T.C. Memo. 2018-155
UNITED STATES TAX COURT
RUBEN DE LOS SANTOS AND MARTHA DE LOS SANTOS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5458-16. Filed September 18, 2018.
David M. Henderson, for petitioners.
Elizabeth S. McBrearty, David Weiner, and Angela B. Reynolds, for
respondent.
MEMORANDUM OPINION
LAUBER, Judge: With respect to petitioners’ Federal income tax for 2011
and 2012, the Internal Revenue Service (IRS or respondent) determined deficien-
cies of $588,637 and $615,546, respectively. It also determined accuracy-related
penalties under section 6662A, which covers “reportable transaction understate- -2-
[*2] ments,” and alternatively under section 6662(a).1 Currently before the Court
are the parties’ cross-motions for partial summary judgment.
Petitioner husband was the sole shareholder of an S corporation that em-
ployed him and his wife. It made contributions of $1.8 million to an employee
welfare benefit plan, which purchased a life insurance policy with a face value of
$12.5 million covering petitioners’ lives. The question presented is whether this
arrangement generated current taxable income for petitioners as a “split-dollar”
life insurance arrangement under section 1.61-22(b), Income Tax Regs.
The arrangement here resembles the split-dollar arrangement we considered
in Our Country Home Enters., Inc. v. Commissioner, 145 T.C. 1 (2015). Reaching
similar conclusions here to those we reached there, we will grant respondent’s mo-
tion for partial summary judgment and deny petitioners’ cross-motion.
Background
There is no dispute as to the following facts, which are drawn from the par-
ties’ motion papers, the stipulation of facts, and the exhibits attached thereto. Peti-
tioners resided in Texas when they petitioned this Court.
1 All statutory references are to the Internal Revenue Code (Code) in effect for the years at issue, and all Rule references are to the Tax Court Rules of Prac- tice and Procedure. We round all monetary amounts to the nearest dollar. -3-
[*3] Petitioner husband is a medical doctor. During the tax years at issue he was
the sole shareholder of Dr. Ruben De Los Santos MD, PA, an S corporation incor-
porated in Texas (S Corp.) The S Corp. employed Dr. De Los Santos and his wife,
who served as the office manager for the medical practice, as well as four other
individuals. Petitioners received annual salaries of $216,000 and $54,000, respec-
tively. Petitioner husband also included in his income, as the sole shareholder of
the S Corp., 100% of its items of income and expense. See sec. 1366.
A. The Legacy/Flex Plan
In July 2004 Legacy Benefit Plans, LLC, an Illinois company (LBP), estab-
lished the Legacy Employee Welfare Benefit Plan (Legacy Plan). The Legacy
Plan was a purported multiple-employer welfare benefit plan under section
419A(f)(6). At all relevant times LBP was the sponsor and administrator of the
Legacy Plan.
An employer elected to participate in the Legacy Plan by adopting a welfare
benefit plan pursuant to the terms of a master plan. The Legacy Plan offered liv-
ing benefits, including disability benefits, and death benefits. The latter were ulti-
mately payable, upon the death of a covered employee, to that person’s spouse or
designated beneficiary. -4-
[*4] Participating employers selected the types of benefits to be provided to their
employees. No employee had any right to withdraw from, borrow against, or sur-
render his interest in the Legacy Plan. An employee covered by the Legacy Plan
designated the beneficiary or beneficiaries who would receive death benefits to
which that employee was entitled.
The Legacy Plan was funded by employer contributions to the Legacy Em-
ployee Welfare Benefit Trust (Legacy Trust). LBP determined the amount of such
contributions through a rate chart, which took into account common risk factors
such as age, gender, number of covered dependents, and benefit terms. The em-
ployees themselves made no contributions to the Legacy Trust and otherwise made
no financial commitment to the Legacy Plan. At no time was the Legacy Trust
recognized by the IRS as tax-exempt under section 501(a).
All employer contributions to the Legacy Trust were irrevocable and were
thereafter inaccessible by the participating employer and its creditors. Participat-
ing employers and their creditors had no access to the income or assets (including
insurance contracts) held by the Legacy Trust. In no event could the assets held
by the Legacy Trust be used for any purpose other than funding benefits for par-
ticipating employees and their beneficiaries or defraying expenses of plan ad- -5-
[*5] ministration. The Legacy Trust invested the contributed funds in multiple
asset classes, including cash, stock, bonds, and life insurance contracts.
In December 2010 the Legacy Plan was merged into the Legacy Employee
Flex Benefit Plan (Flex Plan). The Legacy Trust thereupon transferred its assets to
the Legacy Employee Flex Benefit Trust (Flex Trust). The Flex Plan enabled par-
ticipating employers to offer their employees a wider range of living benefits, such
as day care and vacation benefits. But the operative provisions of the Flex Plan
and the Flex Trust were otherwise substantially similar to the operative provisions
of the Legacy Plan and the Legacy Trust as described above. For convenience we
will sometimes refer to these entities collectively as the Legacy/Flex Plan and the
Legacy/Flex Trust.
