Judges: LARO
Attorneys: Steven S. Brown, Denis John Conlon , Allen James White , and William G. Sullivan, for petitioners. Angela B. Reynolds, David S. Weiner, and K. Elizabeth Kelly, for respondent.
Filed: Jul. 13, 2015
Latest Update: Nov. 21, 2020
Summary: OUR COUNTRY HOME ENTERPRISES, INC., ET AL., 1 PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT Docket Nos. 25764–10, 25765–10, Filed July 13, 2015. 11520–11, 11521–11, 12744–11, 12745–11, 12746–11. SP is a purported welfare benefit plan consisting of the respective separate plans that each participating employer customizes to apply to its employees alone. SP pays death, medical, and disability benefits with respect to a participating employee to the extent that his or her participatin
Summary: OUR COUNTRY HOME ENTERPRISES, INC., ET AL., 1 PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT Docket Nos. 25764–10, 25765–10, Filed July 13, 2015. 11520–11, 11521–11, 12744–11, 12745–11, 12746–11. SP is a purported welfare benefit plan consisting of the respective separate plans that each participating employer customizes to apply to its employees alone. SP pays death, medical, and disability benefits with respect to a participating employee to the extent that his or her participating..
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OUR COUNTRY HOME ENTERPRISES, INC., ET AL., 1
PETITIONERS v. COMMISSIONER OF INTERNAL
REVENUE, RESPONDENT
Docket Nos. 25764–10, 25765–10, Filed July 13, 2015.
11520–11, 11521–11,
12744–11, 12745–11,
12746–11.
SP is a purported welfare benefit plan consisting of the
respective separate plans that each participating employer
customizes to apply to its employees alone. SP pays death,
medical, and disability benefits with respect to a participating
employee to the extent that his or her participating employer
selects. Each employer selects the general provisions, the
participation requirements, and the vesting schedule
applicable to its plan. Each employee designates to whom SP
will pay the benefits with respect to him or her. The death
benefit that SP agrees to pay as to a participating employee
is the face amount of an insurance policy that SP purchases
on the employee’s life. The employer effectively pays the pre-
miums on the insurance policy through its payments to SP,
and the insurance policy usually has a cash value component
that increases annually. SP’s payment of any nondeath ben-
efit as to an employee is generally limited to the cash value
1 Cases of the following petitioners are consolidated herewith: Thomas P.
Blake and Cynthia S. Blake, docket No. 25765–10; Netversity, Inc., docket
No. 11520–11; Juan Carlo Mejia and Yvette Mejia, docket No. 11521–11;
Richard J. Abramo and Catherine S. Abramo, docket No. 12744–11; Robert
V. Brown and Andrea Yogel-Brown, docket No. 12745–11; and John A.
Tomassetti and Cathy C. Tomassetti, docket No. 12746–11.
1
2 145 UNITED STATES TAX COURT REPORTS (1)
of the insurance policy related to that employee. An employer
may terminate its participation in SP and cause each of its
employees to be fully vested in his or her policy (including its
cash value). A participating employee, upon retiring, may take
his or her insurance policy in satisfaction of any postretire-
ment death benefit payable as to the employee. O and N are
C corporations, each wholly owned by a single individual; E
is an S corporation owned equally by three other individuals;
and each of those five individuals was employed by the cor-
poration he owned. O and E each participated in SP and
caused SP to purchase insurance on the lives of their share-
holder/employees. N participated in SP but did not cause SP
to purchase insurance on an employee’s life. Held: The life
insurance policies that were issued on the lives of the four
shareholder/employees incident to their corporations’ partici-
pation in SP were part of a split-dollar life insurance arrange-
ment. Held, further, the economic benefit provisions of sec.
1.61–22(d) through (g), Income Tax Regs., are not invalid, and
the four shareholder/employees with insurance on their lives
realized income (compensation for O’s shareholder and
guaranteed payments for E’s shareholders) as to the split-
dollar life insurance arrangements in amounts as ascertained
from those provisions. The economic benefit provisions are
inapplicable to N and its owner because no life insurance was
issued in those cases. On the basis of Neonatology Assocs.,
P.A. v. Commissioner, 115 T.C. 43 (2000), aff ’d,
299 F.3d 221
(3d Cir. 2002), and its progeny, N’s owner realized dividend
income to the extent of the payments that N made to SP.
Held, further, none of the corporate employers may deduct its
payments to SP. Held, further, Ps are liable for the accuracy-
related penalties that R determined under I.R.C. sec. 6662(a).
Held, further, Ps are liable for the accuracy-related penalties
that R determined under I.R.C. sec. 6662A, to the extent
stated.
Steven S. Brown, Denis John Conlon, Allen James White,
and William G. Sullivan, for petitioners.
Angela B. Reynolds, David S. Weiner, and K. Elizabeth
Kelly, for respondent.
LARO, Judge: These seven cases are before the Court
consolidated for purposes of trial, briefing, and opinion.
Petitioners petitioned the Court to redetermine the fol-
lowing Federal income tax deficiencies and accuracy-related
penalties that respondent determined: 2
2 Unless otherwise indicated, section references are to the Internal Rev-
enue Code (Code) applicable to the relevant years, Rule references are to
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 3
Our Country Home Enterprises, Inc., docket No. 25764–10
Accuracy-related penalties
Year Deficiency Sec. 6662(a) Sec. 6662A
2005 $114,549 $22,910 -0-
2006 193,029 38,606 -0-
2007 45,184 -0- $15,750
Blakes, docket No. 25765–10
Accuracy-related penalties
Year Deficiency Sec. 6662(a) Sec. 6662A
2005 $276,032 $55,206 -0-
2006 402,643 80,529 -0-
2007 428,303 -0- $85,660
Netversity, Inc., docket No. 11520–11
Accuracy-related penalty
Year Deficiency Sec. 6662(a)
2006 $9,872 $1,974
Mejias, docket No. 11521–11
Accuracy-related penalty
Year Deficiency Sec. 6662(a)
2006 $14,000 $2,800
Abramos, docket No. 12744–11
Accuracy-related penalties
Year Deficiency Sec. 6662(a) Sec. 6662A
2005 $92,218 $18,444 -0-
the Tax Court Rules of Practice and Procedure, and dollar amounts are
rounded to the nearest dollar. We interchangeably use the terms ‘‘insur-
ance contract’’ and ‘‘insurance policy’’ for convenience and do not intend to
signify a distinction by our use of either term. We also use the terms ‘‘wel-
fare benefit plan’’ and ‘‘plan’’ for convenience and do not intend to suggest
for Federal income tax purposes that any of the subject arrangements are
either bona fide plans or welfare benefit plans. We use the name ‘‘Sterling
Plan’’ to refer to both the plan and the trust that make up the Sterling
Plan.
4 145 UNITED STATES TAX COURT REPORTS (1)
Abramos, docket No. 12744–11
Accuracy-related penalties
Year Deficiency Sec. 6662(a) Sec. 6662A
2006 116,844 23,369 -0-
2007 123,201 651 $40,920
Browns, docket No. 12745–11
Accuracy-related penalties
Year Deficiency Sec. 6662(a) Sec. 6662A
2005 $96,299 $19,260 -0-
2006 133,582 26,716 -0-
2007 136,910 -0- $45,584
Tomassettis, docket No. 12746–11
Accuracy-related penalties
Year Deficiency Sec. 6662(a) Sec. 6662A
2005 $90,543 $18,109 -0-
2006 122,376 24,475 -0-
2007 125,325 -0- $42,593
The deficiencies stem from petitioners’ participation in the
Sterling Benefit Plan (Sterling Plan), a purported welfare
benefit plan. The parties have selected these seven cases to
serve as test cases for issues related to the Sterling Plan.
The parties in approximately 40 other cases pending before
the Court have agreed to be bound by one or more of the
final decisions in these cases.
Petitioners in two of these test cases are Mr. Blake and his
wholly owned C corporation, Our Country Home Enterprises,
Inc. (Our Country). Respondent disallowed deductions of
$450,000, $450,000, and $150,000 that Our Country claimed
for 2005, 2006, and 2007, respectively (subject years), with
respect to payments that it made to the Sterling Plan.
Respondent determined that the Blakes realized income of
$765,692, $1,127,853, and $1,199,727 for the subject years
from Mr. Blake’s participation in the Sterling Plan.
Petitioners in two of the other test cases are Mr. Mejia and
his wholly owned C corporation, Netversity, Inc. (Netversity).
Respondent disallowed a $50,000 deduction that Netversity
claimed for 2006 with respect to a payment that it made to
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 5
the Sterling Plan. Respondent determined that the Mejias
realized $50,000 of income for 2006 from Mr. Mejia’s partici-
pation in the Sterling Plan.
Petitioners in the remaining three test cases are Mr.
Abramo, Mr. Brown, and Mr. Tomassetti, the equal owners
of Code Environmental Services, Inc. (Environmental), an S
corporation. Respondent disallowed deductions of $220,588,
$236,667, and $237,309 that Environmental claimed for
2005, 2006, and 2007, respectively, with respect to payments
that it made to the Sterling Plan and increased each
Environmental owner’s income by his share of the deduc-
tions. 3 For the subject years, the owners’ shares of the dis-
allowed deductions were $73,529, $78,889, and $79,102 in
the case of Mr. Abramo; $73,529, $78,889, and $79,103 in the
case of Mr. Brown; and $73,529, $78,889, and $79,103 in the
case of Mr. Tomassetti. Respondent also determined that
each owner realized income from his participation in the
Sterling Plan. For the respective years, this income was
$188,797, $266,299, and $302,968 in the case of Mr. Abramo;
$222,089, $304,978, and $346,515 in the case of Mr. Brown;
and $199,454, $279,637, and $318,594 in the case of Mr.
Tomassetti.
We decide the following issues:
(1) whether the life insurance policies issued on the lives
of the shareholder/employees incident to their participation
in the Sterling Plan were part of a split-dollar life insurance
arrangement. We hold they were;
(2) whether the corporate employers may deduct their
payments to the Sterling Plan. We hold they may not;
(3) whether the shareholder/employees must recognize
income from their participation in the Sterling Plan. We hold
they must to the extent stated;
3 Former secs. 6241–6245 generally required that the shareholders of an
S corporation challenge the Commissioner’s adjustments to an S corpora-
tion’s income in a single, corporate-level proceeding. However, the Small
Business Job Protection Act of 1996, Pub. L. No. 104–188, sec. 1307(c)(1),
110 Stat. at 1781, repealed those provisions for taxable years beginning
after December 31, 1996. Respondent’s adjustments to Environmental’s in-
come are therefore properly before us in this proceeding as adjustments to
the income of Environmental’s owners.
6 145 UNITED STATES TAX COURT REPORTS (1)
(4) whether petitioners are liable for the accuracy-related
penalties that respondent determined under section 6662(a).
We hold they are; and
(5) whether Our Country, the Abramos, the Browns, and
the Tomassettis are liable for the accuracy-related penalties
that respondent determined under section 6662A. We hold
they are.
FINDINGS OF FACT
I. Background
Some of the facts have been stipulated. The stipulations of
fact and the facts drawn from stipulated exhibits are incor-
porated herein, and we find those facts accordingly. The par-
ties have stipulated that an appeal of any or all of these
cases would be to the Court of Appeals for the Seventh Cir-
cuit.
II. Petitioners and Related Entities
A. Our Country
Our Country is a C corporation. Its business involves the
manufacture and sale of store fixtures and the sale of
antiques. It had eight full-time employees in each subject
year. It had a post office box in Indiana that was its mailing
address when its petition was filed.
B. Blakes
The Blakes are husband and wife. They resided in Ohio
when their petition was filed.
Mr. Blake was born on June 11, 1949, and graduated from
college in 1971 with a degree in American history and
government. He later worked for 24 years as a high school
teacher, teaching American history, government, geography,
psychology, sociology, and world history. He also worked in
various nonprofessional jobs (e.g., as an antique dealer and
as an auctioneer) during the summers of those 24 years.
Mr. Blake started Our Country’s business incident to his
dealing in antiques. He began working for Our Country on
March 8, 1985, the day it was incorporated. He was the sole
owner and president of Our Country during the subject
years.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 7
C. Netversity
Netversity is a C corporation. It had a mailing address in
California when its petition was filed. Netversity is in the
business of computer programming and consulting with
respect to Internet applications. It had one to three full-time
employees in 2006.
D. Mejias
The Mejias are husband and wife. They resided in Cali-
fornia when their petition was filed.
Mr. Mejia has a bachelor of science degree in electrical
engineering. He worked in both the restaurant and banking
businesses upon graduating from college. He later worked in
an information systems management business.
Mr. Mejia established Netversity in 1998, and he has
worked there since. He was Netversity’s sole owner and
president during 2006.
E. Environmental
Environmental is an S corporation. It is an environmental
remediation company that cleans up contaminated sites.
Mr. Abramo, Mr. Tomassetti, and Mr. Brown equally own
Environmental. Mr. Tomassetti generally manages the finan-
cial side of Environmental’s business. Environmental’s other
two owners manage its sales and nonfinancial operations.
During the subject years Environmental employed approxi-
mately 25 individuals, including its owners. Fifteen of
Environmental’s employees, including the owners, partici-
pated in the Sterling Plan.
F. Abramos
The Abramos are husband and wife. Mr. Abramo was born
in August 1958. They resided in New Jersey when their peti-
tion was filed.
G. Tomassettis
The Tomassettis are husband and wife. They resided in
New Jersey when their petition was filed.
Mr. Tomassetti was born on September 23, 1956. He holds
both a bachelor of science and a master’s degree in geology.
He began working for Environmental in 1989. Before that, he
8 145 UNITED STATES TAX COURT REPORTS (1)
worked as a geologist in the environmental industry and for
two years worked as a financial planner.
H. Browns
The Browns are husband and wife. They resided in New
Jersey when their petition was filed.
Mr. Brown was born on December 18, 1952.
III. Mr. Snyder and His Related Entities
A. Mr. Snyder
Ronald H. Snyder graduated from law school in 1982 and
is admitted to the Utah State Bar. He is also licensed in var-
ious States to work as a third-party administrator and as an
insurance salesman. 4 He was both a licensed and enrolled
actuary from 1975 until recently.
Mr. Snyder has worked with pension plans for over 30
years, and he holds himself out as a specialist in, among
other things, welfare benefit plans and the tax and labor
aspects of employee benefit plans. Mr. Snyder was the
actuary for the Sterling Plan from its inception, and he per-
formed annual calculations, including valuations, for the plan
which he shared with its participating employers. None of
these valuations was peer reviewed.
B. BCA and BSGLLC
During the subject years Mr. Snyder and his family owned
Benefits for Corporate America, Inc. (BCA), of which Mr.
Snyder was president. Mr. Snyder and his wife, Christine,
also owned a limited liability company named Benefit Strate-
gies Group, LLC (BSGLLC). BSGLLC is a third-party
administrator firm of which Mr. Snyder is the managing
member.
Benefit Strategies Group, Inc. (BSG), was Sterling Plan’s
administrator from at least January 1, 2003, through the end
of 2004. Mr. Snyder was BSG’s president. Between January
1, 2005, and the end of the first quarter of 2007, BSGLLC
purchased some of BSG’s assets, and BCA was Sterling
Plan’s administrator from on or about January 1, 2005,
4A third-party administrator administers benefit plans.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 9
through 2007. BCA was also Sterling Plan’s sponsor during
the subject years.
IV. Sterling Plan
A. Background
In the early 1990s Mr. Snyder and two other attorneys
began looking for a way for employers to fund greater bene-
fits than pension plans allowed. Mr. Snyder established the
Sterling Plan in October 2002 as a way for employers to fund
and receive those greater benefits. During the first part of
the subject years, the Sterling Plan’s trustee was Fifth Third
Bank of Florida. National Advisers Trust was the Sterling
Plan’s trustee during the rest of the subject years.
The Sterling Plan ostensibly operates as a single welfare
benefit plan which is an aggregation of separate multiple
single employer welfare benefit plans under section 419(e).
The Sterling Plan offers to pay various benefits, primarily
death, medical, and disability benefits, during a participating
employee’s current employment and/or retirement. 5 The
Sterling Plan lets each participating employer select the
extent of those benefits to be provided under a personal plan
that the employer establishes to apply to its employees alone
as part of the Sterling Plan. The Sterling Plan lets the
employer select the general provisions applicable to its plan
(e.g., the normal and early retirement dates, the number of
annual hours that its employees must work to earn benefits
under the plan), the participation requirements (e.g., min-
imum age, minimum number of years that its employees
must work for the employer), and the vesting schedule for
the benefits payable under the employer’s plan.
A participating employer makes payments to the Sterling
Plan that are used to fund the benefits that the Sterling Plan
promises to pay to the employer’s participating employees.
