UNITED STATES TAX COURT
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136 T C. No
2
UNITED STATES TAX COURT
G. MASON CADWELL, 2R ,9e itioner
.
COMMISSIONER OF INTERNAL REVENUE Resþondent
Docket No.
15456 08.
Filed January 3, *2011.
K, an S corporation 100 percent owned by P' s
spouse? adòpted and, t hrough iÝs subsidiary KSlòda.de
contributions to a multiemployer welfare-benefit plan
(the ylan) .
Through KSM K made a Montrib'ution to the
plan, part of which was used to purchase life insurance
coverage for P and K's other employees; and tihe
remainder of which was an excess contribut.ion. The
plan was amended and converted to a single-employer
plan. The plan's qualification pursuant to sec.
419A(f) (6),
I.R.C.,
is not i'n issue.
Held
R was not required to send P a - "30 day
lettër", and the notice of deficiency ade ùately sets
forth R's position7in this case and is therefore valid.
Held, further, P' s' interest in the plan became
substantially vested upon the plan's conversion from a
multiemployer plan to a single-employer plan. Sec.
1. 402 (b) -1 (b) (1) ,
Income Tax Regs .
SERVED JAN 3 2011
- 2 -
Held, further, P rust include in gross income the
c sh value of the life insurance policy on P's life.
T e value of the life insurance policy is the PERC
(premiums, earnings, and reasonable charges) pursuant
tb Rev. Proc. 2005-25, 2005-1 C.B. 962.
P may not :
rŠduce the PERC value by the surrender charge, as it
spould be disregarded for valuation purposes pursuant
to Rev. Proc . 2005-25, lsupra.
Held, further, P must include in his gross income
the excess contributiorls pursuant to sec. 1.402(b)1 (b) (1) ,
Income Tax Recjs .
Held, further, the' current year cost of insurance
protection is an accesdion to wealth which P must
i clude in gross income pursuant to sec. 61(a), I.R.C.
Held, further, where the fair market value of a
1i.fe insurance policy låas been determined using the
PERC method, P must include in his gross income as the
c st- of life insurance protection an amount equal to
the sum of mortality charges and other expenses.
Held, further, P is liable for the accuracyrelated penalty for a substantial understatement of i come tax pursuant to sec. 6662(a) and (b) (2), I.R.C.
R chard H. Morton and I evin J. Ryan, för petitioner.
K thleen Tagni, Sherri Wilder, and Betty Clary (specially
recognized) , f or respondent
OPINION .
W LLS, Judge:
This case is before the Court on petitioner' s
motion for summary judgment anc respondent's cross-motion for
- 3 -
summary judgment spursuant to Rule 121.
Respondent determined a
deficiency of $33,057 in petitioner's Federal rincome tax for tax
year 2004 and a penalty pursuant to section -6662(a) of $6,611
On August 31, 2009, petitioner filed a motion-for summary
judgment.
On October 5,- 2009, respondent filed a response sto -
petitioner's motion for summary judgment and a -cross-motion for
summary-judgments
On Octobero26, 2009; petitioner filed a motion
to amendehis petition.3 i On November 4, 2009, petit ioner filed a
response to respondent's cross-motion .for summary judgment.
On
November 16, 2009, a hearing wastheld onathe parties' motions.
On November 19, 2009, respondent filed a reply to petitioner's
response to respondent' s motion for summary judgment and anobjection to- petitioner s motion to amend hisopetition.
The issues to be decided as a consequence of Petitioner's
moti'on for summaryejudgmentiandaRespondent's cross-motionsfor
summary judgment are:
(1) Whether respondent was required to
send a "30 day -letter" to petitioner and whether the notice of deficiency adequately sets forthsrespondent's position inethe
instant; case;
(2)e whether petitioners must include in gross income
the cash value of a life insurances policy held, by a multiemployer
Unless otherwise indicated, -section refer.ences are to the
Internal oRevenue Code o f . 198 6 ( Code ) as amende d and in e f f ec t
for the year sin issue, andrRule- references are t o the Tax Court
Rules of Practicemand Procedure.
By separate order
amend his petition.
we will deny petitioner s motionato
- 4 welfare benefit plan that wàs converted to a single-employer
welfare benefit plan during?the year in issue;
(3)*whether
petit oner must include in his gross income payments made by his
emplo er in excešs of the -cêst of current year life insurance
prote$tion (excess contribut ion) ;
(4) whether petitioner must
includel "in his gross income the current year cost of life
insurance protection paid b
his employer; and (5) whether
petiti ner is liable for the penalty under section 6662.
ackground
The abackground facts are drawn- from the pleadings, the
parties' motions, facts deeãed established, and stipulated t
exhibits, and are not in dispute.
t the time "of filing of the petitio , petitioner was a
resident of North Carolina. 3
- 4
Petitioner is married tio Jennifer K. Cadwell (Mrs:. Cadwell) .
Petitioner, and Mrs. Cadwell have two daughters, Jennifer Keady
Cadwelt 1(Jennifer) and Miranda« M., Cadwell (Miranda) .
For his
2002 through 2004 tax yearsy petitioner filed:Forms 1040
U.S.
Individual Income Tax Return, claiming a filing status of married
filinc separately.
For his 2002 through 2004 tax yearsI,
In the notice of deficiency, respondent determined
adjust nents to petitioner's personal exemption and itemized
deductions. These adjustmerits are computational and will depend
on the Court' s resolution of thei issues discussed -herein. 4 ' 'Certain facts were deelned established by separate order of
the Cohrt .
5 -
petitioner did-not report any wages or salaries on line 7 of Form
1040
ræKeady Ltd
-(Keady) , is a Pennsylvania, S corporation
organized during 1998.pursuant to sections 1361-1375.
Keady is,
and has always been; 100 percent< owned by Mrs. Cadwell.
Mrs.
Cadwell is the sole director of Keady.
During .20024through 2004,
Mr. Cadwel-1-servedas the secretary of Keady.
Keady does not
have anyrminutes -of shareholders or directors meetings for 2002
through 2004.
Durings:2002 ythrough 2004, Keady's only income-was
its share of income (or loss) from÷KSM,aLimited Partnership
(KSM) , a Pennsylvania limited partnership formed during 1998 .
During 2002 through 2004, KSM was owned as follows:
90
percent by Mrs: Cadwell;- 5 percent ,by Keady; 2 percent by =
petitioner;t 125 -percent. by Jennifer; and L.5 percent by Mirandas
Keady is the general partner. of KSM.
During December- 2002, petit ioner and Mrs. Cadwell dec ded to
obtain employee welfarerbenefits for petitioner, Jennifer, and
Miranda through therNationalaBenefit; Plan and Trust,.5
The
respective-plan documents- are hereinaftenreferred to as the Plan
and the respective trust created under the Plan is hereinafter
referred to as the Trust.
According to its original terms, the
Plan was organized as a multiemployer welfare benef t plan
3The parties agree that the trust was not exempt from tax,
under sec: 501(a) .
-^6 pursuant to section 419A(f) (6) .'
Plan' s design and operation
The documents describe the
The primary purpose of the Plan is
to pro ide sevérance ánd death benéfits to eligible employees.
According to the Pla'n, each(employer is to bear the full costrof
the benefits provided.
Assåts held by the Trust are 'protectéd
from the claims of each employer's creditors.
Each employer
enrolled in the'Plan is entitlied to elect the ramount of benefits
to pr
ide and the per'iod oyer which such benefits become vested
Upon termination of the Plar oí- employer withdrawal from the
Plan
n employee's nonforf itable benefits are deemedato be 100
percen
vested, - regardless c f the vesting schedul'e "set by the
employer
B fore joiriing the Pla , a prospective employer proŸides to
the "Plan sponsori Niche Plan ~Sponsors (Niche) , employment
information regarding the enployees whom the employer chooses to
1
includh in the Plan.
Niche uses the employer' s information to
create a package of informat ion that contains a summary öf the
Plan's b nefits to the employer änd its employées.
According to
the summåry, petitioner receives $50, 000 a year in wages from
Keády.
.21"
6Ñhether the Plan meets the requirements of sec . 419A ( f ) (6 )
is not in issue.
"The Plan shall terminate upon lleli½ery
The Plan states:
the
Trustee of a written and signed notice
by the P an Sponsor to
of termination."
- 7 On Decembert 3!1; 2002, petitioner signed the document
adopting the Plan as secretary"on behalf-'of Keady.
was 64 years old at the time Keady adoptedt the Plan.
Petitione'r
The
,
adoption agreement identifies Nichegas the Plan sponsor ,National
Plan .Advisory as the Plan Administrator, Wells Fargo Bank as the
Plan Trustee, and «National Benefit Plahn and 'Trust as the Record
Owner of the~ Trusthseassets.'
Keady ,elected «toacover petitioner,
Miranda, and Jennifer withodeath benefits equal -to 20 times the
covered employee's compensation, .severance benefits equal to
14.847 percent of compensation peWyear :up to 10 years r(not to
exceed 200 .percent) , sand a modified 4240 vesting schedules
(vesting schedule) .
