Decisions will be entered for respondent in docket Nos. 1768-07 and 1769-07, and decisions will be entered under
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN,
Accuracy-Related Penalty | ||
Year | Deficiency | |
2001 | $ 79,946 | $ 15,989 |
2002 | 81,568 | 16,314 |
2003 | 72,098 | 14,420 |
2004 | 63,519 | 12,704 |
Accuracy-Related Penalty | ||
Year | Deficiency | |
2001 | $ 79,946 | $ 15,989 |
2002 | 81,568 | 16,314 |
2003 | 71,018 | 14,204 |
2004 | 72,100 | 14,420 |
Accuracy-Related Penalty | ||
Year | Deficiency | |
2003 | $ 64,157 | $ 12,831.40 |
Accuracy-Related Penalty | ||
Year | Deficiency | |
2003 | $ 271,204 | $ 54,240.80 |
The deficiencies are based on respondent's determination that the contributions by the participating companies to the Benistar 419 Plan & Trust are not currently deductible by the companies as ordinary and necessary business expenses under
The issues for decision are, first, whether payments to the Benistar 419 Plan & Trust for employee benefits are ordinary and necessary business expenses under
Unless otherwise indicated, all section references are to the Internal Revenue Code (Code) in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. The parties have stipulated that the proper venue for an appeal of this decision is the Court of Appeals for the Second Circuit. See
The Benistar 419 Plan & Trust was established in December 1997, and was crafted by Daniel Carpenter to be a multiple-employer welfare benefit trust under
The Benistar Plan & Trust was originally based on A Professional's Guide to 419 Plans, a 1997 book by Carpenter. Carpenter wrote the book in response to many financial advisers' impression that Carpenter's section 419 plans were too good to be true. In the book, Carpenter discusses the provisions of
The Benistar 419 Plan & Trust was first sponsored by Benistar Employer Services Trust Corp., and then, beginning in 2002, by Benistar 419 Plan Services, Inc. (both Benistar Plan Sponsor). Carpenter is the chairman and chief executive officer of Benistar 419 Plan Services. Benistar 419 Plan Services contracts with Benistar Admin Services, Inc., to administer the trust. We refer to the trust, sponsor, and administrator collectively as Benistar Plan.
Benistar Plan provides preretirement life insurance to select employees of companies enrolled in the plan. The enrolled companies contribute money to a trust account that funds the benefits, and Benistar Plan issues a certificate of coverage to the employer with the amount of the death benefit payable by the plan. Benistar Plan uses enrolled companies' contributions to acquire one or more life insurance policies 2010 Tax Ct. Memo LEXIS 154">*158 covering the employees insured by the plan, and it withdraws from the trust account as necessary to pay the premiums on those policies. We refer to these insurance policies as the underlying insurance policies, because they underlie each policy issued by Benistar Plan and, as a result, Benistar Plan is fully reinsured. Enrolled companies can choose the number of years that contributions to Benistar Plan will be required in order to fully pay for the death benefit or benefits.
Under the plan and trust documents, the Benistar Plan trust may pay reasonable expenses incurred in the establishment or administration of the plan, including attorney's and accountant's fees. In 2006, Benistar Plan withdrew 9 percent of the net surrender value of the insurance policies as of December 31, 2005, to cover the expenses of the trust in responding to inquiries from and audits by the Internal Revenue Service (IRS).
At all times during the relevant years at least 10 different business entities participated in Benistar Plan.
Since Benistar Plan's inception in December 1997, the plan and trust documents outlining the plan terms have been amended at least five times. The plan operates as though each 2010 Tax Ct. Memo LEXIS 154">*159 amendment to the plan documents is retroactive to December 1997, but only for current participants. Amendments to the plan documents made after a former participant has left the plan are not applied retroactively to that participant.
The first amendment was before 2002, and it made largely cosmetic changes. In the second amendment, dated January 2, 2002, Benistar Plan changed plan sponsors from Benistar Employer Services Trust Corp. to Benistar 419 Plan Services, Inc., switched trustees from First Union to J.P. Morgan, and merged most of its original trust agreement into a plan and trust agreement. It also changed the agreement at section 5.01 by inserting the additional clause that "In no event will the Plan be liable for any death benefit if the Insurer shall, for any reason, fail to pay such insurance proceeds on the life of the Covered Employee."
Two separate amendments were both dated January 1, 2003. The first 2003 amendment was made in response to
The final amendment was dated January 2, 2004. The changes made by this amendment included expanding the scope of the arbitration clause governing the resolution of disputes between Benistar Plan and its participants.
To enroll employers, Benistar Plan does not directly target employers or employees, but rather relies on insurance brokers. To educate insurance 2010 Tax Ct. Memo LEXIS 154">*161 brokers, Benistar Plan conducts numerous seminars.
When enrolling, prospective employers or their employees, with the aid of their insurance brokers, select life insurance policies from a number of major life insurance companies. Employees exercise a large degree of control over their underlying insurance policy. In addition to selecting the carrier, prospective employers or their employees may select the benefit amount, the premium payments, and the type of insurance--term, whole, universal, or variable.