The payments may revert to the employer only in the
atypical case where the payment results from a mistake of
fact. Each employer singlehandedly sets the amount and the
frequency of its payments to the Sterling Plan and the eligi-
bility requirements for its employees to participate in the
5 The medical benefits under the Sterling Plan covered medical expenses
that were not covered by Medicare, by an employer-provided health insur-
ance policy, or by any other plan of health insurance.
10 145 UNITED STATES TAX COURT REPORTS (1)
Sterling Plan. Employees may (but are not required to) make
payments to the Sterling Plan if their employer lets them,
and any such payment that an employee makes is credited
to his or her personal account that is maintained under the
plan.
B. Operation
BSG and BCA executed revised and restated master plan
documents for the Sterling Plan as of January 1, 2003, Sep-
tember 1, 2005, January 1, 2006, January 1, 2007, and
August 1, 2007. These documents stated that employers
established or adopted welfare benefit plans pursuant to the
terms of the documents by executing adoption agreements.
The adoption agreements let the employers set the specific
provisions that applied to their plans.
For each participating employer’s plan, the Sterling Plan
maintains individual personal accounts for each of the
employer’s participating employees. An employer’s payments
to the Sterling Plan are apportioned into each of these
accounts to provide benefits to the corresponding employee,
to his or her dependent, and to his or her beneficiary. An
employer may allow its employees to direct the investments
of the funds in their accounts, and the balance in each
account is adjusted as of each valuation date to reflect the
investment earnings or losses with respect to the funds in
the account. The amount in a nonvested account of any
employee who terminates his or her employment with the
employer is reallocated to the accounts of the employer’s
remaining participating employees. The Sterling Plan will
pay an employee the death, medical, and disability benefits
that his or her employee selects only to the extent of the
amount in the employee’s account.
The Sterling Plan purchases a variety of life insurance
products, including individual policies, group policies, cash
value policies, and term policies in order to fund any benefit
payable to the employees. Typically, the employer selects the
insurance policies that it wants to use to fund the benefits
payable to its employees, and each insurance policy that is
purchased funds all of the benefits that are payable as to the
employee covered by that policy. As of each valuation date,
the administrator adds to an employee’s personal account the
increase in cash value of any insurance policy that the Ster-
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 11
ling Plan holds with respect to the employee. The Sterling
Plan does not set aside any specific amount as reserves for
the postretirement benefits, and the Sterling Plan does not
keep any payment that it receives for post-retirement bene-
fits in a separate bank account.
A participating employee may designate the beneficiary or
beneficiaries to receive the death benefits payable under the
Sterling Plan and the death proceeds of any life insurance
policy maintained on the life of the employee. The amount of
the death benefit payable as to an employee is the face
amount of the insurance policy on the employee’s life, and
that death benefit is payable in accordance with the terms of
the insurance policy. An employee upon retiring from
employment with the employer may elect to receive the paid-
up life insurance policy in satisfaction of a retirement death
benefit.
An employer at any time may discontinue making pay-
ments to the Sterling Plan or otherwise may terminate its
participation in the Sterling Plan. If an employer does either,
all amounts credited to an employee’s personal account
become fully vested and the employer may not receive a
refund or any other benefit. In the case of a termination, the
administrator may distribute the assets in the employer’s
plan to the participants or to their beneficiaries or generally
direct that the assets remaining in the plan be applied to
provide the employees or their beneficiaries with the benefits
selected by the employer. If an employer stops making pay-
ments to the Sterling Plan, the employer may direct that the
trustee (1) retain the plan assets for the employees pursuant
to the provisions of the plan, (2) transfer the plan assets to
a successor trustee, or (3) retain the assets for the benefit of
the employees.
Employers adopting the Sterling Plan were advised in
writing that they might want to consult with various profes-
sionals (including attorneys and accountants) regarding their
participation in the plan.
12 145 UNITED STATES TAX COURT REPORTS (1)
V. Our Country and the Blakes
A. Mr. Blake’s Learning of the Sterling Plan
1. Mr. Ringger and Mr. Reckard
Steven R. Ringger is a certified public accountant (C.P.A.)
who prepared the Blakes’ and Our Country’s income tax
returns for the subject years. Mr. Ringger recommended the
Sterling Plan to Mr. Blake before 2003. Mr. Blake dis-
regarded that recommendation because Mr. Ringger was not
a financial planner.
Mr. Blake eventually invested in the Sterling Plan upon
the recommendations of Corey Reckard, a C.P.A., who
worked as an insurance agent/financial planner, and one of
Mr. Reckard’s colleagues, Daniel Weilbaum. Mr. Blake and
Mr. Reckard had been discussing Mr. Blake’s potential
investment in life insurance (or in a similar product), and
Mr. Reckard stressed to Mr. Blake that the Sterling Plan
would allow him to accumulate value with favorable tax con-
sequences and receive life insurance at no cost. Mr. Blake
considered the Sterling Plan primarily to be a good financial
investment and a way to defer taxes. Mr. Blake also viewed
the Sterling Plan as a way to obtain long-term life insurance
for himself and for his employees.
Mr. Blake invested in the Sterling Plan, relying to a
significant extent on his belief that Mr. Reckard was a
licensed insurance agent who would not sell him an illegit-
imate product. Mr. Blake also presumed that Guardian Life
Insurance Co. of America (Guardian), the insurance company
that would issue the insurance on the lives of Our Country’s
participating employees, was a licensed insurance company.
Mr. Ringger did not advise either Our Country or the Blakes
concerning their participation in the Sterling Plan.
2. Mr. Penner
Ted Penner is an experienced lawyer/C.P.A. and Mr.
Blake’s longtime acquaintance. Mr. Penner specializes to a
significant extent in estate planning. Mr. Penner had a his-
tory of rendering legal and business consulting services to
Mr. Blake and Our Country, respectively, 6 when Mr. Blake
6 Among other things, Mr. Penner helped Mr. Blake start a family foun-
dation.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 13
told Mr. Penner that he had invested in the Sterling Plan
and wanted his advice as to that investment. Mr. Blake and
Mr. Penner briefly discussed the Sterling Plan at that time.
Mr. Penner is not an expert in welfare benefit plans; he does
not purport to be an expert in welfare benefit plans; and he
did not tell Mr. Blake that he was an expert in welfare ben-
efit plans or in employee benefits. Mr. Penner has a limited
knowledge and understanding of welfare benefit plans, and
he considers them to be complex.
In October 2004 after Mr. Blake had been in the Sterling
Plan for approximately one year, Mr. Blake gave Mr. Penner
certain documents relating to the Sterling Plan and they
again discussed the plan but this time in more depth. Their
discussion in 2004 occurred after Mr. Blake was contacted by
both Mr. Reckard and promoters of other plans. 7 In or
around October 2004 Mr. Penner informed Mr. Blake that
his investment in the Sterling Plan would give him tax
deductions and eventually lead to his receipt of his life insur-
ance policy, but Mr. Penner did not tell Mr. Blake that the
tax deductions were legitimate or whether the right to
receive his insurance policy came with any unfavorable con-
sequences. Mr. Penner advised Mr. Blake that the Sterling
Plan from a conceptual point of view was beneficial to his
long-term estate plans but was a risky venture. Mr. Penner
did not review the actuarial computations or the annual
reports that the Sterling Plan gave to Our Country, and he
did not perform any reference checks on the Sterling Plan.
B. Adoption Agreements
1. Background
Our Country adopted the Sterling Plan as of December 2,
2003, and participated in the plan throughout the subject
years. Our Country’s single employer plan was called the
Our Country Home, Inc. Employee Welfare Benefit Plan.
7 At or about the same time or shortly thereafter, Mr. Blake was told
that the Sterling Plan was a ‘‘listed transaction’’ (discussed infra) and that
the main purpose of the plan was to generate the payment of commissions
on the sale of the related insurance policies. Mr. Blake discussed the mat-
ter with Mr. Ringger, Mr. Reckard, and at least one other individual. Mr.
Blake considered terminating Our Country’s participation in the Sterling
Plan but decided to stay with the plan.
14 145 UNITED STATES TAX COURT REPORTS (1)
During 2004 and 2005 the trustee of Our Country’s plan was
Fifth Third Bank of Florida. During 2007 and most (if not
all) of 2006 the trustee of Our Country’s plan was National
Advisors Trust. The trust underlying Our Country’s plan was
neither a voluntary employee beneficiary association under
section 501(c)(9) nor a grantor trust under sections 671–679.
Our Country elected to make payments to the Sterling
Plan in amounts that it desired. Our Country’s funding
policy as to the Sterling Plan allowed its portion of the plan’s
funds to be invested in the cash values of permanent life
insurance policies and in variable annuities, mutual funds,
interest-bearing checking and savings accounts, and stocks
and bonds. Our Country employees did not make any pay-
ment to the Sterling Plan.
2. Initial Adoption Agreement
In its adoption agreement Our Country selected the pre-
and the post-retirement death benefit options. Our Country
selected a preretirement death benefit of 20 times compensa-
tion and did not provide a formula for determining the post-
retirement death benefit. Our Country set the normal retire-
ment age at 59, with 5 years of participation. Mr. Blake
selected his wife as his beneficiary under the Sterling Plan.
3. Second Adoption Agreement
On December 28, 2005, Our Country completed a second
adoption agreement with an effective date of January 1,
2005. Our Country selected pre- and post-retirement death
benefit options and pre- and post-retirement death benefits of
20 times compensation.
4. Third Adoption Agreement
On July 30, 2006, Our Country completed a third adoption
agreement with an effective date of January 1, 2005. Our
Country selected pre- and post-retirement death benefit
options and the medical benefit option. 8 Our Country
selected pre- and post-retirement death benefits of 20 times
compensation.
8 During the subject years no Our Country employee received from the
Sterling Plan any payment for medical expenses.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 15
In the third adoption agreement Our Country changed the
normal retirement age to 57, with 15 years of participation.
Mr. Blake was then 57 years old, and the Sterling Plan
reported him as 100% vested in his benefits following the
change to the retirement age. By virtue of this change, Mr.
Blake, upon retiring, was considered entitled to receive his
paid-up life insurance policy from the Sterling Plan in full
settlement of the life insurance benefits payable under the
Sterling Plan.
C. Life Insurance Policies
1. Background
Our Country Home, Inc. Employee Welfare Benefit Plan
Trust purchased life insurance policies on the lives of Our
Country’s employees, including Mr. Blake, with the pay-
ments that Our Country made to the Sterling Plan (for the
benefit of the Our Country Home, Inc. Employee Welfare
Benefit Plan). 9 Those policies were purchased from
Guardian. Mr. Reckard was the insurance agent who
arranged the purchases of the policies.
2. Blake Policy
One insurance policy was taken out on the life of Mr.
Blake (Blake policy). This insurance policy was issued on
January 27, 2004, as a whole life insurance policy with a face
amount of $6.9 million. Both the owner and the beneficiary
of this insurance policy were stated to be Fifth Third Bank
of Florida, as trustee of the Sterling Plan.
On the application for life insurance, Mr. Blake was
required to, and did, answer various personal questions such
as whether he intended to travel outside the United States;
whether he had smoked or used tobacco products within the
last two years; whether he had been charged with any motor
vehicle moving violation or had had his driver’s license sus-
pended or revoked within the last five years; and whether
within the last three years he had participated in any high-
adventure activity such as piloting an aircraft, scuba diving,
rock or mountain climbing, hang gliding, parachuting, or
9 To the extent that the employer’s payments to the Sterling Plan ex-
ceeded the cost of the insurance, the Sterling Plan invested those excess
proceeds as directed by the employer.
16 145 UNITED STATES TAX COURT REPORTS (1)
motor vehicle racing. Mr. Blake also had to answer questions
about his and his family’s medical history and to support
those answers with the signature of a medical examiner.
Guardian further required that Mr. Blake undergo a medical
examination and that the results of that examination, as well
as a copy of Mr. Blake’s driving record, be submitted as part
of the application for the insurance policy. Guardian rated
(e.g., as preferred, preferred plus, and class 6) Mr. Blake
(and Our Country’s other employees who applied for insur-
ance) for purposes of setting the premium payable on his
(and their respective) insurance policy. Guardian rated Mr.
Blake as a ‘‘class 6’’ 10 and offered to shop for reinsurance to
lower the premium that would be attributable to that rating.
On or about April 11, 2006, the owner of the Blake policy
was changed from the trust for the Sterling Plan to the trust
for the Our Country Home, Inc. Welfare Benefit Plan.
3. Other Policies
From 2005 through 2007 seven of Our Country’s employees
(including Mr. Blake) participated in the Sterling Plan
through the Our County Home, Inc. Welfare Benefit Plan.
The other employees were Cindy Blake, Hope Holley, Sasha
Hullinger, Chris Rohrbaugh, Randel Straka, and Elizabeth
Krohn. The Sterling Plan purchased cash value life insurance
policies for each of these employees but for Cindy Blake.
D. Payments and Valuation
1. 2005
On December 28, 2005, Our Country paid $450,000 to Fifth
Third Bank of Florida. The Sterling Plan treated this pay-
ment as an employer contribution to the Our County Home,
Inc. Welfare Benefit Plan. On or after August 3, 2006, Mr.
Snyder gave Mr. Blake, in his capacity as Our Country’s
president, an ‘‘amended annual valuation report’’ showing
that the amount of the allowable contribution was $450,000.
The Sterling Plan initially used $32,061 of the $450,000 to
pay the premium on additional paid-up insurance on the
Blake policy. The Sterling Plan later used $417,245 of the
$450,000 to pay the premiums on the life insurance policies
10 While the record does not establish the meaning of a class 6 rating,
we understand it to be lower than a rating of preferred or preferred plus.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 17
covering all of Our Country’s employees (including Mr.
Blake). Of the $417,245, $323,606 was paid on the Blake
policy.
Under the Sterling Plan, as of December 31, 2005, both the
pre- and the post-retirement death benefits payable on the
Blake policy were $6.9 million. As of December 10, 2005, the
cash value of the Blake policy was $90,694.
2. 2006
On December 27, 2006, Our Country paid $450,000 to
National Advisors Trust, Inc. The Sterling Plan treated this
payment as an employer contribution to the Our County
Home, Inc. Welfare Benefit Plan. On March 21, 2008, Mr.
Snyder gave Mr. Blake, in his capacity as Our Country’s
president, an ‘‘amended annual valuation’’ for the 2006 plan
year showing that the amount of the allowable contribution
was $325,590.
The Sterling Plan initially used $59,268 of the $450,000
paid in 2006 to pay the premium on additional paid-up insur-
ance on the Blake policy. The Sterling Plan later used
$390,732 of the $450,000 to pay the premiums on the life
insurance policies covering all of Our Country’s employees,
including Mr. Blake. Of the $390,732, $323,606 was paid on
the Blake policy.
Under the Sterling plan, as of December 31, 2006, both the
pre- and the post-retirement death benefits payable on the
Blake policy were $6.9 million. As of December 10, 2006, the
cash value of the Blake policy was $331,364.
3. 2007
On December 27, 2007, Our Country paid $150,000 to
National Advisors Trust. The Sterling Plan treated $124,179
of the $150,000 as an employer contribution to the Our
County Home, Inc. Welfare Benefit Plan. On March 21, 2008,
Mr. Snyder gave Mr. Blake, in his capacity as Our Country’s
president, an ‘‘annual valuation’’ for the 2007 plan year
showing that the amount of the allowable contribution was
$124,179.
The Sterling Plan did not use any of the $150,000 to pay
a life insurance premium. Instead, an insurance policy loan
was extended to cover the premium. The Plan eventually
18 145 UNITED STATES TAX COURT REPORTS (1)
used the $150,000 payment to repay a portion of the insur-
ance policy loan on the Blake policy.
Under the Sterling plan, as of December 31, 2007, both the
pre- and the post-retirement death benefits payable on the
Blake policy were $6.9 million. As of December 10, 2007,
the cash value of the Blake policy was $616,612.
E. Death Benefits of Employees Other Than Mr. Blake
Our Country employees other than Mr. Blake also were
entitled to pre- and post-retirement death benefits in each
subject year. The death benefits for those employees were the
same amount in each year and equaled the face amount of
the life insurance policy taken out on his or her life as to
each employee. Hope Holley’s benefit was $575,000. Sasha
Hullinger’s benefit was $969,600. Chris Rohrbaugh’s benefit
was $880,000. Randel Straka’s benefit was $946,000. Eliza-
beth Krohn’s benefit was $467,600.