Under the vesting schedule, an employee is
first vested in severance benefits at 40 percent of the stated
benefit after 4 years of employment, with vesting increasing to
100 percent at year 10 of employment.
Lifè insurance covering petitioner' s and his daughters'
live's was selécted to fund the death and severance benefits
payabl
u der tta Plan to petÛïoner and his dailgÊters."
For
petitioner, a universal life policy with ari initial death benefit
of $1 million that als
accuniÚlktes cash value (héreinafter
The parties» do not specify howethe severance -benefits are
to be funded, whether through the cash value of 'the life
insurance policy or some other: option. * The adoption agreement
states:
"The adopting employer shallscontribute, for each Covered
Employee the contribution necessary to fund adCoveredi Employee' s
Target Severance Benefit, determined under the formula and rules
set forth in this Article."
- 8 referred to as the life .insurance policy) was selected to fund
his benefit."
The life insurance policy was issued by-Lincoln
National Life Insürance Co.
(Lincoln Life), on December 7, 2002.
Petitioner named Miranda and Jennifer as beneficiaries, of the
life i surance policy.
petit
In his lifeminsurances policy application,
ner .listed himself as "Manager" of Keady.
For Miranda and Jennifer, identical 10-year, level: term life
insurance policies on their lives with death benefits of $300,000
were s lected to fund. their benefits.
The annual combined
premiums ,on those policies t otaled $645.
On their ]:ife insurance
applications, Miranda and Jennifer were identified as
"Consultánts" for Keady.
There are many differeht kinds of life insürance policies.
Term life insuranc e covers the insured only for a
particular period, and upon" expiration of that period
t rminates without value. Whole life insurance covers an
insured for life, duridg which the insured pays fixed
p emiums, accumulates davings from an invested portion of
the yremiums, and receives a guaranteed benefit upon death,
t be paid to a named ßeneficiary. Universal life insurance
is term life insurance in which the premi'ums are yáid from
t e insured's earnings from a money-market fund. » Variable
life insurance is lifeiinsurance in which the premiums are
i vested in securitiesgand whose death benefits thus depend
o the securities' performance, though there is "a minimum
guarànteed death benefit.« * * *
Curcio v. Commissioner, T.C. Memo. 2010-115.
9 -
On December 31-, 20.02
Bank,
KSM paida$75,000 byscheck to Compass
the Plant Trustee; to acover Keady's obliaation under the
Plan,. and $2,O50-for the¿Plan fee.
Both checks were-dràwnion
KSM' s Centennial sBank account and were signed by petitioner..a i
Lincoln Life credit ed petitioner' s li'fe insurance apol-icy for a'
payment of «$7:3>, OOO for thermontheending Januarye6, 2003.a
a
Petitioner 'did not include,any income -on liis 2002 Form 1040 as a
result of any life insurance prentiums paid by KSM;aThe payments
to the Plandrustee were not claimed as'a deduction on KSM' s or
Keadyi' s -20 0 23 Federal income tax return .
Petitioner' s accountant,
Robert W.sNicolini,trC.iP..A.4 (Mr. Nicolini), Wassmoteaware of the
paymentsi or that -KSM lhad a - bank saccount swith: Centennial Bank . On - May~ 20 , 2004 , KSM paid $38, 800 to 419 Plan
Administrators ,
a 1
a?
the snewe Plan Administrator ; to cover Keady' s
obligation sunder ?the-21an'. y Of thats amount, $36, 000s wast paid to
coverathe, Plan contribution and $2,800 was paid as the 'Plan fee.
The checks were 'drawn on the, "KSM Limited Partnership Escrow -*
Account, c o Crawford Wilson and Ryan LLC" s(KSM escrow
account),.
T
The KSM sescrow account was maintained at National
"The record does not reveal at what point Compass Bank
assumed the role of Plan Trustee .
a EThe record adoes not reveal when 419 Plan Administdators
became the Plan Administrator.
KSM paid this amount using two checks,l one for $38, 000,
dated May 20, 2004, and the other for $800, datedrMay 20, 2004.
- 10 Penn Bank. - When Mr. Nicolini -prepared KSM's 2004,'Federal income.
tax return,r he -discovered the =$38;800 in payments añade to 4194
Plan Administrators.
Mr. Nicolini das not aware that'KSM ore
Keady was participating in the Plan.
Mr. Nicolini-asked Miranda,
the tax matters partner ,of KSM, about the payments - " Miranda, who
was unable to verify the payments, thought they were for a horse.
Mr. N colini recorded the a ounts as payments for "horses" and
"bookŠl"; them as an asset on KSM' s balance sheet .
never
Mr .- Nicolini
epreciated the "horses"' on KSM' s balance .sheet / and
during 2006,-;the "horses" wdre distributed to the Cadwells as a
capital distribution.
Lincoln Life credited petitioner's life
insurance poiicy for an $18 000 payment for ithe month ended
September 6, -2004.
»
On Dune 5., 1995, the Internal Revenue Service (IRS) issued
Notice 95 34, 1995-1 C.B. 309, which described certain
multiemployer plans (MEPs) that do not qualify under section 419A (f ) (6) .
In Notice 2001g51,
2001-2 C.B.
190,
,
the I-RS
desigr ated those transactions described ii Notice 95-34, supra,
as "listed transactions" subject to enhanced disclosure
The record does not rgveal why petitioner's life insurance
policy was not credited with a $36, 000 payment or shy
petitioner' s payment in May was not credited until September.
Petitioner' s life insurance policy was not creditied with a
payment for 2005.
e
- 11
requirements.4
Act of 2004,
On Octobere22
Ptib. L. 108-357
2004, t he American Jobs Creation
sec.
811(a),41182 Stat.
157/5, became
law and instituted a new penalty for fallùre to -disclose a listed
transaction.
See sec. 6707A.
On- Novemb¯er 17, 2004, Niche sentalettets to the employers
participating¿ in the Plan announcing* that the Plan had been split
into singlse-employer welfare benefit plans
SEP) . 5
SEPs or individually
The feasons stated in the ietters for the donversion
included more employer control over Plah rassets arid the concern
that the Plan might be subject to listed trarisactiön penalties
under Necti'on 6707A.
Niche's letter acknowledged that the SEPs
no longer quaelified for treatment pursuarituto section 419A(f) (6),
and, therefore, the deductibility of the employer' s contfibutions
would bes limited.« Keady's employees welsfare benefit plan was
"Notice 2001-51 2001-2 C.B. 190, was supplemented and
superseded -by Notice 2003-76, 2003-2 C.B. 1181 which was sa
supplemented and superseded by Notice 2004-67, 2004-2 C.B. 600,
which was .supplemented and supe,rseded by Notices 2009-59, 2009-31
I.R.B. 170. Notice 2009-59, subra, includes transactions
desgribed in Notice 95-34, 1995-1 C.B. 309, as listed
transactions.
Liste transactions are transactions that are the same as or
substantially similar to those transactions that havegeen
determined by the IRS to be tax avoidarice transactions and have
been identified by notice, regulation, or other formeof ,published
guidance . . Sec . 1. 6011-4 (b) (2) , Income- Tax Regs .
asAccording to the letters, the change was made effective,
retroactively to Jan 1, 2004. However, we treat the change as
actually occurring ori-Nova. 17 2004, as this ais the date of the
actual conversion.
a
- 12 -
renam d the "Keady, s Ltd. We fare Benefit Plan't , and. the assets
were maintained by the National Benefit Trust IIr.
Øn December 30, 2004, I iche and Wells Fargo, as Trustee,
entered into a new trust agreement for the National Benefit Trust
II.
By its terms, the: agre ment ist a ,"complete amendment and
restatement" of the original trust agreement.
Significantly, the
new agreement provides that the Plan Administrator is now the
emplo er unless< the employeÊ designates another person or persons
to be Plan Administrator. . The new agreement provides that the
emplo er, Keady, scan terminate the SEP at any time.
In-the event
of Keady's withdrawalN fromithe SEP, at the send of the 123-month
perioc - following the date Kéady terminated the SEP (the 23-month
perioc ) , the Trust has the option to distribute the life
insurance policies to «Keady
sell the life insurance policies to
any ir terested purchaser with an insurable interest in the
employees, or surrender the life insurance policies to the
insurance company for theiricash surrender salue.
Additionally,
the T ust can sell petition r his life insurance policy.'
the 2
month period, Keady
During
ould be required to continué paying
the annual cost of the lifeninsurance.
If petitioner were to die
beford the end of the 23-mo th period, he wòuld still be elig ble
for- tlŠe death benefits undé
the SEP.
The new agreement setting up the SEP appears to use
emplo er "withdrawal" and eàployer "termination", interchangeably.
!!
13 -
" Keady, KSM, pétitioner,' Mrs. Cadwell, Miranda, and Jenniffer
were not consulted by Niche before the split of the Plan into
separate $EPs . . Keady,a KSM, petitioner, Mrs . Cadwell;2 Miranda",
and Jennifer did not attempt to access or use the Plan benefits
at any time during *2004 or 2005.
