Webber v. Commissioner

JEFFREY T. WEBBER, PETITIONER v. COMMISSIONER

OF INTERNAL REVENUE, RESPONDENT

Docket No. 14336–11. Filed June 30, 2015.

P, a U.S. citizen, established a grantor trust that purchased

‘‘private placement’’ variable life insurance policies insuring

the lives of two elderly relatives. P and various family mem-

bers were the beneficiaries of these policies. The premiums

paid for the policies, less various expenses, were placed in

separate accounts whose assets inured exclusively to the ben-

efit of the policies. The money in the separate accounts was

used to purchase investments in startup companies with

which P was intimately familiar and in which he otherwise

invested personally and through private-equity funds he man-

aged. P effectively dictated both the companies in which the

separate accounts would invest and all actions taken with

respect to these investments. R concluded that P retained

sufficient control and incidents of ownership over the assets

in the separate accounts to be treated as their owner for Fed-

eral income tax purposes under the ‘‘investor control’’ doc-

trine. See Rev. Rul. 77–85, 1977–1 C.B. 12. The powers P

retained included the power to direct investments; the power

to vote shares and exercise other options with respect to these

securities; the power to extract cash at will from the separate

accounts; and the power in other ways to derive ‘‘effective

benefit’’ from the investments in the separate accounts. See

Griffiths v. Helvering, 308 U.S. 355, 358 (1939).

1. Held: The IRS revenue rulings enunciating the ‘‘investor

control’’ doctrine are entitled to deference and weight under

Skidmore v. Swift & Co., 323 U.S. 134, 140 (1944).

2. Held, further, P was the owner of the assets in the sepa-

rate accounts for Federal income tax purposes and was tax-

able on the income earned on those assets during the taxable

years in issue.

3. Held, further, P is not liable for the accuracy-related pen-

alties under I.R.C. sec. 6662(a) because he relied in good faith

on professional advice from competent tax professionals.

324

(324) WEBBER v. COMMISSIONER 325

Robert Steven Fink, Megan L. Brackney, and Joseph

Septimus, for petitioner.

Steven Tillem, Shawna A. Early, and Casey R. Kroma, for

respondent.

LAUBER, Judge: Petitioner is a venture-capital investor and

private-equity fund manager. He established a grantor trust

that purchased ‘‘private placement’’ variable life insurance

policies insuring the lives of two elderly relatives. These poli-

cies were purchased from Lighthouse Capital Insurance Co.

(Lighthouse), a Cayman Islands company. Petitioner and var-

ious family members were the beneficiaries of these policies.

The premium paid for each policy, after deduction of a

mortality risk premium and an administrative charge, was

placed in a separate account underlying the policy. The

assets in these separate accounts, and all income earned

thereon, were segregated from the general assets and

reserves of Lighthouse. These assets inured exclusively to the

benefit of the two insurance policies.

The money in the separate accounts was used to purchase

investments in startup companies with which petitioner was

intimately familiar and in which he otherwise invested

personally and through funds he managed. Petitioner effec-

tively dictated both the companies in which the separate

accounts would invest and all actions taken with respect to

these investments. Petitioner expected the assets in the sepa-

rate accounts to appreciate substantially, and they did.

Petitioner planned to achieve two tax benefits through this

structure. First, he hoped that all income and capital gains

realized on these investments, which he would otherwise

have held personally, would escape current Federal income

taxation because positioned beneath an insurance policy.

Second, he expected that the ultimate payout from these

investments, including all realized gains, would escape Fed-

eral income and estate taxation because payable as ‘‘life

insurance proceeds.’’

Citing the ‘‘investor control’’ doctrine and other principles,

the Internal Revenue Service (IRS or respondent) concluded

that petitioner retained sufficient control and incidents of

ownership over the assets in the separate accounts to be

treated as their owner for Federal income tax purposes.

Treating petitioner as having received the dividends,

326 144 UNITED STATES TAX COURT REPORTS (324)

interest, capital gains, and other income realized by the sepa-

rate accounts, the IRS determined deficiencies in his Federal

income tax of $507,230 and $148,588 and accuracy-related

penalties under section 6662 of $101,446 and $29,718 for

2006 and 2007, respectively. 1 We will sustain in large part

the deficiencies, but we conclude that petitioner is not liable

for the penalties.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

The stipulations of facts and the attached exhibits are incor-

porated by this reference. When he petitioned this Court,

petitioner lived in California.

Petitioner’s Background and Business Activities

Petitioner received his bachelor’s degree from Yale College

and attended Stanford University’s M.B.A. program. He left

Stanford early to start a technology consulting firm, and he

later founded and managed a series of private-equity part-

nerships that provided ‘‘seed capital’’ to startup companies.

These partnerships were early-stage investors that generally

endeavored to supply the ‘‘first money’’ to these entities.

Separately, petitioner furnished consulting services to

startup ventures through his own firm, R.B. Webber & Co.

(Webber & Co.).

Each venture-capital partnership had a general partner

that was itself a partnership. Petitioner was usually the

managing director of the general partner. The venture-cap-

ital partnership offered limited partnership interests to

sophisticated investors. These offerings were often oversub-

scribed.

As managing director, petitioner had the authority to

make, and did make, investment decisions for the partner-

ships. To spread the risk of investing in new companies, peti-

tioner often invested through syndicates. A syndicate is not

a formal legal entity but a group of investors (individuals or

funds) who seek to invest synergistically. Generally speaking,

1 All statutory references are to the Internal Revenue Code (Code) as in

effect for the tax years in issue. All Rule references are to the Tax Court

Rules of Practice and Procedure. All dollar amounts have been rounded to

the nearest dollar.

(324) WEBBER v. COMMISSIONER 327

the syndicate’s goal was to make early-stage investments in

companies that would ultimately benefit from a ‘‘liquidity

event’’ like an initial public offering (IPO) or direct acquisi-

tion.

Before investing in a startup company, petitioner per-

formed due diligence. This included review of the company’s

budget, business plan, and cashflow model; his review also

included analysis of its potential customers and competitors

and the experience of its entrepreneurs. Because petitioner,

through Webber & Co., provided consulting services to

numerous startup companies, he had access to proprietary

information about them. On the basis of all this information,

petitioner decided whether to invest, or to recommend that

one of his venture-capital partnerships invest, in a particular

entity. Having made an early-stage investment, petitioner

usually sought to find new investors for that company, so as

to spread his risk, enhance the company’s prospects, and

move it closer to a ‘‘liquidity event.’’

Having supplied the ‘‘first money’’ to these startup ven-

tures, petitioner and his partnerships were typically offered

subsequent opportunities to invest in them. These opportuni-

ties are commonly called ‘‘pro-rata offerings.’’ As additional

rounds of equity financing are required, a pro-rata offering

gives a current equity owner the chance to buy additional

equity in an amount proportionate to his existing equity.

This enables him to maintain his current position and avoid

‘‘dilution’’ by new investors. Depending on the circumstances,

petitioner would accept or decline these pro-rata offerings.

Petitioner invested in startup companies in various ways.

He held certain investments in his own name; he invested

through trusts and individual retirement accounts (IRAs);

and he invested through the venture-capital partnerships

that he managed. To help him manage this array of invest-

ments, petitioner in 1999 hired Susan Chang as his personal

accountant. She had numerous and diverse responsibilities.

These included determining whether petitioner had funds

available for a particular investment; ensuring that funds

were properly transferred and received; communicating with

lawyers, advisers, paralegals, and others about investments

in which petitioner was interested; and maintaining account

balances and financial statements for petitioner’s personal

investments.

328 144 UNITED STATES TAX COURT REPORTS (324)

Because of his expertise, knowledge of technology, and

status as managing director of private-equity partnerships,

petitioner served as a member of the board of directors for

more than 100 companies. As relevant to this opinion, peti-

tioner through various entities invested in, and served on the

boards of, the following companies at various times prior to

December 31, 2007:

Petitioner individually

Board or through a private

member or equity partnership Petitioner through an

Company name officer invested in IRA invested in

Accept Software Yes Yes Yes

Attensity Corp. Yes Yes No

Borderware Tech. Yes Yes Yes

DTL Plum Investments No Yes No

JackNyfe, Inc. Yes Yes No

Lignup, Inc. Yes Yes Yes

Links Mark Multimedia No Yes No

Lunamira, Inc. No Yes No

Medstory, Inc. No Yes No

Milphworld, Inc. No Yes No

Nextalk, Inc. Yes Yes No

Prevarex, Inc. Yes Yes No

Promoter Neurosciences No Yes No

PTRx Media, LLC Yes Yes Yes

Push Media, LLC No Yes No

RJ Research, Inc. No Yes No

Reactrix Systems, Inc. No Yes No

Renaissance 2.0 Media No Yes No

Signature Investments,

RBN, Inc. No Yes No

Soasta, Inc. Yes Yes Yes

Techtribenetworks, Inc. Yes Yes No

Vizible Corp. Yes Yes Yes

WellDunn Restaurant Grp. No Yes Yes

Webify Solutions Yes Yes No

Petitioner’s Tax and Estate Planning

By 1998 petitioner had enjoyed success in his investing

career and accumulated assets in excess of $20 million. An

attorney named David Herbst, who furnished petitioner with

tax advice, recommended that he secure the assistance of an

experienced estate planner. One of petitioner’s college class-

mates referred him to William Lipkind, a partner in the law

firm Lampf, Lipkind, Prupis and Petigrow.

Petitioner met with Mr. Lipkind for the first time in 1998

at Mr. Herbst’s office. Mr. Lipkind laid out a complex estate

plan that involved a grantor trust and the purchase of pri-

vate placement life insurance policies from Lighthouse. He

explained that private placement insurance is a type of vari-

able life insurance that builds value in a separate account.

(The details of this strategy are discussed more fully below.)

(324) WEBBER v. COMMISSIONER 329

Mr. Lipkind acknowledged that this tax-minimization

strategy had certain tax risks, but he orally assured peti-

tioner that the strategy was sound. After several followup

conversations, petitioner hired Mr. Lipkind to do his estate

planning and stated his intention to purchase the private

placement life insurance. Mr. Lipkind then undertook a

series of steps to implement this strategy.

The Grantor Trusts

The first step was the creation of a grantor trust, which

had three iterations between 1999 and 2008. On March 24,

1999, petitioner established the Jeffrey T. Webber 1999

Alaska Trust (Alaska Trust), a grantor trust for Federal

income tax purposes. Mr. Lipkind recommended Alaska as

the situs in part because that State has no income tax; he

was concerned that certain tax risks could arise if the trust

were formed in California, where petitioner resided. Mr.

Lipkind’s firm drafted the trust documents and customized

them to petitioner’s needs.

The trustees of the Alaska Trust were Mr. Lipkind and the

Alaska Trust Co. Petitioner could remove the trustees at any

time and replace them with ‘‘Independent Trustees.’’ 2 The

beneficiaries were petitioner’s children, his brother, and his

brother’s children. Petitioner was named a discretionary

beneficiary of the Alaska Trust, which was necessary to

achieve grantor trust status. 3

In 1999 petitioner contributed $700,000 to the Alaska

Trust. The trustee used these funds to purchase from Light-

house two ‘‘Flexible Premium Restricted Lifetime Benefit

Variable Life Insurance Policies’’ (Policy or Policies). Peti-

tioner timely filed Form 709, United States Gift (and Genera-

2 Independent Trustees could include any bank or an attorney who was

not ‘‘within the meaning of section 672(c) * * * related or subordinate to

the Grantor.’’

3 The Alaska Trust provided that ‘‘any one Independent Trustee acting

alone’’ may distribute to petitioner as Grantor ‘‘such amounts of the net

income and/or principal * * * as such Independent Trustee deems wise.’’

In determining whether to make any such distribution, the trustee was re-

quired to take into consideration ‘‘the Grantor’s own income and property

and any other income or property which may be available to the Grantor.’’

The trustee was empowered to exercise such discretion without regard to

the interest of remaindermen.

330 144 UNITED STATES TAX COURT REPORTS (324)

tion-Skipping Transfer) Tax Return, reporting this $700,000

gift. He attached to this return a disclosure statement

explaining that the Alaska Trust ‘‘purchased two variable life

insurance policies * * * for an aggregate first year’s pre-

mium of $700,000’’ and noting that his ‘‘contributions to the

Trust were completed gifts and the Trust assets will not be

includible in [his] gross estate.’’

The Alaska Trust was listed as the owner of the Policies

from October 28, 1999, to October 8, 2003. During 2003 peti-

tioner became concerned about protecting his assets from

creditors because Webber & Co. was encountering financial

problems, he was going through a divorce, and he feared law-

suits from unhappy private-equity investors following the

‘‘dot.com’’ crash. With the goal of achieving asset protection,

petitioner asked Mr. Lipkind to move the Alaska Trust

assets offshore. Mr. Lipkind advised against doing this

because of the tax disadvantages it could entail. Petitioner

nevertheless persisted in his desire for asset protection, and

Mr. Lipkind complied with his wishes.

On October 9, 2003, Mr. Lipkind established the Chalk

Hill Trust, a foreign grantor trust organized under the laws

of the Commonwealth of the Bahamas. The Alaska Trust

then assigned all of its assets, including the Policies, to the

Chalk Hill Trust. Petitioner filed a timely Form 3520,

Annual Return To Report Transactions With Foreign Trusts

and Receipt of Certain Foreign Gifts, reporting this transfer

and signing the return as ‘‘owner-beneficiary’’ of the Chalk

Hill Trust.

Petitioner was the grantor of the Chalk Hill Trust and is

treated as its owner for Federal income tax purposes. The

trustee was Oceanic Bank & Trust, Ltd.; the U.S. protector

was Mr. Lipkind; and the foreign protector was an entity

from the Isle of Man. Petitioner and his issue were the bene-

ficiaries of the Chalk Hill Trust. During petitioner’s lifetime

the trustee had ‘‘uncontrolled discretion’’ to distribute trust

assets to the beneficiaries. Mr. Lipkind, as the U.S. protector,

could remove and replace the trustee at any time.

The Chalk Hill Trust was listed as the owner of the Poli-

cies from October 9, 2003, through March 6, 2008. It was

thus the nominal owner of the Policies during the tax years

in issue. In early 2008 petitioner became confident that the

credit risks had passed and decided to move the trust assets

(324) WEBBER v. COMMISSIONER 331

back to a domestic grantor trust. The Delaware Trust was

established for that purpose, and all assets of the Chalk Hill

Trust, including the Policies, were assigned to it. The salient

terms of the Delaware Trust arrangement did not differ

materially from the terms of the prior two grantor trust

arrangements. We will sometimes refer to the Alaska Trust,

the Chalk Hill Trust, and the Delaware Trust collectively as

‘‘the Trusts.’’

Lighthouse

Lighthouse is a Cayman Islands class B unlimited life

insurance company established in 1996 and regulated by the

Cayman Islands Monetary Authority. Lighthouse issues

annuity and variable life insurance products. During 1999 it

issued 70 to 100 policies with a total outstanding face value

of $250 to $300 million. Petitioner had no direct or indirect

ownership interest in Lighthouse.

Lighthouse is managed by Aon Insurance Managers (Aon),

a wholly owned subsidiary of Aon PLC, a major insurance

company headquartered in London. Aon was responsible for

the day-to-day operations of Lighthouse, including its record-

keeping, compliance, and financial audits. Lighthouse

reinsures mortality risk arising under its policies with Han-

nover Ru¨ckversicherung-AG (Hannover Re), a well-respected

reinsurer. Lighthouse generally reinsures all but $10,000 of

the mortality risk on each policy, as it did with these Poli-

cies. For some elderly insureds, such as those under peti-

tioner’s Policies, Lighthouse reinsured virtually 100% of the

mortality risk.