F. Tax Return Information
1. Our Country
a. 2005
Our Country filed a Form 1120, U.S. Corporation Income
Tax Return, for 2005. In that return Our Country claimed a
$450,000 deduction for ‘‘employee benefit programs’’. Our
Country did not disclose its participation in the Sterling
Plan. Our Country reported that it had a taxable loss of
$113,091 and that its Federal income tax was zero.
b. 2006
Our Country filed a Form 1120 for 2006. In that return
Our Country deducted $450,000 for pension (or similar type
of ) plans. Our Country did not disclose its participation in
the Sterling Plan. Our Country reported taxable income of
$14,378 and Federal income tax of $2,157.
c. 2007
Our Country filed a Form 1120 for 2007. In that return
Our Country deducted $150,000 for pension (or similar type
of ) plans. Our Country did not disclose its participation in
the Sterling Plan. Our Country reported taxable income of
$14,310 and Federal income tax of $2,147.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 19
On January 25, 2010, Our Country filed a Form 1120X,
Amended U.S. Corporation Income Tax Return, for 2007. The
only change reported on the amended return was the addi-
tion of a Form 8886, Reportable Transaction Disclosure
Statement, disclosing as a ‘‘Protective Filing’’ Our Country’s
participation in the Sterling Plan.
2. The Blakes
a. 2005
The Blakes filed a joint Federal income tax return for
2005. They did not report any income related to Mr. Blake’s
participation in the Sterling Plan, and they did not disclose
his participation in the Sterling Plan. The Blakes reported
taxable income of $534,612 and total Federal income tax of
$160,645.
b. 2006
The Blakes filed a joint Federal income tax return for
2006. They did not report any income related to Mr. Blake’s
participation in the Sterling Plan, and they did not disclose
his participation in the Sterling Plan. The Blakes reported
taxable income of $632,633 and total Federal income tax of
$194,034.
c. 2007
The Blakes filed a joint Federal income tax return for
2007. They did not report any income related to Mr. Blake’s
participation in the Sterling Plan, and they did not disclose
his participation in the Sterling Plan. The Blakes reported
taxable income of $1,699,092 and total Federal income tax of
$562,277.
G. Deficiency Notices
On August 19, 2010, respondent mailed a deficiency notice
to the Blakes for the subject years. On the same day
respondent mailed a deficiency notice to Our Country for the
same years. The deficiency notice mailed to Our Country
stated in relevant part that respondent had disallowed Our
Country’s claimed deductions of the $450,000, $450,000, and
$150,000 payments for 2005, 2006, and 2007, respectively,
that it made to the Sterling Plan because the life insurance
20 145 UNITED STATES TAX COURT REPORTS (1)
arrangement was a split-dollar insurance arrangement sub-
ject to the ‘‘economic benefit regime rules’’, which disallow
those deductions. The deficiency notice mailed to the Blakes
stated in relevant part that the Blakes realized income of
$765,692, $1,127,853, and $1,199,727 for the subject years
from Mr. Blake’s participation in the Sterling Plan and that
the authority for that income was sections 61, 72, 83, and
402(b).
VI. Netversity and the Mejias
A. Learning of the Sterling Plan
Javier Morgan is a C.P.A. He also is Mr. Mejia’s uncle. Mr.
Morgan has been Mr. Mejia’s accountant since 1995 or 1996.
Mr. Morgan told Mr. Mejia in 2005 or 2006 that he should
invest in the Sterling Plan as part of his retirement plans.
Mr. Mejia (1) did not ask Mr. Morgan whether he was an
expert on welfare benefit plans, (2) did not ask Mr. Morgan
what he reviewed to recommend the Sterling Plan, and (3)
did not receive from Mr. Morgan any written opinion on the
Sterling Plan. Mr. Mejia ‘‘blindly expected’’ that he was going
to invest money in the Sterling Plan without any tax con-
sequences.
B. Adoption Agreement
1. Background
Netversity adopted the Sterling Plan as of January 1,
2006. Netversity’s single employer plan was called the
Netversity, Inc. Sterling Benefit Plan. The trust underlying
Netversity’s single employer plan was neither a voluntary
employee beneficiary association under section 501(c)(9) nor
a grantor trust under sections 671–679. Netversity elected to
make discretionary payments to the Sterling Plan, and Mr.
Mejia was the only Netversity employee who participated in
the Sterling Plan during 2006.
2. Elections
In its adoption agreement Netversity selected the pre- and
post-retirement death benefit options as well as medical
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 21
benefits. 11 Netversity selected a pre- and post-retirement
death benefit of seven times annual compensation.
C. Payment and Valuation
On December 21, 2006, Netversity paid $50,000 to Fifth
Third Bank of Florida, noting that the payment related to
the Netversity, Inc. Sterling Benefit Plan. The Sterling Plan
treated this payment as an employer contribution to the
Netversity account maintained as part of the Sterling Plan.
On or after July 6, 2007, Mr. Snyder gave Mr. Mejia on
behalf of Netversity an annual valuation report showing that
the amount of the allowable contribution was $50,000.
Under the Sterling Plan, as of December 31, 2006, there
was neither a pre- nor post-retirement death benefit payable
upon Mr. Mejia’s death because the Sterling Plan had not yet
purchased an insurance policy on his life.
D. Tax Return Information
1. Netversity
Netversity filed a 2006 Form 1120 claiming a $50,000
deduction for ‘‘employee benefit programs’’. Netversity did
not disclose its participation in the Sterling Plan. Netversity
reported taxable income of $23,715 and total Federal income
tax of $3,557.
2. Mejias
The Mejias filed a joint Federal income tax return for
2006. Mr. Morgan prepared the return. The Mejias did not
report any income related to Mr. Mejia’s participation in the
Sterling Plan, and they did not disclose his participation in
the Sterling Plan. The Mejias reported taxable income of
$486,388 and total Federal income tax of $151,304.
E. Deficiency Notices
On February 14, 2011, respondent mailed a deficiency
notice to the Mejias for 2006. On the same day, respondent
mailed a deficiency notice to Netversity for 2006.
The deficiency notice mailed to Netversity stated in rel-
evant part that respondent had disallowed Netversity’s
11 During 2006 no Netversity employee received from the Sterling Plan
any payment for medical expenses.
22 145 UNITED STATES TAX COURT REPORTS (1)
claimed deduction of the $50,000 payment that it made to
the Sterling Plan during 2006 because the life insurance
arrangement was a split-dollar insurance arrangement sub-
ject to the ‘‘economic benefit regime rules’’, which disallow
that deduction. The deficiency notice mailed to the Mejias
stated in relevant part that the Mejias realized income of
$50,000 in 2006 on account of Mr. Mejia’s participation in the
Sterling Plan and that the authority for that income was sec-
tions 61, 72, 79, 83, and 402(b).
VII. Environmental and Its Owners
A. Learning of the Sterling Plan
1. Background
a. Mr. Scutellaro
Joseph Scutellaro is a C.P.A. and a general tax practi-
tioner. He has prepared the tax returns of Environmental’s
owners since 1994 or 1995. He also gave them tax advice
during that period. Mr. Tomassetti relied upon Mr.
Scutellaro to file his and Environment’s tax returns with the
understanding that they were in compliance.
b. Mr. Deavers
In or about 1995 or 1996 Mr. Scutellaro was introduced to
Doug Deavers, a benefits consultant in Naples, Florida, and
to the concept of welfare benefit plans. Shortly thereafter,
Mr. Tomassetti asked Mr. Scutellaro about ways to provide
pretax benefits to employees. Mr. Scutellaro knew that Mr.
Deavers offered his clients welfare benefit plans which pro-
vided pretax benefits, and Mr. Scutellaro introduced Mr.
Tomassetti to Mr. Deavers as a potential investor in one of
those plans. Environmental eventually joined one of Mr.
Deavers’ plans.
On or after July 31, 2000, while Environmental was
participating in one of Mr. Deavers’ plans, Mr. Deavers con-
cluded from the release of Neonatology Assocs., P.A. v.
Commissioner, 115 T.C. 43, 98–99 (2000), aff ’d,
299 F.3d 221
(3d Cir. 2002), and of other then-recent judicial opinions that
his plans were no longer or had never been acceptable. Mr.
Deavers subsequently contacted Mr. Tomassetti and
informed him that he was no longer going to be admin-
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 23
istering his plans and introduced Mr. Tomassetti to Mr.
Snyder. Mr. Tomassetti then learned about the Sterling Plan.
Mr. Tomassetti believed that Mr. Snyder was a recognized
professional in the matter of welfare benefit plans, and Mr.
Tomassetti and Environmental’s other two owners con-
templated investing in the Sterling Plan through Environ-
mental.
c. Environmental’s Owners’ Interest in the Sterling Plan
Mr. Tomassetti was the point person for the Environ-
mental owners regarding their potential investment in the
Sterling Plan, and Mr. Tomassetti asked Mr. Scutellaro
about the plan before investing in it. Mr. Scutellaro was not
an expert in welfare benefit plans, and he did not represent
to Mr. Tomassetti that he had expertise with welfare benefit
plans. Mr. Scutellaro summarily reviewed the Sterling Plan
documents and what he considered to be the applicable provi-
sions of the Code and recommended to Mr. Tomassetti that
Environmental switch to the Sterling Plan because Mr.
Deavers was no longer supporting the plan that Environ-
mental was then in. Mr. Scutellaro made that recommenda-
tion relying primarily on Mr. Snyder’s credentials and on cer-
tain written information that Mr. Snyder gave to him as to
the plan. Mr. Scutellaro knew that the judiciary had sus-
tained the Internal Revenue Service’s (IRS) disallowance of
employer deductions in ‘‘a lot’’ of similar cases which involved
welfare benefits but concluded on the basis of the materials
that Mr. Snyder gave him that those cases were factually
distinguishable. Mr. Scutellaro never received any tax
opinion from anyone other than Mr. Snyder regarding the
validity of the Sterling Plan or of the deductibility of the
contributions. Mr. Scutellaro never gave to any of
Environmental’s owners a written tax opinion regarding the
validity of the Sterling Plan or of the deductibility of the con-
tributions.
Mr. Tomassetti relied solely on Mr. Scutellaro for advice
and did not do any further investigation into the tax con-
sequences of the Sterling Plan. In deciding to participate in
the Sterling Plan, Mr. Tomassetti and Mr. Scutellaro relied
on representations that Mr. Snyder made.
24 145 UNITED STATES TAX COURT REPORTS (1)
B. Adoption Agreements
1. Background
Environmental adopted the Sterling Plan as of November
16, 2004. 12 Environmental’s single employer plan was called
the Code Environmental Services, Inc. Employee Welfare
Benefit Plan. Environmental elected to make payments to
the Sterling Plan in amounts that Environmental selected.
In 2004 and 2005 the trustee of the Code Environmental
Services, Inc. Employee Welfare Benefit Plan was Fifth Third
Bank of Florida. By March 2006 the trustee was National
Advisors Trust. The trust underlying Environmental’s single
employer plan was neither a voluntary employee beneficiary
association under section 501(c)(9) nor a grantor trust under
sections 671–679.
2. Initial Adoption Agreement
In its initial adoption agreement Environmental selected a
preretirement death benefit option but did not specify the
formula for determining the benefit.
3. Second Adoption Agreement
On November 28, 2006, Environmental completed a second
adoption agreement, amending its earlier adoption agree-
ment, with an effective date of January 1, 2005. In the
second adoption agreement Environmental elected to make
discretionary payments to the Sterling Plan. Environmental
selected pre- and post-retirement death benefits and medical
benefits. 13 Environmental selected pre- and post-retirement
death benefits of five times compensation.
12 In 2007 Mr. Scutellaro learned that certain welfare benefit plans were
‘‘listed transactions’’, discussed infra, participation in which had to be dis-
closed on Federal income tax returns. Mr. Snyder gave Mr. Scutellaro a
memorandum stating why the Sterling Plan was not a listed transaction
subject to that requirement. Mr. Scutellaro and Environmental’s owners
opted not to disclose their participation in the Sterling Plan solely on the
basis of the memorandum.
13 During the subject years no Environmental employee received from
the Sterling Plan any payment for medical expenses.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 25
C. Life Insurance Policies
1. Mr. Abramo
Fifth Third Bank of Florida purchased a Minnesota Mutual
Life Insurance Co. (Minnesota Life) insurance policy on the
life of Mr. Abramo (Abramo policy) for the Code Environ-
mental Services, Inc. Employee Welfare Benefit Plan’s trust.
The Abramo policy was issued on November 13, 1998, and
reissued on March 13, 2004, and on January 13, 2005. The
Abramo policy as reissued on March 13, 2004, was a variable
adjustable life insurance policy with a face amount of $1 mil-
lion. The beneficiary of the Abramo policy was the Sterling
Trust.
On the application for life insurance Mr. Abramo was
required to, and he did, answer various personal questions
such as whether he intended to travel outside the United
States; whether within the last year he had missed any work
on account of illness or injury; whether he had been charged
with any motor vehicle moving violation or had had his
driver’s license restricted or revoked within the last five
years; and whether within the last five years he had partici-
pated in any high-adventure activity such as piloting an air-
craft, underwater diving, mountain climbing, hang gliding, or
motor vehicle racing. At the end of each subject year, Min-
nesota Life gave the Sterling Plan ‘‘tax information’’ for that
year stating in part that ‘‘[o]ur records indicate that the
[Abramo] policy listed above provided the insured with life
insurance protection as part of a split-dollar arrangement in
2005 [or 2006 or 2007, as applicable]. The IRS requires that
the ‘‘economic benefit’’ of this coverage be reported as income
for the tax year 2006 [or 2007 or 2008, as applicable].’’
As of November 13, 2005, 2006, and 2007, the cash values
of the Abramo policy were $174,550, $238,799, and $298,659,
respectively.
2. Mr. Brown
Fifth Third Bank of Florida purchased a Minnesota Life
insurance policy on the life of Mr. Brown (Brown policy) for
the Code Environmental Services, Inc. Employee Welfare
Benefit Plan’s trust. The Brown policy was issued on
November 13, 1998, and reissued on March 13, 2004, and
December 13, 2004. The Brown policy as reissued on March
26 145 UNITED STATES TAX COURT REPORTS (1)
13, 2004, was a variable adjustable life insurance policy with
a face amount of $1 million. The beneficiary of the Brown
policy was the Sterling Trust.
On the application for life insurance, Mr. Brown was
required to, and he did, answer various personal questions
such as whether he intended to travel outside the United
States; whether within the last year he had missed any work
on account of illness or injury; whether he had been charged
with any motor vehicle moving violation or had had his
driver’s license restricted or revoked within the last five
years; and whether within the last five years he had partici-
pated in any high-adventure activity such as piloting an air-
craft, underwater diving, mountain climbing, hang gliding, or
motor vehicle racing. At the end of each subject year, Min-
nesota Life gave the Sterling Plan ‘‘tax information’’ for that
year stating in part that ‘‘[o]ur records indicate that the
[Brown] policy listed above provided the insured with life
insurance protection as part of a split-dollar arrangement in
2005 [or 2006 or 2007, as applicable]. The IRS requires that
the ‘‘economic benefit’’ of this coverage be reported as income
for the tax year 2006 [or 2007 or 2008, as applicable].’’
As of November 13, 2005, 2006, and 2007, the cash values
of the Brown policy were $205,689, $276,082, and $341,847,
respectively.
3. Mr. Tomassetti
Fifth Third Bank of Florida purchased a Minnesota Life
insurance policy on the life of Mr. Tomassetti (Tomassetti
policy) for the Code Environmental Services, Inc. Employee
Welfare Benefit Plan’s trust. The Tomassetti policy was
issued on October 24, 1998, and reissued on November 13,
1998, March 13, 2004, and December 13, 2004. The
Tomassetti policy as reissued on March 13, 2004, was a vari-
able adjustable life insurance policy with a face amount of $1
million. The beneficiary of the Tomassetti policy was the
Sterling Trust.
On the application for life insurance, Mr. Tomassetti was
required to, and he did, answer various personal questions
such as whether he intended to travel outside the United
States; whether within the last year he had missed any work
on account of illness or injury; whether he had been charged
with any motor vehicle moving violation or had had his
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 27
driver’s license restricted or revoked within the last five
years; and whether within the last five years he had partici-
pated in any high-adventure activity such as piloting an air-
craft, underwater diving, mountain climbing, hang gliding, or
motor vehicle racing. Mr. Tomassetti also had to answer
questions about his and his family’s medical history. At the
end of each subject year, Minnesota Life gave the Sterling
Plan ‘‘tax information’’ for that year stating in part that ‘‘Our
records indicate that the [Tomassetti] policy listed above pro-
vided the insured with life insurance protection as part of a
split-dollar arrangement in 2005 [or 2006 or 2007, as
applicable]. The IRS requires that the ‘‘economic benefit’’ of
this coverage be reported as income for the tax year 2006 [or
2007 or 2008, as applicable].’’
As of November 13, 2005, 2006, and 2007, the cash values
of the Tomassetti policy were $184,629, $251,559, and
$314,120, respectively.
