1965-84. What is critical to our conclusion is that the excess contributions made by Neonatology and Lakewood conferred an economic benefit on their employee/owners for the primary (if not sole) benefit of those employee/owners, that the excess contributions constituted a distribution of cash rather than a payment of an ordinary and necessary business expense, and that neither Neonatology nor Lakewood expected any repayment of the cash underlying the conferred benefit.32 See Noble v. Commissioner, supra at 443; see also Loftin & Woodard, Inc. v. United States, supra at 1214-1215; Crosby v. United States, supra at 1388; Magnon v. Commissioner, 73 T.C. 980, 993-994 (1980).
Petitioners argue that the excess contributions were paid to the employee/owners as compensation for their services. We disagree. Whether amounts are paid as compensation turns on the factual determination of whether the payor intends at the time that the payment is made to compensate the recipient for services performed. See Whitcomb v. Commissioner, 733 F.2d 191, 194 (1st Cir. 1984), affg. 81 T.C. 505 (1983); King‘s Ct. Mobile Home Park, Inc. v. Commissioner, 98 T.C. 511, 514-515 (1992); Paula Constr. Co. v. Commissioner, 58 T.C. 1055, 1058-1059 (1972), affd. without published opinion 474 F.2d 1345 (5th Cir. 1973). The intent is not found, as petitioners would have it, at or after the time that respondent challenges the payment‘s characterization as something other than compensation. See King‘s Ct. Mobile Home Park, Inc. v. Commissioner, supra at 514; Paula Constr. Co. v. Commissioner, supra at 1059-1060; Joyce v. Commissioner, 42 T.C. 628, 636 (1964); Drager v. Commissioner, T.C. Memo. 1987-483. The mere fact that petitioners now choose to characterize the excess contributions as compensation does not necessarily mean that the payments were compensation in fact.
The facts of this case do not support petitioners’ assertion that Neonatology and Lakewood had the requisite compensatory intent when they made the contributions to their plans. We find nothing in the record, except for petitioners’ assertions on brief, that would support such a finding. See Rule 143(b) (statements on brief are not evidence). Indeed, all reliable evidence points to the contrary conclusion that we reach as to this issue. On the basis of our review of the record, we are convinced that the purpose and operation of the Neonatology Plan and the Lakewood Plan was to serve as a tax-free savings device for the owner/employees and not, as asserted by petitioners, to provide solely term life insurance to the covered employees. To be sure, some of the plans even went so far as to purchase annuities for designated employee/owners.
Lakewood made payments outside of the Lakewood Plan for additional life insurance for two of its employees. Lakewood argues that these payments are deductible in full under
extent they did fund term life insurance for the relevant employees.
3. Neonatology Contributions as to Mr. Mall
Neonatology contributed money to the Neonatology Plan for the benefit of Mr. Mall. Mr. Mall was neither an employee of Neonatology nor an individual who was eligible to participate in Neonatology‘s Plan. We conclude that these contributions served no business purpose of Neonatology, and, hence, that they were not ordinary and necessary expenses paid to carry on Neonatology‘s business. See
4. & 5. Marlton Contributions as to Dr. Lo and Its Two Employees
Marlton contributed money to the Marlton Plan to purchase life insurance on the lives of three individuals; namely, Dr. Lo, Ms. Lo, and Edward Lo. As to Dr. Lo, he was neither a Marlton employee nor an individual who was eligible to participate in Marlton‘s plan. We conclude that the contributions made on his behalf served no legitimate business purpose of Marlton, and, hence, that they were not ordinary and necessary expenses paid to carry on Marlton‘s business. See
As to Ms. Lo, she was a Marlton employee. Under
We agree with respondent‘s conclusion that
Respondent asserts that the policy‘s beneficiary was the Los’ grantor trust. We are unable to find that such was the case. As we view the record, and as we found supra, the beneficiary of Ms. Lo‘s term life insurance policy was the Marlton Plan. Although the trust to which respondent refers was indeed the beneficiary of Dr. Lo‘s policy, we find nothing
We ask whether Dr. Lo is a direct or indirect beneficiary of Ms. Lo‘s term life insurance policy given the fact that the Marlton Plan is the named beneficiary. We conclude that he is.36 In the event of Ms. Lo‘s death, the face value of her life insurance policy would be paid to the Marlton Plan, for which Dr. Lo and Edward Lo would be the remaining beneficiaries. Although Dr. Lo would not be the sole beneficiary of those death benefits,
Dr. Lo, as opposed to Edward Lo, also stood to gain the most from the plan assets, were Ms. Lo to have died. Whereas Edward Lo had a fairly inexpensive term life insurance policy, Dr. Lo had a fairly expensive universal life policy. Ms. Lo‘s life insurance proceeds also could be used to pay the premiums on the policies, thus satisfying the obligation of Marlton to do so. See Rodney v. Commissioner, 53 T.C. 287, 318-319 (1969) (benefit requirement of