Term life insurance covers the insured only for a particular period, and upon expiration of that period, terminates without value. Whole life insurance covers an insured for life, during which the insured pays fixed premiums, accumulates savings from an invested portion of the premiums, and receives a guaranteed benefit upon death, to be paid to a named beneficiary. Universal life insurance is term life insurance in which the premiums are paid from the insured's earnings from a money-market fund. Variable life insurance is life insurance in which the premiums are invested in securities and whose death benefits thus depend on the securities' performance, though there is a minimum guaranteed 2010 Tax Ct. Memo LEXIS 154">*162 death benefit. Because whole life insurance, universal life insurance, and variable life insurance include a savings component in addition to the their insurance component, they almost always have higher premiums than term life insurance, and they accumulate value that may be removed from the policy either via a loan from the insurance company secured by the policy or a cash withdrawal that reduces the savings component of the policy. However, as the owner of the underlying policies,
Benistar Plan does not permit employers or covered employees to withdraw money from their underlying policies through either loans or cash withdrawals. Benistar Plan places three restrictions on the underlying insurance policies that it will purchase. First, prospective participants may request policies only from life insurance companies that are licensed by the State of New York, which Carpenter perceives as more reliable. Second, Benistar Plan requires that any dividend paid out by the policy be reinvested in the policy as a paid-up addition. Paid-up additions increase the death benefit of the underlying policy, although they do not affect the death benefit promised by Benistar Plan to the insured employee. 2010 Tax Ct. Memo LEXIS 154">*163 Third, prospective participants selecting a variable universal life insurance policy must allocate the investment portion of the policy to either the insurance guaranteed fund or the Standard & Poor's (S&P) 500 equity index. The purpose of this restriction is to ensure that participants do not use the underlying insurance policy as a means of accumulating assets within Benistar Plan through diversified or more risky investments. Benistar Plan's policy was not to allow covered employees to change their allocation once selected and to terminate covered employees that use the plan to accumulate assets.
In addition to selecting the policy that would underlie the death benefits promised by the plan, prospective participants, with their insurance agents, have to complete a number of documents, including agreement and acknowledgment forms and a certificate of corporate resolution authorizing the company to enroll in the plan. One of the forms, a disclosure and acknowledgment form, states that The undersigned Employer, on its own behalf, and on behalf of its Participating Employees, hereby acknowledges the following: 1. In determining whether to adopt the Plan and to what extent they would participate, 2010 Tax Ct. Memo LEXIS 154">*164 they have sought and relied on legal and tax advice from their own independent advisors; 2. The Employer and Participating Employees are responsible for the tax consequences resulting from adoption and/or participation in the Plan; 3. * * * The Plan Sponsor, Administrator, Trustee and Carrier cannot and have not guaranteed or promised any particular legal or tax consequences from the Employer's adoption or participation in the Plan; * * * * 7. The plan provides for death benefits for Participating Employees and cannot be used as a vehicle for deferred compensation or retirement income.
Once the employers or their employees fill out the paperwork, the completed life insurance applications are sent to Benistar Plan. Benistar Plan checks the policy applications to ensure that Benistar Plan Sponsor is the owner and that the Benistar 419 Plan & Trust is the beneficiary. Other than those two fields, Benistar Plan does not modify the applications. Once the insurance policies are approved by the insurance companies, employers are sent an "admin packet", which consists of copies of the signed 2010 Tax Ct. Memo LEXIS 154">*165 agreement and acknowledgment forms originally submitted with the application; certificates of coverage for the covered employees; a copy of the corporate resolution; papers detailing the benefits of enrollment; a summary plan description; and an opinion letter from Edwards & Angell, LLP, an independent law firm, claiming that the plan qualifies for the advertised tax consequences. The benefits of enrollment listed in the admin packet include: . Virtually Unlimited Deductions for the Employer; . Contributions can vary from year to year; . Benefits can be provided to one or more key Executives on a selective basis; . No need to provide benefits to rank and file employees; . Contributions to the BENISTAR 419 Plan are not limited by qualified plan rules and will not interfere with pension, profit-sharing or 401(k) plans; . Funds inside the BENISTAR 419 Plan accumulate tax-free; . Death proceeds can be received both income and estate tax-free by beneficiaries; . Program can be arranged for tax-free distribution at a later date; . Funds in the BENISTAR 419 Plan are secure from the hands of creditors.
There were a number of Edwards & Angell opinions issued to Benistar Plan. The firm issued Benistar Plan opinion letters in December 1998, November 2001, and October 2003. In addition, Edwards & Angell issued Benistar Plan a letter in December 2003 stating that Benistar Plan is not a tax shelter as described in
Once the employer is properly enrolled, it makes contributions to Benistar Plan in accordance with notices sent by the plan. The notices, addressed to the employer, list the underlying insurance policy owned by Benistar Plan and the amounts due to keep the particular underlying policy active. If an employer is more than 30 days late in making contributions, the employer may be terminated from the plan.
In addition, the notices of contribution state that "you may contribute additional amounts to the Benistar 419 Plan. If you choose to do so please contact your broker: [broker's name]." If additional amounts are contributed to Benistar Plan, 2010 Tax Ct. Memo LEXIS 154">*167 those amounts remain in the trust account and are not used to make additional payments on the underlying insurance policy. Benistar Plan keeps track of the contribution on internal spreadsheets, and assuming the plan has enough assets to cover current liabilities, the contribution is used only for the policy to which it is allocated. All contributions are deposited in one trust account, and those amounts, plus the values of the policies owned by Benistar Plan, are available to satisfy any claim on the trust. In addition, as mentioned earlier, the trust may pay reasonable expenses incurred in the establishment and administration of the plan, including attorney's fees and accountant's fees.