4. T. Tomassetti
Thomas Tomassetti (T. Tomassetti) was a nonshareholder
employee of Environmental. He was born on February 15,
1963.
Fifth Third Bank of Florida purchased a Minnesota Life
insurance policy on the life of T. Tomassetti for the Code
Environmental Services, Inc. Employee Welfare Benefit
Plan’s trust. This insurance policy was issued on October 28,
1998, and reissued on March 13, 2004, and on April 13, 2006.
This insurance policy as reissued on March 13, 2004, was a
variable adjustable life insurance policy with a face amount
of $600,000.
On the application for life insurance, T. Tomassetti was
required to, and he did, answer various personal questions
such as whether he intended to travel outside the United
States; whether within the last year he had missed any work
on account of illness or injury; whether he had been charged
with any motor vehicle moving violation or had had his
driver’s license restricted or revoked, within the last five
years; and whether within the last five years he had partici-
pated in any high-adventure activity such as piloting an air-
craft, underwater diving, mountain climbing, hang gliding, or
motor vehicle racing. T. Tomassetti also had to answer ques-
tions about his and his family’s medical history. At the end
28 145 UNITED STATES TAX COURT REPORTS (1)
of each subject year, Minnesota Life gave the Sterling Plan
‘‘tax information’’ for that year stating in part that ‘‘Our
records indicate that the [T. Tomassetti] policy listed above
provided the insured with life insurance protection as part of
a split-dollar arrangement in 2005 [or 2006 or 2007, as
applicable]. The IRS requires that the ‘‘economic benefit’’ of
this coverage be reported as income for the tax year 2006 [or
2007 or 2008, as applicable].’’
As of November 13, 2005, 2006, and 2007, the cash values
of this insurance policy were $72,212, $90,021, and $105,685,
respectively.
5. Other Policies
In addition to the policies on the lives of Mr. Abramo, Mr.
Tomassetti, Mr. Brown, and T. Tomassetti, the Sterling Plan
purchased cash value life insurance policies for some of
Environmental’s other employees. These other employees
included Frederick Andlauer, John McGinty, Martin Bru-
baker, William Dauber, and Warren Libutti.
D. Payments and Valuations
1. 2005
On November 25, 2005, Environmental paid $96,621 to
Fifth Third Bank of Florida, as trustee for the benefit of
Environmental. On December 9, 2005, Environmental paid
$123,967 to Fifth Third Bank of Florida, as trustee for the
benefit of Environmental. The Sterling Plan treated the
$220,588 in payments ($96,621 + $123,967) as employer con-
tributions. On or after November 15, 2006, Mr. Snyder gave
Mr. Tomassetti, on behalf of Environmental, an amended
annual valuation report showing that the amount of the
allowable contribution for 2005 was $220,588.
The amended annual valuation report states that Environ-
mental paid Mr. Abramo, Mr. Brown, and Mr. Tomassetti
$144,000 compensation each for 2005. According to the for-
mula in the second adoption agreement, Mr. Abramo, Mr.
Brown, and Mr. Tomassetti were each entitled to a pre- and
post-retirement death benefit in 2005 of $720,000 (i.e., five
times their compensation of $144,000). Under the Sterling
Plan, as of December 31, 2005, both the pre- and post-retire-
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 29
ment death benefits payable on each of the Abramo, Brown,
and Tomassetti policies were $1 million.
2. 2006
On November 17, 2006, Environmental paid $170,639 to
Fifth Third Bank of Florida, as trustee of the Sterling Plan
for the benefit of Environmental. On December 15, 2006,
Environmental paid $66,028 to Fifth Third Bank of Florida,
as trustee of the Sterling Plan for the benefit of Environ-
mental. The Sterling Plan treated the $236,667 in payments
($170,639 + $66,028) as employer contributions. On or after
May 15, 2007, Mr. Snyder gave Mr. Tomassetti, on behalf of
Environmental, an annual valuation report showing that the
amount of the allowable contribution for 2006 was $236,667.
The amended annual valuation report states that Environ-
mental paid Mr. Abramo, Mr. Brown, and Mr. Tomassetti
$125,000 compensation each for 2006. According to the for-
mula in the second adoption agreement, Mr. Abramo, Mr.
Brown, and Mr. Tomassetti were each entitled to a pre- and
post-retirement death benefit in 2006 of $625,000 (i.e., five
times their compensation of $125,000). Under the Sterling
Plan, as of December 31, 2006, both the pre- and post-retire-
ment death benefits payable on each of the Abramo, Brown,
and Tomassetti policies were $1 million.
3. 2007
On December 27, 2007, Environmental paid $237,309 to
Fifth Third Bank of Florida, as trustee for the benefit of
Environmental. The Sterling Plan treated the $237,309 pay-
ment as an employer contribution. On or after May 20, 2008,
Mr. Snyder gave Mr. Tomassetti, on behalf of Environmental,
an annual valuation report showing that the amount of the
allowable contribution for 2007 was $237,309.
The annual valuation report states that Environmental
paid Mr. Abramo, Mr. Brown, and Mr. Tomassetti each
$235,000 compensation for 2007. According to the formula in
the second adoption agreement, Mr. Abramo, Mr. Brown, and
Mr. Tomassetti were each entitled to a pre- and post-retire-
ment death benefit in 2007 of $1,175,000 (i.e., five times
their compensation of $235,000). Under the Sterling Plan, as
of December 31, 2007, both the pre- and post-retirement
30 145 UNITED STATES TAX COURT REPORTS (1)
death benefits payable on each of the Abramo, Brown, and
Tomassetti policies were $1 million. 14
4. Payment of Premiums
During the subject years the payments that Environmental
made to the Code Environmental Services, Inc. Employee
Welfare Benefit Plan were used, in part, to pay the pre-
miums on the Abramo, Brown, and Tomassetti policies.
E. Death Benefits of Nonshareholder Employees
Environmental employees other than the three owners
were entitled to pre- and post-retirement death benefits in
each subject year. The death benefits for the following
employees were the same amount as to each employee in
each year and equaled the face amount of the life insurance
policy taken out on his or her life: Frederick Andlauer’s ben-
efit—$430,000; T. Tomassetti’s benefit—$600,000; Sharon
Jarmon’s benefit—$165,555; John McGinty’s benefit—
$450,000; David Runyon’s benefit—$178,000; Lino Ferrara’s
benefit—$200,000; Ivona Cwiek’s benefit—$146,000; Martin
Brubaker’s benefit—$850,000; and William Dauber’s ben-
efit—$520,000.
In addition to the just-mentioned Environmental
employees, Warren Libutti was an Environmental employee
from August 1, 1999, through October 21, 2005. For 2005 Mr.
Libutti was entitled to pre- and post-retirement death bene-
fits of $475,000. These benefits equaled the face amount of
the life insurance policy taken out on his life.
F. Tax Return Information
1. Background
Mr. Scutellaro’s accounting firm prepared Environmental’s
and its owners’ Federal income tax returns for the subject
years.
14 While the formula in the second adoption agreement set Mr. Abramo’s,
Mr. Brown’s, and Mr. Tomassetti’s death benefits for 2007 at $1,175,000,
their death benefits were limited to $1 million because the face value of
their life insurance policies was $1 million.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 31
2. Environmental
a. 2005
Environmental filed a 2005 Form 1120S, U.S. Income Tax
Return for an S Corporation. Environmental deducted the
$220,588 in payments that it made to the Sterling Plan
during 2005 and did not disclose its participation in the Ster-
ling Plan.
b. 2006
Environmental filed a 2006 Form 1120S. Environmental
deducted $236,667 for contributions that it made to the Ster-
ling Plan and did not disclose its participation in the Sterling
Plan.
c. 2007
Environmental filed a 2007 Form 1120S. Environmental
deducted $237,309 for contributions that it made to the Ster-
ling Plan and did not disclose its participation in the Sterling
Plan.
3. Abramos
a. 2005
The Abramos filed a joint Federal income tax return for
2005. In that return the Abramos did not report any income
related to Mr. Abramo’s participation in the Sterling Plan
and they did not disclose his participation in the plan. The
Abramos reported ordinary business income of $191,556 as
Mr. Abramo’s distributive share of income from Environ-
mental. That business income was computed deducting the
payments to the Sterling Plan. The Abramos reported tax-
able income of $170,051 and total Federal income tax of
$37,426.
The Abramos filed two Forms 1040X, Amended U.S. Indi-
vidual Income Tax Returns, for 2005. Neither the first nor
the second amended return reflected any change related to
Mr. Abramo’s participation in the Sterling Plan.
b. 2006
The Abramos filed a joint Federal income tax return for
2006. The Abramos did not report any income related to Mr.
Abramo’s participation in the Sterling Plan, and they did not
32 145 UNITED STATES TAX COURT REPORTS (1)
disclose his participation in the plan. The Abramos reported
ordinary business income of $209,871 as Mr. Abramo’s
distributive share of income from Environmental. That busi-
ness income was computed deducting the payments to the
Sterling Plan. The Abramos reported taxable income of
$405,147 and total Federal income tax of $119,088.
The Abramos filed a 2006 Form 1040X. The 2006 amended
return did not reflect any change related to Mr. Abramo’s
participation in the Sterling Plan.
c. 2007
The Abramos filed a joint Federal income tax return for
2007. In that return the Abramos did not report any income
related to Mr. Abramo’s participation in the Sterling Plan
and they did not disclose his participation in the plan. The
Abramos reported ordinary business income of $422,074 as
Mr. Abramo’s distributive share of income from Environ-
mental. That business income was computed deducting the
payments to the Sterling Plan. The Abramos reported tax-
able income of $378,954 and total Federal income tax of
$116,457.
The Abramos filed a 2007 Form 1040X. The 2007 amended
return did not reflect any change related to Mr. Abramo’s
participation in the Sterling Plan.
4. Browns
a. 2005
The Browns filed a joint Federal income tax return for
2005. The Browns did not report any income related to Mr.
Brown’s participation in the Sterling Plan, and they did not
disclose his participation in the plan. The Browns reported
ordinary business income of $191,556 as Mr. Brown’s
distributive share of income from Environmental. That busi-
ness income was computed deducting the payments to the
Sterling Plan. The Browns reported taxable income of
$95,192 and total Federal income tax of $19,863.
The Browns filed a 2005 Form 1040X. The 2005 amended
return did not reflect any change related to Mr. Brown’s
participation in the Sterling Plan.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 33
b. 2006
The Browns filed a joint Federal income tax return for
2006. The Browns did not report any income related to Mr.
Brown’s participation in the Sterling Plan, and they did not
disclose his participation in the plan. The Browns reported
ordinary business income of $209,872 as Mr. Brown’s
distributive share of ordinary business income from Environ-
mental. That business income was computed deducting the
payments to the Sterling Plan. The Browns reported taxable
income of $376,541 and total Federal income tax of $109,079.
The Browns filed a 2006 Form 1040X. The 2006 amended
return did not reflect any change related to Mr. Brown’s
participation in the Sterling Plan.
c. 2007
The Browns filed a joint Federal income tax return for
2007. The Browns did not report any income related to Mr.
Brown’s participation in the Sterling Plan, and they did not
disclose his participation in the plan. The Browns reported
ordinary business income of $422,074 as Mr. Brown’s
distributive share of income from Environmental. That busi-
ness income was computed deducting the payments to the
Sterling Plan. The Browns reported taxable income of
$366,691 and total Federal income tax of $112,176.
The Browns filed a 2007 Form 1040X. The 2007 amended
return did not reflect any change related to Mr. Brown’s
participation in the Sterling Plan.
5. Tomassettis
a. 2005
The Tomassettis filed a joint Federal income tax return for
2005. In that return, the Tomassettis did not report any
income related to Mr. Tomassetti’s participation in the Ster-
ling Plan and they did not disclose his participation in the
plan. The Tomassettis reported ordinary business income of
$191,556 as Mr. Tomassetti’s distributive share of income
from Environmental. That business income was computed
deducting the payments to the Sterling Plan. The
Tomassettis reported taxable income of $132,286 and total
Federal income tax of $31,949.
34 145 UNITED STATES TAX COURT REPORTS (1)
The Tomassettis filed a 2005 Form 1040X. The 2005
amended return did not reflect any change related to Mr.
Tomassetti’s participation in the Sterling Plan.
b. 2006
The Tomassettis filed a joint Federal income tax return for
2006. The Tomassettis did not report any income related to
Mr. Tomassetti’s participation in the Sterling Plan, and they
did not disclose his participation in the plan. The
Tomassettis reported ordinary business income of $209,872
as Mr. Tomassetti’s distributive share of ordinary business
income from Environmental. That business income was com-
puted deducting the payments to the Sterling Plan. The
Tomassettis reported taxable income of $377,428 and total
Federal income tax of $110,928.
The Tomassettis filed a 2006 Form 1040X. The 2006
amended return did not reflect any change related to Mr.
Tomassetti’s participation in the Sterling Plan.
c. 2007
The Tomassettis filed a joint Federal income tax return for
2007. In that return the Tomassettis did not report any
income related to Mr. Tomassetti’s participation in the Ster-
ling Plan and they did not disclose his participation in the
plan. The Tomassettis reported ordinary business income of
$422,076 as Mr. Tomassetti’s distributive share of income
from Environmental. That business income was computed
deducting the payments to the Sterling Plan. The
Tomassettis reported taxable income of $357,456 and total
Federal income tax of $112,849.
The Tomassettis filed a 2007 Form 1040X. The 2007
amended return did not reflect any change related to Mr.
Tomassetti’s participation in the Sterling Plan.
G. Deficiency Notices
On March 2, 2011, respondent mailed deficiency notices for
the subject years to the Abramos, the Browns, and the
Tomassettis.
Each deficiency notice stated in relevant part that
respondent had disallowed for the subject years
Environmental’s claimed deductions of $220,588, $236,667,
and $237,309, respectively, for payments that it made to the
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 35
Sterling Plan because the life insurance arrangement was a
split-dollar insurance arrangement subject to the ‘‘economic
benefit regime rules’’, which disallow those deductions. The
notices further stated as to this point that respondent had
increased the income of each of Environmental’s owners by
his share of the disallowed deductions and that, for the
respective years, the owners’ shares of the disallowed deduc-
tions were $73,529, $78,889, and $79,103, respectively, in the
case of Mr. Abramo; $73,529, $78,889, and $79,103, in the
case of Mr. Brown; and $73,529, $78,889, and $79,103 in
the case of Mr. Tomassetti.
The deficiency notices also stated in relevant part that
each of the three owners had realized income on account of
his participation in the Sterling Plan and that the authority
for that income was sections 61, 72, 79, 83, 402(b), and
707(c). The notices further stated as to this point that for the
respective years, that income was $188,797, $266,299, and
$302,968, respectively, in the case of Mr. Abramo; $222,089,
$304,978, and $346,515 in the case of Mr. Brown; and
$199,454, $279,637, and $318,594 in the case of Mr.
Tomassetti.
OPINION
I. Overview
Our Nation’s Federal income tax laws, coupled with the
reality that all accessions to wealth are generally reduced
significantly by the amount of Federal income taxes imposed
thereon, sometimes inspire taxpayers to seek out ways to
shelter their income from taxation. Taxpayers have no patri-
otic responsibility to pay an amount of Federal income tax
greater than that which Congress imposes, and taxpayers
may structure their business and personal affairs to take
advantage of legitimate tax shelters that will reduce the
amounts of Federal income tax that they would otherwise
pay absent the use of the shelters. See Helvering v. Gregory,
69 F.2d 809, 810 (2d Cir. 1934), aff ’d,
293 U.S. 465 (1935).
Promoters of tax shelters obviously know that taxpayers
generally desire to pay less Federal income tax rather than
more, and such promoters regularly devise novel (and on
many occasions highly technical) tax shelters which they rep-
resent are legitimate tax-saving strategies. As is true when
36 145 UNITED STATES TAX COURT REPORTS (1)
seeking to enter into any novel or atypical venture, taxpayers
seeking to implement a novel or an atypical tax-saving
strategy should proceed with caution and with proper inde-
pendent professional guidance. ‘‘[T]hat which we call a rose
[b]y any other name would smell as sweet’’, William Shake-
speare, Romeo and Juliet, act 2, sc. 2, 43–44, but a tax-
payer’s use of an illegitimate tax shelter marketed as a legiti-
mate tax shelter will not. A taxpayer who uses an illegit-
imate tax shelter may, for example, eventually be called
upon to pay not only the Federal income tax that the tax-
payer would have paid had the tax shelter not been used, but
significant amounts of interest and penalties to boot. While
it would be nice if all tax shelters advertised as legitimate
tax shelters were indeed legitimate, the fact of the matter is
that not all marketed tax shelters are legitimate. Taxpayers
who invest in tax shelters should be mindful that the state-
ments of promoters as to the legitimacy of tax shelters carry
no weight in the final say as to the true tax consequences
that flow from the shelters. For it is only the judiciary that
can say definitively that the tax consequences that flow from
a promoted tax-savings strategy are indeed legitimate. Cf.