6. Disallowed Payments
A corporate distribution is taxed as a dividend to the recipient shareholder to the extent of the corporation‘s earnings and profits. The portion of the distribution that is not a dividend is a nontaxable return of capital to the extent of the shareholder‘s stock basis. The remainder of the distribution is taxed to the shareholder as gain from the sale or exchange of property. See
Petitioners challenge the timing of that income, however, arguing that it is not taxable to the employee/owners in the year determined by respondent; i.e., the year in which Neonatology and Lakewood contributed the excess amounts to their plans or, in the three instances where the insurance was purchased directly from Peoples Security, in the year that Lakewood paid Peoples Security for that insurance. Petitioners assert that the income is not taxable to the employee/owners until after the subject years because the conversion credit balance would be forfeited if the underlying policy lapsed or if the insured died. Petitioners observe that the employee/owners’ ability to withdraw the conversion credit balance was limited to the percentage of that balance that was transferred to the C-group conversion UL policy. Petitioners observe that the transferred credits could be reached by an insured only if a C-group term policy was converted to a C-group conversion UL policy, and then only in equal increments over 120 months. Petitioners observe that an insured would forfeit the transferred credits in the event of his or her death. Petitioners rely primarily on
Respondent argues that the income is taxable currently. Respondent asserts that the excess contributions purchased insurance contracts and annuities for the benefit of the employee/owners. Respondent asserts that the employee/owners had the unfettered ability to withdraw the conversion credit balances at their whim.
We agree with respondent that the dividends are taxable in the years that he determined. As mentioned supra, we view Neonatology and Lakewood‘s excess contributions to their plans as passing first through the employee/owners. We view likewise the excess payments which Lakewood made directly to Peoples Security. Accordingly, in both cases, the employee/owners are considered for purposes of the Federal tax law to have received the excess contributions (or payments)
Petitioners rely mistakenly on
7. Accuracy-Related Penalties
Respondent determined that each petitioner was liable for an accuracy-related penalty under
Reasonable cause requires that the taxpayer have exercised ordinary business care and prudence as to the disputed item. See United States v. Boyle, 469 U.S. 241 (1985); see also Hatfried, Inc. v. Commissioner, 162 F.2d 628, 635 (3d Cir. 1947); Girard Inv. Co. v. Commissioner, 122 F.2d 843, 848 (3d Cir. 1941); Estate of Young v. Commissioner, 110 T.C. 297, 317 (1998). The good faith reliance on the advice of an independent, competent professional as to the tax treatment of an item may meet this requirement. See United States v. Boyle, supra;
In sum, for a taxpayer to rely reasonably upon advice so as possibly to negate a
Petitioners assert on brief that they also relied on tax opinion letters written by tax attorneys and accountants. We do not find that such was the case. The record contains neither a credible statement by one or more of the individual petitioners to the effect that he or she saw and relied on a tax opinion letter, nor a tax opinion letter written by a competent, independent tax professional. In fact, petitioners have not even proposed a finding of fact that would support a finding that such a tax opinion letter exists, let alone that any of them ever read or relied on one. See
We also are unpersuaded by petitioners’ assertion that they relied reasonably on the correctness of the contents of their returns simply because their returns were prepared by certified public accountants. The mere fact that a certified public accountant has prepared a tax return does not mean that he or she has opined on any or all of the items reported therein. In this regard, the record contains no evidence that, possibly with the exception of Dr. Hirshkowitz, any of petitioners asked a competent accountant to opine on the legitimacy of his, her, or its treatment for the contributions, or that an accountant in fact did opine on that topic. In the case of Dr. Hirshkowitz, the record does reveal that he showed his accountant something on the SC VEBA and that the accountant expressed some reservations as to the advertised tax treatment of the SC VEBA, but no reservations which Dr. Hirshkowitz considered “major“, as he put it. The record does not reveal what exactly Dr. Hirshkowitz showed his accountant as to the SC VEBA or the particular reservations which the accountant expressed. Nor do we know whether a reasonable person would consider those reservations to be “major” from the point of view of accepting Mr. Cohen‘s representations of the tax consequences which flowed from the SC VEBA.