Petitioner. didGnot include on
his Form 1040 for his 2004 tax year any income resulting from the
conversion of the Plan from an MEP to an SEP
-
During December 2004, the life insurance policy hovering a
petitioner had a death benefit value equal to $1,070,529, a
"fund" value equal to $70 529 and a surrenders valuee equal to
$25,237."
The fund value was determined by adding the premiums
paid ($91,000 = $73,000 + $18 000) and interest credited ($6,134
$3, 340 + $2;793)
less. mortality chargesM ($16, 235 =2$7, 738 +
"The death benefit is the projected amount payable upon the
death of the insured. The "fund" value represents the equity in
the life insurance~ policy and is also known as tife casl value "of
the life insurance policy.
"Mortality charges are also referred to as "cost of
insurance charges." The IRS provided the following explanation
of mortality charges in Priv. Ltr. Rul. 2009206 001 n.5 (Oct 17,
2008) :
COI/mortality charges are sdetermined, by multiplying a
mortality rate (which increases with the age of a the insured)
by the "net amount ate risk" (theadifference between the
death benefit and :the cash value, i.e., the pure insurance
element of the contract). Mortality rates are determined
with refei-ence to a particular mortality table * * *.
In other words, the mortality charges approximate the term' life
insurance component of a whole life or universal life policy.
However, because of concerns that finsurers might manipulate such
(cont inueds . . )
$8,497)
and other expenses
($10,370 = $7,730 + $2,64;0) .9
The
a
surrer der value was the amount of cash that petitioner would
recei e upon surrender of the ,life insurance policy to Lincoln
Life
nd ,was calculated by
ubtracting a surrender charge of
$45,2 1 from the fund valuedof $70,529, yielding a surrender
value of $25,237/.
I evin Ryan (Mr . "Ryan) , petitioner' s .counse1 in this case
prepa ed two legal opinionstfor Niche, dated December 6, - 2004
and J ne 16, 2005.
Mr. Ryan began serving as counsel to Niche
after
etitioner was involved yin the Plan.
lette
of December 6, 2004, he stated:
In Mr. Ryan's opinion
QUE$TION: Will p rticipants. in the Trust have iricome
on the current value of the death benefits provided under
tihe -Trust equal to the lower of the so-called ""PS 58 Rates"
r the insurance company' s term insurance rates? * * *
!
ANSWER:
Yes * * *
In his explanation of the t xation of Plan benefits; Mr. Ryan
stated:
( . . continued)
rates, the IRS will not view the mortality charges as the act ual
premium rates for term life insurance unless the insure
generally makes such rates Available to those who apply for term
insurance coverage and the nsurer . regularly sells terin insurance
cover e at such rates. See Notice 2002-8, 2002-1 C.B. 398, 398399.
The interest credits, mortality charges, and expenses are
for 20i03 and 2004.
These dollar amounts are rounded down to the nearest whole
number
-
15 - a
The death benefit
are nontransferable, therefore
subject to a substantial risk of forfeiture and employees
haire no riïght to any cash value, employees should not be
taxed on the death benefit as a transfer of a permanent life
insurance policy. Nevertheless participating employees
receive an economic benefit each year for the death benefit
coverage that is provided for that year. Thus, in
accordance with Regulation Section 1.83-14(a) (2), employees
should be* taxed each year on the 'cost of the Yife insurance
protection under Code Section 61 and the Regulations
thereundea in an amount which is equal to the reasonable, net
premium cost as determined by the Commissioner of the
current-l'ife inéurance protection as defined fin Regulation
Section 1.72-16(b) (3) provided by such contract.
The
reasonable net premium- costs of the current life insurance
protection as defined in Regulation Section 1.72-16 (b) (3) is
the samesmeasure of value fòrelife insurance protection that
qualified retirement plans use. The Service has determined
the reasonable net premium- costs and published those amounts
as "PS 58 rates."
In Rev. Rul; 66-110,
1966-1 C.B. 12,
the
Service held that an employer may use the current published
premium rates charged by an insurer for individual. one-year
term life-insurance availabl'e to all standard risks for
determining the costs of insurance in connection with
individualapo]icies instead òf the PS 58 costs table:
In
Notice 2001-10, an alternative table is set forth labeled
Table 2001.
It tis the Firm' s opinion that þart cipating employees
in the Trust receive an economic benefit for the death
benefit4rotection provided each Cÿear under the-Trust . The
annual tax for such benefits shall be determined in
3 accordance eith Code Section 83 and thea Regulations
thereunder and shall be the lower of the PS 58 table costs
or the insured's term insurance rates in accordance with
Rev. Rul. 66-110.
[Fn. ref. omitted.]
On April 2, 2008, respondent sent petitidner a notice of
deficiency in which he determined that petitioner's gross income
for 2004 should be increäsed by $102, 039.
The unreported income
det ermined by respondent consists of :
(1) The f
life insurance policy as of Decenber 6
Ô04,
f
d value of the
70 529
(2) the
å
- 16 -
excess contribution to the Olan of $18,000," and ( ) the cost of
term life insurance on petitioner's life for 2004 of $13,510.
Petitifoner timely filed a petition in this Court.
Discussion
Rule 121(a) allows a party to move "for a summary
adjudication in the moving party's favor upon all or any part of
the 1 gal issues in controv rsy."
Rule 121(b) directs that a
decision on such a motion shall be rendered "if the pleadings,
answe s to interrogatories, depositions, admissions, and any
otSer acceptable materials, together with the affidavits, if any
show that there is no genuir e issue as to any material fact and
that
d cision may be rendered as a matter of law."
The moving party«bears the burden of demonstrating.that no
genuine issue of material fact exists and that the moving party
is -ent itled to judgment as a matter of law.
Commissioner, 98 T.C. 518, 520
(7th Cir. 1994) .
Sundstrand Corp. v.
(1992), affd. 17 F.3d 965
Facts are viewed in the light most favorable to
the nohmoiring party.
Id.
However, where a motion for summary
judgment has been properly made and supported, the opposing party
may not
est upon mere alle ations
denials in that party' s
In the notice of defiaiency, respondent contends that the
value of the excess contribution was $18 , O O0 . Respondent concedes that of the $38,800'contributed, $2,800 was for the Plan
fee ar d $18, 645 was for life insurance premiums ($18, 000 for
petitioner and $645 for MirÅncia and Jennifer) . Therefore,
respondent contends that the excess contribution of $17, 355
should be included in petitioner' s gross income .
17 -
pleadings· but must by affidavits or otherwise0 set forth specific
facts showing that there is a genuinesissue fot trial
Rule
121 (d) .
I
Caselaw Concerning Section 419A (f) (6). Plans
The issues -wes must .decides concern the income tax
consequences±of.employee we]:fare benefits;.«
Generally
contributions to welfare benefit planse are deductiblie bya an
employer when paid if they qualify.as ordinary :and necessary
business expenses, but only to the extents allowed byssections 419
and 419A.
Secs . 1624a) / 419,319A (f) (6)
In recent: years, a
adopted -multiemployermplans have been claiming to satisfyrsection
419A(f) (6) and purporting:to generate de.ductionss for the e
,
insurance benefits ];>rovided underethe plans , "Notice 95 34,
supra.
This Court has decided several cases regarding purported
section 419A ( f ) (6 ) plans .
2
In Booth v. Commissioner»<108, T.C.
524,a 565
(1997)
we held
that the plan in issue did not meet the requirementse of secti:on
419A (f) (6) because, it, was, "an aggregation of separateswelfare i
benefituplans, each -of which has an experience-rating arrangement
with the contributing employer."
v. Commissioner, 115 T.C
43
In Neonatology AssociatesoP.A.
(2000)
affd. 299f.3d 221 (3d Cir.
2002) , without deciding whether the plans in issue met the
requirements of section 419A(f) (6), we helde that the corporate
employer/participants may not "deduct contributions in excess of
- 18 -
the co t of .term life insurance-.
disallowed deductions shoul
We' also held that the
-
be treated as divi'dend distributions
to the employee-owners of tl e C corporations to the extent- of
earnings and profits.
Id..
t 96-97.
In V.R. DeAngelis M.D.P.C.
v. Commissioner; T.C. Memo. 2007-360, affd. per curiam 574 F.3d
789 ( 2
Cir. 2009) , similar]y without ruling on whether the plan
met tl e requirements of- sect ions 419A(f) (6)', wes held that payments
for life instirance were essentially a distribution of S
corporation profits: rather t han payments inade with compensatory
intent.
r
In Curcio v. CommiÈsioner, T.C. Mem'o. 2010-115, aga~in
without ruling - on whether tlie plan met the requirements of -
section 419A(f) (6) , we held that contributions were distributions
of prc its to the employee-owners andonot deductible pursuant to
section 162 (a) .