Before issuing a policy Lighthouse would conduct an

underwriting analysis and seek medical information about

the prospective insured. Where (as here) the policyholder was

not the insured, Lighthouse performed due diligence

regarding the source of funds. It also confirmed the existence

of an insurable interest.

The Policies

The Policies, initially acquired by the Alaska Trust and

later transferred to the Chalk Hill Trust, insured the lives of

two of petitioner’s relatives. The first Policy insured the life

of Mabel Jordan, the stepgrandmother of petitioner’s then

332 144 UNITED STATES TAX COURT REPORTS (324)

wife. Ms. Jordan, who was 78 years old when the Policy was

issued, died in November 2012 at age 92. The second Policy

insured the life of Oleta Sublette, petitioner’s aunt. She was

77 years old when the Policy was issued and was still alive

at the time of trial. Each Policy had a minimum guaranteed

death benefit of $2,720,000.

Each Policy required Lighthouse to establish a separate

account pursuant to section 7(6)(c) of the Cayman Islands

Insurance Law to fund benefits under that Policy. On

receiving the initial premiums in 1999, Lighthouse debited

against them the first-year policy charges (a one-year mor-

tality risk premium and one year’s worth of administrative

fees). Lighthouse kept the administrative fees and trans-

ferred most of the mortality risk premium to Hannover Re.

The remainder of each premium was allocated to the rel-

evant separate account. On an annual basis thereafter,

Lighthouse debited each separate account for that year’s

mortality and administrative charges. If the assets in the

separate account were insufficient to defray these charges,

the policyholder had to make an additional premium pay-

ment to cover the difference; otherwise, the policy would

lapse and terminate.

The annual administrative fee that Lighthouse charged

each Policy equaled 1.25% of its separate account value.

There was an additional fee to cover services nominally pro-

vided by the Policies’ ‘‘investment manager.’’ (As explained

below, that fee was modest.) The mortality risk charge was

determined actuarially, but it rapidly decreased as the value

of the separate accounts approached or exceeded the min-

imum death benefit of $2,720,000. The mortality risk charges

debited to the separate accounts during 2006–2007 totaled

$12,327.

The minimum death benefit was payable in all events so

long as the Policy remained in force. If the investments in

the separate account performed well, the beneficiary upon

the insured’s death was to receive the greater of the min-

imum death benefit or the value of the separate account. The

Policies provided that the death benefit would be paid by

Lighthouse ‘‘in cash to the extent of liquid assets and in kind

to the extent of illiquid assets (any in kind payment being in

the sole discretion of Lighthouse), or the Death Benefit shall

be paid by such other arrangements as may be agreed upon.’’

(324) WEBBER v. COMMISSIONER 333

The Policies permitted the policyholder to add additional

premiums if necessary to keep the Policies in force. On Sep-

tember 7, 2000, the Alaska Trust made an additional pre-

mium payment of $35,046 to cover a portion of the second-

year mortality/administrative charge. The assets in the sepa-

rate accounts performed so well that no subsequent premium

payments were required. Thus, the total premiums paid on

the Policies by the Alaska Trust (and by its successor grantor

trusts) amounted to $735,046.

The Policies granted certain rights to the policyholder prior

to the deaths of the insureds. Each Policy permitted the

policyholder to assign it; to use it as collateral for a loan; to

borrow against it; and to surrender it. If the policyholder

wished to assign a Policy or use it as collateral for a loan,

Lighthouse had the discretion to reject such a request.

However, the Policies significantly restricted the amount of

cash the policyholder could extract from the Policies by sur-

render or policy loan. This restriction was accomplished by

limiting the Cash Surrender Value of each Policy to the total

premiums paid, and by capping any policy loan at the Cash

Surrender Value. For this purpose, ‘‘premiums’’ were defined

as premiums paid in cash by the policyholder, to the exclu-

sion of mortality/administrative charges debited from the

separate accounts.

Thus, if the separate accounts performed poorly and the

policyholder paid cash to cover ongoing mortality/administra-

tive charges, those amounts would constitute ‘‘premiums’’

and would increase the Cash Surrender Value. By contrast,

if the separate accounts performed well and ongoing mor-

tality/administrative charges were debited from the separate

accounts, those amounts were not treated as premiums that

increased the Cash Surrender Value, but as internal charges

paid by Lighthouse. 4 The result of this restriction was that

the maximum amount the Trusts could extract from the Poli-

cies prior to the deaths of the insureds, by surrendering the

Policies or taking out policy loans, was $735,046.

4 For 2006 and 2007 the separate accounts paid Lighthouse $130,000 and

$161,500, respectively, to cover annual mortality/administrative charges.

The 2007 charges were higher because the separate accounts’ values had

increased.

334 144 UNITED STATES TAX COURT REPORTS (324)

Investment Management of the Separate Accounts

Lighthouse did not provide investment management serv-

ices for the separate accounts. Rather, it permitted the

policyholder to select an investment manager from a Light-

house-approved list. For most of 2006 and 2007 Butterfield

Private Bank (Butterfield), a Bahamian bank, served as the

investment manager for the separate accounts. The Policies

specified that Butterfield would be paid $500 annually for

investment management services and $2,000 for accounting. 5

In November 2007 Experta Trust Co. (Bahamas), Ltd.

(Experta), became the investment manager. No one testified

at trial on behalf of Butterfield or Experta. We will refer to

these entities collectively as the ‘‘Investment Manager.’’

As drafted, the Policies state that no one but the Invest-

ment Manager may direct investments and deny the policy-

holder any ‘‘right to require Lighthouse to acquire a par-

ticular investment’’ for a separate account. Under the Poli-

cies, the policyholder was allowed to transmit ‘‘general

investment objectives and guidelines’’ to the Investment

Manager, who was supposed to build a portfolio within those

parameters. The Trusts specified that 100% of the assets in

the separate accounts could consist of ‘‘high risk’’ invest-

ments, including private-equity and venture-capital assets.

Lighthouse was required to perform ‘‘know your client’’ due

diligence, designed to avoid violation of antiterrorism and

moneylaundering laws, and was supposed to ensure that ‘‘the

Separate Account investments [were managed] in compliance

with the diversification requirements of Code Section 817(h).’’

Besides setting the overall investment strategy for a sepa-

rate account, a policyholder was permitted to offer specific

investment recommendations to the Investment Manager.

But the Investment Manager was nominally free to ignore

such recommendations and was supposed to conduct inde-

pendent due diligence before investing in any nonpublicly

traded security. Although almost all of the investments in

5 It appears that the separate accounts paid Butterfield $8,500 in overall

fees for 2006 and 2007, but there is no evidence that any amount in excess

of $500 per year was allocable to investment management. Petitioner di-

rects the Court’s attention to an accounting entry showing ‘‘Administrative

Fees’’ of $20,500 paid in 2007, but there is no evidence to establish what

these were paid for.

(324) WEBBER v. COMMISSIONER 335

the Policies’ separate accounts consisted of nonpublicly

traded securities, the record contains no compliance records,

financial records, or business documentation (apart from

boilerplate references in emails) to establish that Lighthouse

or the Investment Manager in fact performed independent

research or meaningful due diligence with respect to any of

petitioner’s investment directives.

Lighthouse created a series of special-purpose companies to

hold the investments in the separate accounts. The Light-

house Nineteen Ninety-Nine Fund LDC (1999 Fund), orga-

nized in the Bahamas, was created when the separate

accounts were initially established. During the tax years in

issue the principal special-purpose company was Boiler Riffle

Investments, Ltd. (Boiler Riffle), likewise organized in the

Bahamas. These investment funds were owned by Light-

house but were dedicated exclusively to funding death bene-

fits under the Policies through the separate accounts. These

special-purpose vehicles were not available to the general

public or to any other Lighthouse policyholder.

The ‘‘Lipkind Protocol’’

Mr. Lipkind explained to petitioner that it was important

for tax reasons that petitioner not appear to exercise any

control over the investments that Lighthouse, through the

special-purpose companies, purchased for the separate

accounts. Accordingly, when selecting investments for the

separate accounts, petitioner followed the ‘‘Lipkind protocol.’’

This meant that petitioner never communicated—by email,

telephone, or otherwise—directly with Lighthouse or the

Investment Manager. Instead, petitioner relayed all of his

directives, invariably styled ‘‘recommendations,’’ through Mr.

Lipkind or Ms. Chang.

The record includes more than 70,000 emails to or from

Mr. Lipkind, Ms. Chang, the Investment Manager, and/or

Lighthouse concerning petitioner’s ‘‘recommendations’’ for

investments by the separate accounts. Mr. Lipkind also

appears to have given instructions regularly by telephone.

Explaining his lack of surprise at finding no emails about a

particular investment, Mr. Lipkind told petitioner: ‘‘We have

relied primarily on telephone communications, not written

336 144 UNITED STATES TAX COURT REPORTS (324)

paper trails (you recall our ‘owner control’ conversations).’’

The 70,000 emails thus tell much, but not all, of the story.

Investments by the Separate Accounts

In April 1999, shortly after the Alaska Trust initiated the

Policies, the 1999 Fund purchased from petitioner, for

$2,240,000, stock that petitioner owned in three startup

companies: Sagent Technology, Inc., Persistence Software,

Inc., and Commerce One, Inc. Petitioner was unsure how the

1999 Fund could have paid him $2,240,000 for his stock

when the Alaska Trust at that point had paid premiums

toward the Policies of only $700,000 (before reduction for

very substantial first-year mortality charges). He speculated

that he might have made an installment sale.

Petitioner testified that he expected the stock in these

three companies to ‘‘explode’’ in value. They did. Not long

thereafter, each company had a ‘‘liquidity event’’—either an

IPO or direct sale—that enabled the separate accounts to sell

the shares at a substantial gain. Those profits were used to

purchase other investments for the separate accounts during

the ensuing years.

During 2006–2007 Boiler Riffle was the special-purpose

entity through which petitioner effected most of his invest-

ment objectives for the Policies. 6 (In their email correspond-

ence, petitioner and Mr. Lipkind often refer to Boiler Riffle

as ‘‘BR’’ or ‘‘br,’’ and various parties refer to petitioner as

‘‘Jeff.’’). Petitioner achieved his investment objectives by

entering into transactions directly with Boiler Riffle and by

offering through his intermediaries ‘‘recommendations’’ about

assets in which Boiler Riffle should invest.

The net result of this process was that every investment

Boiler Riffle made was an investment that petitioner had

‘‘recommended.’’ Apart from certain brokerage funds, vir-

tually every security that Boiler Riffle held was issued by a

startup company in which petitioner had a personal financial

interest, e.g., by sitting on its board, by investing in its secu-

6 Boiler Riffle had 5,000 shares of stock outstanding, and its Register of

Members showed 2,500 shares as ‘‘owned’’ by each Policy. Since an insur-

ance policy cannot own property, the Court interprets this reference to

mean that half of the assets held by Boiler Riffle were dedicated respec-

tively to each Policy.

(324) WEBBER v. COMMISSIONER 337

rities personally or through an IRA, or by investing in its

securities through a venture-capital fund he managed. The

Investment Manager did no independent research about

these fledgling companies; it never finalized an investment

until Mr. Lipkind had signed off; and it performed no due

diligence apart from boilerplate requests for organizational

documents and ‘‘know your customer’’ review. The Invest-

ment Manager did not initiate or consider any equity invest-

ment for the separate accounts other than the investments

that petitioner ‘‘recommended.’’ The Investment Manager

was paid $500 annually for its services, and its compensation

was commensurate with its efforts.

The 70,000 emails in the record establish that Mr. Lipkind

and Ms. Chang served as conduits for the delivery of instruc-

tions from petitioner to Lighthouse and Boiler Riffle. The fact

that Boiler Riffle invested almost exclusively in startup

companies in which petitioner had a personal financial

interest was not serendipitous but resulted from petitioner’s

active management over these investments. The following

table shows the startup companies in which Boiler Riffle held

investments at yearend 2006 and 2007, the form of those

investments, and whether petitioner invested in the same

entities outside of the Policies:

Convertible debt/ Petitioner invested in

Company Equity promissory note outside policies

Accept Software 2006 &2007 2007 Yes

Attensity Corp. 2006 &2007 --- Yes

Borderware Tech. 2006 &2007 2006 & 2007 Yes

DTL Plum Investments 2006 &2007 --- Yes

JackNyfe, Inc. 2007 --- Yes

Lignup, Inc. 2006 & 2007 2007 Yes

Links Mark Multimedia --- 2007 Yes

Lunamira, Inc. 2007 --- Yes

Medstory 2006 --- Yes

Milphworld, Inc. --- 2007 Yes

Nextalk, Inc. 2007 --- Yes

Prevarex, Inc. 2007 --- Yes

Promoter Neurosciences 2007 --- Yes

PTRx Media, LLC 2006 & 2007 2007 Yes

Quintana Energy 2006 & 2007 --- Yes

Push Media, LLC 2006 & 2007 --- Yes

RJ Research, Inc. --- 2007 Yes

Reactrix Systems, Inc. 2006 & 2007 --- Yes

Renaissance 2.0 Media 2006 & 2007 --- Yes

Signature Investments,

RBN, Inc. --- 2006 & 2007 Yes

Soasta, Inc. 2007 --- Yes

Techtribenetworks, Inc. 2006 & 2007 2006 & 2007 Yes

Vizible Corp. 2006 & 2007 --- Yes

WellDunn Restaurant Grp. 2006 & 2007 --- Yes

338 144 UNITED STATES TAX COURT REPORTS (324)

Though Mr. Lipkind was careful to insulate petitioner from

direct communication with the Investment Manager, he fre-

quently represented to the personnel of target investments

that he and petitioner controlled Boiler Riffle and were

acting on its behalf. Indeed, he often referred to Boiler Riffle

as ‘‘Jeff ’s wallet.’’ (Ms. Chang once suggested that the target

companies change their email protocol ‘‘in order to maintain

the appearance of separation.’’) ‘‘When Butterfield gets some-

thing with respect to Boiler Riffle,’’ Mr. Lipkind told one tar-

get company, ‘‘they always solicit my views before doing any-

thing.’’ ‘‘While it [may] sound complex,’’ he told another com-

pany, ‘‘the process does move quite rapidly. Besides,

Butterfield will do nothing unless and until both I and Light-

house sign off.’’ We set forth below a representative sample

of communications among Mr. Lipkind, Ms. Chang, Light-

house, the Investment Manager, and the startup companies

in which petitioner wished Boiler Riffle to invest.

Accept Software. Petitioner invested in Accept Software

personally and through funds he managed and was a

member of its board of directors. In January and June 2006

he communicated directly with its representatives, prior to

any consultation with the Investment Manager, and com-

mitted to have Boiler Riffle purchase its series B equity

round shares. Petitioner made a personal financial commit-

ment to officers of Accept Software and then directed Boiler

Riffle to finance that commitment. In December 2006 Mr.

Lipkind emailed a staff person at Butterfield and informed

her that petitioner wished to make this investment: ‘‘It is

most strongly recommended that BR go forward with this. If

there are any questions, please call.’’ The Investment Man-

ager duly complied with this recommendation.

In mid-2007 Accept Software offered its shareholders a

chance to participate in a bridge financing. Petitioner ini-

tially indicated that he wished Boiler Riffle to participate for

its ‘‘pro-rata amount,’’ and this instruction was relayed to the

Investment Manager. Later, Mr. Lipkind thought petitioner

had changed his mind and emailed a staff person at

Butterfield: ‘‘An issue has now arisen with respect to going

as high as ‘pro-rata.’ Have papers been sent in? If not, hold.