Originally, the enrolled employer and its insurance agent would determine the amount of any additional contributions to make to Benistar Plan. Starting in 2000, Benistar Plan required that the contributions be sufficient to fully fund the underlying insurance policy in a maximum of five annual contributions.
In 2002, Benistar Plan began to encourage new employers to fund their employees' participation in the plan through one large lump-sum contribution. In 2003, lump-sum funding became mandatory. The 2010 Tax Ct. Memo LEXIS 154">*168 primary reason, according to Carpenter, was to make sure Benistar Plan was not experience rated, in violation of
Short of dying, there are three ways a covered employee may leave Benistar Plan. First, the employee may stop working for the enrolled employer. Second, the enrolled employer may choose to leave Benistar Plan or may be terminated involuntarily. Third, Benistar Plan 2010 Tax Ct. Memo LEXIS 154">*169 may terminate or discontinue the plan.
If an employee stops working for an enrolled employer, according to the terms of the plan and trust agreement the employee has 30 days to purchase the underlying policy from Benistar Plan at a value determined by Benistar Plan Sponsor. If the employee does not purchase the policy, the trustee of Benistar Plan may surrender the policy to the insurance company and add the proceeds to the trust account. Originally the employer could also request that the policy be transferred to another welfare benefit trust, but that clause was removed in the first 2003 amendment to the plan and trust agreement.
Employers could terminate their participation in the plan at any time by sending a letter of termination on company letterhead to Benistar Plan and paying a $ 500 termination fee. Under the plan's original terms, if an enrolled employer left Benistar Plan voluntarily, the plan could, assuming the liabilities of the plan were currently met, distribute the underlying policies to the insured employees at no cost. These terms were changed by the first 2003 amendment to the plan and trust agreement. From mid-2002 to mid-2005, it was Benistar Plan's general practice 2010 Tax Ct. Memo LEXIS 154">*170 to distribute the policies to the insured employees for the price per policy of 10 percent of the net surrender value of that policy. The net surrender value was calculated as of December 31 of the previous year, and premium payments that were made during the year of the distribution were not included. If the policy had no net surrender value, Benistar Plan charged $ 1,000 for the distribution.
After mid-2005, Benistar Plan began to charge covered employees the fair market value of the underlying policy, as defined in 2. The [Benistar 419] Trust's interest in the Policy shall be limited to: (a) The right to be repaid its cumulative loans plus interest paid or, if less, the net cash surrender value of the Policy, in the event the Policy is totally surrendered or cancelled by the Participant; (b) The right to be repaid its cumulative loans plus outstanding interest, 2010 Tax Ct. Memo LEXIS 154">*171 in the event of the death of the Insured; (c) The right to be repaid its cumulative loans plus outstanding interest, or, if less, the net cash surrender value of the Policy, or to receive ownership of the Policy, in the event of termination of the Agreement; (d) An amount not to exceed $ 300,000 if less than the amount listed above. 3. The Participant shall retain all incidents of ownership in the Policy, including, but not limited to, the sole and exclusive rights to: borrow against the Policy; make withdrawals from the Policy; assign ownership interest in the Policy; change the beneficiary of the Policy; exercise settlement options; and, surrender or cancel the Policy (in whole or in part). All of these incidents of ownership shall be exercisable by the Participant unilaterally and without the consent of any other person.
An employer may also be terminated from Benistar Plan involuntarily if it fails to contribute the amount previously billed by the plan. In this case, 2010 Tax Ct. Memo LEXIS 154">*172 Benistar Plan may surrender the policy to the insurance carrier and add the proceeds to the trust.
If Benistar Plan terminates, the underlying policy may be distributed to either the covered employee or to a trust for that employee's benefit at the discretion of Benistar Plan Sponsor.
Aside from termination, an enrolled employer or its covered employee may not withdraw contributions made to Benistar Plan. Benistar Plan allows potential enrolled employers who prepaid contributions to request a refund if they later decide not to participate in the plan, but this is viewed by the plan as an annulment of the transaction, rather than a forbidden distribution.
Petitioners Mark and Barbara Curcio and Ronald and Lorie Jelling resided in New Jersey at the time they filed their petitions. Mark Curcio (Curcio) has a bachelor's degree in accounting. Curcio was born in 1955, and Ronald Jelling (Jelling) was born in 1957.
Curcio and Jelling are business partners owning and operating car dealerships, and neither has any plans to retire. They have always split ownership of their car dealerships 50-50. Their first dealership was Chrysler of Paramus, founded 2010 Tax Ct. Memo LEXIS 154">*173 about 1990. About 1994, they founded Grand Dodge of Englewood, and in about 1995 they founded Dodge of Paramus. In about 2002, they founded Westwood Chrysler Jeep, and they hold it through an entity treated as a partnership for tax purposes, JELMAC, LLC. Collectively, we refer to these equally owned entities as the car dealerships.
Dodge of Paramus enrolled in Benistar Plan in December 2001, and it elected to provide life insurance benefits through the Benistar Plan to Curcio and Jelling as employees. It did not provide benefits through Benistar Plan to any of the other approximately 75 full-time employees. None of the approximately 220 employees employed by the other car dealerships (other than Curcio and Jelling themselves) received benefits through Benistar Plan.