We did not address in any of the foregoing cases the taxe
conseduences to- a nonowner
that
rportedly met "the recuirements of section 419A(f)?(6) and
subsecuently was converted
We mus
nto a splan that no longer qual-ified
decide the consequei ces to spetitioner of cont ibutions to
such a plan. II.
m];Šloyee for contributions to a plan
C
Whethei Respòhdent Was Rdquired- To Sènd a "30 day letter" to
etitioner and Whether the Notice of Deficiency Is Invalid
Because Respondent' s Posi-tion Is Not Adequately Set Forth
his petition and mot ion for summary "judgment, petitioner
conterds that respondent failed to provide him with a "30-day
19 -
letter", befores issuing a notice 'of deficiency and failed to
provide a speciTic theory of the''case in the notice of r
deficiency.
Generally, we wïll not look behind a notice of
deficiency to examine the 'evidencé used', the proprietys of the.
Commissioner's motives, of administrative policy or procedure
usedein making the determination.
Greenberq'á Express, Inc. v.
Commissioner, 62 T.C. 324,2 327 '(1-974) .
Accordingly, we will' not
look into respondèntis .alleged failure to issues a 30-day letter,
NId.
As to whether the notice of deficiency; is invalid behause it
insufficiently sets forth respondent s pdsitior
section 7522(a)
requires that the notice "describe the basis for, änd identify
the amoiints (if any) of, the taxsdue
interest, additional
amounts, additioris to the tax, and -assessable penalties included
in such no'tice"."
Theepurposes:of section 7-522 is ito provide the
taxpayer with notice of the Commissioner's basis for determining
a deficiency.
Shea v. Commissioner,
112 T.C.
183,
196
(1999) .
The notice needs to be sufficient to permit the taxpayer to
comply with the requirement of Rule 34 (b) that ,the taxpayer make
clear arid côncise ässignmerits of every error älleged against the
Cömniissioner."
id.' at i96 197
We há.Yë held ,that section
"Rule 34 (b) requires that the petition contain:
4) Cleaf and concisë assignments of each and every
-error which the petitioner alleges to have been committed by
(continued. . . )
20 -
7522 ( ) does not require th
Commissioner, to identify the
speci ic statutory provisior supporting each adjustment in the
notice of deficiency.
(20 06) ,
af f d.
Wheeler v. Commissioner, 127 T,.C.. 200, 205
521 F . 3d 128 9
(10th Cir . - 2008) ; Rogers v .
Commi sioner, T.C. Memo. 2001-20, affd. without published opinion
281 F.3d 1278
not r
(5th Cir. 2001) .
Additionally, the Commissioner is
uired to lay out the afactual basis for his determination
in the notice of deficiency
Commissioner,
Cir.- 2010) .
132 T.C.
105,
Ocmulgee" Fields,- Inc. v.
113
(2009) ,
affd.
613 F.3d 1360
(11th
Moreover, evendan inadequate description of the
Commi sioner's basis in the notice of deficiency will not
invalidate the notice .
Sec
7522 (a) .
etitioner received a I orm 886-A, Explanation ofaItems,
accom anying his notice of deficiency.
2The F
m 886.-A explains how3the IRS determined petitioner' s
defici ncy and states:
(. . . continued)
the Commissioner in the determination of the deficiency or
liability. The assignåents of 'error shall include- issue9 in
espect of which the burden of proof is on the Commissioner.
Eny issue not raised iri the assignment 'of error shall'bé
deemed to be conceded. Each assignment of error shall be
separately lettered.
(5) Clear and concise lettered statements of the facts
n which petitioner bases the assignments of error, except
ith respect to those Åssignments of error as to which the
urden proof is on the Commissioner.
- 21 -
7 a
e OthersIncome - Niche,Conversion/Contribution
It has been determined ethat you received income in the
amount of $102,339.00 in the taxable year ending December
31,
,
a
2004, unders the provisions .of I.R. C.- §§ 61
72
83 and
402 (b) as a result of your participation in the National
Benefit-Plan and :Trust -Plan..and it's- [sic] companion Trust
and the Keady Ltd Welfare Benefit Plan Single Employer Plan
and it's [sic] companioniTrusta.» Accordingly, your taxable
income is increased by $102,039.00 for the taxable year
December -31 2004.
The quoted explanation -recites -the Code sections .on which the IRS
relies even though -specific citations are not required for the
notice to beavalids.
See Wheeler v.- Commissioner, supra at 205;
Rogers v. Comniissioner, supra.,
Ins therinstant case, the a ,
explanation provides suf ficient, detail- that petitioner should be
able tosunderstand thate the Plan s conversion to an SEP is the
source of the income respondent determined.
Accordingly, we hold
that the notice of deficiency, with the accompanying Form 886-A,
provides an adequate basis for understanding the IRS'
determination of tax due .
Consequently
we hold that
petitioner' s contention is without merit and the notice of
deficiency is valid.
III. Inclusion in Petitioner's Income of the Cash Value of the
Insurance Policy Upon Conversions From MEP-to SEP
«We next address whetherapetitioner must include inshist gross
income the, cash- value of- the insurance: policy upon conirersionhof
the Plan from an MEP to an SEP.
Respondentecontends that
petitioner became substantially vested in the-Plan -upon-its
doriVer'sion from an MEP to "an SEP pursuan
tå se26ion 1.4 2 (b) a
- 22 -
1 (b) , Income Tax *Regs .
Petitioner contends' that he has no
interest in the Plan because the terms "of the Plan and the
involuntary nature of the cònversion of the Plan from an'MEP to
an SE
preclude him from being "substantiially" vested in the Plan
or the Plan assets .
Incomd Tax Regs.
See se . 402 (b) (1) ; sec . 1. 402 (b) a l (a) (1) ,
Additionally, petitioner contends that the life
insurance policy premiums were. paid with Mrs: Cadwell's after2tax
funds and, therefore, .result
section 2523.
in a gift to Mr. Cadwell pursuant to
In the alterAative, petitioner contends that,« if
he has an interest in the, P an, respondent has overstated itsa
value.
We address each of
hese issues below.
hether PetitioneÝ Is Substantially Vested in His
Interest in the Plan
S ction 402(b) (1) provides that employer contributions made
to a
onexempt employee truât" are included in the gross income
of the eit1ployee to the extent that the employee' s interest in
such contribution is substantially vested (within the meaning of
section 1.83-3(b), Income Tax Regs.) at the time the contribution
is made .
Sec . 1. 402 (b) -1 (a) (1) , Income Tax Regs .
If the rights
of an employee under a none empt employee trust become
substantially vested duringsa tiaxable year of the employee and
the' taxable year of the trust ends with ~or withinasuch yeaf, the
value oft the employee' s inter'est iF the trust on the "date
f buch
n employee trust is ä nonexempt trust if it is not exempt
from taxation under sec. 501(a). Sec. 402(b) (1).
23 -
change is included sin thee employee's g oss incdme for that
taxable year .
Sec . 1. 4 0 2 (b) 1 (b) (1)
Income Tax Regs .
The
"value of an employee' s interest in a trust" means the amount of
the employee'
beneficial interest in: the, net fair market value
of all of tihe isset's in thettrust 'as ofs~any date on which some or
all of the employee' s intérest in, the' trusts becomes substanti-ally
vested.
Sec . 1 40 2 (b) 1 (b) (2) (i) , Income Tax Regs
The "net <f air
market v¯alue cof all of the assets in the trust is the total
-
amount of the fairamarket valu s r(deteianined without regard to
any lapse restrictiori, asadefined? in sectilon K.83 3 (h) ,2 Inchmen
Tax Regs.) of all of the assets in the trust
lessAthe amount of
liabilities, as of the date orr which some ör all of the a
employee' s interest in the trust becoines substantially vested.
Id.
If only a portion of an employee' s interest in thei trust
becomes, substant'ial];y avested during a taxable year, only the
corresponding part of the trust valùe is incladable in the
employee' s gros s income .«
Sec . 1. 402 (b) -1 (b) (4) , Income Tax Regs .
An employee' s interest in property is substantially vested
when it is either transferable or not subjëct to a substantiial
risk of f orf eiture .
Sec . 1. 83 -3 (b) , Income Tax Regs .
Whether a
risk of forfeiture is substantial depends on the facts and
circumstances.
Sec. 1.83-3(c) (1), Income Tax Regs.
A
substantial bisk of forfeiture exists:
where rights in property that are transferred are
conditioned, directly or indirectly, upon the future
- 24 -
e
erformance (or refrai ing from performance) of substantial
services by any person or the occurrence of a condition
elated to a purpose o the transfer, and the possibility of
forfeiture is substantial if such condition is not
satisfied.
* * *
Id. , Property is not subjects to a substantial risk of forfeitùre
if the employer must pay fair market value for its return or .
there is risk that the property'ssvalue may decline.
Id.
In
instances= where an employee of a corporation owns a significant
amount of the total combined voting power or value of all classes
of st ck in the employer coiporation, the issue of whether an s
employee' s interest is, subj ct to a substantial risk of
forfeiture -also depends upon:
i) the employee' s relätionship to other stockholders and
t he extent of their coiitrol, potential control and possible
]oss of control of the corporation, (ii) the position of the
mployee in the corporåtion and the extent to which he is subordinate to other employees, (iii) the employee' s
elationship to the of(icers and directors of the
corporation, (iv) the yerson or persons who must approve
the employee' s discharcje, and (v) past actions of - the
employer in enforcing he provisions of the restrictions;
* * *
Sec.