I should get matter cleared up by tomorrow. If papers went

in already, I will deal with it at Company level.’’ The staff

person responded: ‘‘I have not sent the paper work as yet

(324) WEBBER v. COMMISSIONER 339

[and] I will hold until I h[ear] f[rom] you.’’ Petitioner ulti-

mately decided to take his pro-rata share, and Boiler Riffle

obediently made that investment.

PTRx Media. Petitioner invested in PTRx personally and

through funds he managed and was a member of its board

of directors. In March 2006 petitioner told Mr. Lipkind that

he wanted Boiler Riffle to invest $50,000 in PTRx’s series B

financing. On March 31, 2006, Mr. Lipkind emailed Ms.

Strachan of Butterfield as follows: ‘‘Boiler Riffle should

participate in the attachments for Series B to the tune of

$50,000, the same amount it did on Series A. I assume you

will process same.’’ Boiler Riffle purchased the PTRx stock.

PTRx later offered a series D financing, and Mr. Lipkind

asked petitioner whether Boiler Riffle should participate.

Petitioner responded: ‘‘[PTRx is] doing great [and] they

should be break even by the end of the year. They have just

hired a killer sales guy. We cut a great deal this morning

with a bank. * * * I would do pro-rata at the minimum.’’ Mr.

Lipkind emailed the Investment Manager and ‘‘strongly rec-

ommended that Boiler Riffle * * * participate at least to

their pro-rata.’’ Boiler Riffle duly purchased its pro-rata

share of the series D financing.

WellDunn Restaurant Group. Petitioner invested in

WellDunn personally and through a fund he managed. On

September 1, 2006, Mr. Lipkind emailed Ms. Strachan at

Butterfield as follows: ‘‘We recommend WellDunn as an

investment for Boiler Riffle. WellDunn had hoped that BR

would invest $250,000, but I advised them it was unlikely

that the investment would exceed $150,000. Until they

indicate that is OK, it is unnecessary to proceed.’’

WellDunn subsequently acquiesced in the reduced invest-

ment amount and Mr. Lipkind sent a followup email to Ms.

Strachan: ‘‘Please proceed with BR investing $150,000 in this

deal.’’ Mr. Lipkind then informed his contact at WellDunn: ‘‘I

have * * * instructed Kimberly to proceed and to deal

directly with you. BR’s investment should now proceed

quickly and smoothly.’’ On September 13, 2006, Boiler Riffle

invested $150,000 in WellDunn.

JackNyfe, Inc. Petitioner invested in JackNyfe personally

and through a fund he managed and was on its board of

directors. On August 27, 2007, petitioner informed Mr.

Lipkind that he had structured a $1.2 million financing for

340 144 UNITED STATES TAX COURT REPORTS (324)

JackNyfe that would be effected in $200,000 tranches. He

told Mr. Lipkind that ‘‘the participants in these financings

will be br and others. * * * br should consider to be on point

for the first $400,000.’’ On September 6, 2007, Ms. Chang

sent Mr. Lipkind wire instructions that Boiler Riffle was to

use when making its initial $200,000 investment.

Mr. Lipkind forwarded these wire instructions to a staff

person at Butterfield but noted: ‘‘I am still reviewing certain

documents so that I have not given a green light rec-

ommendation yet.’’ On September 10, 2007, Mr. Lipkind com-

pleted his document review and emailed the Investment

Manager with instructions that ‘‘we proceed.’’ On September

18, 2007, Mr. Lipkind sent a followup email instructing the

Investment Manager to get the investment in JackNyfe done

‘‘ASAP’’ because ‘‘Jeff wanted to close this tranche as soon as

possible.’’ Boiler Riffle followed Mr. Lipkind’s instructions

and invested $200,000 in JackNyfe.

Lignup, Inc. Petitioner invested in Lignup personally and

through a fund he managed and was on its board of direc-

tors. On December 16, 2005, without approval from the

Investment Manager, petitioner committed to Lignup’s rep-

resentatives that Boiler Riffle would invest $300,000 in the

company. In late December 2005 Mr. Lipkind followed up

with a ‘‘recommendation’’ to the Investment Manager. Boiler

Riffle made the desired investment in the desired amount.

After instructing Boiler Riffle to invest in Lignup, peti-

tioner directed what actions Boiler Riffle should take in its

capacity as a Lignup shareholder. On May 19, 2006, Mr.

Lipkind relayed petitioner’s instructions that Boiler Riffle

consent to an amendment of Lignup’s certificate of incorpora-

tion, but that it reject participation in a subsequent financing

round. Mr. Lipkind told the Investment Manager to ‘‘[k]indly

process’’ petitioner’s instructions, and it did so.

As a shareholder in his own right, petitioner had the

opportunity to subscribe for pro-rata offerings of Lignup

shares, but on certain occasions he assigned his rights to

Boiler Riffle. On June 1, 2006, Ms. Chang told Mr. Lipkind

that ‘‘Jeff would like Boiler Riffle to take his pro rata of

74,743 shares of Lignup Series B stock.’’ Mr. Lipkind passed

this recommendation on to the Investment Manager, and

Boiler Riffle purchased the shares. Six months later, Mr.

Lipkind noted that ‘‘Jeff in all of his incarnations’’ would

(324) WEBBER v. COMMISSIONER 341

take his pro-rata share of a subsequent Lignup offering and

would assign part of his share to Boiler Riffle. Mr. Lipkind

said, ‘‘Full speed ahead on this one,’’ and a staff person from

Butterfield replied that this could ‘‘get done next week.’’

Techtribenetworks, Inc. Petitioner invested in Techtribe-

networks personally and through funds he managed and was

on its board of directors. In early 2006 he lent the company

$50,000 in exchange for a promissory note. Later that year

he sold that promissory note to Boiler Riffle for $50,000. In

early 2007 petitioner advanced an additional $200,000 to

Techtribenetworks. At petitioner’s request, Boiler Riffle then

lent Techtribenetworks $200,000 so that it could reimburse

petitioner for the funds he had invested several months pre-

viously.

The $200,000 note Boiler Riffle received from Techtribe-

networks was convertible into its series B stock. When a ‘‘B’’

financing round was announced later in 2007, Mr. Lipkind

instructed Boiler Riffle to invest $250,000. A staff person

from Butterfield asked whether Boiler Riffle should convert

the $200,000 note and add $50,000 in cash, or whether it

should invest $250,000 of new money on top of the note. Mr.

Lipkind directed that Boiler Riffle do the former, and it did.

Quintana Energy. On September 19, 2006, Mr. Lipkind

emailed a representative of Quintana Energy stating: ‘‘Our

entity, Boiler Riffle, a Bahamian corporation, would like to

invest an aggregate of $600,000. In addition, Jeff ’s IRA

would like to invest $200,000.’’ The following week, Mr.

Lipkind emailed that individual and others stating: ‘‘For very

important reasons, please do not, in any communication with

me concerning Quintana and Boiler Riffle, include Jeff

Webber as a copy.’’ On September 22, 2006, Boiler Riffle

made a substantial investment in Quintana Energy.

In January 2007 Quintana Energy issued a capital call to

its shareholders. On January 22, 2007, a Butterfield staff

person emailed Mr. Lipkind asking him to ‘‘confirm whether

Boiler Riffle is interested in the Quintana capital call for

Jan. 30th.’’ Mr. Lipkind responded, ‘‘ Yes. BR should honor

the capital call.’’ Boiler Riffle evidently did so.

Signature Investments RBN, Inc. In 2006 petitioner wanted

Boiler Riffle to invest $500,000 in Longboard Vineyards, LLC

(Longboard), a California winery. (Petitioner had previously

owned a winery himself.) He began negotiations directly with

342 144 UNITED STATES TAX COURT REPORTS (324)

Longboard without consulting the Investment Manager.

Because Longboard was a pass-through entity for Federal

income tax purposes, Mr. Lipkind advised petitioner that ‘‘it

is tax inefficient for it to be owned by Boiler Riffle.’’

On Mr. Lipkind’s advice, petitioner accordingly organized

Signature Investments RBN, Inc. (Signature), a domestic C

corporation of which he was the president and beneficial

owner, and capitalized it with $50,000 of his own funds. Peti-

tioner then made arrangements for Boiler Riffle to lend

$450,000 to Signature, with the plan that Signature would

then lend $500,000 to Longboard. Longboard was experi-

encing financial difficulty at this time, but petitioner assured

Mr. Lipkind that the loan from Signature ‘‘brings everything

in compliance’’ and ‘‘the bank is in the loop.’’

Petitioner’s personal attorneys reviewed the operating

agreement for Longboard, made comments on it, and worked

with Longboard’s representatives to draft the promissory

note. During these negotiations petitioner asked that the

note from Longboard to Signature act as security for the note

from Signature to Boiler Riffle. Longboard’s representative

told Mr. Lipkind that ‘‘this would probably be okay if Boiler

is owned or controlled by Webber.’’ Mr. Lipkind responded:

‘‘Boiler Riffle is 100% owned by two variable life insurance

policies * * * both of which are owned by a Trust of which

Jeff [Webber] is the Settlor and a discretionary beneficiary.’’

This explanation satisfied Longboard.

After getting Longboard’s signoff on the security agree-

ment, Mr. Lipkind instructed his associate to send the draft

promissory note to the Investment Manager ‘‘explaining the

transaction which is contemplated and ‘recommend’ and seek

their approval both for the loan and the form of the note.

Thereafter, please coordinate * * * to get this thing done.’’

On November 11, 2006, Boiler Riffle lent Signature $450,000

in exchange for its note, and on December 18, 2006, Signa-

ture lent Longboard $500,000 in exchange for its note.

Longboard’s note to Signature was subordinated to the

winery’s outstanding bank loans.

Boiler Riffle made two additional loans to Signature the

following year. In September 2007 Longboard required more

capital, and petitioner arranged a $100,000 loan from Boiler

Riffle through Signature to the winery. Ms. Chang asked Mr.

Lipkind ‘‘to request that Boiler Riffle proceed with its consid-

(324) WEBBER v. COMMISSIONER 343

eration of a $100,000 advance to Signature.’’ As soon as Mr.

Lipkind’s staff drafted the note and petitioner had signed it,

Ms. Chang requested that it ‘‘be presented to Boiler Riffle to

fund along with wire instructions.’’ Boiler Riffle promptly

complied.

Later that month Boiler Riffle lent Signature another

$80,000. As Ms. Chang explained to Mr. Lipkind, this loan

had nothing to do with the winery: ‘‘Jeff needs to borrow

from Boiler Riffle $80,000 as soon as possible for a deposit

on the Canada Maximas lodge, to be purchased through Wild

Goose Investments.’’ Boiler Riffle promptly complied.

Philtap Holdings, Ltd. In April 2006 petitioner wanted to

invest in Post Ranch Investments Limited Partnership (Post

Ranch), which was developing a luxury property in Big Sur,

California. Without prior approval from the Investment Man-

ager, petitioner began negotiations directly with Post Ranch’s

representatives. On April 4, 2006, Ms. Chang informed Mr.

Lipkind of the status: ‘‘Jeff wants to invest in an LP that will

be a part owner of a luxury resort in Big Sur * * *. We

thought Jeff could purchase 250K interest through his IRA,

but there are a number of hurdles. * * * Would you * * *

be able to make such an investment happen by early next

week?’’ She later followed up: ‘‘Since [Jeff] insists on making

this investment and it is not a wise use of onshore dollars

at this time given existing capital commitments and the

bank’s liquidity requirements, he is looking towards Boiler

Riffle.’’

After reviewing Post Ranch’s offering materials, Mr.

Lipkind advised petitioner against making this investment:

‘‘When one adds up the various and conflicting roles of the

promoters, one concludes there is virtually no way in law to

protect oneself adequately. Thus, you are giving your money

to these promoters and praying to God that they treat their

LPs fairly.’’ Although Mr. Lipkind warned that ‘‘a reasonably

prudent investor with no personal knowledge or relationship

with the promoters would take a pass,’’ petitioner decided to

invest anyway.

Mr. Lipkind then passed petitioner’s ‘‘recommendation’’ on

to the Investment Manager. He was told that Boiler Riffle

had $250,000 available but that Lighthouse preferred to have

the investment made by an entity other than Boiler Riffle.

Mr. Lipkind then instructed the Investment Manager to form

344 144 UNITED STATES TAX COURT REPORTS (324)

a new entity ‘‘ASAP’’ to complete the deal. The Investment

Manager followed Mr. Lipkind’s instruction and set up a new

company, Philtap Holdings, Ltd. (Philtap), which was owned

by Lighthouse. On April 19, 2006, Philtap invested $250,000

in Post Ranch as petitioner had instructed.

Webify Solutions. Petitioner and two other investors pro-

vided the initial seed money to Webify Solutions (Webify),

and petitioner served on its board of directors. In October

2002 Webify issued petitioner warrants to purchase 250,000

shares of its common stock for 5 cents per share. Petitioner

wanted Boiler Riffle to acquire these warrants from him, and

Mr. Lipkind conveyed this ‘‘recommendation’’ to the Invest-

ment Manager. On March 31, 2003, Boiler Riffle purchased

the warrants from petitioner for $3,085. He reported this sale

on a 2003 gift tax return, attaching an appraisal supporting

the $3,085 value. In 2004 Boiler Riffle exercised the warrants

and purchased 250,000 shares of Webify for $12,500.

Petitioner was aware that International Business

Machines (IBM) might be interested in Webify, and he rec-

ommended that Boiler Riffle make additional Webify invest-

ments. In a series of transactions during 2002–2004, Boiler

Riffle purchased $412,500 of Webify convertible debentures

and entered into an agreement to purchase series B pre-

ferred stock for an amount in excess of $400,000. In July

2006 IBM agreed to purchase Boiler Riffle’s aggregate invest-

ment in Webify for more than $3 million. Of this sum,

$2,731,087 was paid in 2006, and the remainder was put into

escrow to indemnify IBM against certain risks. An additional

$212,641 was paid to Boiler Riffle from the escrow in 2007,

and the remaining balance was apparently paid in 2008. As

shown on Butterfield’s financial records, Boiler Riffle’s aggre-

gate basis in its Webify investment was $838,575.

Milphworld, Inc. While acknowledging that Lighthouse

implemented ‘‘the vast bulk’’ of his instructions, petitioner

contends that it demurred to his recommendation to buy

shares of Milphworld. This was supposedly because Light-

house thought the company’s name had a derogatory con-

notation. There is no documentary evidence of such reluc-

tance, and Boiler Riffle in fact invested in Milphworld.

Petitioner initially suggested the Milphworld investment in

August 2006, but SEC restrictions apparently prevented

Boiler Riffle from acquiring its stock. To get around these

(324) WEBBER v. COMMISSIONER 345

restrictions, petitioner made loans to Milphworld and

arranged to have Boiler Riffle purchase its promissory notes

from him. A staff person from the Investment Manager

emailed Mr. Lipkind: ‘‘Kindly advise if we are to proceed

with the Milphworld investment in Boiler Riffle.’’ Mr.

Lipkind responded, ‘‘[Y]es.’’ In February 2007 Boiler Riffle

purchased from petitioner six Milphworld promissory notes

with an aggregate face value of $186,600.

Lehman Brothers Fund. Besides investing in startup

companies that petitioner ‘‘recommended,’’ Boiler Riffle

placed funds in money-market and other investment vehicles

offered by brokerage firms. Petitioner cites a Lehman

Brothers fund as another of his recommendations that the

Investment Manager supposedly rejected. There is no record

support for this contention; in fact, the record establishes the

opposite.