One of the purposes of enrolling in Benistar Plan was to fund a buy-sell purchase agreement between Curcio and Jelling. The buy-sell agreement stipulated that should one partner die, the other partner would buy, and the deceased partner's estate would sell, the deceased partner's stake in the car dealerships for a previously agreed-upon value, which was set at $ 6 million. By naming each other as beneficiaries of the Benistar 2010 Tax Ct. Memo LEXIS 154">*174 Plan policy, Curcio and Jelling ensured that each had sufficient liquidity to purchase the other's stake for the agreed-upon price. Although Dodge of Paramus enrolled in Benistar Plan in 2001, the buy-sell agreement was not executed until March 2003. Curcio and Jelling both believed that the buy-sell agreement and the Benistar enrollment occurred within about a year's time.
Before enrolling in Benistar Plan, Curcio and Jelling consulted Stuart Raskin, the accountant for Dodge of Paramus. Neither Raskin nor anyone in his firm is an expert, or appears to be an expert, in welfare benefit plans. Raskin reviewed the Edwards & Angell opinion letter and advised Curcio and Jelling that, solely on the basis of the opinion letter, Dodge of Paramus could claim deductions for contributions to Benistar Plan.
Consistent with the procedures for enrolling in Benistar Plan, Curcio and Jelling met with their respective insurance agents to select life insurance policies from third-party insurers to be purchased as investments by Benistar Plan. The policies they selected both carried death benefits of approximately $ 9 million, which would underlie a total death benefit payable by Benistar Plan of $ 9 million 2010 Tax Ct. Memo LEXIS 154">*175 each even though, as of the 2003 version of the buy-sell agreement, the most Curcio or Jelling would be forced to pay for the other's interest was $ 6 million. Curcio and Jelling also contemplated having to make contributions for 10 years, after which they would receive life insurance coverage but would no longer have to contribute.
Curcio's insurance agent was Robert Iandoli. Iandoli met Curcio around 1998, when he sold Curcio life insurance and some securities and assisted Curcio with basic investment and estate planning. Curcio was not particularly knowledgeable regarding life insurance and relied at the time on Iandoli's expert advice. Curcio and Iandoli selected an Ensemble III flexible premium variable life policy from Jefferson Pilot Financial. The policy paid a death benefit of $ 9 million. Curcio chose to have the accumulation value of the life insurance policy invested in the S&P 500 equity index.
Because of a certain health condition, Curcio's underlying insurance policy was rated, which means the premiums were more expensive. Iandoli estimated that $ 200,000 annually would be sufficient to cover the premium payments for the selected policy, and therefore elected to make $ 2010 Tax Ct. Memo LEXIS 154">*176 200,000 contributions annually to Benistar Plan.
In 2004, Iandoli, on his own initiative but with Curcio's knowledge, was successful in having the rating removed from the policy, thereby reducing the cost of the underlying insurance on Curcio; but Jefferson Pilot required that the death benefit be raised to $ 9.1 million. The underlying policy's annual premium and the death benefit from the Benistar Plan policy remained the same.
Jelling's insurance agent was Alan Solomon, whom he had known at the time for over 30 years. Jelling was not particularly knowledgeable about insurance and relied on Solomon's advice. Jelling and Solomon selected two life insurance policies from Security Mutual Life Insurance Co.--the first, a flexible premium whole life with adjusted amounts policy, and the second, a flexible premium universal life policy. The two policies were structured so that Jelling's contributions to Benistar Plan would be the same as Curcio's, $ 200,000 annually, and the death benefit would be $ 9 million. Solomon thought that the two policies would provide the optimum mixture of insurance for Jelling because "A whole life policy gives you very good values, gives you a contract that 2010 Tax Ct. Memo LEXIS 154">*177 has stringent parameters, where a universal life is much more flexible," because with a universal life insurance policy the term component of the insurance comes from a savings account, and as long as the savings account has enough funds to cover the term premium, the coverage will not lapse. The policies carried a combined death benefit of $ 9,000,836.
Once the underlying life insurance policies were selected, Iandoli and Solomon filled out the necessary paperwork, leaving the beneficiary and owner fields blank. The forms were then sent to Benistar Plan to fill in the remaining information and forward to the insurance companies to apply for the policy.
Dodge of Paramus paid Benistar Plan a total of $ 400,000 in both 2001 and 2002. On its Forms 1120S, U.S. Income Tax Return for an S Corporation, Dodge of Paramus claimed a deduction for the $ 400,000 payment for both 2001 and 2002. In 2003, JELMAC paid Benistar Plan the $ 400,000 and claimed a deduction for the payment on its Form 1065, U.S. Return of Partnership Income. In 2004, Chrysler Plymouth of Paramus paid Benistar Plan the $ 400,000 and claimed a deduction for the payment on its Form 1120S.
On October 25, 2006, the IRS sent the 2010 Tax Ct. Memo LEXIS 154">*178 Curcios and the Jellings notices of deficiency, determining deficiencies in their 2001-2004 Federal income taxes, as well as accuracy-related penalties under
Petitioners Samuel and Amy Smith resided in Virginia at the time they filed their petition. Samuel Smith (Smith) was born in 1963.
In 1998, Smith started SH Smith Construction, Inc., after having run the painting division of his father's company for 4 years. On June 11, 2002, SH Smith Construction adopted a certificate of resolution electing to enroll in Benistar Plan. At the time, SH Smith Construction had 35 to 40 employees, but it chose to insure only Smith's life through the plan. Smith, with his financial adviser Richard Emery, selected a flexible-premium variable life insurance policy from ING Group with a death benefit of $ 5 million and annual premium payments of $ 54,000 to be purchased by Benistar Plan. On the insurance application, Smith 2010 Tax Ct. Memo LEXIS 154">*179 indicated that the purpose of the insurance was retirement planning. The policy was sent to Benistar Plan, and upon approval from ING Group, Benistar Plan issued a certificate of coverage dated July 15, 2003, insuring Smith with a death benefit of $ 5 million.