1.83-3(c) (3),
Income T x Regs.
Both parties treat petitioner' s interest in the Plan as
subjedt to a substantial risk of forfeiture before the Plan' s
conversion to an SEP on November 17, 2004.
issue
As stated above, the
f whether the Plan qùalified pursuant to section
419 (A) (f) (6) before conversion is not in issue.
Therefore, for
purpo es of the instant motions, we will assume that before the
25 -
PlÃn' s
onŸersion from' an -MEP to an "SEP; the Plan' s assets wére
subject to a substantial*êisklof forfeitur'e.
On November 1
2004,I Niáhe imeñded dhe
Plan 'fróm an MEPito an ŠEP.
Kèady'
ÈEP YeceíÝed its
proportional shanè of 4the Olan' s assŠ€s
Eolverdion öf the Plan, 4tn
only to pay
lan to eonvert the
FolloNing i the
assets ain*Keady' s SEP could be used
e cl'aitúa of 'Keady emplóÿees
The econversion of the
Pl'an from an MEP to an SEP eliminated the r s
that Keady' s
assetis båuld be used to pay othef èmÿloyers' claims .
In oEher
words, a future conditi'on that cotild náve occurred undêrathe
original Plan ad ar MËÈ
cash4Ÿalue of Keady
i . e . , another côtåpany' s å laimr to the
'
life insurance policies, no "longer existed
uhder thè Plan as añ SEP.
See sec. l 83-1 (c) (1) , IncomeGTax a *
Regs .
According to it
time.
terms, Káady could terminate the "SEP' at any
In the event- of ari ehþloye
withdrawal from*the SEP, the
Trust-could distribute the life sinsuiance policies to Keady, sell
the life insurance pòËicieå to any interested purchaser with an
insurable interest in the emplófees, or eurrendeEthe life
*
insurance policies to- the insuí-ance company- för their cash
surrender value'.
Additionally, the iTruste could sell petitioner
his life insurancé policy.
While section 1.83-1(c) (3), Income Tax Regs., is not
direct-ly applicable because petitioner does not own any of
26 -
Keady' s stock, it is instructive under the circumstances of the
instant case .
Keady."
Petitioner' s
ife is the sole shareholder of
At the time of the hearing, petitioner and Mrs. Cadwell
were still married.
The recòrd does not contain any evidence of
strife in petitioner's working or personal rélat ionship with Mrs.
Cadwel .
and th
Petitioner listed Îlis position as "Secretary" of Keady,
record does not include any information regarding other
of f icers .
Mrs . Cadwell r is the only direc tor .
Ac cordingly ,- we
conclude that petitioner is Åhe sole officer of Keady and that he
was not subordinate to any oÊher employee.
Stat.
nn. sec. 1732(a)
(Wesp 1995)
See also 15 Pa. Cons.
(every corporation must have
a pres dent, a secretary, an
a treasurer and these offices mgy -
be hel
As the sole officer of Keady, hê
by the same person) .
had coÀtrol over his own eligibility under Keady's SEP.
-Additi nally, as the sole officer, petitioner could terminate the
Plan a d have the assets distributed to Keady.
Petitioner cites Booth v. Commissioner, 108 T.C. at 564,<for
the pr position that his power to terminate the Plan does not
requir
the inclusion of the cash value of the life insurance
policy in his income.
Petitioner contends that if he were
required to realize income based on his power to terminate, the
Plan contributions would be taxable upon funding.
In Booth, the
I'he parties do not colitend that fainily attribution rule's
apply
e 27 -
Court determined whether the plan in issuerwas
compensation plan.
deferred
We stated:
Although frespondent is concerned that, the ability of a' participating employer to terminate voluntarily its
participation in the, * * * [planl allows the employer too
control the timing of income to its employees, we regard
that concern as - misplaced. Respondent ' s cóncern could also
be expressed with respect to the pension plan of a
corporation owned by a single ,shareholder.. Although the
shareholder may be the only employee, it does not
necessarily follow that such a þension plan provides -for
receipt of deferred compensation merely because the
owner/shareholder has the" ability to terminate theapension
plan at will.
Id.
Booth is distinguishable from the instant case as deferred
compensation is not in issue here.
Moreover, because the Plan is
a nonexempt trust, the taxation of an employee on contributions
;
made .on his behalf turns on whether the employee's interest is
substantially vested.
Regs .
See sec . 1. 402 (b) -1 (b) (1) , Income Tax
Whether an employee' s interest is substantially vested
depends-upon all of the fact s .and circumstances, .including the
employer's ability to terminate the Plan.
See sec. 1.83-3(c) (1),
Income Tax Regs.
Petitiòner, also contends that the vesting schedule prevents
him from having a vest ed inderes
in the
P during Š00 .
Additionally, petitionei- contends thay, if aby intei-est was
vested, Mrs. Cadwell could fire him at will, and, the efore, hi.s
benefits under the SEP remained su
fårfeitu e.
W
disagi-e .
ec
tó a sub tantial risk of
28 -
We conclude that- the vestings restrictions are illusory under
the c-ircumstances of the instant case.2s
When the Trust's assets
came under Keady's exclusivé control, they became subject -to
petitiloner's control.
As nåted above, petitioner could terminate
the SEP and have the plan assets or their cash: equivalent
distrrbuted to Keady.
apply
Moreðver, if the vesting schedule were to
the power to enforce the restrictions against pet:itioner
would be in the hands of pet itioner, his wife, or hi-s daughters.
Under such circumstances, the restrictions on petitioner's power
to obt ain the Plan proceeds are illusory.
Petitioner relies upon Olmo v. Commissioner, T.C. Memo.
1979-286, a case in which we held that the taxpayers' interest in
nonexempt trusts was substantially vested only to the extent of
the vesting schedule.
by tw
In Olmo, a professional corporation owned
unrelated taxpayers, each a 50 percent shareholder,
establis
d a pension trust and
profit-sharing trust.
taxpayers were each 40 percènt vested.
The
To increase their vesting
We note that according to its terms, if the Plan no longer
qualifies as an MEP pursuant to sec. 419A(f) (6), the Trustee was
to tejmihate the Plan. Upog termination,- the assets would be
distributed to each coveredli employee' in an amount, equal to h'is òr
her b nefit balance. Additionally, each covered employee ,would
be 10 percent vested in hiil or her benefits upon termination
Howev r, the Plan could be, àmended at, any time with the, vesting
sched le potentially remainirig in effect. The record iå not
suffidiently developed to determine whether the iPlan was properly
amended before it was converted to an SEP. Because we find the
vestir g restrictions illusory, we need not address this argument.
29 -
rights, ethe taxpayers wereerequired to complete future years of
service
and, if theyeleft the business
they-forfeited their
rightse to the nonvested portion of -the plan:
Upon termination of
the trusts, each participant wouldebe 100 percent vested.
Additionally,aif a matter aroses affecting an individual a
taxpayer's status as a participating; member of a trust, the y
taxpayer wassautomatically disqualified from participating in a
decision as to that niatter,.a The Court concluded thats the
taxpayers'· nonvestedainterests were subject to a substantial risk
of forfeiture onsaccount-of the internal controls present.
d.
The - facts of the i:nstant case are distinguishable "from those
of Olmo. a ;In the instant case-, the terms of the-SEP provide that
the : Plan Administrator is the employer .
In ef f ec t , pe t it ioner ,
as the.onlysoffic.er, is the Plan Administrator,.
The Plan
Administratór ,decides all questionsz relating to the "eligibility
of employees to participate" in the : Plan
Unlike in Olmo, ethe-
SEP does "not have a disqualification provision that would prevent
petitioner from deciding questions regarding his own eligibility.
Even if Keady did elect to appoint another person as Plan
Administrator, that person would be chosen by either petitioner,
as sole officer of Keady, or Mrs. Cadwell, as Keady's sole
director.
Therefore
any decision regarding petitioner's
eligibility would be decided by someone with a potential interest
in the li f e insurance policy , i . e . , Mrs . Cadwell , -pe t it ioner' s
- 30 -
wife; or petitioner himself
We concluded above that any -
restr' ctions on 'petitioner'
right to control the disposition3of
the Trust assets are illuso y -
case
Consequently, we find the instant
s distinguishable froà'Olmo v. Commissioner, supra:
etitioner's contention that he could be fired and therefore
lose
is benefits is also w thout merit.
As of the hearing,
petit oner was stiill married to Mrs. Cadwell who was: the 100-
percent shareholder of Keady, his employer.
Petitioner argues
only. that there is a possib..lity that he could be fired by Mrs.
Cadwe]l.
that
Under such circumÙtances, we conclude that the thréat
etitioner could be fired by his wife is illusory and his
interest is not subject to a substantial risk ofi forfeiture.
n the basis of the re ord, we conclude that petitioner's
inter si äin the postconvers on SEP was no longer subject to a
substàntial:risk of forfeitä.re; i.e-.", was substantially vested
upon conversion of the Plan to an SEP.
B.