Marbury v. Madison, 5 U.S. (1 Cranch) 137, 177 (1803) (‘‘It
is emphatically the province and duty of the judicial depart-
ment to say what the law is.’’).
The parties dispute the tax consequences that flow from
the Sterling Plan, a plan that promotes the purchase of life
insurance products and the payment of commissions thereon
in the setting of a coupled tax-saving and tax-deferral
strategy. The shareholder/employees generally caused their
corporations to invest in the Sterling Plan with the assur-
ance that the investments would safeguard their designated
beneficiaries if the shareholder/employees died during the
insurance policy year and allow the shareholder/employees to
receive the significant cash value of the policies if, as they
more likely expected, they did not die during that time. The
corporations essentially deducted the payments of the pre-
miums on the life insurance policies through their deductions
of their payments to the Sterling Plan, and the shareholder/
employees recognized no income corresponding to those
deductions. The shareholder/employees, in fact, recognized no
income at all from their participation in the Sterling Plan.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 37
Respondent determined that the corporations were not
entitled to deduct their payments to the Sterling Plan. Fur-
ther, respondent determined, the shareholder/employees
failed to recognize income from their participation in the
Sterling Plan. Petitioners disagree with those determinations
and have brought the matter before this Court. In addition,
the parties agree that petitioners bear the burden of proof
except with respect to the accuracy-related penalties that
respondent determined applied to the noncorporate peti-
tioners. Further, the parties agree that the noncorporate
petitioners bear the burden of persuasion as to the accuracy-
related penalties related to them but that respondent first
bears a burden of production as to those items.
II. Compensatory Split-Dollar Life Insurance Arrangements
A. Overview
Respondent determined that Our Country’s participation
and Environmental’s participation in the Sterling Plan are
parts of split-dollar life insurance arrangements. 15 To that
end, respondent primarily asserts each life insurance
arrangement underlying that participation meets the three-
prong definition of a ‘‘compensatory arrangement’’ set forth
in the special rule of section 1.61–22(b)(2)(ii), Income Tax
Regs. 16 Petitioners argue that the life insurance arrange-
ments fail all of those prongs. As petitioners see it, the Ster-
ling Plan is a permissible welfare benefit plan that holds the
funds and administers the benefits for its participating
employers’ single employer welfare benefit plans. Petitioners
add that a finding that the Sterling Plan is not a permissible
welfare benefit plan may result in unfavorable tax con-
sequences to the nonparty employees of Our Country and of
Environmental. Petitioners invite the Court to construe the
applicable law taking that possibility into account. We con-
15 Respondent does not assert that Netversity’s and Mr. Mejia’s partici-
pation in the Sterling Plan was part of a split-dollar life insurance ar-
rangement. This is most likely because Netversity during or before 2006
did not cause life insurance to be issued as to any of its employees. As dis-
cussed infra, a split-dollar life insurance arrangement requires the
issuance of life insurance.
16 Respondent argues secondarily that the Sterling Plan is generally a
shareholder arrangement under sec. 1.61–22(b)(2)(iii), Income Tax Regs.
We need not and do not address that argument.
38 145 UNITED STATES TAX COURT REPORTS (1)
clude on the basis of a plain meaning application of the law
(and with no need to consider or to discuss the consequences
of our conclusion for the nonparty employees) that Our Coun-
try’s participation and Environmental’s participation in the
Sterling Plan are compensatory arrangements that make
them split-dollar life insurance arrangements.
In general, a split-dollar life insurance arrangement is any
arrangement between an owner and a nonowner of a life
insurance contract that meets the rules set forth in section
1.61–22(b)(1), Income Tax Regs. 17 See sec. 1.61–22(b)(1),
Income Tax Regs. These rules essentially describe a split-
dollar life insurance arrangement as any arrangement
between an owner and a nonowner of a life insurance con-
tract, other than an arrangement that is group term life
insurance, where one party pays the premiums and is enti-
tled to recover all or a portion of the premiums from the pro-
ceeds of the life insurance contract. See generally Cadwell v.
Commissioner, 136 T.C. 38, 63–64 (2011), aff ’d, 483 F. App’x
847 (4th Cir. 2012). Section 1.61–22, Income Tax Regs., is
effective for split-dollar life insurance arrangements entered
into after September 17, 2003, and an arrangement that is
‘‘materially modified’’ after that date is generally considered
to be ‘‘entered into’’ after that date. Sec. 1.61–22(j)(1) and
(2)(i), Income Tax Regs. The parties agree that the life insur-
ance arrangements at hand were entered into after Sep-
tember 17, 2003, for purposes of section 1.61–22, Income Tax
17 Sec. 1.61–22(b)(1), Income Tax Regs., provides:
A split-dollar life insurance arrangement is any arrangement between
an owner and a non-owner of a life insurance contract that satisfies the
following criteria—
(i) Either party to the arrangement pays, directly or indirectly, all or
any portion of the premiums on the life insurance contract, including a
payment by means of a loan to the other party that is secured by the
life insurance contract;
(ii) At least one of the parties to the arrangement paying premiums
under paragraph (b)(1)(i) of this section is entitled to recover (either con-
ditionally or unconditionally) all or any portion of those premiums and
such recovery is to be made from, or is secured by, the proceeds of the
life insurance contract; and
(iii) The arrangement is not part of a group term life insurance plan
described in section 79 unless the group term life insurance plan pro-
vides permanent benefits to employees (as defined in § 1.79–0).
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 39
Regs., and that section 1.61–22, Income Tax Regs., applies to
these cases. 18
As an exception to the general rule of section 1.61–22(b)(1),
Income Tax Regs., an arrangement between an owner and a
nonowner of a life insurance contract is a split-dollar life
insurance arrangement if it is either a compensatory
arrangement or a shareholder arrangement under the special
rules of section 1.61–22(b)(2)(ii) and (iii), Income Tax Regs.,
respectively. See id. subdiv. (i). An arrangement is a compen-
satory arrangement if it meets each prong of a three-prong
test. See id. subdiv. (ii). The first prong requires that the
arrangement be ‘‘entered into in connection with the
performance of services and * * * not [as] part of a group
term life insurance plan described in section 79’’. Id. subdiv.
(ii)(A). The second prong requires that ‘‘[t]he employer or
service recipient pays, directly or indirectly, all or any por-
tion of the premiums’’. Id. subdiv. (ii)(B). The third prong
requires that either ‘‘(1) The beneficiary of all or any portion
of the death benefit is designated by the employee or service
provider or is any person whom the employee or service pro-
vider would reasonably be expected to designate as the bene-
ficiary; or (2) The employee or service provider has any
interest in the policy cash value of the life insurance con-
tract.’’ Id. subdiv. (ii)(C). A compensatory (or shareholder)
arrangement that falls within the special rule is a split-dollar
life insurance arrangement even if it does not meet the gen-
18 On September 18, 2013, the Court ordered each party to file a memo-
randum that set forth their and his understanding of, and positions as to,
the issues of fact and law to be decided in these cases. The order stated
that the parties were precluded from advancing positions not included in
the memorandums. Petitioners filed their memorandum on February 12,
2014, and supplemented their memorandum on March 6, 2014. Petitioners’
memorandum, as supplemented, does not challenge the applicability of sec.
1.61–22, Income Tax Regs., to these cases. To the contrary, petitioners’
supplement informs the Court that ‘‘[p]etitioners agree with Respondent
that the arrangements were entered into after September 17, 2003’’, for
purposes of sec. 1.61–22, Income Tax Regs. Petitioners in their opening
brief now invite the Court to decide whether the life insurance arrange-
ments involving Environmental were entered into after September 17,
2003, for purposes of the effective date provision. We decline that invita-
tion. Petitioners did not in their memorandum raise the applicability of the
referenced regulations as an issue with respect to Environmental, and we
therefore consider petitioners to have waived or otherwise to have aban-
doned any such argument.
40 145 UNITED STATES TAX COURT REPORTS (1)
eral rule of section 1.61–22(b)(1), Income Tax Regs. See id.
subdiv. (i).
B. Owner of Policies
The owner of a life insurance contract is generally the per-
son that the insurance contract names as the owner. See id.
para. (c)(1)(i). Notwithstanding this general rule, however, an
employer is considered to be the owner of a life insurance
contract under a split-dollar life insurance arrangement
entered into in connection with the performance of services
if the insurance policy is owned by, inter alia, a trust
described in section 402(b) or a welfare benefit fund
described in section 419(e)(1). See id. subdiv. (iii)(A), (C).
A nonowner is any person other than an owner of the life
insurance policy who has a direct or indirect interest in the
insurance policy. See sec. 1.61–22(c)(2), Income Tax Regs.
The parties agree that the relevant corporate employers here,
Our Country and Environmental, are treated as the owners
of the life insurance policies at hand for purposes of section
1.61–22(b)(2)(i), Income Tax Regs.
C. Our Country and Environmental Single Employer Plans
The life insurance arrangements related to the Our
Country and the Environmental single employer plans are
split-dollar life insurance arrangements in that they are
compensatory arrangements within the meaning of the spe-
cial rule. They fall within the special rule because each prong
of the three-prong test is met as to the arrangements. First,
each of those single employer plans provided life insurance
benefits to the employees in exchange for their performance
of services, and the benefits were not provided as part of a
group term life insurance plan described in section 79.
Second, each single employer plan paid the premiums on the
life insurance policies through the employer’s payments to
the Sterling Plan. Third, the employees participating in the
single employer plans designated the beneficiaries of the
death benefits payable under the plans, which in substance
were the death benefits payable under the insurance policies.
We also find as to the third prong that the employees in each
single employer plan had an interest in the cash value of the
respective life insurance policies that covered them.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 41
Petitioners argue that the first prong of the three-prong
test fails to be met because, they assert, the Sterling Plan is
part of a group term life insurance plan within the meaning
of section 79. To that end, petitioners assert that the amount
of life insurance is based on the compensation paid to the
employee, without regard to any employee’s health. We dis-
agree with petitioners’ assertion that the Sterling Plan’s life
insurance benefit is part of a group term life insurance plan
within the meaning of section 79.
The life insurance policies are not group term life insur-
ance policies for Federal income tax purposes. Section 1.79–
1(a), Income Tax Regs., sets forth the conditions that must
be met for life insurance to be characterized as group term
life insurance, 19 and at least one of those conditions is not
met. Specifically, the record does not establish that ‘‘[t]he
amount of insurance provided to each employee is computed
under a formula that precludes individual selection.’’ Id.
subpara. (4).
The regulations do not define the term ‘‘individual selec-
tion’’ for purposes of section 1.79–1(a)(4), Income Tax Regs.
As petitioners see it, the amount of insurance that the Ster-
ling Plan provided to each participating employee was com-
puted under a formula that precluded individual selection
because the formula mechanically ascertained the amount of
that insurance on the basis of each participating employee’s
compensation. Respondent argues that the amount of insur-
19 Sec. 1.79–1(a), Income Tax Regs., provides:
(a) What is group-term life insurance?—Life insurance is not group-
term life insurance for purposes of section 79 unless it meets the fol-
lowing conditions:
(1) It provides a general death benefit that is excludable from gross
income under section 101(a).
(2) It is provided to a group of employees.
(3) It is provided under a policy carried directly or indirectly by the
employer.
(4) The amount of insurance provided to each employee is computed
under a formula that precludes individual selection. This formula must
be based on factors such as age, years of service, compensation, or posi-
tion. This condition may be satisfied even if the amount of insurance
provided is determined under a limited number of alternative schedules
that are based on the amount each employee elects to contribute. How-
ever, the amount of insurance provided under each schedule must be
computed under a formula that precludes individual selection.
42 145 UNITED STATES TAX COURT REPORTS (1)
ance that the Sterling Plan provided to each participating
employee depended on individual selection. To that end,
respondent asserts the death benefits provided to the share-
holder/employees were on many occasions larger than the
death benefits as ascertained by the formula. Respondent
also states that individual selection is found in the fact that
the issuance of the life insurance policies as to each share-
holder/employee was based upon the underwriting criteria for
that employee.
We conclude that the issuance of the insurance policies on
the lives of Our Country and Environmental shareholder/
employees (and as it appears on the lives of all of the Our
Country and the Environmental participating employees)
was based on individual selection. While the employers
participating in the Sterling Plan formally set the amount of
life insurance provided to their employees as a multiple of
compensation, the mere fact that the Sterling Plan stated on
its face that it would pay death benefits in amounts that
turn on employee compensation does not necessarily mean
that the underlying life insurance is group term life insur-
ance. The life insurance issued as to the Our Country and
the Environmental shareholder/employees was not group
term life insurance given our finding above that the multiple-
of-compensation formula did not actually correspond to death
benefits payable and otherwise failed to always limit the
amount of insurance that actually was provided to those
shareholder/employees. Cf. Towne v. Commissioner, 78 T.C.
791 (1982) (holding that an insurance policy was not part of
a group term life insurance plan because it individually
selected only the company’s president as a participant to
receive excess insurance).
We also agree with respondent’s argument that the life
insurance related to Our Country and Environmental was
not group term life insurance because the issuance of the
insurance took into account the personal risks characteristics
of at least those corporations’ shareholder/employees (and
most likely all of those corporations’ participating
employees). In Towne v. Commissioner, 78 T.C. at 799–800,
the Court discussed the genesis of the ‘‘individual selection’’
test and noted that individual selection has never been
allowed to occur in the case of group term life insurance. The
Court explained:
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 43
The reason why the insurance industry has traditionally defined group
insurance as not including policies of insurance providing for individual
selection is that a group insurer has less opportunity to exercise under-
writing judgment with respect to particular persons in the group. Group
insurance is usually issued without medical examination or other evi-
dence of insurability. If there were no requirement that the amount of
insurance per participant be determined under some formula applicable
to all the employees, there would necessarily be adverse selection
against the insurance company because the older employees and those
in poor health would naturally take disproportionately large amounts of
insurance. * * * [Id. at 799 n.5; citations omitted.]
Guardian and Minnesota Life required that the Our
Country and Environmental shareholder/employees tender
information on their health, traveling tendencies, and/or
driving traits. The need to submit that type of personal
information as a condition to receiving the insurance strongly
suggests, and we find, that the insurers were exercising
underwriting judgment with respect to at least the Our
Country and Environmental shareholder/employees in
connection with the issuance of the life insurance related to
them. This finding is further strengthened by the fact that,
in the case of Guardian at least, Guardian specifically rated
each of Our Country’s participating employees for purposes
of setting the premiums payable on their policies and offered
to try to find a way to reduce the premium attributable to
the Blake policy. The mere fact that an insurer such as
Guardian or Minnesota Life may add up the premiums that
apply to separate policies that it sells on a specific group of
insureds and then tender the total as the amount due on a
‘‘group policy’’ does not necessarily recharacterize the sepa-
rate policies as part of a single group term life insurance
plan. Instead, as we have stated, the exercise of underwriting
judgment with respect to the specific persons in a group is
indicative of the issuance of individual insurance policies
rather than group policies. We hold that the insurance poli-
cies at hand are not group term life insurance policies for
Federal income tax purposes. 20
20 The life insurance polices related to Our Country also fail to qualify
as group term life insurance because the insurance was not provided in
any of the subject years to at least 10 of Our Country’s full-time employ-
ees. See sec. 1.79–1(c)(1), Income Tax Regs. (stating that life insurance
fails to qualify as group term life insurance under sec. 79 where the
Continued
44 145 UNITED STATES TAX COURT REPORTS (1)
Petitioners make no specific argument as to the second
prong of the three-prong test. They argue that the third
prong is not met because, they assert, the employees do not
designate the beneficiaries. Petitioners also assert that the
employees have no direct or indirect interest in the life insur-
ance policies, including the cash values thereof. We disagree
on both points.
The third prong is met if the employees who participated
in the Sterling Plan either designated the beneficiaries of the
life insurance policies or had an interest in the cash value of
those policies. Our Country and Environmental shareholder/
employees both designated the beneficiaries of the death ben-
efit payable under the policies on their lives and had
interests in those policies.