SH Smith Construction deducted $ 177,966 on its Form 1120S for 2003 under "Employee benefit programs". Of that sum, $ 750 was an administrative fee paid to Benistar Plan, and $ 54,000 was contributed to Benistar Plan. Benistar Plan paid the premium on the ING Group policy when the policy was issued in late 2002 and paid premiums again in late 2003 and early 2005. When the policy was issued, its accumulation value, as listed on the insurance policy statement, was invested in the Janus Aspen Balanced fund. Sometime between July and September 2003, the accumulation value of the policy was shifted from the Janus Aspen Balanced fund to the Alger American Leverage All Capital fund. Between July and September 2005, the accumulation value of the policy was shifted from the Alger American Leverage All Capital fund and distributed among five other funds, referred to on the policy statement as AIM VI Utilities, ING Inv. VanKmpn Real Estate, 2010 Tax Ct. Memo LEXIS 154">*180 ING INV Evergreen Omega, ING INV MFS Utilities, and ING PRT AC Small Cap.
On September 27, 2005, SH Smith Construction notified Benistar Plan that it intended to terminate its participation in the plan and requested that Smith be allowed to purchase his policy. On October 21, 2005, the necessary paperwork, including a general release form and a plan termination and policy transfer release form, was executed. To receive the underlying policy, Smith paid the termination fee of $ 500 plus 10 percent of the net surrender value of the policy. He also signed a collateral assignment agreement. To calculate the 10-percent fee, Benistar Plan used the net surrender value of the policy as of December 31, 2004, which was $ 29,704.77, instead of the net surrender value at the time, which was, according to the quarterly statement ending September 30, 2005, $ 83,158.85.
On November 8, 2005, Benistar Plan and Smith executed a transfer of ownership form, transferring ownership of the underlying policy from Benistar Plan to Smith. Smith did not receive a loan repayment schedule, and he could identify no additional payments to Benistar in connection with the collateral assignment agreement or ownership 2010 Tax Ct. Memo LEXIS 154">*181 of the policy. On April 17, 2006, Smith requested a partial withdrawal of $ 77,300 from his policy. On January 9, 2007, Smith requested a policy loan of $ 16,000 from his policy.
On March 27, 2007, the IRS sent the Smiths a notice of deficiency determining a deficiency in their 2003 Federal income tax as well as an accuracy-related penalty under
Petitioners Stephen and Roberta Mogelefsky resided in New York at the time they filed their petition. Stephen Mogelefsky (Mogelefsky) has an associate's degree in real estate and finance. Mogelefsky was born in 1940.
Mogelefsky has been the president and owner of Discount Funding Associates, Inc., an S corporation, continuously since 1979. The company, at various times, had between 2 and 20 employees. On December 20, 2002, Discount Funding Associates adopted a certificate of 2010 Tax Ct. Memo LEXIS 154">*182 resolution electing to enroll in Benistar Plan. It elected to provide life insurance benefits through Benistar Plan to Mogelefsky and his stepson, a manager at the company.
Before enrolling in Benistar Plan, Mogelefsky consulted his accountant, Philip Dedora, who is also the accountant for Discount Funding Associates. Dedora did not conduct research with respect to Benistar Plan. Dedora had no particular expertise in welfare benefit plans, nor did he tell Mogelefsky that he had such expertise. He relied on the opinion of Edwards & Angell in advising Mogelefsky that Discount Funding Associates could claim a deduction for contributions to Benistar Plan. Mogelefsky was aware that Dedora was basing his advice on the Edwards & Angell opinion letter.
Mogelefsky, with the help of his insurance agent, Gary Frisina, selected policies from John Hancock Life Insurance Co. to be purchased by Benistar Plan. To cover himself, Mogelefsky selected a flexible premium adjustable life insurance policy--a universal life insurance policy--with a death benefit of $ 1.35 million (Mogelefsky's first policy). To cover his stepson, Mogelefsky selected a flexible premium universal life insurance policy. Benistar 2010 Tax Ct. Memo LEXIS 154">*183 Plan issued a certificate of coverage dated September 18, 2003, insuring Mogelefsky with a death benefit of $ 1.35 million, insuring his stepson with a death benefit of $ 350,000, and listing the enrolled employer as Discount Funding Associates.
On December 16, 2003, Discount Funding Associates adopted a certificate of resolution electing to further participate in Benistar Plan. It elected to provide additional life insurance benefits to Mogelefsky. Mogelefsky selected a second flexible premium universal life insurance policy from John Hancock Life Insurance Co. with a death benefit of $ 1.02 million (Mogelefsky's second policy). Benistar Plan issued a certificate of coverage dated December 28, 2004, insuring Mogelefsky with a death benefit of $ 1.35 million and insuring his stepson with a death benefit of $ 350,000--the same death benefits as outlined in the certificate of coverage issued in 2003. The 2004 certificate listed the enrolled employer as Oldfield Management Corp, another S corporation owned by Mogelefsky.