In May 2006, without prior approval from the Investment

Manager, Mr. Lipkind emailed a broker at Lehman Brothers

regarding that firm’s Co-Investment Partners fund (CIP),

inquiring how they might ‘‘splice this investment into an

appropriate place in Jeff ’s universe.’’ Two days later Mr.

Lipkind emailed Butterfield, stating: ‘‘We recommend Boiler

Riffle sign up for a $1,000,000 investment’’ in CIP. One week

later, Mr. Lipkind emailed petitioner to confirm that Boiler

Riffle had made this investment. Later in 2006 CIP issued a

capital call. On November 7, 2006, Mr. Lipkind emailed Ms.

Strachan: ‘‘This is a Jeff Webber/BR investment. I assume

you will take care of the capital call.’’ There is no evidence

that the Investment Manager failed to do so. 7

7 Petitioner cites only one other occasion on which the Investment Man-

ager allegedly declined to implement an investment recommendation that

petitioner had made, concerning a company called Safeview. The Invest-

ment Manager apparently pointed out to petitioner a ‘‘due diligence’’ issue

concerning this company—the State of California had issued a complaint

against one of its principals—but petitioner himself made the final decision

not to invest. On July 12, 2007, Mr. Lipkind accordingly emailed the In-

vestment Manager: ‘‘I want Safeview Investment to be ‘on hold’ until I rec-

ommend further.’’ Later in 2007 petitioner again suggested an investment

in Safeview. The record contains no evidence that the Investment Manager

opposed the investment at that time.

346 144 UNITED STATES TAX COURT REPORTS (324)

Mr. Lipkind’s Tax Advice

After explaining the mechanics of private placement life

insurance at their 1998 meeting, Mr. Lipkind noted that

there were certain Federal tax risks associated with this tax-

minimization strategy. He told petitioner that he had

reviewed pertinent IRS rulings, relevant judicial precedent,

and opinion letters from several U.S. law firms. These

opinion letters, issued by Powell Goldstein, Rogers & Wells,

and other firms, addressed the U.S. tax consequences of

Lighthouse private placement life insurance products gen-

erally. James A. Walker, Jr., the author of the Powell Gold-

stein opinions, later became outside general counsel for

Lighthouse. Mr. Lipkind had lengthy discussions with Mr.

Walker about the Lighthouse products and the tax risks

associated with them.

Three of these opinion letters specifically addressed the

‘‘investor control’’ doctrine. They stated that ‘‘investor control

is a factual issue and uncertain legal area’’ but concluded

that the Lighthouse policies as structured would comply with

U.S. tax laws and avoid application of this doctrine. Mr.

Lipkind told petitioner that he concurred in these opinions.

Acknowledging the risk that the IRS would challenge the

strategy, Mr. Lipkind concluded that the ‘‘investor control’’

doctrine would not apply because petitioner would not be in

‘‘constructive receipt’’ of the assets held in the separate

accounts. While assuring petitioner that the outside legal

opinions supported this conclusion, Mr. Lipkind did not pro-

vide a written opinion himself. Mr. Herbst approved the

Lighthouse transaction but did not provide a written opinion

either.

For their work preparing Trust documents and all other

work for petitioner, Mr. Lipkind and his colleagues charged

time at their normal hourly rates. Neither Mr. Lipkind nor

his firm received from petitioner any form of bonus or other

remuneration apart from hourly time charges. Neither Mr.

Lipkind nor his firm received compensation of any kind from

Lighthouse or the Investment Manager.

IRS Examination and Tax Court Proceedings

The IRS examined petitioner’s timely filed 2006 and 2007

Federal income tax returns. Initially, petitioner directed his

(324) WEBBER v. COMMISSIONER 347

staff to produce all documents and other information that the

IRS requested. He declined, however, to let the IRS interview

Ms. Chang, and respondent therefore issued an administra-

tive summons for her testimony. Petitioner’s attorneys moved

to quash this summons contending (among other things) that

IRS personnel had made false statements about petitioner to

third parties. IRS representatives eventually interviewed Ms.

Chang.

After the examination the IRS advanced a variety of theo-

ries to support its determination that petitioner was taxable

on the income that Boiler Riffle derived from the investments

it held for the Polices’ separate accounts. These theories

included the contention that the Lighthouse structure lacked

economic substance or was a ‘‘sham’’; that Boiler Riffle was

a ‘‘controlled foreign corporation’’ (CFC) whose income was

taxable to petitioner under section 951 through the Chalk

Hill Trust; and that petitioner should be deemed to own the

assets in the separate accounts under the ‘‘investor control’’

doctrine. The parties have stipulated that Boiler Riffle had

the following items of book income and expense during 2006

and 2007:

Item 2006 2007

Realized gain $1,913,237 $28,379

Unrealized gain -0- 82,562

Unrealized loss (21,555) -0-

Dividends/interest 78,595 214,799

Loan interest -0- 210,741

Miscellaneous/other income 40 212,641

Total income 1,970,317 749,122

Policy mortality/admin. charges 130,000 161,500

Bank service charges 2,172 6,157

Butterfield bank fees 8,500 -0-

Administration fees -0- 20,500

Government fees and taxes 350 1,871

Miscellaneous/other expense 1,163 454

Total expense 142,185 190,482

Net income per books 1,828,132 558,640

Boiler Riffle had total assets of $7.2 million and $12.3 mil-

lion at the end of 2006 and 2007, respectively. The separate

accounts appear to have held other assets, owned by Philtap

or other special-purpose entities, but the record does not

348 144 UNITED STATES TAX COURT REPORTS (324)

reveal the amounts of those other assets. The IRS issued

petitioner a notice of deficiency on March 22, 2011. He timely

sought review in this Court.

OPINION

I. Burden of Proof

When contesting the determinations set forth in a notice of

deficiency, the taxpayer generally bears the burden of proof.

See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933). If a taxpayer introduces ‘‘credible evidence with

respect to any factual issue,’’ the burden of proof on that

issue will shift to the Commissioner if certain conditions are

met. Sec. 7491(a)(1). ‘‘Credible evidence is the quality of evi-

dence which, after critical analysis, the court would find

sufficient upon which to base a decision on the issue if no

contrary evidence were submitted.’’ Higbee v. Commissioner,

116 T.C. 438, 442 (2001) (quoting H.R. Conf. Rept. No. 105–

599, at 240–241 (1998), 1998–3 C.B. 747, 994–995). To

qualify for a shift in the burden of proof, the taxpayer must

(among other things) have ‘‘cooperated with reasonable

requests by the Secretary for witnesses, information, docu-

ments, meetings, and interviews.’’ Sec. 7491(a)(2)(B). The

taxpayer bears the burden of proving that all of these

requirements have been satisfied. See Rolfs v. Commissioner,

135 T.C. 471, 483 (2010), aff ’d, 668 F.3d 888 (7th Cir. 2012).

As explained infra p. 363, petitioner did not introduce

‘‘credible evidence’’ on the central factual issues in this case.

Nor did he fully cooperate with respondent’s reasonable dis-

covery requests. He rejected respondent’s request to inter-

view Ms. Chang, forcing the IRS to issue a summons; when

the summons was issued, petitioner’s attorneys moved to

quash it. An interview with Ms. Chang could reasonably

have led, and did lead, to relevant evidence. See Polone v.

Commissioner, T.C. Memo. 2003–339, aff ’d, 479 F.3d 1019

(9th Cir. 2007). By seeking to block respondent’s access to

Ms. Chang, petitioner failed to ‘‘cooperate[ ] with reasonable

requests by the Secretary for witnesses, * * *, meetings, and

interviews.’’ See sec. 7491(a)(2)(B); see Rolfs, 135 T.C. at 483.

The burden of proof thus remains on him. 8

8 In any event, whether the burden has shifted matters only in the case

(324) WEBBER v. COMMISSIONER 349

II. Tax Treatment of Life Insurance and Annuities

The Policies in this case are a form of private-placement

variable life insurance. Private-placement insurance is sold

exclusively through a private-placement offering. These poli-

cies are marketed chiefly to high-net-worth individuals who

qualify as accredited investors under the Securities Act of

1933. See 15 U.S.C. sec. 77b(a)(15) (2006); 17 C.F.R. sec.

230.501(a) (2006).

Variable life insurance is a form of cash value insurance.

Under traditional cash value insurance, the insured typically

pays a level premium during life and the beneficiary receives

a fixed death benefit. Under a variable policy, both the pre-

miums and the death benefit may fluctuate. The assets held

for the benefit of the policy are placed in a ‘‘segregated asset

account,’’ that is, an account ‘‘segregated from the general

asset accounts of the [insurance] company.’’ Sec. 817(d)(1).

The policy does not earn a fixed or predictable rate of return

but a return dictated by the actual performance of the invest-

ments in this separate account.

If the assets in the separate account perform well, the pre-

miums required to keep the policy in force may be reduced

as the account buildup lessens the insurer’s mortality risk. If

those assets perform extremely well, as was true here, the

value of the policy may substantially exceed the minimum

death benefit. Upon the insured’s death, the beneficiary

receives the greater of the minimum death benefit or the

value of the separate account.

Life insurance and annuities enjoy favorable tax treat-

ment. Under section 72, earnings accruing to cash value and

annuity policies—often referred to as the ‘‘inside buildup’’—

are not currently taxable to the policyholder (and generally

are not taxable to the insurance company). The cash value of

the policy thus grows more rapidly than that of a taxable

of an evidentiary tie. See Polack v. Commissioner, 366 F.3d 608, 613 (8th

Cir. 2004), aff ’g T.C. Memo. 2002–145. In this case, we discerned no evi-

dentiary tie on any material issue of fact. See Payne v. Commissioner, T.C.

Memo. 2003–90, 85 T.C.M. (CCH) 1073, 1077 (‘‘Although assignment of the

burden of proof is potentially relevant at the outset of any case, where

* * * the Court finds that the undisputed facts favor one of the parties,

the case is not determined on the basis of which party bore the burden of

proof, and the assignment of burden of proof becomes irrelevant.’’).

350 144 UNITED STATES TAX COURT REPORTS (324)

investment portfolio. The policyholder may access this value,

often on a tax-free basis, by withdrawals and policy loans

during the insured’s lifetime. See sec. 72(e). If the contract is

held until the insured’s death, the insurance proceeds gen-

erally are excluded from the beneficiary’s income under sec-

tion 101(a). With proper structuring, the death benefit will

also be excluded from the estate tax. See sec. 2042. 9

A variable contract based on a segregated asset account

‘‘shall not be treated as an annuity, endowment, or life insur-

ance contract for any period * * * for which the investments

made by such account are not, in accordance with regulations

prescribed by the Secretary, adequately diversified.’’ Sec.

817(h)(1). Under these regulations, a separate account is

‘‘adequately diversified’’ if no more than 55% of the total

value is represented by any one investment; no more than

70% of the total value is represented by any two invest-

ments; no more than 80% of the total value is represented by

any three investments; and no more than 90% of the total

value is represented by any four investments. Sec. 1.817–

5(b)(1), Income Tax Regs. The separate accounts underlying

the Policies invested in dozens of startup companies in which

petitioner was interested. Respondent does not contend that

the separate accounts fail the section 817(h) asset-diversifica-

tion requirements.

III. The ‘‘Investor Control’’ Doctrine

A. Background

The preceding discussion assumes that the insurance com-

pany owns the investment assets in the separate account.

The ‘‘investor control’’ doctrine posits that, if the policy-

holder’s incidents of ownership over those assets become

sufficiently capacious and comprehensive, he rather than the

insurance company will be deemed to be the true ‘‘owner’’ of

those assets for Federal income tax purposes. In that event,

a major benefit of the insurance/annuity structure—the

deferral or elimination of tax on the ‘‘inside buildup’’—will be

9 Under section 7702(a), a contract is considered to be ‘‘life insurance’’ for

Federal income tax purposes only if it meets certain tests. See infra pp.

371–373. Respondent does not contend that the Policies fail any of the sec-

tion 7702(a) requirements.

(324) WEBBER v. COMMISSIONER 351

lost, and the investor will be taxed currently on investment

income as it is realized.

The ‘‘investor control’’ doctrine has its roots in Supreme

Court jurisprudence dating to the early days of the Federal

income tax. Section 1 imposes a tax on the taxable income

‘‘of ’’ every individual. Construing the predecessor provision of

the Revenue Act of 1926, ch. 27, 44 Stat. 9, the Court stated

in Poe v. Seaborn, 282 U.S. 101, 109 (1930): ‘‘The use of the

word ‘of ’ denotes ownership.’’ The principle thus became

early established that, ‘‘in the general application of the rev-

enue acts, the tax liability attaches to ownership.’’ Blair v.

Commissioner, 300 U.S. 5, 12 (1937). And ‘‘ownership’’ for

Federal tax purposes, as the Court stated in Griffiths v.

Helvering, 308 U.S. 355, 357–358 (1939), means ownership in

a real, substantial sense:

We cannot too often reiterate that ‘‘taxation is not so much concerned

with the refinements of title as it is with actual command over the prop-

erty taxed—the actual benefit for which the tax is paid.’’ Corliss v.

Bowers, 281 U.S. 376, 378 (1930). And it makes no difference that such

‘‘command’’ may be exercised through specific retention of legal title or

the creation of a new equitable but controlled interest, or the mainte-

nance of effective benefit through the interposition of a subservient

agency. * * *

In Corliss, 281 U.S. at 377, the taxpayer transferred assets

to a trust, directing the trustee to pay the income to his wife

for life, but reserving the power to modify or revoke the trust

at any time. In an opinion by Justice Holmes, the Court held

the taxpayer taxable on the trust income even though he did

not receive the income or hold title to the assets that gen-

erated it. The Court reasoned: ‘‘The income that is subject to

a man’s unfettered command and that he is free to enjoy at

his own opinion may be taxed to him as his income, whether

he sees fit to enjoy it or not.’’ Id. at 378.

In Helvering v. Clifford, 309 U.S. 331 (1940), the taxpayer

contributed securities to a trust, directing himself as trustee

to pay the income to his wife for a five-year period. At the

end of five years, the trust was to terminate and the corpus

would revert to the taxpayer. The trust instrument author-

ized the taxpayer to vote the shares held by the trust and to

decide what securities would be bought or sold. The trust

instrument also afforded him ‘‘absolute discretion’’ to deter-

352 144 UNITED STATES TAX COURT REPORTS (324)

mine whether income should be reinvested rather than paid

out.

Speaking through Justice Douglas, the Court noted that

the taxpayer’s control over the securities remained essen-

tially the same before and after the trust was created. ‘‘So far

as * * * [the taxpayer’s] dominion and control were con-

cerned,’’ the Court reasoned, ‘‘it seems clear that the trust

did not effect any substantial change.’’ Id. at 335. The Court

was not concerned that the taxpayer could not ‘‘make a gift

of the corpus to others’’ or ‘‘make loans to himself ’’ for five

years. This ‘‘dilution in his control,’’ in the Court’s view, was

‘‘insignificant and immaterial, since control over investment

remained.’’ Ibid. The Court’s conclusion that the taxpayer

effectively retained the attributes of an owner, and should be

treated as the owner of the trust assets for Federal tax pur-

poses, was based on ‘‘all considerations and circumstances’’ in

the case. Id. at 336. 10

Drawing on the principles of these and similar cases, the

IRS developed the ‘‘investor control’’ doctrine in a series of

revenue rulings beginning in 1977. On the basis of 38 years

of consistent rulings in this area, respondent urges that his

position deserves deference under Skidmore v. Swift & Co.,

323 U.S. 134, 140 (1944). 11 We are not bound by revenue

rulings; under Skidmore, the weight we afford them depends

10 Appellate decisions following these cases are well illustrated

by N. Trust Co. v. United States, 193 F.2d 127 (7th Cir. 1951). The tax-

payer purchased shares of stock, which were placed in escrow with a trust

company until he made payment in full. The taxpayer directed how to vote

the escrowed shares, and any dividends paid reduced the balance due the

seller. The Court of Appeals for the Seventh Circuit held that the taxpayer

was in substance the owner of the shares, even though he was not the title

owner, so that the dividends paid on the escrowed stock were taxable to

him. Id. at 131.