Ñhether the,Contributioris to the Plan Were a Gift From Mrs.
Cadwell to Petitioner
Alternatively, petitioner contends that the contributions to
the Plan, i.e., the payment
a gift
for the life insurance policy, were
from Mrs. Cadwell to him pursuant to section 2523 and that
all p yments were made using her after-tax dollars.
Petitioner
conter ds that we should apply the substance over form doctrine,
citing Commissioner v. Court Holding Co. , 324 U.S. 331, 334
(1945)
to recognize such payments as a nontaxable gift.
-- 31 -
- Section 2523 allows a donor a deduction in computing taxable
gifts for purposes of computing the gift tax
As Mrs. Cadwell
would be the' hypotlietical' donorain' thé scehario posited by
petitioner, we conclude that section 2523^ does not" apply.
-
Petiltionery may have meantato ácite as support for his contention
sec tion 102 (a) , which exc ludes f rom- gros s income the value of
property acquired by Égift
However, fori reasons discessed below,
section 102 (a) is inapplicable . A
Pursuants tó* the substancenover form doctrine, although the
form of a transaction may literally áomplyawith the'provisions of
the Code, thataform will not be given 'effects where it has no i
business purpose and operates simplys as a device; to conceal the
true character of a transaction.
eU:S. -465, 4692470 (1935) .
See Gregory v.SHelveritig, 293
f, however, the ssubstance of a
transaction accords with its fortn
gi"yén-effëct for stax purpogeš*.
e
that forms wi]:L:be: upheld and
See Blueberri Land Co
Commissioner,
361 F 2d 93,
1002101. (5th Cir.
1966)
1137 (1964) .
Additionally, it is welal settled that "a
v.
affg. 42 T.C.
e ,
transaction is to be agiven its, tax effect in abcord with what
actua-llymoccurred andonot in accord with what might haveoccurred.2"
e
Commissioner v.s NatldAlfalfa Deh drating E Milling
Co., 417 Ü;S.
134
148
(1974)i.
Petitioner' s contention rëgarding "substance over foirmnis
misplaced./The record reveals that tlie $75, 000Epayment made
32 -
during 2002 was paid from a
account held in the name of KSM.
The $38, 800 in payments made during 2004 was paid out of the KSM
escro
account-.
In his declaration filed after the hearing ,on
the instant- motions,, petitioner contends that the premium
paymer ts were made with "aft er-tax funds distributable to [Mrs.
Cadwe 1) , as primary owner of KSM."
In other words, petitioner
claims that the funds belonged to KSM,sbut were "distributable"
to Mrs. Cadwell.
As the payments were not distributed to Mrs.
Cadwe 1, therefore, they would have been made by funds still
owned by KSM:
Consistent with -Natl. Alfalfa, we shall give:
effect to the transaction a
it actually occurred as opposed to
revising the transaction .to create a gift.
On the basis of the record, we- conclude that the substance
and tl e form of the contribàtions were payments by KSM, not Mrs.
Cadwe 1.
C.
Consequently, section 102 (a) is inapplicable .
hether the Cash Value Is Income to Petitioner Where His e
Émployer Did Not Claim Corresponding Deductions for Its
dontributions to the Policy
We next address petitioner' s contention that the cash value
of the life sinsurance policy is, not income to him because neither
Keady nor KSM claimed deductions for contri-butions made during
2002 a;nde 2004.
Petitioner contends that, because a deductions is
avail ble under section 83 (1 ) , the cash value of the .lif e
insurance policy was not income. to him
since Keady would have
claim d a corresponding dedúction for the premium payments .
-
3 33 -
Petitioner' s dontention is emisplaced
Section 402 (b) (1) doe
not
condition the inclusion ainancome on angemployer' s deduction of
the payment
Katherginclusion in gross Tiincome is basedaupon
whether- the trust isanot exempt and whethe
thè taxpayer? s
interesti-isusubstantiainly vested. . See s~ec. 402;(b)"(1) ; sec.
1. 402 (b) -1 (a) (1) ,
(b); (1) ,
Income Max Rege.
section 83 (h) allows a deduction,
Moreover, shïle.
it is not required for a a
contribution to :be included in gross income pursuant to sect-ion
83 (a) .
Therefore, whethenKeady or :KSM claimed a deduction for.
the contributions is immaterial
e
Accordingly, we hold 5thattthe cash values of the life
insurance spolitcy must, be sincluded rin
etit ioner' s grossfincome
for.,his 12004 tax year pursuant to section 1.4020(b)-1(b)S(1),
Income Tax ,Regs. a
D. 4
.
Mt d a e
The AmountuTo Be Included in Petitioner's Gross Income
Respondent contends that the cashavalue ofethe lifet a
insurance apolicy fi's the afund value of :$7,0 , 52 9 .
Pe t it ioner
contends that if ;hemmust includes any amount in his gross income,
only thetcash,surre'nderavalues of the life insurance-policy after
deducting surrender charges of $45, 291- shóùId be so included;
i e . , ,$25, 2382 e:
o Section 1.7402 (b)
e
1(b) (2)t(i)
Income TaxeRegst, provides that
the value of an-employee's intefest-is ethe amount of the
employee's beneficial interest in the net fai'ramarkets value of
- 34 -
all' the assets in the, trust as of many adate ,on which' some nor "all
of the emúloyee's interest inithe trust becomesgsubstantiàlly
vested."
value
The net fair market "va-lue is the totals fair market
:
etermined without rešard 'to any "lapse -restrictions" as
defindd in section, 1.83-3(h), Income Tax Regs.
of liabilities to which suc1 assets, are subject
1(b) ( ) (i) ,
less the amount
Sec. 19402(b)-
Income Tax Regs
Sectional.83±3(h), Income Tax Regs., defines a "nonlapse
restriction" as a restrictión that will never lapse .-
A nonlapse
restr ction is "a permanent limitation on the transferability of
prope ty" ande žequires the transferee to se]"l, or offer to sell,
the p
perty at a price determined under; as formula, andethe
restri t'ion will, continue t
subsequent holder.
Id.
refusad in a particula
apply against the stransferee or iny
For example, a permanent right of first
person, atf price dêtermined under a
formula would' be , a nonlapse y restriction.
-Id. ; see alsö sec .
1.83
(c)
A "lapse restriction"
is an
restriction other than a .nonlapse restrictioni and
Example (.;t), Income Tax Regs.
includes,abut is not limiteckto, a restriction that carries a
substantial -risk of forfeitÚre.
Sec. 1.83-3(i),1 Income "Tax Règs
The f]ush language of sectiön 1.83-3(h), Income Tai Regs., .cites
limit
ions imposed "by registration requirements of Stahe or
Federa
security laws as ex mples of 'restrictions that ga're not
nonlapsea restrictions .
35 Rev.
Proc.
2005-25,
2005-1 C.B.
962, provides a safe harbor
for determining the fair market value of a life insurance policy
for purposes of applying section 402(b), and petitionerchas not
suggested any reason for deviating from the formula its a
provides.
For a nonvariable-or variable life insurance
s
contract the safe-harbor fair market value is the greater-of:
A).the,sum of the interpolated terminal reserver and any
unearned premiumš plus a pro rata portion of a reasonable :
estimate of dividends expected to be paid for that policy
year based on company experience, and B) the product of the
PERC amount (the amount * * * based on premiums earnings,
and reasonable charges) and the applicable Average Surrender
Factor * * *
_Id.
sec.
3.02
2005-1a C.B. at 963-964.
The PERG amount ,is the
aggregate of :
(1) the premiums paid from the date ,of issue through the
valuation date without reduction for dividends that offset
those premiums, plus (2).dividends applied to purchase paidùp insurande prior to the valuation date, plus (3) any
amounts credited (or otherwise madesavailable) sto the
policyholder with respect to premiums, including interest
and similaraincome items (whether credited oramade available
under the contract or to some other account), but not
including dividends used to offsetspremiums andsdividends
used to purchase paid up insurance; minus (4) explicit or
implicit reasonable mortality charges sand reasonable charges
(other than mortality charges) , but only if those charges
are actually charged on or before the valuation date and
those charges are not expected to be refunded, rebated or
otherwise reversed at a later date, minus (5) any
distributions (including distributions of dividends and
dividends held on account), withdrawals, or partial
surrenders taken prior to the valuation date.
is applicable to
e
nonexempt employees' t-rusts for purposes of sec. 402(b): for
periods on or after Feb. 13, 2004. Rev. Proc. 2005-25,asec
Rev. Proc.
2005-25
5,
2005-1 C.B. at 965.
2005-1 C.B.
962,
- 36 Id.
For variable contracts
the revenue procedure defines the
fair narket value' in a subs antially similar mannei 'as for
|
nonvariable contrac t . "
Id .
se~c . 3 . 0 3 .
As the valuat ion
methods are substantially similar, we need not decide whether the
life
nsurance policy is a
ariable or nonvariable life insurance
contr ct.
ccording to Rev. Proc. 2005-25, supra, the surrender charge
should be disregarded for váluation- purposes.