We conclude that each of petitioners is liable for the accuracy-related penalties determined by respondent.
8. Addition to Tax for Failure To File Timely
Lakewood filed its 1992 tax return with the Commissioner on May 28, 1993. The unextended due date of the return was March 15, 1993, and Lakewood neither requested nor received an extension from that date. Respondent determined that Lakewood‘s untimely filing made it liable for an addition to tax under
9. Penalties Under Section 6673(a)(1)(B)
Respondent moves the Court under
Petitioners argue that their positions are meritorious. Petitioners assert that respondent‘s motion to impose sanctions against each of them is frivolous and that the Court should sanction respondent‘s counsel under
We disagree with respondent‘s assertion that we should order each petitioner to pay a penalty to the Government under
The mere fact that petitioners are defending the position that was advertised to them in connection with their investment
We conclude our report directing the parties to prepare computations under Rule 155 in all but one of the docketed cases, taking into account the cost of term life insurance for those employees who were eligible to receive that protection. In reaching our holdings we have considered all of petitioners’ arguments for contrary holdings; those arguments not discussed herein are irrelevant or without merit. We also have considered respondent‘s arguments as to his determinations to the extent necessary to reject or sustain each determination. We also have considered all of respondent‘s arguments as to his motion to impose a penalty against each petitioner.
As mentioned supra,
Decision will be entered for respondent in docket No. 4572-97, decisions will be entered under Rule 155 in all other dockets, and an appropriate order will be issued denying respondent‘s motion to impose penalties under section 6673(a)(1)(B).
Notes
In summary, respondent determined that the disallowed contributions were attributable to the following persons:
| 1991 | 1992 | 1993 | |
| Dr. Hirshkowitz | $254,051 | $136,678 | $211,120 |
| Dr. Desai | 122,750 | 42,056 | 55,000 |
| Dr. McManus | 20,000 | 17,921 | 18,186 |
| Dr. Sobo | 83,100 | 13,214 | 5,000 |
| Dr. Sankhla | — | — | 5,750 |
| Trustee’s fees | 1,000 | — | 1,000 |
| 480,901 | 209,869 | 296,056 |
The term “10-or-more employer plan” is defined by
(6) Exception for 10-or-More Employer Plans.--
(A) In general.--This subpart [i.e., the rules of subpt. D that generally limit an employer‘s deduction for its contributions to a welfare benefit fund to the amount that would have been deductible had it provided the benefits directly to its employees] shall not apply in the case of any welfare benefit fund which is part of a 10 or more employer plan. The preceding sentence shall not apply to any plan which maintains experience-rating arrangements with respect to individual employers.
(B) 10 or more employer plan.--For purposes of subparagraph (A), the term “10 or more employer plan” means a plan--
(i) to which more than 1 employer contributes, and
(ii) to which no employer normally contributes more than 10 percent of the total contributions contributed under the plan by all employers.
See generally Booth v. Commissioner, 108 T.C. 524, 562-563 (1997), for a discussion of the tax consequences which flow from a 10-or-more employer plan vis-a-vis another type of welfare benefit fund, on the one hand, or a plan of deferred compensation, on the other hand.
(...continued)
these excess contributions.
That the distributing corporations and/or the employee/owners may not have intended that the excess contributions constitute a taxable distribution does not preclude (continued...)
(...continued)
dividend treatment. Nor is it precluded because the corporations did not formally distribute the cash directly to the owner/employees. See Loftin & Woodard, Inc. v. United States, 577 F.2d 1206, 1214 (5th Cir. 1978); Crosby v. United States, 496 F.2d 1384, 1388 (5th Cir. 1974).
SEC. 264. CERTAIN AMOUNTS PAID IN CONNECTION WITH INSURANCE CONTRACTS.
(a) General Rule.--No deduction shall be allowed for--
(1) Premiums paid on any life insurance policy covering the life of any officer or employee, or of any person financially interested in any trade or business carried on by the taxpayer, when the taxpayer is directly or indirectly a beneficiary under such policy.
SEC. 83. PROPERTY TRANSFERRED IN CONNECTION WITH PERFORMANCE OF SERVICES.
(a) General Rule.--If, in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed, the excess of--
(1) the fair market value of such property (determined without regard to any restriction other than a restriction which by its terms will never lapse) at the first time the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier, over
(2) the amount (if any) paid for such property,
shall be included in the gross income of the person who performed such services in the first taxable year in which the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever (continued...)
is applicable. * * *