B. The S Corp.’s Participation in the Legacy/Flex Plan
In October 2006 the S Corp. elected to participate in the Legacy Plan by ex-
ecuting an adoption agreement with an effective date of November 14, 2006. The
S Corp. selected the benefits to be provided to petitioners and its four other em-
ployees under the Legacy Plan. Petitioners were entitled thereunder to a $12.5
million death benefit, and the S Corp.’s four rank-and-file employees were entitled
to a $10,000 accidental death and dismemberment (AD&D) benefit. Under the
Flex Plan petitioners continued to receive a $12.5 million death benefit; the rank- -6-
[*6] and-file employees received a $10,000 death benefit and several flexible
benefits, including a critical illness benefit and a prepaid legal benefit.
The Legacy Plan required that life insurance be purchased to fund the prom-
ised death benefits. In January 2007 the Legacy Trust accordingly purchased a life
insurance policy (Policy) insuring the lives of petitioners. The Policy, issued by
American General Life Insurance Co. (AGLI), was a “flexible premium variable
universal life” policy, with accumulation values based on the investment experi-
ence of a separate fund. The Policy provided base insurance coverage of $12.5
million, equal to the death benefit that the S Corp. had selected for petitioners.
The Legacy Trust (later the Flex Trust) was named as the owner and beneficiary of
the Policy.2
AGLI considered several risk factors when issuing the Policy, including pe-
titioners’ age and status as nonsmokers. (At the time petitioner husband was age
54 and his wife was age 47.) The policy was a survivor policy, under which AGLI
would pay $12.5 million to the Legacy Trust when the second of petitioners died.
2 The original Policy documents list the policy owner as the “Legacy Em- ployee Benefit Plan and Trust.” But the parties have stipulated that the Legacy Trust was “the owner and beneficiary” of the Policy when it was issued in 2007. In October 2011 the Flex Trust was substituted as the policy owner and bene- ficiary. -7-
[*7] The Legacy Trust in turn would pay $12.5 million to the beneficiary or
beneficiaries whom petitioners had designated.
The Legacy Trust invoiced the S. Corp. for the required upfront contribu-
tions. Each invoice showed $100 as the cost of AD&D coverage for the four rank-
and-file employees, with the balance attributable to the cost of the Policy. During
2006-2010 the S Corp. made to the Legacy Trust the following contributions,
which it treated as tax-deductible expenses of the medical practice:
Date Contribution
11/14/2006 $372,446 12/05/2007 372,446 10/08/2008 372,486 11/19/2009 372,485 10/27/2010 372,486 Total 1,862,349
During 2007-2012 the Legacy Trust (and later the Flex Trust) paid premi-
ums on the Policy as follows:
Date Premium paid
02/24/2007 $353,767 03/24/2008 353,767 02/20/2010 75,000 02/24/2011 51,000 02/24/2012 51,000 Total 884,534 -8-
[*8] Because of these premium payments and the investment gains thereon, the
“accumulation value” of the Policy was $640,358 at the end of 2011 and $744,460
at the end of 2012, according to the quarterly statements issued by AGLI.
If an employer participating in the Flex Plan made all required contributions
before December 1, 2011, and thereafter terminated participation, employees who
were entitled to death benefits would continue to receive that coverage for the rest
of their lives. The S Corp. had made, by October 27, 2010, all contributions re-
quired to fund the promised death benefits. Because subsequent events could not
cause petitioners to lose their entitlement to the $12.5 million death benefit, they
were fully vested in that benefit during the tax years at issue.
C. Tax Return Filings
Petitioners timely filed joint Federal income tax returns for 2011 and 2012,
reporting adjusted gross income of $830,370 and $927,797, respectively. They
did not report on these returns any income related to their participation in the
Legacy/Flex Plan. On December 4, 2015, the IRS issued petitioners a timely no-
tice of deficiency for 2011 and 2012, in which it determined deficiencies and pen-
alties on the basis that petitioners had received taxable economic benefits from
their participation in the Legacy/Flex Plan. Petitioners timely petitioned this
Court for redetermination. -9-
[*9] Discussion
The purpose of summary judgment is to expedite litigation and avoid un-
necessary and time-consuming trials. See FPL Grp., Inc. & Subs. v. Commission-
er, 116 T.C. 73, 74 (2001). We may grant summary judgment or partial summary
judgment when there is no genuine dispute of material fact and a decision may be
rendered as a matter of law. Rule 121(b); Elec. Arts, Inc. v. Commissioner, 118
T.C. 226, 238 (2002). The parties agree on all material facts relevant to the issues
we must decide, and they have expressed that consensus by filing cross-motions
for partial summary judgment. We conclude that these issues may be adjudicated
summarily.