Discount Funding Associates deducted $ 398,597 on its 2002 Form 1120S corresponding to a contribution to Benistar Plan made in early 2003. Discount Funding Associates also 2010 Tax Ct. Memo LEXIS 154">*184 deducted $ 354,821 on its 2003 Form 1120S corresponding to a contribution to Benistar Plan made in early 2004. Discount Funding Associates' 2003 Form 1120S reported that the company had no accumulated earnings and profits at the close of 2003.
Between March 8 and 16, 2006, Mogelefsky and his stepson completed the documents to withdraw from Benistar Plan. The paperwork included a general release form and a plan termination and policy transfer release form. To receive the underlying insurance policies, Mogelefsky paid 10 percent of the net surrender value of the policies. He also signed a collateral assignment agreement, which listed the employer as Oldfield Management Group. To calculate the 10-percent fee on Mogelefsky's first policy, Benistar Plan used $ 285,773.41 as the net surrender value. As of December 22, 2005, the account value was $ 313,745.43 and the cash surrender charge was $ 28,330.62, yielding a net surrender value of $ 285,414.81. There were no further premium contributions made to the policy. To calculate the 10-percent fee on Mogelefsky's second policy, Benistar Plan used $ 146,328.15 as the net surrender value. As of December 16, 2005, the account value listed on the 2010 Tax Ct. Memo LEXIS 154">*185 insurance policy statement was $ 166,798 and the surrender charge was $ 20,803.71, yielding a net surrender value of $ 145,994.38. As of March 16, 2006, the account value was $ 255,089.19. As of December 16, 2006, the surrender charge was $ 19,647.95.
Between March 8 and 16, Benistar Plan and Mogelefsky executed a transfer of ownership form, transferring ownership of the underlying policies from Benistar Plan to Mogelefsky. Mogelefsky did not think that he had borrowed money from Benistar Plan and could not recall signing any loan agreements promising to repay Benistar Plan by a particular time.
On June 25, 2007, the IRS sent the Mogelefskys a notice of deficiency determining a deficiency in their 2003 Federal income tax as well as an accuracy-related penalty under
OPINION
Petitioners argue that (1) contributions to Benistar Plan are ordinary and necessary business expenses deductible under
We first consider whether the contributions made by the participating companies are ordinary and necessary business expenses deductible under
We acknowledge that the evidence at trial and the arguments in the briefs in large part deal with Carpenter's attempts to fashion the Benistar Plan to qualify as a welfare benefit plan under
As a preliminary matter, we note that under the annual accounting system of Federal income taxation, the amount of income tax payable for a taxable year is generally determined on the basis of those events happening or circumstances present during that tax year. See
If, in any court proceeding, a taxpayer introduces credible evidence with respect to any factual 2010 Tax Ct. Memo LEXIS 154">*189 issue relevant to ascertaining the liability of the taxpayer for any tax imposed by subtitle A or B, the Secretary shall have the burden of proof with respect to such issue.
Respondent argues that petitioners failed to satisfy the requirements of
Regardless, the burden of proof is determinative only when there is an evidentiary tie. See
Petitioners argue in their brief that It is hard to imagine a more natural and legitimate business deduction than the 'ordinary and necessary' contribution made to a welfare benefit plan by a company to purchase life insurance or other benefits for the benefit of a key employee who may be a shareholder or owner of the business and his/her family.
The record does not allow us to determine petitioners' annual term life insurance cost. See
Petitioners argue that the contributions are not excessive because, according to rates published by the Government, it would cost over $ 3 million to purchase $ 1 million in life insurance coverage to age 90 and the contributions to Benistar Plan total significantly less. Petitioners confuse the total cost of term life insurance over a set number of years with the annual cost. The relevant consideration is the amounts of contributions to Benistar Plan in excess of the amounts necessary to fund annual term life insurance. We must consider why petitioners would pay such excess amounts and whether those contributions were ordinary and necessary business expenses or payments to petitioners personally.
Petitioners cite three cases in support of their argument. In the first case,
Petitioners also rely upon
We found that contributions to plans similar to Benistar Plan were not deductible under
The Court decided similarly in The insurance premiums at hand pertained to the participating doctors' personal investments in whole life insurance policies that primarily accumulated cash value for those doctors personally. VRD/RTD's contributions to the STEP [Severance Trust Executive Program Multiple Employer Supplemental Benefit Plan and Trust] plan were used to pay the initial year's cost of providing life insurance for each participating doctor and to create an investment fund for the insured within his whole life insurance policy * * *. As to each investment fund (and as to each insurance policy in general), the insured doctor regarded that fund (and policy) as his own, as did the STEP plan trustee, the STEP plan administrator, and MetLife. Very little (if any) value in one participating doctor's fund was available to pay to another insured, and any distribution of cash from the STEP plan to a participating doctor was directly related to the cash value of 2010 Tax Ct. Memo LEXIS 154">*198 his policy. In many instances, a participating doctor dealt with his own insurance agent in selecting and purchasing the policy on his life, received illustrations on an assortment of life insurance investments that could be made through the STEP plan, determined the amount of his investment in his life insurance policy, selected the form of the insurance policy to be issued for him (e.g., single whole life versus survivor whole life), and selected his policy's face amount. * * * The use of whole life insurance policies and the direct interactions between the participating doctors and the STEP plan representatives support our finding that the participating doctors in their individual capacities fully expected to get their promised benefits and that any receipt of those benefits was not considered by anyone connected with the life insurance transaction to rest on any unexpected or contingent event. Each whole life insurance policy upon its issuance was in and of itself a separate account of the insured doctor, and the insured (rather than the STEP plan) dictated and directed the funding and management of the account and bore most risks incidental to the account's performance. * * *
The facts in these cases are strikingly similar to those in
Petitioners acted as though they owned personally both their Benistar policies and the underlying policies. For example, at their deposition, neither Curcio nor Jelling was able 2010 Tax Ct. Memo LEXIS 154">*200 to articulate a single advantage of obtaining life insurance through Benistar Plan over owning the underlying policy directly, implying that the issue was one they had not considered. When Curcio's underlying policy was rated, thereby making the premium payments more expensive for Benistar Plan, it was Iandoli, Curcio's insurance agent, who worked to remove the rating with no help from the plan. Solomon, Jelling's insurance agent, selected a mixture of whole life and universal life insurance for the underlying Benistar Plan insurance policy even though the terms of the policy issued to Jelling from Benistar Plan were the same. Curcio and Jelling contributed to Benistar Plan using three different companies between 2001 and 2004, and when asked about this at trial Jelling responded that "the concept to me, and maybe it's just simple, is there are multiple entities owned 50-50 by two partners, we file them all at the same time, the revenue falls through a stream to the bottom line." It was irrelevant to them which of their companies actually made the contribution to Benistar Plan, because they viewed the Benistar policies as their own.