The shareholder/employees named the beneficiaries of the
death benefits payable under their insurance policies by des-
ignating through the Sterling Plan the individuals who
would receive the death benefits under the plan, which, in
turn were the death benefits under the policy. In addition,
those shareholder/employees were assured that their des-
ignated beneficiaries would receive any death benefits pay-
able on those policies to the extent that the shareholder/
employees died while participants in the plan. Petitioners
seek a contrary holding essentially by looking at the life
insurance policies through the wider end of a telescope
towards its narrower end and seeing that the Sterling Plan
is named as the beneficiary on the policies. They conclude
from this view that none of the individuals who the partici-
pating employees designate to receive the death benefits pay-
able by the Sterling Plan is ‘‘[t]he beneficiary of all or any
portion on the death benefit’’ for purposes of section 1.61–
22(b)(2)(ii)(C), Income Tax Regs. We, on the other hand, look
telescopically at the life insurance benefit from the narrower
end towards the wider end, as one commonly does, and see
the ultimate recipient of the death proceeds as the person
designated by the shareholder/employees. The fact that the
insurance is not provided during the calendar year to 10 or more full-time
employees). While the regulations go on to state that this 10-or-more em-
ployee rule may be avoided where coverage is provided to all full-time
employees, see sec. 1.79–1(c)(2), Income Tax Regs., the record fails to estab-
lish that all of Our Country’s full-time employees were covered by the Ster-
ling Plan.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 45
death proceeds from the life insurance policies are funneled
through the Sterling Plan to each of the ultimate recipients
does not blur our view (or our conclusion) that each of those
recipients is the beneficiary of the death benefit for purposes
of section 1.61–22(b)(2)(ii)(C), Income Tax Regs. Cf. Commis-
sioner v. Court Holding Co., 324 U.S. 331, 334 (1945) (‘‘To
permit the true nature of a transaction to be disguised by
mere formalisms * * * would seriously impair the effective
administration of the tax policies of Congress.’’); Minn. Tea
Co. v. Helvering,
302 U.S. 609, 613 (1938) (‘‘A given result at
the end of a straight path is not made a different result
because reached by following a devious path.’’). The light at
the end of the tunnel brightly illuminates our conclusion,
given that the Sterling Plan would pay no death benefit were
it not for the life insurance policies, and the employee to
whom a policy relates, rather than the Sterling Plan, is
assured of receiving the entire amount that is payable under
the terms of the policy.
We also conclude that the shareholder/employees of Our
Country and Environmental had interests in the their life
insurance policies and the cash values thereof. This conclu-
sion is supported by at least five facts. First, each life insur-
ance policy and any funds related thereto were intended to
be received by the corresponding employee or his or her des-
ignee(s) and no one else, and those employees were the only
ones who had the right to receive or otherwise to redirect to
someone else the cash value of the life insurance policies
related to them. Second, the employees could elect to receive
their policies upon retiring from employment with the
employer. Third, the funds in the Sterling Plan could not be
accessed by either the employer or by the employer’s credi-
tors, and Our Country and the Environmental employees,
upon retiring or alternatively upon their employers’ ceasing
participation in the Sterling Plan, were certain to get those
funds in the form of the policies that then passed to the
employees. Fourth, a participating employee, before actually
receiving the funds in his or her account, could be allowed
to direct the investment of those funds and thus enjoy the
benefit of any investment gain or suffer the detriment of any
investment loss. Fifth, if the participating employee were to
die while his or her insurance policy was in force, then the
death benefit under that policy would ultimately be paid to
46 145 UNITED STATES TAX COURT REPORTS (1)
his or her beneficiary in accordance with the terms of the
policy.
We also find important to our just-stated conclusion that
the plan benefits were set to be fully vested either when a
shareholder/employee satisfied the vesting requirements that
he or she chose (or possibly could choose) in the name of the
employer or when the employer terminated the plan. And as
to vesting, the shareholder/employees were not necessarily
bound by the vesting requirements that were initially set in
their plans. Instead, at their whim they could accelerate or
otherwise change the vesting requirements to their pref-
erence. In the case of Mr. Blake, for example, he executed an
adoption agreement on July 30, 2006, retroactive to January
1, 2005, that lowered the normal retirement age for the
employee participants in the Our Country plan and acceler-
ated his complete vesting to the then-present time.
We conclude that the life insurance contracts relating to
the Our Country and the Environmental single employer
plans were part of split-dollar life insurance arrangements. 21
D. Netversity Single Employer Plan
No life insurance was purchased or outstanding during the
subject years as to the Netversity plan. Any arrangement
involving Netversity and the Sterling Plan, therefore, was
not a split-dollar life insurance arrangement during those
years.
III. Deductions
A. Overview
Respondent argues that the corporate employers may not
deduct the payments that funded the life insurance pre-
miums. Petitioners argue that the corporate employers may
deduct the payments as ordinary and necessary business
expenses under section 162(a). We agree with respondent.
21 Minnesota Life concluded similarly as to the Environmental policies
that it issued on the lives of Environmental’s owners. Minnesota Life re-
ported to the Sterling Plan that each of those insurance policies was part
of a split-dollar life insurance arrangement.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 47
B. Section 162(a)
Section 162(a) is generally the primary hurdle that a tax-
payer must clear to deduct a business expense. Section
162(a) lets taxpayers deduct ‘‘all the ordinary and necessary
expenses paid or incurred during the taxable year in carrying
on any trade or business’’. Under that section, an expendi-
ture is deductible if it is: (1) an expense, (2) an ordinary
expense, (3) a necessary expense, (4) paid (in the case of a
cash method taxpayer) or incurred (in the case of an accrual
method taxpayer) during the taxable year, and (5) made to
carry on a trade or business. See Commissioner v. Lincoln
Sav. & Loan Ass’n, 403 U.S. 345, 352–353 (1971); Lychuk v.
Commissioner,
116 T.C. 374, 386 (2001).
C. Our Country and Environmental
Our Country and Environmental must clear another
hurdle in addition to section 162(a). We have held that the
life insurance policies related to Our Country and to
Environmental are split-dollar life insurance arrangements
because they are compensatory arrangements. In the light of
this holding, Our Country and Environmental may deduct an
expense related to the arrangements only if the deduction
meets the rules of section 1.83–6(a)(5), Income Tax Regs. See
sec. 1.61–22(f)(2)(ii), Income Tax Regs. Section 1.83–6(a)(5),
Income Tax Regs., provides that the amount of an allowable
deduction in such a situation equals the sum of the amount
of income that the employee recognizes under section 1.61–
22(g)(1), Income Tax Regs., plus the amount determined
under section 1.61–22(g)(1)(ii), Income Tax Regs. Section
1.61–22(g)(1), Income Tax Regs., explains that an employee
generally must recognize income upon the transfer to the
employee of the ownership of the life insurance policy. Sec-
tion 1.61–22(g)(1), Income Tax Regs., explains that the
amount of that income equals the excess of the fair market
value of the life insurance contract over the sum of the
amount that the employee pays to the employer to obtain the
insurance contract plus the amount of all economic benefits
already included in income by the employee.
Our Country and Environmental did not transfer any life
insurance policy to their participating employees during the
subject years. Nor did the shareholder/employees recognize
48 145 UNITED STATES TAX COURT REPORTS (1)
any income from their participation in the Sterling Plan. We
conclude that Our Country and Environmental may not
deduct their payments to the Sterling Plan.
D. Netversity
As previously discussed, Netversity’s $50,000 payment to
the Sterling Plan is not related to a split-dollar life insurance
arrangement. While the same rules that apply to Our Coun-
try’s and to Environmental’s deductions of their payments to
the Sterling Plan therefore do not apply to Netversity, the
result in all three instances is the same.
The Court has repeatedly held in settings similar to
Netversity’s setting here that section 162(a) does not allow
an employer to deduct its payments to a purported welfare
benefit plan where the participating employees could receive
the value reflected in insurance policies purchased by those
plans. See Neonatology Assocs., P.A. v. Commissioner, 115
T.C. at 90–92; see also White v. Commissioner, T.C. Memo.
2012–104, 103 T.C.M. 1560, 1571–1572 (2012) (and
cases cited thereat). The Court found in those cases that the
employers’ payments were for the personal benefit of the
shareholder/employees, that the plans were not intended to
provide welfare benefits to the employees, and that the pur-
ported welfare benefit plans were a means to transfer funds
from the corporations to their shareholders tax free. The
Court held that the employers failed to establish that the
payments to the plans were ordinary and necessary business
expenses deductible under section 162(a).
Although those referenced cases involved the actual pur-
chase of life insurance and Netversity’s case does not, the
holdings in those cases apply here with equal force. The Ster-
ling Plan was never intended primarily to provide welfare
benefits. Instead, as we find, the purpose and the operation
of the Sterling Plan were to serve as a tax-free savings device
for the shareholder/employees under the guise of possibly
providing welfare benefits. Accord Neonatology Assocs., P.A.
v. Commissioner, 115 T.C. at 92. While the framer(s) of the
Sterling Plan apparently intended that the plan would allow
a shareholder to accumulate substantial amounts of cash
value tax-free in life insurance policies, while at the same
time allowing the corporation to deduct the premium pay-
ments with no recognition of income by the employees, the
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 49
plan was more transparently designed to serve as a vehicle
for distributing corporate earnings to the shareholders with-
out the occurrence of an event that would trigger the pay-
ment of a welfare benefit. The fact that employees who were
not owners were allowed to participate in the Sterling Plan
does not change our view. The benefits payable to those
employees were insignificant when viewed in the light of the
benefits flowing to the shareholder/employees. We conclude
that Netversity may not deduct its $50,000 payment to the
Sterling Plan.
IV. Income
A. Our Country and Environmental Employees
1. Background
Respondent argues that the Our Country and the Environ-
mental shareholder/employees must include in income all of
the economic benefits that the Sterling Plan provided to
them through the life insurance policies related to them.
Petitioners argue that none of these employees received an
economic benefit during the subject years in excess of the
consideration that he or she paid for the benefit. In this vein,
petitioners assert, the employees did not have a current or
future right to the cash value of the life insurance policies
related to them, either by direct receipt of the cash or by
causing the cash to be used to pay other benefits provided
under the plan. Petitioners also assert that the employees
could not cause any of the life insurance policies to be
distributed to them. We agree with respondent that the Our
Country and the Environmental shareholder/employees must
include in income all of the economic benefits that the Ster-
ling Plan provided to them through the life insurance policies
related to them.
2. Economic Benefit Provisions
a. Overview
The Federal income tax consequences of a split-dollar life
insurance arrangement are generally determined either
through the economic benefit and accompanying provisions of
section 1.61–22(d) through (g), Income Tax Regs. (collectively,
economic benefit provisions), or through the loan provisions
50 145 UNITED STATES TAX COURT REPORTS (1)
of section 1.7872–15, Income Tax Regs. (loan provisions). See
sec. 1.61–22(a)(2), (b)(3)(i), Income Tax Regs. In general, the
loan provisions apply where this is a ‘‘split-dollar loan’’
within the meaning of section 1.7872–15(b)(1), Income Tax
Regs. Sec. 1.61–22(b)(3)(i), Income Tax Regs. As exceptions to
this general rule, the economic benefit provisions apply
where there is a split-dollar loan if (1) the employer owns the
life insurance contract and the arrangement is entered into
in connection with the performance of services or (2) a donor
and a donee enter into the arrangement and the donor owns
the life insurance contract. See id. subdiv. (ii). The economic
benefit provisions also apply where there is not a split-dollar
loan unless the nonowner of the life insurance contract
makes premium payments on the insurance contract as other
than consideration for economic benefits. See sec. 1.61–
22(b)(3)(i), (5), Income Tax Regs. In the case of this latter
exception concerning the nonowner’s payment of premiums,
general tax principles apply to set the Federal tax treatment
of the premium payments. See id. subpara. (5).
The parties agree that the loan provisions do not apply to
these cases. 22 The parties dispute the applicability of the
economic benefit provisions, as previously stated. When
applicable, the value of the economic benefits provided to a
nonowner in a taxable year equals the sum of (1) the cost of
current life insurance protection that the nonowner receives
during the year; (2) the amount of the insurance policy cash
value to which the nonowner has current access during the
year (to the extent the amount was not previously included
in income), and (3) any other economic benefit provided to
the nonowner (to the extent not previously included in
income). See id. para. (d)(2). The nonowner is treated as
having current access to that portion of the insurance policy’s
cash value (1) to which the arrangement gives the employee
a current or future right and (2) that is directly or indirectly
currently accessible by the employee, inaccessible by the
employer, or inaccessible by the employer’s general creditors.
See id. subpara. (4)(ii).
22 We agree as well. No split-dollar loan is present in these cases because
neither the Our Country nor the Environmental employees made pay-
ments to their employers for which they expected to be repaid. See sec.
1.7872–15(a)(2), Income Tax Regs.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 51
b. Applicability
The economic benefit provisions apply to these cases
because no split-dollar loans are involved and the employees
did not make any premium payments on the insurance con-
tracts. The employers, as the owners of the life insurance
contracts, have therefore provided economic benefits to their
employees, as the nonowners of the insurance contracts. See
id. subpara. (1). The employees must recognize the full value
of the economic benefits, net of any consideration that the
employees paid to their employers for the benefits. See id.
Where, as here, the arrangement underlying the split-dollar
life insurance arrangement is a ‘‘compensatory arrangement’’
within the meaning of the applicable regulations, an
employer’s provision of the economic benefits to its employees
generally is deemed to be the payment of compensation
except where the employer is an S corporation that provides
the benefits to a 2% shareholder in consideration for services
rendered. See sec. 1.61–22(d)(1), Income Tax Regs. In the
case of such an S corporation, the 2% shareholder is treated
as a partner for purposes of applying the employee fringe
benefit rules, the economic benefits are categorized as
guaranteed payments under section 707(c), and the 2%
shareholder must recognize the amount of the guaranteed
payments as gross income under section 61(a). See secs.
707(c), 1372.
Petitioners argue that the economic benefit provisions are
inapplicable because, petitioners state, those provisions are
invalid. According to petitioners, the Secretary lacked the
authority to prescribe those provisions in that the provisions
are inconsistent with ‘‘fundamental principles of federal tax
law’’. Petitioners assert that these fundamental principles
require, contrary to the economic benefit provisions, that
employees be able to compel current distributions of the cash
values of the insurance policies in order to have an interest
in the values. Petitioners conclude that the shareholder/
employees have therefore not realized any of the cash value
and need not include that value in income. We disagree that
the economic benefit provisions are invalid.
Petitioners’ challenge to the economic benefit provisions
requires that we apply the two-step analysis of Chevron,
U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837,
52 145 UNITED STATES TAX COURT REPORTS (1)
842–844 (1984). The U.S. Supreme Court has recently con-
firmed that this analysis applies to Treasury regulations
such as we have here. See Mayo Found. for Med. Educ. &
Research v. United States,
562 U.S. 44 (2011). The first step
of the analysis requires that we decide whether Congress has
spoken directly on the matter to which the economic benefit
provisions relate. See Chevron, U.S.A., Inc., 467 U.S. at 842–
844. If Congress has spoken directly on that matter, then
that is the beginning and the end of our inquiry for we must
interpret and apply the statute in accordance with the
unambiguously expressed intent of Congress. See id. We turn
to the second step, however, if Congress has not spoken
directly on the matter. The second step requires that we
decide whether the economic benefit provisions are a reason-
able interpretation of the statute which they construe. See id.
The economic benefit provisions are invalid under the second
step only if they are ‘‘arbitrary or capricious in substance, or
manifestly contrary to the statute.’’ Mayo Found. for Med.
Educ. & Research, 562 U.S. at 53 (quoting Household Credit
Servs., Inc. v. Pfennig,
541 U.S. 232, 242 (2004)).
We start with Chevron’s first step. The statutory provision
to which the economic benefit provisions primarily relate is
section 61(a), which generally defines gross income as ‘‘all
income from whatever source derived’’. That section ‘‘sweeps
broadly’’ to encompass any accession to a taxpayer’s wealth
and reflects Congress’ use of the full measure of its taxing
power. See United States v. Burke,
504 U.S. 229, 233 (1992).
While our reading of section 61(a) in the light of its broad
construction supports the issuance of equally far-reaching
regulations on the subject of gross income, we do not find the
term ‘‘economic benefit’’ anywhere in section 61(a). We con-
clude that Congress has not directly spoken on the matter at
hand. Accord Perez v. Commissioner,
144 T.C. 51, 58–59
(2015) (holding that Congress had not spoken on the defini-
tion of a word where the word was undefined in the Code).
We turn to Chevron’s second step. The economic benefit
provisions, which operate in part to tax accessions to wealth
resulting from split-dollar life insurance arrangements, fit
reasonably within the wingspan of the broad definition of
‘‘gross income’’ set forth in section 61(a). We find instructive
that the economic benefit provisions track longstanding
judicial jurisprudence related to section 61(a). Respondent
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 53
argues, and we agree, that the economic benefit provisions
are reasonably tailored from the economic benefit doctrine
applied in cases such as Brodie v. Commissioner,
1 T.C. 275
(1942), and Sproull v. Commissioner,
16 T.C. 244 (1951),
aff ’d,
194 F.2d 541 (6th Cir. 1952). Those cases hold that the
benefit derived from an employer’s irrevocable set-aside of
money or property as compensation for services rendered is
includible in the service provider’s gross income at the time
of the set aside, where the money or property is beyond the
reach of the employer’s creditors. See also Pulsifer v.