Respondent contends that the Policy issued on petitioners’ lives incident to
their participation in the Legacy/Flex Plan was part of a compensatory split-dollar
life insurance arrangement under section 1.61-22(b)(2), Income Tax Regs., and
that petitioners must include in gross income the economic benefits thus conferred
on them. Petitioners do not dispute that economic benefits received from a split-
dollar life insurance arrangement constitute taxable income. Rather, they contend
that their participation in the Legacy/Flex Plan did not involve a split-dollar ar-
rangement. - 10 -
[*10] A. Governing Legal Framework
The term “split-dollar” was originally applied to life insurance arrangements
under which an employer paid part of the premiums on a policy insuring an em-
ployee’s life, with the understanding that the employer would recover part or all of
the premiums from the insurance proceeds. See Rev. Rul. 64-328, 1964-2 C.B. 11,
revoking Rev. Rul. 55-713, 1955-2 C.B. 23. In September 2003 the Department of
the Treasury issued final regulations that define split-dollar life insurance arrange-
ments more comprehensively. T.D. 9092, 2003-2 C.B. 1055; see sec. 1.61-22,
Income Tax Regs. These regulations govern all split-dollar life insurance
arrangements entered into or materially modified after September 17, 2003. Sec.
1.61-22(j), Income Tax Regs.; see Our Country Home Enters., Inc., 145 T.C. at
38-39. The parties agree that these regulations govern the outcome here.
The regulations generally define a split-dollar life insurance arrangement to
include any arrangement (other than group-term life insurance) between an owner
of a life insurance contract and a non-owner of the contract if certain conditions
are met. Sec. 1.61-22(b)(1), Income Tax Regs. One of these conditions is that one
party must be entitled to recover from the insurance proceeds “all or any portion”
of the premiums previously paid. Id. subpara. (1)(ii). Because the arrangement at
issue here does not meet that condition, respondent does not contend that petition- - 11 -
[*11] ers’ participation in the Legacy/Flex Plan constituted a split-dollar
arrangement under the general definition set forth in the regulations.
The regulations set forth a “special rule,” however, that applies “regardless
of whether the criteria of paragraph (b)(1) of this section are satisfied.” Id.
subpara. (2)(i). Under this special rule, an arrangement is treated as a split-dollar
life insurance arrangement if it is either a compensatory arrangement or a share-
holder arrangement. See id. subpara. (2)(ii) and (iii). Because neither party con-
tends that the Legacy/Flex Plan involved a shareholder arrangement, the question
we must decide is whether it constituted a compensatory arrangement.
An arrangement between an owner and a non-owner of a life insurance con-
tract constitutes a compensatory arrangement if three conditions are met. First, the
arrangement must be entered into “in connection with the performance of serv-
ices” and must not be “part of a group-term life insurance plan described in section
79.” Id. subdiv. (ii)(A). Second, the employer or other service recipient must pay,
“directly or indirectly, all or any portion of the premiums” on the policy. Id. sub-
div. (ii)(B). Third, as relevant here, the beneficiary of the death benefit must be
“designated by the employee or service provider” or must be a person “whom the
employee or service provider would reasonably be expected to designate as the
beneficiary.” Id. subdiv. (ii)(C)(1). - 12 -
[*12] “[T]he person named as the policy owner of [a life insurance] contract gen-
erally is the owner of such contract.” Id. para. (c)(1). However, the regulations
include attribution rules that apply in the case of compensatory arrangements. See
id. subpara. (1)(iii). If the arrangement is entered into in connection with the
performance of services, the employer or other service recipient “is treated as the
owner of the life insurance contract” if the owner is (among other things) a “wel-
fare benefit fund within the meaning of section 419(e)(1).” Id. subdiv. (iii)(C).
The Federal income tax consequences of a split-dollar life insurance ar-
rangement are generally determined either through the economic benefit provi-
sions of section 1.61-22(d) through (g), Income Tax Regs., or through the loan
provisions of section 1.7872-15, Income Tax Regs. See Estate of Morrissette v.