11 In United States v. Mead Corp., 533 U.S. 218 (2001), the Supreme

Court recognized that there are various types of agency pronouncements

that may be entitled to different levels of deference, and that Skidmore

deference, the lowest level of deference, has continuing vitality under

Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837

(1984). See Mead Corp., 533 U.S. at 234 (‘‘Chevron did nothing to eliminate

Skidmore’s holding that an agency’s interpretation may merit some def-

erence whatever its form, given the ‘specialized experience and broader in-

vestigations and information’ available to the agency’’ (quoting Skidmore,

323 U.S. at 139)); ADVO, Inc. v. Commissioner, 141 T.C. 298, 322 n.18

(2013).

(324) WEBBER v. COMMISSIONER 353

upon their persuasiveness and the consistency of the

Commissioner’s position over time. See PSB Holdings, Inc. v.

Commissioner, 129 T.C. 131, 142 (2007) (‘‘[W]e evaluate the

revenue ruling under the less deferential standard enun-

ciated in Skidmore v. Swift & Co.’’). We thus consider the

rulings at hand under the ‘‘power to persuade’’ standard

enunciated in Skidmore. 12

B. Evolution of the Doctrine

In Revenue Ruling 77–85, 1977–1 C.B. 12, a taxpayer pur-

chased an investment annuity contract from an insurance

company. The initial ‘‘premium,’’ less various charges, was

deposited into a separate account held by a custodian. The

custodian invested the funds in accordance with the tax-

payer’s directions but only in assets from an approved list. At

a certain date in the future—the ‘‘annuity starting date’’—

the assets in the separate account would fund an annuity,

which would make monthly payments to the taxpayer based

on the performance of the underlying assets.

Prior to the annuity starting date, the policyholder exer-

cised significant control over the assets in the separate

account. By issuing directions to the custodian, the taxpayer

had de facto power ‘‘to sell, purchase or exchange securities’’;

to ‘‘invest and reinvest principal and income’’; to vote the

shares; and to exercise ‘‘any other right or option relating to

[the] assets.’’ Id., 1977–1 C.B. at 13. The taxpayer could also

make ‘‘a full or partial surrender of the policy’’ and receive

cash equal to the value of the account less applicable

charges. After the annuity starting date, the taxpayer contin-

ued to exercise investment control over the account, but he

could no longer surrender the policy.

The policy in Revenue Ruling 77–85 was meant to qualify

as a ‘‘variable contract’’ based on a ‘‘segregated asset

account’’ within the meaning of section 817(d) (then section

12 Appeal of the instant case, absent stipulation to the contrary, would

lie to the Court of Appeals for Ninth Circuit. See sec. 7482(b)(1)(A). That

Court has not decided whether revenue rulings are entitled to Chevron or

Skidmore deference. See Taproot Admin. Servs., Inc. v. Commissioner, 679

F.3d 1109, 1115 n.14 (9th Cir. 2012), aff ’g 133 T.C. 202 (2009); Bluetooth

SIG, Inc. v. United States, 611 F.3d 617, 622 (9th Cir. 2010). Because re-

spondent urges only Skidmore deference, we need not decide how the

Ninth Circuit would resolve this question.

354 144 UNITED STATES TAX COURT REPORTS (324)

801(g)). But for this treatment to be available, the IRS noted,

‘‘the insurance company must be the owner of the assets in

the segregated accounts.’’ Id., 1977–1 C.B. at 14. The IRS

concluded that the taxpayer possessed such significant

incidents of ownership over those assets that he should be

considered their owner for Federal tax purposes. The fact

that the assets were titled in the custodian’s name did not

alter this analysis because, in the Commissioner’s view,

‘‘[t]he setting aside of the assets in the custodial account

* * * [was] basically a pledge arrangement.’’ Id. at 14–15.

The IRS noted:

When property is held in escrow or trust and the income therefrom bene-

fits, or is to be used to satisfy the legal obligations of, * * * [another]

person * * * , such person is deemed to be the owner thereof, and such

income is includible in that person’s gross income, even though that per-

son may never actually receive it.

On the basis of this analysis, the IRS concluded in Rev-

enue Ruling 77–85 that ‘‘the assets in the custodial account

are owned by the individual policyholder, not the insurance

company.’’ Id., 1977–1 C.B. at 15. Therefore, ‘‘any interest,

dividends and other income received by the custodian on

securities and other assets held in the custodial accounts are

includible in the gross income of the policyholder under sec-

tion 61 * * * for the year in which they are received by the

custodian.’’ Id.

The IRS reached the same conclusion three years later

where an annuity contract was supported by a separate

account held by a savings and loan association. Rev. Rul. 80–

274, 1980–2 C.B. 27. The funds in the separate account were

‘‘invested in a certificate of deposit for a term designated by

the depositor,’’ who had the right to ‘‘withdraw all or a por-

tion of the cash surrender value of the contract at any time

prior to the annuity starting date.’’ Id., 1980–2 C.B. at 28.

The IRS concluded that the policyholder/depositor should be

considered the owner of the assets because he possessed

‘‘substantial incidents of ownership in an account established

by the insurance company at * * * [his] direction.’’ Ibid.

Subsequent rulings address situations in which separate

accounts supporting variable contracts invest, not in securi-

ties selected directly by the policyholder, but in shares of

mutual funds with their own investment manager. In Rev-

(324) WEBBER v. COMMISSIONER 355

enue Ruling 81–225, 1981–2 C.B. 13, the IRS considered four

scenarios in which the mutual fund shares were available for

purchase by the general public wholly apart from the annuity

arrangement. The policyholder had the right initially to des-

ignate the fund in which the separate account would invest,

and the right periodically to reallocate his investment among

the specified funds.

In these four scenarios, the IRS concluded that the insur-

ance company was ‘‘little more than a conduit between the

policyholders and their mutual fund shares.’’ Id., 1981–2 C.B.

at 14. Because the ‘‘policyholder’s position in each of these

situations [wa]s substantially identical to what his or her

position would have been had the mutual fund shares been

purchased directly,’’ the IRS concluded that the policyholder

had sufficient investment control to be considered the shares’

owner for Federal tax purposes. Id. The IRS reached the

opposite conclusion in the fifth scenario, where investments

in the mutual fund shares were controlled by the insurance

company and the fund’s sole function was ‘‘to provide an

investment vehicle to allow * * * [the insurance company] to

meet its obligations under its annuity contracts.’’ Id. Because

these shares were not available to the general public but

were ‘‘available only through the purchase of an annuity con-

tract,’’ id. at 13, the IRS considered the insurance company

to be the true owner of these assets. 13

In Revenue Ruling 82–54, 1982–1 C.B. 11, the segregated

account underlying the variable policies comprised three

funds that invested respectively in common stocks, bonds,

and money-market instruments. The insurance company was

the investment manager of these funds, and the funds were

not available for sale to the general public. Policyholders had

the right to allocate or reallocate their investments among

the three funds.

13 The IRS likewise treated the insurance company as the owner where

the separate account invested in shares of mutual funds that were ‘‘closed’’

to the general public. See Rev. Rul. 82–55, 1982–1 C.B. 12, 13. On the

other hand, the IRS treated the policyholder as the owner of a separate

account supporting a variable life insurance policy where the account in-

vested in hedge funds that were available for sale to the general public,

albeit only to ‘‘qualified investors.’’ See Rev. Rul. 2003–92, 2003–2 C.B.

350.

356 144 UNITED STATES TAX COURT REPORTS (324)

‘‘[I]n order for the insurance company to be considered the

owner of the mutual fund shares,’’ the IRS reasoned, ‘‘control

over individual investment decisions must not be in the

hands of the policyholders.’’ Id., 1982–1 C.B. at 12. Under

this standard, the IRS concluded that the insurance company

owned the assets in the separate account:

[T]he ability to choose among broad, general investment strategies such

as stocks, bonds or money market instruments, either at the time of the

initial purchase or subsequent thereto, does not constitute sufficient con-

trol over individual investment decisions so as to cause ownership of the

private mutual fund shares to be attributable to the policyholders.

In Revenue Ruling 2003–91, 2003–2 C.B. 347, a life insur-

ance company offered variable life insurance and annuity

contracts. The contracts were funded by assets held in a

separate account divided into 12 subaccounts. Each sub-

account followed a specific investment strategy keyed to

market sector or type of security (e.g., money-market, large

company growth, telecommunications, international growth,

or emerging markets). None of these funds was available for

sale to the general public, and all of them met the asset

diversification requirements of section 1.817–5(b)(1), Income

Tax Regs.

The policyholder had the right to change the allocation of

his premiums among subaccounts at any time and transfer

funds among subaccounts. All investment decisions regarding

the subaccounts, however, were made by an independent

investment manager engaged by the insurance company. The

IRS stated its assumptions that: (1) the policyholder ‘‘cannot

select or recommend particular investments’’ for the sub-

accounts; (2) the policyholder ‘‘cannot communicate directly

or indirectly with any investment officer * * * regarding the

selection * * * of any specific investment or group of invest-

ments’’; and (3) ‘‘[t]here is no arrangement, plan, contract, or

agreement’’ between the policyholder and the insurance com-

pany or investment manager regarding ‘‘the investment

strategy of any [s]ub-account, or the assets to be held by a

particular sub-account.’’ Rev. Rul. 2003–91, 2003–2 C.B. at

348.

In short, although the policyholder had the right to allo-

cate funds among the subaccounts, all investment decisions

regarding the particular securities to be held in each sub-

(324) WEBBER v. COMMISSIONER 357

account were made by the insurance company or its invest-

ment manager ‘‘in their sole and absolute discretion.’’ Id.

Under these circumstances, the IRS concluded that the

insurance company would be treated as owning the assets in

the separate accounts for Federal income tax purposes. The

IRS indicated that this ruling was intended to ‘‘present[ ] a

‘safe harbor’ from which taxpayers may operate.’’ Id., 2003–

2 C.B. at 347.

C. Deference

The ‘‘investor control’’ doctrine posits that, if a policyholder

has sufficient ‘‘incidents of ownership’’ over the assets in a

separate account underlying a variable life insurance or

annuity policy, the policyholder rather than the insurance

company will be considered the owner of those assets for

Federal income tax purposes. The critical ‘‘incident of owner-

ship’’ that emerges from these rulings is the power to decide

what specific investments will be held in the account. As the

Commissioner stated in Revenue Ruling 82–54, 1982–1 C.B.

at 12, ‘‘control over individual investment decisions must not

be in the hands of the policyholders.’’ Other ‘‘incidents of

ownership’’ emerging from these rulings include the powers

to vote securities in the separate account; to exercise other

rights or options relative to these investments; to extract

money from the account by withdrawal or otherwise; and to

derive, in other ways, what the Supreme Court has termed

‘‘effective benefit’’ from the underlying assets. Griffiths, 308

U.S. at 358.

We believe that the IRS rulings enunciating these prin-

ciples deserve deference. The rulings are grounded in long-

settled jurisprudence holding that formalities of title must

yield to a practical assessment of whether ‘‘control over

investment remained,’’ Clifford, 309 U.S. at 335, and that

ownership for tax purposes follows ‘‘actual command over the

property taxed.’’ N. Trust Co. v. United States, 193 F.2d 127,

129 (7th Cir. 1951) (quoting Griffiths, 308 U.S. at 355–358).

These revenue rulings span a 38-year period and reflect a

consistent and well-considered process of development. After

stating bedrock principles in Revenue Ruling 77–85, the IRS

examined more complex scenarios corresponding to newer

products being offered in the financial markets. The Commis-

sioner’s consideration of these scenarios appears nuanced

358 144 UNITED STATES TAX COURT REPORTS (324)

and reasonable, resolving particular fact patterns favorably

or unfavorably to taxpayers in light of the bedrock principles

initially set forth. Cf. Sewards v. Commissioner, 785 F.3d

1331, 1335 (9th Cir. 2015) (affording ‘‘substantial deference’’

to interpretation of regulations ‘‘adopted by the IRS in Rev-

enue Rulings issued over the last 40 years’’), aff ’g 138 T.C.

320 (2012).

The ‘‘investor control’’ doctrine reflects a ‘‘body of experi-

ence and informed judgment’’ that the IRS has developed

over four decades. Skidmore, 323 U.S. at 140; Fed. Express

Corp. v. Holowecki, 552 U.S. 389, 299 (2008); see Kasten v.

Saint-Gobain Performance Plastics Corp., 563 U.S. 1, 15-16

(2011) (‘‘The length of time the agencies have held * * *

[these views] suggests that they reflect careful

consideration[.]’’). As evidenced by the absence of litigation in

this area during the past 30 years, these rulings have engen-

dered stability and long-term reliance through the private

ruling process and otherwise. See Taproot Admin. Servs., Inc.

v. Commissioner, 133 T.C. 202, 212 (2009) (history of con-

sistent private letter rulings based on published ruling favors

a finding of deference under Skidmore), aff ’d, 679 F.3d 1109

(9th Cir. 2012). 14 The relative expertise of the IRS in admin-

istering a complex statutory scheme and its longstanding,

unchanging policy regarding these issues amply justify def-

erence to the IRS under Skidmore. See Alaska Dep’t of Envtl.

Conservation v. EPA, 540 U.S. 461, 488–492 (2004).

Our decision to afford Skidmore deference to these rulings

is supported by the unanimous opinion of the U.S. Court of

Appeals for the Eighth Circuit in Christoffersen v. United

States, 749 F.2d 513 (8th Cir. 1985), rev’g 578 F. Supp. 398

(N.D. Iowa 1984). The taxpayers there purchased from a life

insurance company a variable annuity policy supported by a

separate account. The initial ‘‘premium,’’ less various

charges, was invested at the taxpayers’ direction in a mutual

fund. Prior to the annuity starting date, the taxpayers could

withdraw all or part of their investment on seven days’

notice, but they were limited to withdrawing cash.

14 These revenue rulings have formed the basis for numerous private let-

ter rulings. See, e.g., Priv. Ltr. Rul. 201105012 (Feb. 4, 2011); Priv. Ltr.

Rul. 200420017 (May 14, 2004); Priv. Ltr. Rul. 9433030 (Aug. 19, 1994);

Priv. Ltr. Rul. 8820044 (May 20, 1988).

(324) WEBBER v. COMMISSIONER 359

Finding that the taxpayers had ‘‘surrendered few of the

rights of ownership or control over the assets of the sub-

account,’’ the Court of Appeals for the Eighth Circuit held

that they were ‘‘the beneficial owners of the investment

funds’’ even though the insurance company ‘‘maintain[ed] the

shares in its name.’’ Christoffersen, 749 F.2d at 515 (citing

Clifford, 309 U.S. 331). In the court’s view, ‘‘[t]he payment of

annuity premiums, management fees and the limitation of

withdrawals to cash, rather than shares, d[id] not reflect a

lack of ownership or control.’’ Id. at 515–516. Quoting

Corliss, 281 U.S. at 378, the court reasoned that ‘‘taxation is

not so much concerned with the refinements of title as it is

with the actual command over the property taxed.’’