The surrender
charg s apply in decreasing amounts beginning in the life
insur nce policy's first year and are reduced to zero in'the life
insur nce policy' s 15th yeá½.
life
In other words, any holder of the
nsurance policy beyond 15 years could redeem therlife
insurance policy for its stäted cash value with no penalty.
Accorclingly, it will be dis egarded for purpose of valuing
petitioner' s interest -in th
life insurance policy.
Proc.
2005-1 C.B. at 964
2005-25,
sec.
3.04(1)
Surrender' Factor for purposes of § * * * 402 (b)
See Rev.
("The Average
(for which no -
adjust ment for potential suírender charges is permitted)
18
1.00.") .
For variable contractå, the only difference occurs in step
3. Fór step 3, "all adjuståents (whether credited or made available under the contraci or to some other account) that
reflec t the investment retuên änd the market value of segregated
asset accounts" are added or subtracted to determine the PERC
value.
Rev. Proc. 2005-25,
sec.
3.03,
2005-1 C.B. at 964.
é
37
-
On December 31, 2002, AKSM paidt $75, 000 to the Plan Trustee
to cover Keady' s initial contribution and $2, 050 to cover the MEP
fee.
Of the $75,000 payment, $73;000 was credited to
petitioner's life insurance policy.
On May 20, 2004, KSM
contributed $36, 000 for the Plan' s premiums and $2, 800 to cover
the Plan fee.
Of the $36,000 contribution, $18,000 was credited
to petitioner's life insurance policy.
During 2003 and 2004,
petitioner' s life insurance policy was also increased by interest
payments of $6,134, for a total of $97,134.
Petitioner's life
insurance policy was decreased during 2003 and 2004 for mortality
charges of $16,235 and other expenses of $10,370, respectively,
for a total of $26, 605.
As noted above, petitioner' s interest in
the life insurance policy is not' reduced by any surrender
charges .
Accordingly, we conclude that the PERC value of
petitioner's interest in the life insurance policy is $70,529.
Neither party contends that the alternative valuation
measure allowed pursuant to ReÝ. Proc. 2005-25, supra, would
result in a higher valuation.
Additionally, neither party
contends that petitioner's life insurance policy is subject to
any liabilities .
See sec . 1. 402 (b) -1 (b) (2) (i) , Income Tax Regs .
Accordingly, we hold that petitioner must include in gross income
the cash value- of the life insurance policy of $70,529.
"Petitioner does not contend that the premitimà, iriterest
credits, mortality charges, or other expenses should he prorated.
Accordingly, we deem this argument conceded.
!
- 38 -
IV.
Whether Petitioner Must Include in Gross Income the Excess
Contributions
During 2004, KSM contributed ]ife insurance policy premiums
of $36 000.
Petit-ioner's lífe insurance policy was credited with
a payment of $18,000.
Respondent concedes that $645 of the
remair ing $18, 000 was used to pay the annual premium on Miranda' s
and Jennifer's policies.
Respondent contends that the excess
contribution, $17, 355, should be included in petitioner' s gross
income pårsuant to section 1. 40 2 (b) -1 (b) (1) , Income Tax Regs .
És discussed above, the parties treat petitioner' s interes
n the P an before conversi n as being subject to a substantial
risk of forfeiture, i.e., not substantially vested.
above
We concluded
hat, following the conversion of the Plan to an SEP,
petitioner' s interest was stíbstantially vested.
See id
Additionally, neither party contends that the excess contribution
is sul j ec t to any liabilities .
Tax R gs.
Sec . 1. 402 (b) -1 (b) (2) (i) , Income
(the net fair market value of a taxpayer's interest iri
the trüst is the fair market value of all the assets less any
liabilities to which such assets are subject)
Petitioner makes the same contentions with respect to 'the
inclusion of the excess contributions in gróss income as he did
with respect to the cash value of the life insurance policy
i.e., the Plan contributions were a-gift from Mrs. Cadwell, and
he has no interest in the Plan.
We apply the same analysis as we
39 -
did above and conclude ethat petitioner s contentions are without
merit.
Petitioner also contends that the excess contributions have
been accounted for in the cash value of the life insurance
policy.
Of the $36, 000 contribution for life insurance
protection made during 2004, $645 was credited towards Miranda's
and Jennifer's life insurance policies.
In the PERC calculation
set forth above, $18,000 of thee$36,000 was credited towards the
cash value of petitioner' s life insurance policy.
The $17, 355
excess contribution was not credited toward the cash value of the
life insurance policy covering petitioner discussed in the PERC
valuation above .
Consequently, the inclusion of the excess
contribution in petitioner' s inconie would not be "doublec ount ing" .
Accordingly, we hold that the excess contribution of $17, 355
must be included in petitioner s gross income for his 2004 tax
year
Petitioner cont rids that respondent has overitatedOhe
value of the excess contributions. Where a motion for summary
judgment has*been proberly niade and súp½orted, the onposing pärty
may no,t rest upon mere, allegations or, denials in that,party's
pleadincjs but must by afficiavits or othei-wise set forth'specific
facts showing that there is a genuine issue for trial. Rule
121(d) . Nespondent's motioå was properly made and supported
Petitioner has not offered specific facts to show that there is a
genuine issue" för" trial begarding' the Nalue of the excess
contributions . Accordingly, we sconclude that summary judgment is
appropriate on this issue.
- 40 -
V. 3
Whether Petitioner Must Include the Cost of the Life
Ínsurance Protection iå His Gross Income
Respondent contends thÅt the cost of life insurance
proteòtion Keady provided to petitioner during 2004 was an
economic benefit and, therefore, should be included in -his gross
income under section 402 (b) or section 61.
that neither section is applicable .
Petitioner contends
We agree with respondent
that dhe value of the cost of life insurance protection is
included in petitioner' s gross income under section 61.
Gross income includes income from whatever source derived,
including income for services.
Sec. 61(a).
The term "gross
income" is construed broadly, as opposed to exclusions from gross
income, which are construed narrowly.
515 U S. 323, 328 (1995) .
Commissioner v. Schleier,
Generally, life insurance premiums
paid
y an employer on the life of his employee, where the
proce
s of such insurance are payable to the beneficiary of the
emplo ee, are included in the gross income of the employee.
1.61-
(d) (2) (ii) (A) ,
Sec.
Income Tax Regs.
We note that section 1 61-2 (d) (6) , Income Tax Regs . , does
li
not a ply, because, pursuant to section 1.83-3 (e) ,. Income Tax
Regs . , current life insuranae protection is not "property" /
noted
bove, section 402(b) 1) is inapplicable.
cost
f life insurance protection generally is taxable under
Moreove , the
section 61 and the regulations pursuant to section 61.
1.83-
(a) (2),
Income Tax Re s.
As
Sec.
- 41 Pèt-itióner rede ved life insurance -protection pursuant to
the payments mades by KSM to purch'ase the life "insúrance policy on
þetitioner's lifes
That life insurance proteetion wasaarvaluable
benefit ande significant accession to þetitioner's wealth; i.e.,
$1 millaion- payable to' his2daughters if he were' ato die during
2004. leSee Uh'ited States
Burke,
("Conejresi-intèrided throughã§-61(a)
definition of income Iany
(1992)
* * * to bring within the -
a cession to wealth "
Coinmissio~rièr' v.a Glenshaw Glass
In V R. DeAngelis M.D.P.C
504-U.S: .229, 2233
Co . ,E348 U. S
(quoting
426, 431
(1955) ) ) .
Y. Commissioner, T.C. Mema. 2007-360,
a group of doctors aombined-to form"a~trúst,spurportedly
quali'f ied pur'suant to seet ion 41ŠA( f ) :(6 ) , whose purpose* was to
fund the" purchase of li<fe insùrance poLicies".
'Inidiscussïng the
tai conse uences i of- the premium payments int V. R.« DeAngelis
M.D.P/C., we steted that t e "payments of the premiums were
indeed accessions to athe doctors' wealth"
° NSiinilarly
the -
pre nium paymerfts are accessions to petitio'ner' se wealth and should
be incl~uded irChïs g os's income þursuant to section 61.-
3°In V.R. DeAngelis M.D.P.C. v. Commissioner, T.C. Memo.
2007-360, we held that the premium payments were "essentially a
distribution to the doctors of corporate profits rather, than a
payment that the PCs made to the doctors with a compensatory
intent", because -the doctor-employees were also the owners of the
S corporations that provided them with benefits.
See also
Neonatology Associates P.A. v. Commissioner, 115 T..C., 43 (2000)
(premium payments are a dividend to the extent of earnirigs and
profits to employee-owners of a C corporation) , affd. 299 f.3d,
221 (3d Cir. 2002) .
- 42 P titioner:offers the sáme-theories regarding the current
year.cost of life insuranceoprotection as he-did for the
inclusion of the cash value cof the life insurance policy and the
excess contributions.
Thoses theories, are si'milarly unpersuasive
I
regarding the inclusion of the current year cost of lif.e
insura ce in his gross income . s Accordingly,
-
e hold thati
petiti ner must include in his gross income for-his 2004 tax year
the current- year cost of .life insurance, protection.