Similarly, on the certificate of coverage for Mogelefsky, 2010 Tax Ct. Memo LEXIS 154">*201 the enrolled employer changed from Discount Funding Associates to Oldfield Management Corp between 2003 and 2004. Smith appears to have actively managed the accumulation value in the underlying policy he selected, switching investments three times between 2002 and 2005--despite Carpenter's assurances that covered employees could invest an underlying policy's accumulation value only in the insurance company's guaranteed fund or the S&P 500 equity index. Tellingly, on the application for the policy, Smith indicated that his purpose for getting insurance was retirement planning.
Not only did petitioners act as though they personally owned the underlying insurance policies, Benistar Plan itself promoted the implication that it was merely a conduit to the underlying policies and not the actual insurer. For example, Benistar Plan did not issue Jelling notices of contribution based on the amount of life insurance benefits it provided, but rather based on the number of underlying policies that Jelling selected. Since Jelling selected two underlying policies, he received two separate notices of contributions, one for each policy. Further, Benistar Plan took measures to completely hedge its insurance 2010 Tax Ct. Memo LEXIS 154">*202 risk, to the point that for a brief period in 2002 the liability of the plan for death benefits was contingent on the underlying policy's payment of death benefits to Benistar Plan. And although contributions to the plan were deposited in one account, Benistar Plan maintained spreadsheets that allocated every contribution to an employer and a corresponding underlying policy.
Although Benistar Plan is very similar to the employee benefit plan in
It is unclear whether this recharacterization occurred in 2005 or later. At trial, Carpenter testified that If somebody wants to buy their policy we will give them a hundred percent financing where they pay interest equal to the short-term, mid-term, and long-term rate as published by the Treasury every month. We'll charge them that interest and then we'll also have them sign a collateral assignment for the full [fair market] value.
The 10-percent withdrawal fee/prepaid interest was a fiction. The fee was calculated using the net surrender value of the policy as of the close of the previous year. In both Smith's policy and Mogelefsky's second policy, significant contributions were made by Benistar Plan right before those policies were withdrawn from the plan. These contributions reduced the fee to significantly below 10 percent. Smith withdrew from Benistar Plan when the underlying policy had a net surrender value of $ 83,158.85 and he paid $ 2,970.47, yielding a fee of 3.6 percent. Mogelefsky withdrew from Benistar Plan when his second policy had an account value of $ 255,089.19 and an approximate surrender charge of $ 20,803.71, yielding a net surrender value of $ 234,285.48. He paid $ 14,632.81, a fee of 6.3 percent. Only the fee charged for Mogelefsky's first policy actually reflected 10 percent of the net surrender value at the time the policy was withdrawn from the plan.
Petitioners claim that Smith and Mogelefsky withdrew their policies after 2010 Tax Ct. Memo LEXIS 154">*206 2005 and paid for the fair market values of the policies under
"Whether a transfer of money creates a bona fide debt depends upon the existence of an intent by both parties, substantially contemporaneous to the time of such transfer, to establish an enforceable obligation of repayment."
We therefore conclude that before 2002 Benistar Plan would distribute the underlying insurance policies to covered employees for free. After 2002, and for all the following relevant years, Benistar Plan would charge a withdrawal fee that was much lower than 10 percent. Thus petitioners, by causing Benistar Plan to distribute the underlying policies, could easily retrieve the value in those policies with minimal expense.
Petitioners argue that Benistar Plan has over $ 20 million in forfeitures, a reflection of its rigorous enforcement of its forfeiture policies. Statistics regarding Benistar Plan operations do not alter how Benistar Plan treated petitioners. It is also unclear whether the $ 20 million figure includes amounts due to Benistar Plan from the purported loans issued by the plan to withdrawing employees after mid-2005.
As Carpenter acknowledged, as long as plan participants were willing to abide by Benistar Plan's distribution policies, there was no reason ever to forfeit a policy to the plan. In fact, in estimating life insurance rates, petitioners' expert assumed that 2010 Tax Ct. Memo LEXIS 154">*209 there would be no forfeitures, even though he admitted that an insurance company would generally assume a reasonable rate of policy lapse.