Commissioner,
64 T.C. 245 (1975) (applying Sproull to hold
that taxpayers were currently taxable on prize money that
they would receive in the future but which was irrevocably
set aside for their benefit). The economic benefit provisions
state similarly that a nonowner of a life insurance policy has
current access to the portion of the insurance policy’s cash
value (1) to which the arrangement gives the employee a cur-
rent or future right and (2) that is directly or indirectly cur-
rently accessible by the employee, inaccessible by the
employer, or inaccessible by the employer’s general creditors.
See sec. 1.61–22(d)(4)(ii), Income Tax Regs.; see also id.
subpara. (6), Example (2) (demonstrating that the split-dollar
provisions apply there because the employer and the
employer’s general creditors cannot access a portion of the
cash value). We conclude that the economic benefit provisions
are not arbitrary or capricious in substance or manifestly
contrary to the statute.
c. Value of Economic Benefits
The value of the economic benefits provided to a nonowner
in a taxable year equals the sum of (1) the cost of current
life insurance protection that the nonowner receives during
the year, (2) the amount of the insurance policy cash value
to which the nonowner has current access during the year (to
the extent the amount was not previously included in
income), and (3) any other economic benefit provided to the
nonowner (to the extent not previously included in income).
See sec. 1.61–22(d)(2), Income Tax Regs. The cost of the cur-
rent life insurance protection takes into account the life
insurance premium factors that the Commissioner publishes
for this purpose. See id. subpara. (3)(ii). The amount of the
current life insurance protection is the death benefit of the
54 145 UNITED STATES TAX COURT REPORTS (1)
life insurance contract (including paid-up additions) reduced
by the sum of the amount payable to the owner plus the por-
tion of the cash value taxable to (or paid for by) the non-
owner. See id. subdiv. (i). The amount of the insurance policy
cash value is determined disregarding surrender charges or
other similar charges or reductions and including insurance
policy cash value attributable to paid-up additions. See id.
subpara. (4)(i).
We have found supra that the relevant nonowners of the
life insurance policies, namely, Mr. Blake, Mr. Abramo, Mr.
Brown, and Mr. Tomassetti, were the only ones who had a
right to the cash value of the policies that related to them.
In addition, we have concluded supra that those individuals
must recognize income for each subject year from their
participation in the Sterling Plan. We hold that the amount
of the income that they must recognize equals the value of
their economic benefits as ascertained through the rules we
have just discussed. The parties shall apply those rules in
their calculation(s) of the decisions to be entered under Rule
155.
B. Mr. Mejia
Respondent argues that Mr. Mejia, Netversity’s sole
employee, realized income of $50,000 on account of
Netversity’s $50,000 payment to the Sterling Plan. We agree.
We have found that Netversity’s $50,000 payment to the
Sterling Plan is not an ordinary and necessary business
expense deductible under section 162(a). Given that the pay-
ment is not a deductible business expense under section
162(a) and that it conferred an economic benefit on Mr. Mejia
for his primary (if not sole) benefit, we conclude that the pay-
ment was a constructive distribution from Netversity to Mr.
Mejia. See Neonatology Assocs., P.A. v. Commissioner, 115
T.C. at 91–92; see also White v. Commissioner, 103 T.C.M.
(CCH) at 1572. In that the parties do not dispute that
Netversity had sufficient earnings and profits to characterize
the distribution as a dividend under section 301(c)(1) (and it
appears from the record that it did), we hold that the dis-
tribution is a taxable dividend to Mr. Mejia.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 55
V. Accuracy-Related Penalties
A. Overview
Respondent determined that each petitioner is liable for
one or more accuracy-related penalties under sections
6662(a) and 6662A. As to section 6662(a), respondent deter-
mined that it applied to the Abramos for each subject year;
to the Blakes, the Browns, the Tomassettis, and Our Country
for 2005 and 2006; and to the Mejias and Netversity for
2006. As to section 6662A, respondent determined that it
applied to the Blakes, the Abramos, the Browns, the
Tomassettis, and Our Country for 2007. Respondent has
since conceded that section 6662A does not apply to the
Blakes.
Except in the cases of Our Country and Netversity,
respondent bears the burden of production as to the applica-
bility of these accuracy-related penalties. See sec. 7491(c).
Section 7491(c) does not apply either to Our Country or to
Netversity because they are C corporations. See NT, Inc. v.
Commissioner, 126 T.C. 191, 195 (2006) (holding that section
7491(c) does not apply to a C corporation’s liability for a pen-
alty, an addition to tax, or an additional amount).
B. Section 6662(a)
1. Background
Respondent determined that the 20% accuracy-related pen-
alty under section 6662(a) applies on account of substantial
understatements of income tax, or alternatively, of neg-
ligence or of disregard of rules and regulations. Section
6662(a) and (b)(1) and (2) imposes a 20% accuracy-related
penalty on the part of an underpayment of tax required to
be shown on a return that is due to, among other reasons,
negligence, disregard of rules or regulations, or a substantial
understatement of income tax. These accuracy-related pen-
alties do not apply to any portion of an underpayment for
which a taxpayer had reasonable cause and acted in good
faith. See sec. 6664(c)(1).
Petitioners argue that section 6662(a) is inapplicable
because, they state, there was no substantial understatement
of income tax, no negligence, and no disregard of rules or
regulations. In addition, petitioners assert, they had substan-
56 145 UNITED STATES TAX COURT REPORTS (1)
tial authority for their positions, the items in question were
adequately disclosed, and they had a reasonable basis for
their tax treatment of the items in question. Finally, peti-
tioners assert, they reasonably relied in good faith on the
advice of their professional advisers.
2. Substantial Understatement
An individual’s understatement of Federal income tax is
‘‘substantial’’ if the understatement exceeds the greater of
10% of the tax required to be shown on the return or $5,000.
Sec. 6662(d)(1)(A). A corporation’s understatement of Federal
income tax is ‘‘substantial’’ if the understatement exceeds the
lesser of 10% of the tax required to be shown on the return
(or, if greater, $10,000) or $10 million. Sec. 6662(d)(1)(B).
An understatement generally exists to the extent that the
correct tax exceeds the tax reported on the corresponding
income tax return. See sec. 6662(d)(2)(A). In calculating this
excess, items to which section 6662A applies are dis-
regarded. 23 See sec. 6662(d)(2). The portion of the under-
stated tax that is attributable to an item for which the tax-
payer has substantial authority, or which the taxpayer ade-
quately disclosed with a reasonable basis for the tax treat-
ment thereof, also is not included in the understatement. See
sec. 6662(d)(2)(B); see also sec. 1.6662–4(d)(3)(i), Income Tax
Regs. (stating that a taxpayer has substantial authority
where the weight of authority supporting the tax treatment
of the item is substantial in relation to the contrary
authority). Where understatements are attributable to tax
shelters, the exceptions supported by substantial authority
and adequate disclosure are not available. See sec.
6662(d)(2)(C). A tax shelter is any plan or arrangement
where a significant purpose of the plan or arrangement is the
avoidance or evasion of Federal income tax. See sec.
6662(d)(2)(C)(ii).
3. Negligence
Negligence includes any failure to make a reasonable
attempt to comply with the provisions of the Code or to exer-
23 The amount of a reportable transaction understatement, however, is
added when determining whether the understatement is substantial. See
sec. 6662A(e)(1)(A).
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 57
cise ordinary and reasonable care in the preparation of a tax
return. See sec. 6662(c); sec. 1.6662–3(b)(1), Income Tax
Regs. The term ‘‘negligence’’ also has been defined as a ‘‘lack
of due care or failure to do what a reasonable and ordinarily
prudent person would do under the circumstances.’’ Neely v.
Commissioner, 85 T.C. 934, 947 (1985) (quoting Marcello v.
Commissioner,
380 F.2d 499, 506 (5th Cir. 1967), aff ’g in
part, remanding in part
43 T.C. 168 (1964), and T.C. Memo.
1964–299). ‘‘[N]egligence is strongly indicated where * * *
[a] taxpayer fails to make a reasonable attempt to ascertain
the correctness of a deduction, credit or exclusion on a return
which would seem to a reasonable and prudent person to be
‘too good to be true’ under the circumstances’’. Sec. 1.6662–
3(b)(1)(ii), Income Tax Regs.
A taxpayer is not negligent as to an item for which the
return position has a reasonable basis. See id. subpara. (1).
An application of this reasonable basis exception is a rel-
atively high standard of tax reporting that requires more
than simply showing that the position taken on the return is
not frivolous or patently improper. See id. subpara. (3). This
high standard is not met by a return position that is
arguably correct or merely a colorable claim. See id.
4. Disregard
Disregard includes any careless, reckless, or intentional
disregard. See sec. 6662(c).
C. Section 6662A
1. Background
Respondent determined that the 30% accuracy-related pen-
alty under section 6662A applies because the Sterling Plan
is substantially similar to the transactions identified as listed
transactions in Notice 2007–83, 2007–2 C.B. 960. Petitioners
argue that this accuracy-related penalty does not apply
because the Sterling Plan is not a listed or reportable trans-
action. In addition, petitioners argue, this accuracy-related
penalty does not apply because the transaction was ade-
quately disclosed.
58 145 UNITED STATES TAX COURT REPORTS (1)
2. Overview
Congress enacted section 6662A as part of the American
Jobs Creation Act of 2004 (AJCA), Pub. L. No. 108–357, sec.
812(a), 118 Stat. at 1577. Section 6662A imposes a 20%
accuracy-related penalty on reportable transaction under-
statements and is effective for taxable years ending after
October 22, 2004. See sec. 6662A(a); see also AJCA sec.
812(f ), 118 Stat. at 1580. The penalty increases to 30% if the
taxpayer does not adequately disclose the transaction. See
sec. 6662A(c); see also sec. 6664(d)(3)(A). A ‘‘reportable trans-
action understatement’’ is the sum of—
(A) the product of—
(i) the amount of the increase (if any) in taxable income which
results from a difference between the proper tax treatment of an item
to which this section applies and the taxpayer’s treatment of such item
(as shown on the taxpayer’s return of tax), and
(ii) the highest rate of tax imposed by section 1 (section 11 in the
case of a taxpayer which is a corporation), and
(B) the amount of the decrease (if any) in the aggregate amount of
credits determined under subtitle A which results from a difference
between the taxpayer’s treatment of an item to which this section
applies (as shown on the taxpayer’s return of tax) and the proper tax
treatment of such item. [Sec. 6662A(b)(1).]
A transaction is a reportable transaction for purposes of
section 6662A if it is either a ‘‘reportable transaction’’ or a
‘‘listed transaction’’ as those terms are defined in section
6707A(c). See sec. 6662A(b)(2), (d). As to the latter term, sec-
tion 6707A(c)(2) generally defines a ‘‘listed transaction’’ as a
transaction that is the same as, or substantially similar to,
a transaction that the Commissioner has identified as a tax-
avoidance transaction for purposes of section 6011. See sec.
6707A(c)(2). Regulations under section 6011 provide that a
listed transaction is a transaction that is the same as or
substantially similar to any transaction that the IRS identi-
fies as such in a ‘‘notice, regulation, or other form of pub-
lished guidance’’. Sec. 1.6011–4(b)(2), Income Tax Regs. The
regulations provide that a substantially similar transaction is
a transaction ‘‘that is expected to obtain the same or similar
types of tax consequences and that is either factually similar
or based on the same or similar tax strategy.’’ Id. para. (c)(4).
The Commissioner published Notice 2007–83, 2007–2 C.B.
at 960, to alert taxpayers and their representatives that
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 59
[t]he Internal Revenue Service (IRS) and Treasury Department are
aware of certain trust arrangements claiming to be welfare benefit funds
and involving cash value life insurance policies that are being promoted
to and used by taxpayers to improperly claim federal income and
employment tax benefits. This notice informs taxpayers and their rep-
resentatives that the tax benefits claimed for these arrangements are
not allowable for federal tax purposes. This notice also alerts taxpayers
and their representatives that these transactions are tax avoidance
transactions and identifies certain transactions using trust arrange-
ments involving cash value life insurance policies, and substantially
similar transactions, as listed transactions for purposes of § 1.6011–
4(b)(2) of the Income Tax Regulations and §§ 6111 and 6112 of the
Internal Revenue Code. This notice further alerts persons involved with
these transactions of certain responsibilities that may arise from their
involvement with these transactions.
* * * * * * *
1. Promoted Arrangements
Trust arrangements utilizing cash value life insurance policies and
purporting to provide welfare benefits to active employees are being pro-
moted to small businesses and other closely held businesses as a way to
provide cash and other property to the owners of the business on a tax-
favored basis. The arrangements are sometimes referred to by persons
advocating their use as ‘‘single employer plans’’ and sometimes as
‘‘419(e) plans.’’ Those advocates claim that the employers’ contributions
to the trust are deductible under §§ 419 and 419A as qualified cost, but
that there is not a corresponding inclusion in the owner’s income.
A promoted trust arrangement may be structured either as a taxable
trust or a tax-exempt trust, i.e., a voluntary employees’ beneficiary
association (VEBA) that has received a determination letter from the
IRS that it is described in § 501(c)(9). The plan and the trust documents
indicate that the plan provides benefits such as current death benefit
protection, self-insured disability benefits, and/or self-insured severance
benefits to covered employees (including those employees who are also
owners of the business), and that the benefits are payable while the
employee is actively employed by the employer. The employer’s contribu-
tions are often based on premiums charged for cash value life insurance
policies. For example, contributions may be based on premiums that
would be charged for whole life policies. As a result, the arrangements
often require large employer contributions relative to the actual cost of
the benefits currently provided under the plan.
Under these arrangements, the trustee uses the employer’s contribu-
tions to the trust to purchase life insurance policies. The trustee typi-
cally purchases cash value life insurance policies on the lives of the
employees who are owners of the business (and sometimes other key
employees), while purchasing term life insurance policies on the lives of
the other employees covered under the plan.
It is anticipated that after a number of years the plan will be termi-
nated and the cash value life insurance policies, cash, or other property
60 145 UNITED STATES TAX COURT REPORTS (1)
held by the trust will be distributed to the employees who are plan
participants at the time of the termination. While a small amount may
be distributed to employees who are not owners of the business, the
timing of the plan termination and the methods used to allocate the
remaining assets are structured so that the business owners and other
key employees will receive, directly or indirectly, all or a substantial por-
tion of the assets held by the trust.
Those advocating the use of these plans often claim that the employer
is allowed a deduction under § 419(c)(3) for its contributions when the
trustee uses those contributions to pay premiums on the cash value life
insurance policies, while at the same time claiming that nothing is
includible in the owner’s gross income as a result of the contributions
(or, if amounts are includible, they are significantly less than the pre-
miums paid on the cash value life insurance policies). They may also
claim that nothing is includible in the income of the business owner or
other key employee as a result of the transfer of a cash value life insur-
ance policy from the trust to the employee, asserting that the employee
has purchased the policy when, in fact, any amounts the owner or other
key employee paid for the policy may be significantly less than the fair
market value of the policy. Some of the plans are structured so that the
owner or other key employee is the named owner of the life insurance
policy from the plan’s inception, with the employee assigning all or a
portion of the death proceeds to the trust. Advocates of these arrange-
ments may claim that no income inclusion is required because there is
no transfer of the policy itself from the trust to the employees.
Notice 2007–83, 2007–2 C.B. at 961, further states that
any transaction that has all of the following elements, and
any transaction that is substantially similar to such a trans-
action, are listed transactions for purposes of sections 6111
and 6112 and section 1.6011–4(b)(2), Income Tax Regs., effec-
tive October 17, 2007:
(1) The transaction involves a trust or other fund described
in § 419(e)(3) that is purportedly a welfare benefit fund.
(2) For determining the portion of its contributions to the trust or
other fund that are currently deductible the employer does not rely on
the exception in § 419A(f)(5)(A) (regarding collectively bargained plans).
(3) The trust or other fund pays premiums (or amounts that are pur-
ported to be premiums) on one or more life insurance policies and, with
respect to at least one of the policies, value is accumulated either:
(a) within the policy (for example, a cash value life insurance policy);
or
(b) outside the policy (for example, in a side fund or through an agree-
ment outside the policy allowing the policy to be converted to or
exchanged for a policy which will, at some point in time, have accumu-
lated value based on the purported premiums paid on the original
policy).