Christoffersen, 749 F.2d at 515. And citing Griffiths, 308 U.S.

at 358, the court found it immaterial that the taxpayers’

command over these assets was exercised by means other

than the ‘‘specific retention of legal title.’’ Christoffersen, 749

F.2d at 515. The court accordingly ruled that the

‘‘Christoffersens, and not * * * [the insurance company],

own the assets of the sub-account.’’ Id. at 516.

The only other case that has considered these matters is

the District Court opinion in Inv. Annuity, Inc. v.

Blumenthal, 442 F. Supp. 681 (D.D.C. 1977), rev’d, 609 F.2d

1 (D.C. Cir. 1979). The District Court held Revenue Ruling

77–85 invalid, but its opinion has no precedential force. It

was reversed because, under the Anti-Injunction Act and the

tax exception to the Declaratory Judgment Act, the District

Court lacked jurisdiction to consider the case ab initio. See

Inv. Annuity, Inc., 609 F.2d at 10 (remanding with instruc-

tions ‘‘to dismiss the complaint for lack of jurisdiction’’).

In any event, we agree with the Eighth Circuit’s assess-

ment in Christoffersen, 749 F.2d at 514: ‘‘[W]e cannot endorse

the approach of the district court in the Investment Annuity

case.’’ The District Court, ruling in 1977, was troubled by

what it regarded as the novelty of the position the IRS enun-

ciated in Revenue Ruling 77–85. As of today, the Commis-

sioner has enunciated that position consistently for 38 years.

The District Court appeared to believe that Revenue Ruling

77–85 had been undermined by an IRS private letter ruling,

erroneously issued a few months later, that was inconsistent

with the published ruling. See Priv. Ltr. Rul. 7747111 (Aug.

29, 1977). This private letter ruling was revoked as soon as

360 144 UNITED STATES TAX COURT REPORTS (324)

this error came to the Commissioner’s attention. See Priv.

Ltr. Rul. 7805020 (Sept. 13, 1977). For these reasons, and

because the District Court gave insufficient weight to rel-

evant Supreme Court precedent, we find its opinion

unpersuasive.

In sum, we conclude that the IRS revenue rulings enun-

ciating the ‘‘investor control’’ doctrine are entitled to weight

under Skidmore. Over four decades, they have reasonably

applied well-settled principles of Supreme Court jurispru-

dence to a complex area of taxation. In any event, the legal

framework urged by respondent is consistent with prior case

law, and we would adopt it regardless of deference.

D. Ownership of the Separate Account Assets

The investments in the separate accounts were titled to

the 1999 Fund, Boiler Riffle, Philtap, and other special-pur-

pose entities owned by Lighthouse but pledged to the Poli-

cies. Lighthouse, rather than petitioner, thus nominally

owned these assets during the tax years in issue. Respondent

contends that petitioner, under the ‘‘investor control’’ doc-

trine, should nevertheless be treated as their owner for Fed-

eral income tax purposes. We agree.

As drafted, the Policies allowed the policyholder to submit

only ‘‘general investment objectives and guidelines’’ to the

Investment Manager, who was supposed to build a portfolio

within those parameters by selecting individual securities for

purchase or sale. We need not decide whether Lighthouse

would be considered the owner of the separate account assets

if the parties to the arrangement had meticulously complied

with these strictures. They did not.

In determining whether petitioner owned the assets under-

lying the Policies, we consider whether he retained signifi-

cant incidents of ownership. In making this assessment,

‘‘[t]echnical considerations, niceties of the law * * *, or the

legal paraphernalia which inventive genius may construct as

a refuge from surtaxes should not obscure the basic issue.’’

Clifford, 309 U.S. at 334. We focus instead on the actual

level of ‘‘control over investment’’ that petitioner exercised.

Id. at 335.

The determination whether a taxpayer has retained signifi-

cant incidents of ownership over assets is made on a case-by-

case basis, taking into account all the relevant facts and cir-

(324) WEBBER v. COMMISSIONER 361

cumstances. See Clifford, 309 U.S. at 336. The core ‘‘incident

of ownership’’ is the power to select investment assets by

directing the purchase, sale, and exchange of particular secu-

rities. Other ‘‘incidents of ownership’’ include the power to

vote securities and exercise other rights relative to those

investments; the power to extract money from the account by

withdrawal or other means; and the power to derive, in other

ways, what the Supreme Court has termed ‘‘effective benefit’’

from the underlying assets. Griffiths, 308 U.S. at 358. Peti-

tioner enjoyed all of these powers.

1. Power To Direct Investments. Petitioner enjoyed the

unfettered ability to select investments for the separate

accounts by directing the Investment Manager to buy, sell,

and exchange securities and other assets in which petitioner

wished to invest. Although the Policies purported to give the

Investment Manager complete discretion to select invest-

ments, this restriction meant nothing in practice. We assess

the true nature of the agreement by looking to its substance,

as evidenced by the parties’ actual conduct. See Gregory v.

Helvering, 293 U.S. 465, 469 (1935); Sandvall v. Commis-

sioner, 898 F.2d 455, 458 (5th Cir. 1990), aff ’g T.C. Memo.

1989–189 and T.C. Memo. 1989–56. In reality, the Invest-

ment Manager selected no investments but acted merely as

a rubber stamp for petitioner’s ‘‘recommendations,’’ which we

find to have been equivalent to directives.

It is no coincidence that virtually every security Boiler

Riffle held (apart from certain brokerage funds) was issued

by a startup company in which petitioner had a personal

financial interest. Petitioner sat on the boards of most of

these companies, and he invested in each of them through

his personal accounts, through IRAs, and through private-

equity funds that he managed. He admitted that Boiler Riffle

could not have obtained access to any of these investment

opportunities except through him.

It is likewise no coincidence that every investment Boiler

Riffle made was an investment that petitioner had ‘‘rec-

ommended.’’ The Investment Manager took no independent

initiative and considered no investments other than those

petitioner proposed. The record overwhelmingly dem-

onstrates that petitioner directed what investments Boiler

Riffle should make, when Boiler Riffle should make them,

and how much Boiler Riffle should invest.

362 144 UNITED STATES TAX COURT REPORTS (324)

Although nearly 100% of the investments in the separate

accounts consisted of nonpublicly traded securities, the

record contains no documentation to establish that Light-

house or the Investment Manager engaged in independent

research or meaningful due diligence with respect to any of

petitioner’s investment directives. Lighthouse exercised

barebones ‘‘know your customer’’ review and occasionally

requested organizational documents. But these activities

were undertaken to safeguard Lighthouse’s reputation, not to

vet petitioner’s ‘‘recommendations’’ from an investment

standpoint.

It was not uncommon for petitioner to negotiate a deal

directly with a third party, then ‘‘recommend’’ that the

Investment Manager implement the deal he had already

negotiated. Through directives to the Investment Manager,

petitioner invested in startup companies in which he was

interested; lent money to these ventures; sold securities from

his personal account to the Policies’ separate accounts; pur-

chased securities in later rounds of financing; and assigned

to Boiler Riffle rights to purchase shares that he would

otherwise have purchased himself. Without fail, the Invest-

ment Manager placed its seal of approval on each trans-

action.

Two deals that petitioner negotiated himself exemplify the

parties’ modus operandi. Without informing the Investment

Manager, petitioner began negotiations to acquire an interest

in Longboard Vineyards, a financially troubled winery, with

a $500,000 loan. On Mr. Lipkind’s advice, petitioner orga-

nized Signature, a domestic C corporation, as the vehicle for

making this loan. Mr. Lipkind reviewed the operating agree-

ment for Longboard and worked with it to draft the promis-

sory note and accompanying security agreement. Only after

the paperwork was completed did Mr. Lipkind notify the

Investment Manager, with instructions to ‘‘get this thing

done.’’ Within days Boiler Riffle lent Signature $450,000,

which enabled Signature to lend Longboard $500,000 as peti-

tioner wished.

There is no evidence that the Investment Manager per-

formed any due diligence for this transaction. Petitioner was

thus able to negotiate a complex deal with a financially trou-

bled winery, extract money from Boiler Riffle for the benefit

of an entity he owned, and have the security for the resulting

(324) WEBBER v. COMMISSIONER 363

promissory note be subordinated to a bank loan that

Longboard was having trouble paying, all without the Invest-

ment Manager’s raising a whisper. As if that were not

enough, petitioner proceeded to extract another $180,000

from Boiler Riffle via loans to Signature. The first $100,000

covered a second cash infusion for the winery. An email from

Ms. Chang explains the other loan: ‘‘Jeff needs to borrow

from Boiler Riffle $80,000 as soon as possible for a deposit

on the Canada Maximas lodge, to be purchased through Wild

Goose Investments.’’

Petitioner also wanted to acquire an interest in Post

Ranch, which was developing a luxury property in Big Sur.

He initially planned to make a $250,000 investment through

his IRA, but decided it was ‘‘not a wise use of onshore dollars

at this time given existing capital commitments and the

bank’s liquidity requirements.’’ As Ms. Chang explained, peti-

tioner was therefore ‘‘looking towards Boiler Riffle’’ for the

funds with which to invest. Mr. Lipkind advised petitioner

that a prudent investor would not make this investment, but

petitioner insisted on going ahead anyway. The Investment

Manager raised no question about this risky business. And

Lighthouse agreed to create Philtap, a new special-purpose

entity, for the sole purpose of implementing petitioner’s

wishes. The Post Ranch and Longboard deals vividly display

petitioner’s unfettered control over the investments in the

separate accounts.

Petitioner testified as to his belief that the Investment

Manager performed ‘‘an appropriate level of due diligence.’’

He cites no record evidence to support this proposition, and

we did not find his testimony credible. Employees of the

Investment Manager would be in the best position to explain

what due diligence and investment research they performed

in exchange for their $1,000 annual fee. Petitioner’s failure

to call them as witnesses creates an inference that their

testimony would not have assisted his position. See Am.

Police & Fire Found., Inc. v. Commissioner, 81 T.C. 699, 705

(1983) (citing Wichita Terminal Elevator Co. v. Commis-

sioner, 6 T.C. 1158 (1946), aff ’d, 162 F.2d 513 (10th Cir.

1947)). 15

15 Mr. Walker, outside general counsel for Lighthouse, testified that

Continued

364 144 UNITED STATES TAX COURT REPORTS (324)

Among the hundreds of investments that the separate

accounts made, petitioner cites only three occasions on which

the Investment Manager supposedly declined to follow his

recommendations. With respect to two of these investments—

a Lehman Brothers fund and Milphworld—the record shows

precisely the opposite. Boiler Riffle invested more than $1

million in the Lehman Brothers CIP Fund after Mr. Lipkind

expressed the desire to ‘‘splice this investment into an appro-

priate place in Jeff ’s universe.’’ Boiler Riffle invested in

Milphworld by purchasing from petitioner six Milphworld

promissory notes with an aggregate face value of $186,600.

And while Lighthouse initially discerned a ‘‘reputational

risk’’ regarding Safeview, it was petitioner, not the Invest-

ment Manager, who put this investment on a temporary

hold. There is no evidence that the Investment Manager ever

refused to implement one of petitioner’s ‘‘recommendations.’’

In sum, petitioner actively managed the assets in the sepa-

rate accounts by directing the Investment Manager (through

his agents) to buy, sell, and exchange securities and other

property as he wished. These facts strongly support a finding

that he retained significant incidents of ownership over those

assets. See Clifford, 309 U.S. at 335 (finding lack of absolute

control immaterial ‘‘since control over investment remained’’);

Rev. Rul. 77–85, 1977–1 C.B. at 14 (policyholder possesses

investment control when he ‘‘retains the power to direct the

custodian to sell, purchase or exchange securities, or other

assets held in the custodial account’’).

2. Power To Vote Shares and Exercise Other Options.

Besides directing what securities the separate accounts

would buy and sell, petitioner through his agents dictated

what actions Boiler Riffle would take with respect to its

ongoing investments. The Investment Managers took no

action without a signoff from Mr. Lipkind or Ms. Chang.

With respect to routine shareholder matters, these signoffs

may often have occurred by phone. As Mr. Lipkind noted to

petitioner: ‘‘We have relied primarily on telephone commu-

nications, not written paper trails (you recall our ‘owner con-

Lighthouse did not conduct due diligence regarding investments, but that

the ‘‘Investment Managers would.’’ Mr. Walker had no personal knowledge

of the Investment Manager’s daily activities, and we found his testimony

vague and unhelpful.

(324) WEBBER v. COMMISSIONER 365

trol’ conversations).’’ But examples from the email traffic dis-

play a revealing tip of the iceberg.

Petitioner repeatedly directed what actions Boiler Riffle

should take in its capacity as a shareholder of the startup

companies in which he was interested. He directed how

Boiler Riffle should vote concerning an amendment to

Lignup’s certificate of incorporation and participation in a

second financing round. With respect to Quintana Energy

and Lehman Brothers, he directed how Boiler Riffle should

respond to capital calls. With respect to Accept Software, he

directed whether Boiler Riffle should participate in a bridge

financing. With respect to PTRx, he directed whether Boiler

Riffle should take its pro-rata share of a series D financing.

With respect to Techtribenetworks, he directed whether

Boiler Riffle should convert its promissory notes to equity.

And with respect to Lignup, he directed whether Boiler Riffle

would exercise pro-rata rights that he had assigned to it.

These facts support a finding that petitioner retained signifi-

cant incidents of ownership over the separate account assets.

See Clifford, 309 U.S. at 332, 335 (power to vote shares was

a significant incident of ownership); Rev. Rul. 77–85, 1977–

1 C.B. at 13–14 (significant incidents of ownership included

powers to vote shares and exercise ‘‘any other right or option

relating to [the] assets’’).

3. Power To Extract Cash. Petitioner had numerous ways

to extract cash from the separate accounts, beginning with

the traditional mechanisms of life insurance policies. Each

Policy permitted the policyholder to assign it; to use it as

collateral for a loan; to borrow against it; and to surrender

it. Given how the Policies were constructed, however, the

amount petitioner could extract by surrender or policy loan

was limited to ‘‘premiums paid.’’ Because the investments

petitioner selected performed very well, no ‘‘premiums’’ had

to be paid after 2000; thereafter, ongoing mortality/adminis-

trative charges were defrayed by debiting the separate

accounts. Thus, even though the assets in the separate

accounts were worth $12.3 million by 2007, the amount of

cash petitioner could extract by surrender or policy loan was

capped at $735,046, the initial premiums paid during 1999

and 2000.

Petitioner urges that this restriction distinguishes the

instant case from Christoffersen, where the policyholder,

366 144 UNITED STATES TAX COURT REPORTS (324)

prior to the annuity starting date, could withdraw the full

value of the account on seven days notice. We need not

decide whether the type of restriction to which petitioner and

Lighthouse agreed, if it meaningfully limited the policy-

holder’s ability to extract cash, would be sufficient to render

an insurance company the owner of assets in a segregated

account. On the facts here, this restriction was trivial. Peti-

tioner was able to extract, and did extract, cash from the

separate accounts without any need to resort to policy loans.

One method was by selling assets to the separate accounts.

Shortly after the Policies were initiated, petitioner sold

shares of three startup companies to the 1999 Fund for

$2,240,000. Through these transactions, petitioner was able

to derive liquidity from assets that might otherwise have

been difficult to sell.