Pétitioner contends that the fair market value of the cost
of lif
insurance is $8,496; i.e., the 2004 mortality charges3
ResponÈl.ent contends that the value of the life insurance
protecNon is $13,510; i.e., -the annual cost, according to Not ice
2001-10, Table,2001,
of lif
2001;-1 C.B. 459,
463,
for $1 mi-llion worth
insurance for an individual who is 66 years old.
The
regulations provide little guidance .in determining the cost of
life insurance protection that is included in gross income
pursuant to section 61.
Accordingly, it is helpful, to examine
how ot er parts of the Code, including provisions governing the
ta:¿ati >n of split-dollar life insurance and .group 2term, life
insurance, calculate the cost of l' year of life insurance
protection.
Generally, split dollar li e insurance is any arrang ment
betweeÈ an owner and a nonodner oÈ a life" insurance contract
where one party pays the prèmiums and is entitled
o recove
al
43 -
or a portion pf such premiums from the proceeds of othe life
irisurance "contract and the arrangem'ent
insurances.
Sec
s not group term life
1. 61222 (b) (1) , Incomë Taxe Regs : RRev . Rul
328, -1964±2: C.B. 11
64
provides that an employee amust include in
gross income etheaannual value of the benefit theaemployee
receives under a split-dollar arrangement,a which is an amount
equal to «the 1-year term cost of life*'insurance protections to
which the employee isv eittitled :from yearNto y'ear, less the
portion, "if any, thetemployee p-rovides.»MSee also Johnson v.
Commissioner; 74 T C
1316
1322 (1980) . AWeenote that Rev. Rul.
64-328, supra, is not an attempt to include in gross income the
entire- life -insurance premium
but rather only the- costrof the
current year' s life insu ance protection.
The 1-year cost of
lifezinsurance protection is. the amount- to be determined in the
instarit case.
«Rev. Rul. 64-328, supra, provides; that the cost3 of life insurance protectionnshould be balculated «using the P.S
58 rates
found in Rev . Rule. e55 -747, 1955 -2 C. B/228d Notice 20 01-10 ,
supra, revoked Rev. Rul. 55-747, supra, and provided Table 2001
as a substitute for the P.S. 58 rates
In, Curc io - v . Commis s ioner , T . C . Memo
rates in section 1.79-3 (d) ,
estimate" of'the
cs
c
2010 -115 , we used the
Income Tax Regs.
as a "rough
life insurance protection to. decide
whether the taxpayer s expenses for fife iËsuranck Were
deductible pursuanti to section 162 (a) .
versi n o
Table 2001 is an updated
the rates found inesection 1.79-3(d), Income. Tax Regs.
See Nc$tice 2001.-10, 2001-1
.B. at 462
("Table 2001 is based on
the mortality experience reÈlected in the y table of uniform
.
premiums promulgated under lection 7.9 (c) of the Code (see § 1.793 (d) ( ) of the regulations)
with extensions for ages below 25
and a ove 70, and the elimination of the five-year age
i
brack ts") ; see also Notice 2002 8, 2002-1 C.B. 398.
«
AccordingjLy, we conclude that
Table
-
for purposes of the instant^ case,
001 .is a reasonable estimate oft the cost of 1 year of life
insurance protection.
ursuant to Table 2001
the cost of $1 million worth of life
insurance coverage for a 66 year-old .is $13, 510 .
As neither
party hasi arguedithat the life insurance policy in issue is
split do).lar life insurance
we need not address any issue
regarding' the effect of split-dollar life insurance on the
calcu ation of the cost of the life insurance policy in issue."
+
Addit onally, neither party contends that petitioner paid for
such
ife insurance coverage.
J:
We note that, if we were to include the entire .$13, 510 amount
in petitioner's incoše, there would be double counting.
The life insurance po .icy in issue may qualify as splitlife insurance pursuant to sec. 1.61-22 (b) (2) , Income Tax
Regs.
However, the outcome would be the same if we classified
the life insurance policy id issue as split-dollar life
insurance .
dolla
- 45 -
Petitioner'.s gìosk incometalready includes ethe cash valüe of the
life insurance policy calculated under the-PERC method.
That
method takes into account the premiums paid and any :other income
thealife insurance policy earns, buti it subtracts mortelity
charges and other expenses.
To' include the entire $13,510cin -
additaion ato- the PERC tvalue would partiall
o
double count a portion
.the premium paymentsthat hast already beèneincluded in the PERC
amount .
Instead,àthe value for currerit year lifet insürance
protect-ion should be calculatedebyyaddingethe inortality charges
($8 4296) ,and othera expenses
($2, 640) .
The sum of $11;136
reflects the -charges zfore currentayearolifeminsurance: that were
already subtractedyfrom theefair market value calcu]:ation
:
4
determineduusing-the PERCuamount, pursuant to Reve Proc-. 2005/25,
supras : Therefore,. we conclude that when thesPERC formula has
"Under the PERC method for 2004, petitioner' s policy yas
credited~ eith an" $18 000 premium payment and Nas credÏted with
$2,793 in interest, yielding a total ofs$20,793. ,However,
petitioner'â ]'ife insurance policy incurred a mortality charge of
$8, 496 and other expenses of $2, 640, for, a net value for his 2004
tax yRr of $9 è$7
Indludidg the entire $1C510 from Notice
2001-10,
Table 2001,
2001-1 C.B.
459,
463, would include .in
petitiorfer's cfrösis irc9me an amount equal to $23~,T67 ($9,657 +
$13 , 510 ) .
In ot-her words , , inc luding the entire $13 , 510. would
double count the cost of life insurarice protîction by an amount
equal to $2, 373 .
($23, 161 (or $13, 510 + $9, 657) minus. $20 , 7.93
(or Šl8, 000 + $2, 793) éqifals $2, 37 . ) Consequently, we deem the,
$2, 373 an amount al eady contributed by peti ioner for purposes
of such calcùlatri'on and, accordingry sübtract that amount from
the $13, 510 in costs . Therefore,, petitioner musta .include in his
gross incoine the valde f Ehe cÏirrent yeak life iniurance
protection as a taxable benefit to him of $11,136.
4
- 46 -
been used to calculated the fair market value of. the ,policy, the
cost
f insurance may be ¡cal.culated by -adding the mortality
charges and other expenses .
i
etitioner contends thät we should only sconsider the current
!.
morta ity chargesurather than the Table 2001 rates.
Petitioner
in es ence contends that the current mortality charges sareuthe
"insu er's published premiudi rates for one-year termeinsurance"
pursuant to Rev. Rul. 66-110, 1966-1 C.B. 12.
2002-8, .2002-1 C.B. at 9398
Pursuant to Notice
99, the insurer'ss published premium
rates may be used only if tl e taxpayer can showsthat the insurer
gener fly makes the availability 'of sucherates known to persons
who a ply for term insuranc
coverage from tihe insurér and ithe
insurer regularly sells tera insurance at such ratestto
individuals who apply for term insurance coverage athrough the
insurer'es normal distributionachannels.
Petitioner does not
argue that the requirements of Notice 2002-8
unrêasonable or incorrect.
judgm
supra,-are
Furthermore, on a motion f r summary
t thàt is prð];>erly'm de and supported,
the o poeing party
must 9et forth specific facts showing that there is a genuine
issue fo
trial.
Rule 121(d) .
Petitioner does not allege that-
he has any evidence that wo ld sat-isfy 'that requirements of
Notice 2002-8, supra.
Furthermore, petitioner does not suggest
that there is a "material ifa tual issue t hat c ul
trial.
Accordingly, we con lude that summa
be resölvec at
udgment is
47 -
appropriate on this issue and that the requirements sof Notice
2002-8, supra; have not been met.
Therefore, w
hold that
petitioner must include in his gross income for his 2004etaxgear
the cost of cuirent year life insurance -protection of $113/136.
VI. - Whether Petitioner Is Liableifor the Sectiona6662 Penalty
Respondent contends thatupetitioner is liable for the s
accuracy-related penalty pursuant rto section 6662 (a) on account
of a substantial understatement of tax, or in the alternative,
on account of negligence or disregard of rules and regulations .
See sec .
6662 (b) (1)
and (2) .
A substantial understatement of income tax is an
understatement that is greater than 10 percent of the tax
required to be shown on the return for the taxable year or
$5, 000.
Sec. 6662 (d) (1) (A) .
An understatement" is the excess of
the amount required to, be shown on the return for the taxable
year over the amount actually shown on the return.
Sec.
66623(d) (2) .
The record reveals that petitioner' s understatement will be
greater than $5, 000 .
Petitioner has failed to establish any
defense to the accuracy-related penalty.
Consequently, we hold that petitioner is liable for the
accuracy-related penalty under 6662 (b) (2) ;
- 48 -
e shall therefore graNt respondent's cross-motion for
summar
judgment and deny petitioner's motion for summary
judgm nt .
e have considered allaof the issues raised by the parties,
and, t
the extent they are anot discussed herein, we conclude
that t hey are without merit, unnecessary to reach, or moot .
o reflect the foregoi g
An order and decision will
be entered under Rule 155.
s
-1
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