After considering the facts and weighing the evidence, we conclude, as we did similarly in
Petitioners have not argued that they should be entitled to deduct the annual cost of term life insurance purchased 2010 Tax Ct. Memo LEXIS 154">*210 through Benistar Plan, nor have they identified evidence that would enable us to establish that cost. As a result, we find that no part of petitioners' contributions to Benistar Plan is deductible. See
Similarly, the record is devoid of information regarding Mogelefsky's stepson. Absent from the record is any information regarding how Mogelefsky's stepson's underlying policy was selected. While Mogelefsky's stepson did sign a collateral assignment agreement, we have already determined that the agreement did not create a bona fide debt. Although it is clear that Discount Funding Associates enrolled Mogelefsky's stepson in Benistar Plan, the record does not allow us to determine what portions of the 2003 and 2004 contributions were for his benefit. Petitioners do not argue that contributions to Benistar Plan on behalf of Mogelefsky's stepson should be treated differently from other contributions. We therefore do not distinguish between contributions for Mogelefsky's benefit and contributions for his stepson's benefit. We find that no part of Mogelefsky's contributions to Benistar Plan is deductible. Cf.
Our interpretation and application of
Finally, we note that our treatment of Benistar Plan is consistent with
Respondent argues that in addition to finding that the distributions made by the participating companies are not deductible, we should include Discount Funding Associates' early 2003 contribution to Benistar Plan directly in Mogelefsky's income as a constructive distribution.
Petitioners argue that respondent is treating Mogelefsky inconsistently because respondent is treating the 2003 contribution and the 2004 contribution under different and contradictory theories. On the one hand, respondent is treating the 2004 contribution as nondeductible, with the result that Mogelefsky must include that amount in income under
Respondent's treatment of Mogelefsky is not inconsistent. As in
However, Discount Funding Associates' income is not increased by the 2003 contribution because the deduction was claimed in 2002 and we have no jurisdiction to review the tax for that year because the Mogelefskys are not petitioning the Court from a notice of deficiency issued to them for that year. See
Petitioners do not argue that Mogelefsky has sufficient basis in Discount Funding Associates to offset the distribution. See
Petitioners argue that the 2003 contribution should not be included in Mogelefsky's 2003 income because the distribution occurred in 2002. Respondent argues that Mogelefsky received the distribution in early 2003, when Discount Funding Associates actually made the contribution to Benistar Plan.
The date of the distribution is the date on which the property is unqualifiedly made subject to the taxpayer's demands.
Petitioners contest the imposition of accuracy-related penalties for the tax years in issue.
Under
Respondent has met the burden of production. Respondent has shown that petitioners improperly deducted tens of thousands of dollars used to purchase life insurance which could then be redistributed to petitioners for free or for a small fraction of the value of the insurance policy. This evidence is sufficient to indicate that it is appropriate to impose penalties under
Petitioners argue that they had substantial authority for their deduction of contributions to Benistar Plan. Substantial authority exists when "the weight of the authorities supporting the treatment is substantial in relation to the weight 2010 Tax Ct. Memo LEXIS 154">*219 of authorities supporting contrary treatment."
The accuracy-related penalty under
Petitioners claim that they relied on the tax advice of their accountants. However, there is no evidence that petitioners' accountants had any particular expertise in employee benefit plans or that petitioners thought their accountants had such expertise. See
Petitioners also claim that they relied on the tax 2010 Tax Ct. Memo LEXIS 154">*222 advice of their insurance agents. However, there is no evidence that petitioners' agents were educated in tax law or held themselves out to be tax advisers, or that petitioners believed their agents were educated in tax law. See
Petitioners, regardless of their formal education, are experienced businessmen. By the years at issue, Curcio and Jelling had owned car dealerships for over 10 years; Smith had run the painting division of his father's company for 4 years and owned his own company for 5 years; and Mogelefsky had owned Discount Funding Associates for over 20 years. Yet petitioners failed to conduct thorough research regarding deductions of tens or hundreds of thousands of dollars that were exclusively for their own benefit. Furthermore, some admin packets sent to Benistar Plan enrolled employers listed "virtually unlimited deductions" as a perk of participating in the plan. Carpenter wrote A Professional's Guide to 419 Plans because most financial advisers thought Carpenter's section 419 plans were too good to be true. In these cases, they were. See
Petitioners argue that their cases are similar to
Petitioners also compare their case to This is a close case. In the end, we are searching for clear error in the district court's factual determinations, and we are unable to find it. Whether any judge on this panel might have reached a different conclusion after hearing the evidence first-hand is not the appropriate concern. * * *
We conclude that petitioners' underpayments of Federal income tax were the result of their negligence or disregard of rules or regulations under
Petitioners argue that the complexity of the cases and the first-impression issues presented justify 2010 Tax Ct. Memo LEXIS 154">*225 abatement of the accuracy-related penalty. This is not an issue of first impression. We decide these cases similarly to and on the same principles as
In reaching our decision, we have considered all arguments made by the parties. To the extent not mentioned or addressed, they are irrelevant or without merit.
For the reasons explained above,
1. Case of the following petitioners are consolidated herewith: Ronald D. Jelling and Lorie A. Jelling, docket No. 1769-07; Samuel H. Smith, Jr., and Amy L. Smith, docket No. 14822-07; Stephen Mogelefsky and Roberta Mogelefsky, docket No. 14917-07.↩