Petitioner extracted cash from the separate accounts in

numerous other ways. In November 2006 he extracted

$450,000 from Boiler Riffle by causing it to lend that amount

to Signature, his C corporation, for an investment he wished

to make in Longboard Vineyards. In 2006 petitioner

extracted $50,000 from Boiler Riffle by causing it to purchase

from him a Techtribenetworks promissory note. In February

2007 he extracted an additional $186,600 from Boiler Riffle

by causing it purchase from him six Milphworld promissory

notes. In early 2007 he extracted $200,000 from Boiler Riffle

by causing it to lend that sum to Techtribenetworks, which

enabled that company to repay its $200,000 promissory note

to him. In September 2007 he extracted $100,000 from Boiler

Riffle for a second cash infusion through Signature to

Longboard. And in fall 2007 he extracted $80,000 from Boiler

Riffle to cover a deposit he wished to make on a Canadian

hunting lodge.

Within the space of 12 months petitioner thus extracted

from Boiler Riffle more than $1 million in cash for personal

use. There is nothing in the record to suggest that he could

not have extracted more if he had wished. Given his ability

to withdraw cash at will, he had no need to surrender the

Policies or use policy loans to extract cash. The fact that

these latter mechanisms were capped at $735,046 is thus

immaterial.

As the Supreme Court emphasized in Clifford, 309 U.S. at

335, a taxpayer need not have absolute control over invest-

(324) WEBBER v. COMMISSIONER 367

ment assets to be deemed their owner. The taxpayer there

could not ‘‘make a gift of the corpus to others’’ or ‘‘make loans

to himself ’’ for five years. But the Court found this ‘‘dilution

in his control [to be] insignificant and immaterial, since con-

trol over investment remained.’’ Petitioner’s ability to with-

draw cash at will from the separate accounts supports a

finding that he retained significant incidents of ownership.

4. Power To Derive Other Benefits. Petitioner used Boiler

Riffle to finance investments that may have been a source of

personal pleasure, including a winery, a Big Sur resort, and

a Canadian hunting lodge. More tangible benefits flowed

from the fact that the investments in the separate accounts

mirrored or complemented the investments in his own per-

sonal portfolio and the portfolios of the private-equity funds

he managed. Petitioner regularly used the separate accounts

synergistically to bolster his other positions.

After making an early stage investment, petitioner sought

to find new investors for his startup ventures, aiming to

enhance their prospects and move them closer to a ‘‘liquidity

event.’’ Boiler Riffle provided a readily available source of

new investment funds. Petitioner often made personal finan-

cial commitments to these fledgling ventures, then had Boiler

Riffle discharge those commitments on his behalf. When peti-

tioner lacked the desire (or liquidity) to exercise pro-rata

offering rights on his own shares, he assigned those rights to

Boiler Riffle for exercise, thus avoiding dilution in his overall

position. Boiler Riffle sometimes provided the critical missing

piece of the puzzle, as when petitioner structured a $1.2 mil-

lion financing for JackNyfe and needed Boiler Riffle ‘‘to be on

point for the first $400,000.’’ In all these ways, petitioner

derived ‘‘effective benefit’’ from the separate accounts. See

Griffiths, 308 U.S. at 358.

‘‘[W]here the head of the household has income in excess

of normal needs, it may well make but little difference to him

(except income-tax-wise) where portions of that income are

routed—so long as it stays in the family group.’’ Clifford, 309

U.S. at 336. Petitioner used Boiler Riffle as a private invest-

ment account through which he actively managed a portion

of his family’s securities portfolio. Formalities aside, he main-

tained essentially the same rights of ownership over those

assets, apart from current receipt of income, that he would

have possessed had he chosen to title the assets in his own

368 144 UNITED STATES TAX COURT REPORTS (324)

name. 16 Since petitioner owned the separate account assets

for Federal income tax purposes, all dividends, interest, cap-

ital gains, and other income received by Boiler Riffle during

the tax years in issue were includible in petitioner’s gross

income under section 61. 17

E. Petitioner’s Counterarguments

1. ‘‘Constructive Receipt.’’ Petitioner contends that he may

not be taxed on the income realized by Boiler Riffle during

2006–2007 because he was not in ‘‘constructive receipt’’ of

this income. The ‘‘constructive receipt’’ doctrine prevents cash

basis taxpayers from manipulating the annual accounting

principle by artificially deferring receipt of income to a later

tax year. See generally Boris I. Bittker & Lawrence Lokken,

Federal Taxation of Income, Estates and Gifts, para. 105.3.3,

at 105–61 (3d ed. 2012). Under this doctrine, ‘‘[i]ncome

although not actually reduced to a taxpayer’s possession is

constructively received by him in the taxable year during

which it is credited to his account, set apart for him, or

otherwise made available so that he may draw upon it at any

time.’’ Sec. 1.451–2(a), Income Tax Regs. ‘‘[I]ncome is not

constructively received,’’ however, ‘‘if the taxpayer’s control

over its receipt is subject to substantial limitations or restric-

16 Petitioner contends that his position differed in one respect from that

of an actual owner: Because the death benefit could be paid in cash rather

than in kind, Lighthouse conceivably could keep, rather than distribute to

him, the stock of the startup companies he caused it to buy. But the Poli-

cies provided that Lighthouse would pay the death benefit ‘‘in cash to the

extent of liquid assets and in kind to the extent of illiquid assets.’’ Since

the shares held by the separate accounts were not publicly traded, they

were presumably illiquid; the Policies thus explicitly anticipated that the

death benefit would to this extent be paid in kind. Although Lighthouse

nominally had discretion to reject in-kind payment, it rubber-stamped all

of petitioner’s other ‘‘recommendations.’’ There is no reason to believe it

would countermand his preference as to the form of the death benefit. In

any event, the Eighth Circuit in Christoffersen, 749 F.2d at 516, held that

the ‘‘limitation of withdrawals to cash, rather than shares, d[id] not reflect

a lack of ownership or control’’ by the policyholders over the mutual fund

shares in the segregated account.

17 Petitioner is the tax owner of the underlying assets even though the

Policies are nominally owned by the Trusts. If the Trusts were deemed to

be the owners of the underlying assets, it appears that their income would

be attributable to petitioner under the grantor trust rules. See secs. 671,

677, 679.

(324) WEBBER v. COMMISSIONER 369

tions.’’ Ibid. Petitioner contends that he could enjoy actual

receipt of Boiler Riffle’s income only by surrendering the

Policies for their (relatively puny) cash surrender value of

$735,046. In his view this constituted a ‘‘substantial limita-

tion or restriction’’ that precludes constructive receipt.

Although the Eighth Circuit in Christoffersen, 749 F.2d at

516, briefly mentioned the ‘‘doctrine of constructive receipt,’’

that principle has no necessary application here. ‘‘As summa-

rized by a much-quoted metaphor, constructive receipt means

that ‘a taxpayer may not deliberately turn his back upon

income and thus select the year for which he will report it.’ ’’

Bittker & Lokken, supra, at 105–62 (quoting Hamilton Nat’l

Bank v. Commissioner, 29 B.T.A. 63, 67 (1933)). The

‘‘investor control’’ doctrine addresses a different problem, and

a finding of ‘‘constructive receipt’’ is not a prerequisite to its

application.

It is undisputed that the owner of the separate account

assets during 2006–2007 actually received the income at

issue. The question we must decide is whether petitioner or

Lighthouse was that ‘‘owner.’’ If petitioner was the true

owner, he is treated as having actually received what the

separate accounts actually received; resort to ‘‘constructive

receipt’’ is not necessary. The taxpayer in Clifford, 309 U.S.

at 355, could not access the trust income for five years, yet

the Supreme Court held that he nevertheless owned the

assets titled to the trust. We reach the same conclusion

here. 18

2. Application to Life Insurance. Petitioner contends that

the ‘‘investor control’’ doctrine, if it applies to anything,

should not be applied to life insurance contracts. As he points

out, Revenue Ruling 77–85 and its immediate successors

addressed segregated asset accounts supporting variable

annuity contracts. In 2003 the Commissioner applied the

same principles to segregated asset accounts supporting vari-

able life insurance contracts. See Rev. Rul. 2003–91; Rev.

Rul. 2003–92. Citing Skidmore, 323 U.S. at 140, petitioner

18 In any event, we reject petitioner’s premise that the $735,046 limita-

tion on cash surrender value constituted a ‘‘substantial limitation[ ] or

restriction[ ],’’ sec. 1.451–2(a), Income Tax Regs., that would preclude con-

structive receipt. As noted previously, petitioner was able to withdraw un-

limited amounts of cash from the separate accounts in other ways. See

supra pp. 365–367.

370 144 UNITED STATES TAX COURT REPORTS (324)

contends that the latter two rulings ‘‘are not entitled to def-

erence as they are not ‘thoroughly considered’ * * * as to the

application of investor control to life insurance.’’

We disagree. The statutory text fully supports the Commis-

sioner’s position that variable life insurance and variable

annuities should be treated similarly in this (and in other)

respects. As pertinent here, section 817(d)(2) defines a ‘‘vari-

able contract’’ as a contract that is supported by a segregated

asset account and that ‘‘(A) provides for the payment of

annuities [or] (B) is a life insurance contract.’’ If ‘‘investor

control’’ principles apply to the former, they would seem to

apply to the latter by a parity of reasoning.

Petitioner contends that fundamental differences exist

between annuity and insurance contracts because, under the

latter, ‘‘the insurance company has assumed a significant

obligation to pay a substantial death benefit.’’ In petitioner’s

view, the ‘‘investor control’’ doctrine should apply only where

the policyholder occupies essentially the same position that

he would have occupied if he had purchased the assets in the

separate account directly. Here, petitioner says that his posi-

tion differs because Lighthouse’s obligation to pay the min-

imum death benefit ‘‘substantially shifts the risks between

the parties.’’

The existence of an insurance risk, standing alone, does

not make Lighthouse the owner of the separate account

assets for Federal income tax purposes. Lighthouse agreed to

assume the mortality risk in exchange for premiums that it

(or its reinsurer, Hannover Re) actuarially determined to be

commensurate with this risk. After 2000 these premiums

were replaced by mortality and administrative charges deb-

ited to the separate accounts. Unless the Trusts continued to

pay the actuarially determined mortality charges, directly via

premiums or indirectly via debits to the separate accounts,

the Policies would have lapsed and Lighthouse would have

had no more insurance risk.

During the tax years in issue the insurance risk borne by

Lighthouse was almost fully reinsured with Hannover Re

and was actually quite small. As of yearend 2006 and 2007,

the values of the assets in the separate accounts exceeded

the Policies’ minimum death benefit by at least $1.7 million

and $6.8 million, respectively. In any event, whatever mor-

tality risk existed was fully compensated by mortality risk

(324) WEBBER v. COMMISSIONER 371

charges ($12,327 for the years in issue) paid directly or

indirectly by the policyholder. Under these circumstances,

the insurer’s obligation to pay a minimum death benefit does

not tell us who owns the separate account assets, any more

than the insurer’s obligation to pay an annuity benefit deter-

mined who owned the separate account assets in Revenue

Ruling 77–85. To the extent the ‘‘investor control’’ doctrine

seeks to limit misuse of tax-favored investment assets, there

is no good reason to limit its application to annuities. In the

case of both annuities and insurance contracts, ownership is

determined by which party has ‘‘significant incidents of

ownership’’ over the underlying assets. Here that party was

petitioner.

3. Section 7702. In 1984 Congress created a statutory defi-

nition of the term ‘‘life insurance contract’’ for Federal

income tax purposes. Under section 7702(a), a policy will be

treated as a ‘‘life insurance contract’’ only if it satisfies either

the ‘‘cash value accumulation’’ test or both the ‘‘guideline pre-

mium’’ test and the ‘‘cash value corridor’’ test. These tests

require complex calculations involving the relationships

among premium levels, mortality charges, interest rates,

death benefits, and other factors. Respondent does not con-

tend that the Policies fail these tests or that they otherwise

fail to qualify as ‘‘life insurance contracts’’ within the

meaning of section 7702(a).

After enacting section 7702 Congress continued to examine

the use of insurance contracts as investment vehicles. This

led to the 1988 enactment of section 7702A, which defines a

‘‘modified endowment contract.’’ Congress concurrently

directed the Secretary of the Treasury to study ‘‘the effective-

ness of the revised tax treatment of life insurance and

annuity products in preventing the sale of life insurance pri-

marily for investment purposes.’’ Technical and Miscella-

neous Revenue Act of 1988, Pub. L. No. 100–647, sec.

5014(a), 102 Stat. at 3666; see H.R. Conf. Rept. No. 100–

1104, 1988 U.S.C.C.A.N. 5048, 5159 (Oct. 21, 1988).

Sections 7702 and 7702A impose quantitative restrictions

on life insurance and endowment contracts that have signifi-

cant investment aspects. From this premise, petitioner con-

cludes that the ‘‘investor control’’ doctrine cannot be applied

to an insurance policy that satisfies the statutory definition.

This is a variation on petitioner’s preceding argument—that

372 144 UNITED STATES TAX COURT REPORTS (324)

the ‘‘investor control’’ doctrine should not be applied to life

insurance.

As we explained previously, petitioner’s conclusion does not

follow from his premise. The fact that the Policies constitute

‘‘life insurance contracts’’ within the meaning of section

7702(a) does not determine, for Federal income tax purposes,

who owns the separate account assets that support the Poli-

cies. The latter inquiry depends on who has substantial

‘‘incidents of ownership’’ over those assets. Section 7702, with

its focus on quantitative relationships among premiums,

interest rates, and mortality charges, does not purport to

address this question.

Petitioner alternatively contends that, if the ‘‘investor con-

trol’’ doctrine is applied to treat him as the owner of the

separate account assets, the tax results should be dictated by

section 7702(g). Subsection (g) provides that, in specified cir-

cumstances, the policyholder shall be treated as receiving

‘‘the income on the contract’’ accrued during a particular

year. The ‘‘income on the contract’’ is defined as ‘‘the increase

in the net surrender value,’’ plus ‘‘the cost of life insurance

protection provided,’’ minus ‘‘the premiums paid.’’ Sec.

7702(g)(1)(B). Here, there was no increase in the Policies’

cash surrender value during 2006–2007, and there were no

‘‘premiums paid.’’ Petitioner accordingly contends that sec-

tion 7702(g) limits his income inclusion to ‘‘the cost of life

insurance protection provided’’ during the years in issue.

According to petitioner, that cost would be $12,327, the mor-

tality charges paid by the separate accounts during 2006–

2007.

Petitioner’s argument fails at the threshold. Section

7702(g) dictates the annual income inclusion for a policy-

holder ‘‘[i]f at any time any contract which is a life insurance

contract under the applicable law does not meet the defini-

tion of life insurance contract under subsection (a).’’ Both

parties agree that the Policies meet the definition of ‘‘life

insurance contract’’ in section 7702(a). Given the statute’s

express terms, section 7702(g) is thus inapplicable.

Under the ‘‘investor control’’ doctrine, the separate account

assets are treated for tax purposes as being owned by the

policyholder, not by the insurance company. Consistently

with this premise, Revenue Ruling 77–85 and its successors

uniformly treat the policyholder as taxable on the ‘‘inside

(324) WEBBER v. COMMISSIONER 373

buildup,’’ that is, on the dividends, interest, capital gains,

and other income realized on those assets annually. It would

be illogical to find that petitioner owns the underlying assets,

then tax the income earned on those assets as if they were

owned by the insurance company. Petitioner’s reliance on

section 7702(g) is accordingly misplaced.

4. Section 817(h). In 1984 Congress amended the Code to

include section 817(h), captioned ‘‘Treatment of Certain

Nondiversfied Contracts.’’ It provides that a variable contract

based on a separate account ‘‘shall not be treated as an

annuity, endowment, or life insurance contract for any period

* * * for which the investments made by such account are

not, in accordance with regulations prescribed by the Sec-

retary, adequately diversified.’’ Id. In authorizing the Depart-

ment of the Treasury to prescribe diversification standards,

Congress stated its intention that

the standards [should] be designed to deny annuity or life insurance

treatment for investments that are publicly available to investors and

investments which are made, in effect, at the direction of the investor.