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 61
(4) The employer has taken a deduction for any taxable year for its
contributions to the fund with respect to benefits provided under the
plan (other than post-retirement medical benefits, post-retirement life
insurance benefits, and child care facilities) that is greater than the sum
of the following amounts:
(a) With respect to any uninsured benefits provided under the plan,
(i) an amount equal to claims that were both incurred and paid during
the taxable year; plus
(ii) the limited reserves allowable under § 419A(c)(1) or (c)(3), as
applicable; plus
(iii) amounts paid during the taxable year to satisfy claims incurred
in a prior taxable year (but only to the extent that no deduction was
taken for such amounts in a prior year); plus
(iv) amounts paid during the taxable year or a prior taxable year for
administrative expenses with respect to uninsured benefits and that are
properly allocable to the taxable year (but only to the extent that no
deduction was taken for such amounts in a prior year).
Notice 2007–83, 2007–2 C.B. at 962, states:
Whether a taxpayer has participated in the listed transaction described
in this notice will be determined under § 1.6011–4(c)(3)(i)(A). However,
an individual who is not the employer will be treated as a participant
for a taxable year if, and only if the individual owns, directly or
indirectly, 20 percent or more of an entity, other than a C corporation,
that is a participant in the listed transaction for the taxable year. For
this purpose, indirect ownership is determined under rules similar to the
rules of § 318 but without regard to the family attribution
rules of § 318(a)(1).
D. Section 7491(c)
1. Overview
As previously stated, the Commissioner bears the burden
of production with respect to an individual taxpayer’s
liability for a section 6662(a) or 6662A accuracy-related pen-
alty. This burden requires that respondent produce sufficient
evidence indicating that it is appropriate to impose either or
both penalties in these cases. See sec. 7491(c); Higbee v.
Commissioner, 116 T.C. at 438, 446–447 (2001). Once the
Commissioner meets his burden of production, the taxpayer
must come forward with persuasive evidence that the
Commissioner’s determination is incorrect or that the tax-
payer had reasonable cause or substantial authority for the
position. See Higbee v. Commissioner, 116 T.C. at 446–447.
62 145 UNITED STATES TAX COURT REPORTS (1)
2. Application
a. Determinations Under Section 6662(a)
i. Our Country and the Blakes
A substantial majority of Our Country’s payments to the
Sterling Plan went toward the payment of premiums on the
Blake policy, a cash value life insurance policy. Our Country
deducted the full amount of its payments to the Sterling Plan
even though the amounts of the payments were significantly
greater than the current benefits provided by the plan and
bore no relationship to the benefits that the plan provided.
Mr. Blake, in his individual capacity and as Our Country’s
sole shareholder, participated in the Sterling Plan as an
investor in a good investment, rather than as a participant
in a bona fide welfare benefit plan. The Blakes failed to
report any income resulting from Mr. Blake’s participation in
the plan although Mr. Blake maintained control over the
funds that Our Country paid to the Sterling Plan, e.g., he
could receive his policy by causing Our Country, his wholly
owned employer, to terminate its participation in the plan,
and he could change the criteria for vesting at his desire. Mr.
Blake also knew that he could access the Blake policy and
the cash value that inhered therein, as evidenced by the fact
that he caused Our Country to lower the retirement age
applicable to its plan and fully vest him in the insurance
policy taken out on his life.
ii. Environmental and Its Owners
Environmental deducted the full amount of its payments to
the Sterling Plan even though the amounts of the payments
were significantly greater than the current benefits provided
by the plan and bore no relationship to the benefits that the
plan provided. Environmental paid amounts to the Sterling
Plan and deducted those payments without relying on the
valuation reports from Mr. Snyder that purportedly showed
the allowable and deductible contribution amounts. Environ-
mental failed to take the steps that a prudent taxpayer
would take in determining the tax effects of participation in
the Sterling Plan.
None of Environmental’s owners reported any income as to
his participation in the Sterling Plan, and the record shows
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 63
that they each failed to take the steps that a prudent tax-
payer would have taken in determining the tax effects of
participation in the Sterling Plan. They (through Mr.
Tomassetti) relied on information provided by Mr. Snyder, an
insider to the Sterling Plan, to the effect that the plan was
legitimate.
iii. Netversity and the Mejias
Netversity deducted the full amount of its payments to the
Sterling Plan even though the amounts of the payments were
significantly greater than the current benefits the plan pro-
vided and bore no relationship to the benefits that the plan
provided. The Mejias did not report any income as to Mr.
Mejia’s participation in the Sterling Plan, and the record
shows that they failed to take the steps that a prudent tax-
payer would have taken in determining the tax effects of
participation in the Sterling Plan.
iv. Conclusion
We conclude and hold that petitioners significantly under-
reported income on their Federal income tax returns for each
subject year. In addition, the evidence shows (and we find)
that petitioners consciously participated in a plan that, as
advertised to them, they should have known (and probably
knew) was too good to be true. A reasonable person in the
position of petitioners also would not have been oblivious to
the fact that the judiciary had rejected the use of cash value
life insurance to fund welfare benefits in similar settings, see
Neonatology Assocs., P.A. v. Commissioner, 299 F.3d 221; id.,
115 T.C. 43, and would have looked for more concrete guid-
ance on the Sterling Plan before investing significant funds
in it, as petitioners did.
We hold as to the noncorporate petitioners that respondent
has met his burden of producing evidence showing that sec-
tion 6662(a) penalties for underpayments of tax attributable
to negligence or disregard of rules or regulations are appro-
priate with respect to the portions of the underpayments
resulting from the unreported income. The actions of Mr.
Blake during the first two subject years constituted ‘‘neg-
ligence’’ for purposes of section 6662(a), and those actions
also were in disregard of the rules pertaining to welfare ben-
efit plans. Likewise, the actions of Environmental’s owners
64 145 UNITED STATES TAX COURT REPORTS (1)
during the first two subject years, and also of Mr. Abramo
during the last subject year as well, constituted ‘‘negligence’’
for purposes of section 6662(a), and those actions also were
in disregard of the rules pertaining to welfare benefit plans.
Likewise, the actions of Mr. Mejia during 2006 constituted
‘‘negligence’’ for purposes of section 6662(a), and those
actions also were in disregard of the rules pertaining to wel-
fare benefit plans.
We further hold as to the noncorporate petitioners that
respondent has met his burden of producing evidence
showing that a section 6662(a) penalty for a substantial
understatement of income tax applies to the extent that the
tax, as determined on the basis of this Opinion, results in a
‘‘substantial understatement’’ as previously defined. 24
b. Determinations Under Section 6662A
We have found that the Sterling Plan ostensibly operated
as a welfare benefit plan, that Our Country and Environ-
mental made payments to the Sterling Plan that were used
to pay the premiums on cash value life insurance policies,
and that the Sterling Plan used those policies to fund the
‘‘welfare benefits’’ that it promised to pay under the Sterling
Plan. We also have found that those corporate employers
deducted the full amounts of the payments that they made
to the Sterling Plan and that neither of those corporations
nor any of Environmental’s owners disclosed its or his
participation in the Sterling Plan. We conclude that Our
Country and Environmental participated in transactions that
were substantially similar to the transaction described in
Notice 2007–83, supra. We also conclude that each of
Environmental’s owners participated in the described trans-
actions in that each owned at least 20% of Environmental,
their employer, and participated in the transactions as
24 We disagree with petitioners that their reporting of items stemming
from the Sterling Plan meets the adequate disclosure or substantial au-
thority test, and that this in turn leads to a reduction of their understate-
ments for purposes of sec. 6662(d). We note, however, that to the extent
that petitioners did meet one or both of those tests, they would still not
prevail on this point. This is because the Sterling Plan falls within the def-
inition of a ‘‘tax shelter’’ under sec. 6662(d)(2)(C)(ii). See sec. 6662(d)(2)(C)
(stating that those grounds do not reduce an understatement of tax attrib-
utable to a tax shelter).
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 65
employees covered by the Sterling Plan. In the light of these
conclusions, we hold as to Environmental’s owners that
respondent has met his burden of producing evidence
showing the appropriateness of the section 6662A penalties
that he determined applied to them. 25
E. Reasonable Cause
1. Section 6662(a)
a. Overview
An accuracy-related penalty under section 6662(a) is not
appropriate in a case where a taxpayer demonstrates that
reasonable cause existed for an underpayment of tax and
that the taxpayer acted in good faith with respect to the
underpayment. See sec. 6664(c)(1). A taxpayer’s reliance on
professional advice may sometimes meet this standard. See
Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 98–
99; see also sec. 1.6664–4(b)(1), Income Tax Regs. Reliance on
a tax professional will generally meet this standard where
the facts and circumstances coupled with the applicable law
establish that (1) the taxpayer selected a competent tax
adviser, (2) supplied the adviser with all relevant informa-
tion, and (3) relied in good faith on the adviser’s professional
judgment. See Neonatology Assocs., P.A. v. Commissioner,
115 T.C. at 98–99. Reliance tends to be unreasonable when
it is based on insiders, promoters, or their offering materials
or when the person relied upon has an inherent conflict of
interest that the taxpayer knew or should have known about.
See id.
b. Our Country and the Blakes
We do not find that the three-prong Neonatology test has
been met either as to Our Country or as to Mr. Blake. Mr.
Blake caused Our Country to invest in the Sterling Plan
upon the recommendation of Mr. Reckard, who, while a
25 A sec. 6662 accuracy-related penalty generally may not be imposed on
the portion of an underpayment to which an accuracy-related penalty
under sec. 6662A also is imposed. See sec. 6662(b) (flush language). Excep-
tions to this general rule are found in sec. 6662A(e)(1) and (2)(B). See id.
The sec. 6662(a) accuracy-related penalty that respondent determined for
the Abramos’ 2007 taxable year therefore applies only to the extent that
it fits within the flush language or one of the referenced exceptions.
66 145 UNITED STATES TAX COURT REPORTS (1)
C.P.A., was then acting in his capacity as an insurance
agent/financial planner. 26 Mr. Blake considered the invest-
ment primarily to be a good financial investment and a way
to defer taxes, and he effected the investment relying to a
significant extent on his perception of the reputation of
Guardian, the insurance company selling the life insurance
that pertained to Our Country’s employees. While Mr. Blake
eventually sought out the advice of Mr. Penner, his longtime
friend who was an estate planning attorney, as to the appro-
priateness of his already-made investment in the Sterling
Plan, the record does not establish the extent of their discus-
sion(s) or the professional advice that Mr. Penner gave Mr.
Blake as to this matter. 27 Nor does the record establish
whether Mr. Blake left their discussion(s) with the necessary
foundation to rely in good faith upon any advice that Mr.
Penner gave him. We do know, however, that the proffered
benefits of the Sterling Plan were too good to be true and
that Mr. Penner advised Mr. Blake that an investment in the
Sterling Plan was risky. We also know that the Sterling Plan
explicitly warned potential investors in the plan that they
might want to consult with a professional as to the con-
sequences of such an investment and that while the record
establishes that petitioners (either directly or indirectly
through their owners or representatives) discussed the Ster-
ling Plan with accountants and/or attorneys, the record does
not establish the specifics or breadth of those discussions.
We hold that Our Country and Mr. Blake have failed to
demonstrate that reasonable cause existed for their under-
payments of tax or that they acted in good faith with respect
to the underpayments.
c. Environmental’s Owners
We do not find that the three-prong Neonatology test has
been met as to any of Environmental’s owners. As to Mr.
Abramo and Mr. Brown, the record contains no information
regarding any steps that they personally took to determine
26 Previously, Mr. Blake had disregarded the recommendation of another
C.P.A., Mr. Ringger, to invest in the Sterling Plan, because Mr. Ringger
was not a financial planner.
27 We infer from the record, however, that Mr. Penner reached his con-
clusions as to the Sterling Plan relying mainly (if not solely) upon the
statements and views of individuals connected with the Sterling Plan.
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 67
their proper tax liabilities. The actions of Mr. Tomassetti, the
point person for the other two owners, were equally unclear.
The record does not establish whether and to what extent
Mr. Tomassetti sought the advice of Mr. Scutellaro, testifying
that he did not ‘‘specifically recall’’ whether he asked Mr.
Scutellaro to advise him on whether the contributions would
be deductible to the corporation or would result in income to
the shareholders.
The mere fact that Mr. Tomassetti relied upon Mr.
Scutellaro, a C.P.A., to file his and Environmental’s tax
returns correctly does not necessarily mean that Mr.
Tomassetti or any of Environmental’s other owners had
reasonable cause and acted in good faith with respect to
those returns. Moreover, to whatever extent the Environ-
mental owners relied on Mr. Scutellaro’s advice, it is not
sufficient to relieve them of liability for the accuracy-related
penalties. Mr. Scutellaro was not an expert in welfare benefit
plans, he did not purport to be such an expert, he did not
prepare or seek a tax opinion regarding the validity of the
Sterling Plan or of the deductibility of the contributions, and
he relied entirely or almost entirely on information from the
promoter, Mr. Snyder, in providing any advice he gave. In
fact, as we find, Mr. Scutellaro for the most part simply
relayed to Mr. Tomassetti the view of Mr. Snyder as to the
tax consequences flowing from the Sterling Plan.
We hold that each of Environmental’s owners has failed to
demonstrate that reasonable cause existed for his underpay-
ments of tax or that he acted in good faith with respect to
the underpayments.
d. Netversity and the Mejias
We do not find that the three-prong Neonatology test has
been met either as to Netversity or as to Mr. Mejia. While
the record establishes that Mr. Morgan told Mr. Mejia that
he should invest in the Sterling Plan, the record does not
establish that Mr. Morgan gave Mr. Mejia any advice as to
the tax consequences of any such investment. In fact, the
record leads to a contrary conclusion. Mr. Mejia, by his own
admission, acknowledged that he ‘‘blindly expected’’ that he
was going to invest money in the Sterling Plan without any
tax consequences.
68 145 UNITED STATES TAX COURT REPORTS (1)
Moreover, even if Mr. Morgan did give Mr. Mejia tax
advice as to the Sterling Plan, the mere fact that Mr. Morgan
was a C.P.A. does not necessarily mean that he was a com-
petent tax adviser, especially on the subject of the tax con-
sequences flowing from Mr. Mejia’s participation in the Ster-
ling Plan. Nor does the record establish that Mr. Mejia sup-
plied Mr. Morgan with all relevant information or that Mr.
Mejia relied in good faith on the adviser’s professional judg-
ment.
We hold that Netversity and Mr. Mejia have failed to dem-
onstrate that reasonable cause existed for their underpay-
ments of tax or that they acted in good faith with respect to
the underpayments.
2. Section 6662A
a. Overview
A taxpayer may avoid a section 6662A penalty if there is
reasonable cause for the taxpayer’s treatment of the trans-
action and the taxpayer acted in good faith. See sec. 6664(d).
In this context, a taxpayer has reasonable cause and acted
in good faith if: (1) the taxpayer followed the disclosure
provisions of the section 6011 regulations, (2) the taxpayer
has substantial authority for his or her position, and (3) the
taxpayer reasonably believed that the position was more
likely than not the proper treatment. See sec. 6664(d)(2). If
the transaction was not adequately disclosed, the reasonable
cause and good faith defense is not available and the tax-
payer is liable for a higher 30% penalty.
b. Application
None of the relevant petitioners adequately disclosed his or
its participation in the Sterling Plan. 28 The reasonable cause
28 We are not unmindful that Our Country amended its tax return for
2007 to include a statement disclosing its participation in the Sterling
Plan. We do not consider that action to be adequate disclosure for purposes
of this defense. See sec. 1.6011–4(e)(1), Income Tax Regs. (requiring that
a taxpayer such as Our Country attach a disclosure statement to its tax
return for each taxable year for which it participates in a reportable trans-
action and to each amended return that reflects that participation and
send a copy of the disclosure statement to the IRS Office of Tax Shelter
Analysis). Petitioners do not argue in their brief that the amended return
was a ‘‘qualified amended return’’ within the meaning of sec. 1.6664–
(1) OUR COUNTRY HOME ENTERS., INC. v. COMMISSIONER 69
and good faith defense is therefore not available to any them.
Each of these petitioners is liable for the 30% penalty.
VI. Conclusion
We have considered all of the arguments that petitioners
made, and to the extent not discussed above, conclude that
those arguments not discussed herein are irrelevant, moot, or
without merit. We have considered respondent’s arguments
only to the extent stated herein.
To reflect the foregoing,
Decisions will be entered under Rule 155.
f
2(c)(3), Income Tax Regs., and we therefore do not consider the applica-
bility of that section to this issue. See Swords Trust v. Commissioner, 142
T.C. 317, 339 n.30 (2014) (holding that the Commissioner decided to forgo,
or otherwise waived, an argument that he did not make in his opening
brief ); cf. Griffin v. Bell,
694 F.3d 817, 822 (7th Cir. 2012) (stating that
‘‘arguments raised for the first time in a reply brief are deemed waived’’).