Thus, annuity or life insurance treatment would be denied to variable

contracts (1) that are equivalent to investments in one or a relatively

small number of particular assets (e.g., stocks, bonds, or certificates of

deposits of a single issuer); (2) that invest in one or a relatively small

number of publicly available mutual funds; (3) that invest in one or a

relatively small number of specific properties (whether real or personal);

or (4) that invest in a nondiversified pool of mortgage type investments.

* * * [H.R. Conf. Rept. No. 98–861, at 1055 (1984), 1984–3 C.B. (Vol.

2) 1, 309.]

Citing this language, petitioner contends that Congress

intended section 817(h) to eliminate the ‘‘investor control’’

doctrine altogether. Petitioner’s reliance is again misplaced.

Congress directed that the new diversification standards

should govern situations where the investments in the sepa-

rate account ‘‘are made, in effect, at the direction of the

investor.’’ H.R. Conf. Rept. No. 98–861, supra at 1055,

1984–3 C.B. (Vol. 2) at 309. This would be true, Congress

noted, where the investments, though actually selected by

the insurance company, are so narrowly focused and

undiversified as to be a proxy for mutual funds or other

‘‘investments that are publicly available to investors.’’ Ibid.

In adopting a regulatory regime to identify situations in

which investments ‘‘are made, in effect, at the direction of

374 144 UNITED STATES TAX COURT REPORTS (324)

the investor,’’ Congress expressed no intention to displace the

‘‘investor control’’ doctrine. That doctrine identifies situations

in which investments are made at the actual direction of the

investor, such that he exercises actual control over the

investment account. See Rev. Rul. 77–85, 1977–1 C.B. at 14

(policyholder possesses investment control when he ‘‘retains

the power to direct the custodian to sell, purchase or

exchange securities, or other assets held in the custodial

account’’). 19

Apart from one safe harbor in section 817(h)(2), Congress

left the diversification requirements to be implemented

through ‘‘regulations prescribed by the Secretary.’’ Sec.

817(h)(1). The Secretary issued temporary and proposed

regulations outlining diversification standards in 1986. 51

Fed. Reg. 32633 (temporary), 32664 (proposed) (Sept. 15,

1986). The preamble stated, 51 Fed. Reg. at 32633:

The temporary regulations * * * do not address any issues other than

the diversification standards[.] * * * In particular, they do not provide

guidance concerning the circumstances in which investor control of the

investments of a segregated asset account may cause the investor, rather

than the insurance company, to be treated as the owner of the assets

in the account. For example, the temporary regulations provide that in

appropriate cases a segregated asset account may include multiple sub-

accounts, but do not specify the extent to which policyholders may direct

their investments to particular sub-accounts without being treated as

owners of the underlying assets. Guidance on this and other issues will

be provided in regulations or revenue rulings under section 817(d),

relating to the definition of variable contract.

Final regulations concerning diversification standards were

issued in 1989. T.D. 8242, 1989–1 C.B. 215; see sec. 1.817–

5, Income Tax Regs. Since issuing those final regulations, the

IRS has continued to issue both public and private rulings

invoking the ‘‘investor control’’ doctrine to determine owner-

ship of assets in segregated asset accounts. See, e.g., Rev.

19 As commentators have noted, the section 817(h) diversification stand-

ards may supersede some aspects of the pre-1984 revenue rulings that dis-

cuss publicly available investments held by segregated asset accounts. See,

e.g., David S. Neufeld, ‘‘The ‘Keyport Ruling’ and the Investor Control

Rule: Might Makes Right?,’’ 98 Tax Notes 403, 405 (2003). But Congress

did not, expressly or by implication, indicate any intention that section

817(h) should displace the bedrock ‘‘investor control’’ principles enunciated

in Revenue Ruling 77–85, which address situations where the policyholder

exercises actual control over the investments in the separate accounts.

(324) WEBBER v. COMMISSIONER 375

Rul. 2003–91, 2003–2 C.B. 349–350; Rev. Rul. 2003–92,

2003–2 C.B. 351–352; Priv. Ltr. Rul. 201105012 (Feb. 4,

2011); Priv. Ltr. Rul. 200420017 (May 14, 2004); Priv. Ltr.

Rul. 9433030 (Aug. 19, 1994); see also C.C.A. 200840043

(October 3, 2008). As the Commissioner has explained: ‘‘[T]he

final regulations do not provide guidance concerning the

extent to which policyholders may direct the investments of

a segregated asset account without being treated as the

owners of the underlying assets.’’ Priv. Ltr. Rul. 9433030. 20

In sum, by enacting section 817(h), Congress directed the

Commissioner to promulgate standards for determining when

investments in a segregated asset account, though actually

selected by an insurance company, ‘‘are made, in effect, at

the direction of the investor.’’ H.R. Conf. Rept. No. 98–861,

supra at 1055, 1984–3 C.B. (Vol. 2) at 309. It would be

wholly contrary to Congress’ purpose to conclude that the

enactment of section 817(h) disabled the Commissioner from

determining, under the ‘‘investor control’’ doctrine, that

investments in a segregated asset account are made, in

actual reality, at the direction of the investor. The Secretary

clearly stated, when promulgating the new diversification

standards, that the ‘‘investor control’’ doctrine would con-

tinue to apply, and the Commissioner’s public and private

rulings during the ensuing 30 years confirm his view that

this doctrine remains vital. Congress has certainly evidenced

no disagreement with that position. 21 For all these reasons,

20 In Private Letter Ruling 9433030, for example, the taxpayer sought a

ruling that assets held in a separate account would be treated as owned

by the insurance company and not the policyholder. The taxpayer rep-

resented that the separate accounts would be adequately diversified under

section 817(h). The Commissioner then proceeded to consider whether the

policyholder or the insurance company should be treated as the owner of

the separate account assets under Christoffersen, 749 F.2d 513, Revenue

Ruling 77–85, and other authorities. The Commissioner followed the same

path in Revenue Rulings 2003–91 and 2003–92.

21 Congress in one respect has expressed its disagreement with the Com-

missioner’s implementation of section 817(h), countermanding a provision

of the 1986 proposed regulations that would have deemed all Government

securities to be issued by a single entity. See 134 Cong. Rec. 29723 (1988).

Congress then revised the statute by adding section 817(h)(6), which pro-

vides that, ‘‘[i]n determining whether a segregated asset account is ade-

quately diversified * * *, each United States Government agency or in-

strumentality shall be treated as a separate issuer.’’ See Technical and

Continued

376 144 UNITED STATES TAX COURT REPORTS (324)

we conclude that the enactment of section 817(h) did not dis-

place the bedrock ‘‘investor control’’ principles enunciated in

Revenue Ruling 77–85.

IV. Subsidiary Issues

A. Webify Stock Basis

The bulk of the income realized by Boiler Riffle during the

tax years in issue consisted of capital gain on the sale of

Webify stock. IBM purchased these shares in 2006 for more

than $3 million, of which $2,731,087 was paid in 2006 and

$212,641 in 2007. The parties disagree as to the basis of

these shares.

We have found as a fact that the basis of the Webify

shares when sold was $838,575. Petitioner was unable to

locate copies of wire transfers or similar documents covering

the numerous transactions in which these shares were

acquired. However, Butterfield Bank’s financial statements

for Boiler Riffle provide a consistent picture. Although

Butterfield Bank did not provide robust investment manage-

ment services, no one has criticized its bookkeeping or

accounting. Indeed, both parties relied, in numerous respects,

on the integrity of the financial statements and other docu-

ments that it prepared. In determining the long-term capital

gain in 2006 and 2007 on the sale of Webify stock, therefore,

the parties shall use a basis of $838,575. See secs. 1001,

1221. 22

Miscellaneous Revenue Act of 1988, Pub. L. No. 100–647, sec. 6080, 102

Stat. at 3710 (Nov. 10, 1988). Since Congress has revisited section 817(h)

to revise one aspect of the Commissioner’s implementation of the diver-

sification standards, the fact that it has left undisturbed the Commis-

sioner’s continuing invocation of ‘‘investor control’’ principles is not without

significance. Courts ordinarily are slow to attribute significance to Con-

gress’ failure to act on particular legislation, Aaron v. SEC, 446 U.S. 680,

694 n.11 (1980), but in some situations Congress’ inaction may provide a

‘‘useful guide,’’ see Bob Jones Univ. v. United States, 461 U.S. 574, 600–

602 (1983). The latter would seem to be true here.

22 Petitioner appears to argue that all of the basis should be allocated

to payments received in 2006. If there is any disagreement on this point,

the parties can resolve it as part of the Rule 155 computations.

(324) WEBBER v. COMMISSIONER 377

B. Boiler Riffle Distributions

Respondent argues that the distributions Boiler Riffle

made to Lighthouse in 2006–2007 to cover the Policies’

annual mortality and administrative charges should be

included in petitioner’s income. These payments were derived

from income Boiler Riffle realized on the separate account

investments. We have held that petitioner, as the owner of

these investments, is taxable in full on the income they gen-

erated. If petitioner were separately taxed as the deemed

beneficiary of the payments made from this income, as

respondent asks us to hold, petitioner in effect would be sub-

ject to double taxation. We decline that request. 23

V. Accuracy-Related Penalty

Section 6662 imposes a 20% accuracy-related penalty upon

the portion of any underpayment of tax that is attributable

(among other things) to a substantial understatement of

income tax. See sec. 6662(a), (b)(2). An understatement is

‘‘substantial’’ if it exceeds the greater of $5,000 or 10% of the

tax required to be shown on the return for that year. Sec.

6662(d)(1)(A). The Commissioner bears the burden of produc-

tion with respect to a section 6662 penalty. Sec. 7491(c). If

respondent satisfies his burden, petitioner then bears the

ultimate burden of persuasion. See Higbee v. Commissioner,

116 T.C. 438, 446–447 (2001).

The section 6662 penalty does not apply to any portion of

an underpayment ‘‘if it is shown that there was a reasonable

cause for such portion and that the taxpayer acted in good

faith with respect to * * * [it].’’ Sec. 6664(c)(1). The decision

whether the taxpayer acted with reasonable cause and in

good faith is made on a case-by-case basis, taking into

account all pertinent facts and circumstances. Sec. 1.6664–

4(b)(1), Income Tax Regs. A taxpayer may be able to dem-

23 As an alternative to his ‘‘investor control’’ position, respondent con-

tends that the Chalk Hill Trust in effect owned Boiler Riffle, with the re-

sult that petitioner, as the owner of that grantor trust, would be taxable

on Boiler Riffle’s income under subpart F. See sec. 1.958–1(b), Income Tax

Regs. (providing that a CFC owned by a foreign grantor trust is treated

as owned by the grantor). Whereas we have found petitioner to be the

owner of the assets in the separate accounts, Lighthouse was the owner

of Boiler Riffle and other special-purpose entities it created. Because Boiler

Riffle had no U.S. shareholders, the CFC rules do not apply.

378 144 UNITED STATES TAX COURT REPORTS (324)

onstrate reasonable cause and good faith by showing reliance

on professional tax advice. Sec. 1.6664–4(c)(1), Income Tax

Regs.; see Neonatology Assocs., P.A. v. Commissioner, 115

T.C. 43, 99 (2000), aff ’d, 299 F.3d 221 (3d Cir. 2002).

‘‘Advice’’ must take the form of a ‘‘communication’’ that

sets forth the adviser’s ‘‘analysis or conclusion.’’ Sec. 1.6664–

4(c)(2), Income Tax Regs. In assessing whether the taxpayer

reasonably relied on advice, we consider whether the adviser

was competent; whether the adviser received accurate and

complete information from the taxpayer; and whether the

taxpayer actually relied in good faith on the advice he was

given. Neonatology Assocs., P.A., 115 T.C. at 99.

Petitioner urges that he reasonably relied on Mr. Lipkind’s

advice. Mr. Lipkind was clearly a competent tax adviser. He

is an expert in income and estate tax, and he diligently

researched the relevant legal issues. He also received

accurate and complete information about the Lighthouse

arrangements because he set up petitioner’s estate plan.

Mr. Lipkind provided petitioner with ‘‘advice.’’ Mr. Lipkind

did not himself render a written legal opinion, but he

reviewed and considered written opinion letters from rep-

utable law firms addressing the relevant issues. Three of

these opinion letters specifically addressed the ‘‘investor con-

trol’’ doctrine; they concluded that the Lighthouse policies, as

structured, would comply with U.S. tax laws and avoid

application of this doctrine. By informing petitioner that he

concurred in these opinions, Mr. Lipkind provided petitioner

with professional tax advice on which petitioner actually

relied in good faith.

We likewise conclude that petitioner’s reliance was

‘‘reasonable.’’ Petitioner made multiple filings with the IRS

setting forth details about the Trusts and Lighthouse,

including gift tax returns filed for 1999 and 2003 and Form

3520 filed when the Policies were transferred to an offshore

trust. Petitioner did not attempt to hide his estate plan from

the IRS. This supports his testimony that he believed this

strategy would successfully withstand IRS scrutiny, as Mr.

Lipkind had advised.

The revenue rulings discussing the ‘‘investor control’’ doc-

trine adopted consistent positions and ultimately set forth a

‘‘safe harbor.’’ Rev. Rul. 2003–91, 2003–2 C.B. at 347. How-

ever, the outer limits of the doctrine were not definitively

(324) WEBBER v. COMMISSIONER 379

marked when Mr. Lipkind rendered his advice in 1998.

Whether an investor exercises impermissible ‘‘control’’ pre-

sents a factual issue, and Mr. Lipkind dictated the ‘‘Lipkind

protocol’’ as a mechanism for keeping petitioner on the sup-

posed right side of the line. Although the ‘‘Lipkind protocol’’

was formalistic and ultimately unsuccessful, we do not fault

petitioner, who had no expertise in tax law, for following his

lawyer’s advice on this point. Cf. Van Camp & Bennion v.

United States, 251 F.3d 862, 868 (9th Cir. 2001) (‘‘Where a

case is one ‘of first impression with no clear authority to

guide the decision makers as to the major and complex

issues,’ a negligence penalty is inappropriate.’’ (quoting

Foster v. Commissioner, 756 F.2d 1430, 1439 (9th Cir.

1985))); Montgomery v. Commissioner, 127 T.C. 43, 67 (2006);

Williams v. Commissioner, 123 T.C. 144, 153–154 (2004)

(reasonable cause may be found where return position

involves issues that were novel as of the time that return

was filed). 24

For these reasons, we conclude that petitioner is not liable

for the accuracy-related penalty for any of the years in issue.

To reflect the foregoing,

Decision will be entered under Rule 155.

f

24 We disagree with respondent’s submission that Mr. Lipkind was a

‘‘promoter’’ upon whom petitioner could not reasonably rely. See 106 Ltd.

v. Commissioner, 136 T.C. 67, 79–80 (2011), aff ’d, 684 F.3d 84 (D.C. Cir.

2012). Mr. Lipkind has maintained a continuous attorney-client relation-

ship with petitioner for more than a dozen years. Mr. Lipkind had no stake

in petitioner’s estate plan apart from his normal hourly rate, and Mr.

Lipkind received no remuneration or other benefit from Lighthouse, Boiler

Riffle, or the Investment Manager. Mr. Lipkind did not plan the private

placement life insurance structure, but only advised petitioner to purchase

such a policy after thoroughly vetting Lighthouse, an unrelated insurance

company. The evidence established that Mr. Lipkind recommended the

Lighthouse estate plan only to his wife, to petitioner, and to a small num-

ber of other clients.