Commissioner, 146 T.C. 171, 179 (2016); Our Country Home Enters, Inc., 145
T.C. at 49-50. The parties agree that, if we find the Legacy/Flex Plan to involve a
split-dollar life insurance arrangement, the economic benefit provisions will apply
here. Under those provisions, the owner of the life insurance contract is treated as
providing current economic benefits to the non-owner of the policy. See sec. 1.61-
22(d)(1), Income Tax Regs. - 13 -
[*13] B. Analysis
Petitioners first contend that there can be no split-dollar arrangement here
because the Legacy/Flex Plan is not “life insurance.” This contention is mis-
guided. The regulations provide that a compensatory split-dollar arrangement
exists if specified criteria are met with respect to an owner and a non-owner of “a
life insurance contract.” Sec. 1.61-22(b)(2), Income Tax Regs. Petitioners do not
dispute (and they could not plausibly dispute) that the Policy is a “life insurance
contract” as defined by section 7702(a). The Policy was issued by AGLI, a life
insurance company, and provides insurance of $12.5 million on petitioners’ lives.
Petitioners contend that the Legacy/Flex Plan is not life insurance because it
lacks a sufficient element of risk. But it is irrelevant under the regulations whether
the Legacy/Flex Plan as whole constitutes life insurance. The relevant fact is that
this Plan required that life insurance be purchased to fund the promised death
benefit, and the Trust purchased the Policy for that reason.
The first step of the analysis requires that we identify the owner of the
Policy under the regulatory attribution rules. The Legacy Trust (later the Flex
Trust) was the named owner of the Policy. But when a split-dollar arrangement is
entered into in connection with the performance of services, the employer “is
treated as the owner of the life insurance contract” if the actual owner is (among - 14 -
[*14] other things) a “welfare benefit fund within the meaning of section
419(e)(1).” Sec. 1.61-22(c)(1)(iii)(C), Income Tax Regs.
Section 419(e)(1) defines a welfare benefit fund as a fund that is part of an
employer plan and through which the employer “provides welfare benefits to
employees or their beneficiaries.” Section 419(e)(2) generally defines a welfare
benefit as any benefit other than a benefit covered by section 83(h) (property
transferred in connection with performance of services), section 404 (deferred
payment plan), or section 404A (foreign deferred compensation plan).
Petitioners do not challenge the status of the Legacy Trust (and later the
Flex Trust) as a welfare benefit fund within the meaning of section 419(e)(1).
Section 419(e)(3) defines a fund to include “any trust, corporation, or other
organization not exempt” from Federal income tax. Neither the Legacy Trust nor
the Flex Trust was tax exempt under section 501(a). Each trust was “part of the
plan of an employer” through which the S Corp. “provide[d] welfare benefits to
employees or their beneficiaries.” See sec. 419(e)(1)(A) and (B). And the benefits
thus provided were welfare benefits because they were not covered by section
83(h), 404, or 404A. See sec. 419(e)(2). For purposes of applying the split-dollar
regulations, therefore, the S Corp. is treated as the owner of the Policy and peti-
tioners are treated as the “non-owners.” See sec. 1.61-22(c)(1) and (2), Income - 15 -
[*15] Tax Regs.; cf. Our Country Home Enters., Inc., 145 T.C. at 40 (reaching the
same conclusion on the basis of the taxpayer’s concession).
The first prong of the test for a compensatory arrangement requires that the
arrangement between the owner and the non-owner be entered into “in connection
with the performance of services” and not be “part of a group-term life insurance
plan described in section 79.” Sec. 1.61-22(b)(2)(ii)(A), Income Tax Regs.
Petitioners concede that the S Corp. provided them benefits under the Legacy/Flex
Plan “in connection with the performance of services.” However, they contend
that the insurance coverage they received under the Policy was part of a “group-
term life insurance plan.” That is assertedly so because all of the S Corp.’s eligi-
ble employees “received death benefits from the Flex Plan, in varying amounts,”
and because eligibility to receive such benefits “was based solely on factors re-
lated to employment,” such as years of service.
Petitioners’ argument misses the mark for at least two reasons. First, the
insurance coverage that funds petitioners’ promised death benefits is not group-
term life insurance. See sec. 79(a). The Policy insuring petitioners’ lives covers
them alone, and it does not provide term insurance. Rather, it is a self-described
“flexible premium variable universal life insurance” policy with accumulation
values based on the investment experience of a separate fund. See Norem v. - 16 -
[*16] Lincoln Ben. Life Co., 737 F.3d 1145, 1147 (7th Cir. 2013) (distinguishing
a “Flexible Premium Variable Life Insurance Policy” from term life insurance).
Second, “[l]ife insurance is not group-term life insurance for purposes of
section 79” unless “[t]he amount of insurance provided to each employee is com-
puted under a formula that precludes individual selection.” Sec. 1.79-1(a)(4),
Income Tax Regs. This requirement is not satisfied if the formula takes into ac-
count the personal risk characteristics of particular employees. See Our Country
Home Enters., Inc., 145 T.C. at 41-42.
Eligibility to receive benefits under the Legacy/Flex Plan was open to all six
S Corp. employees. But petitioners have not established that “[t]he amount of in-
surance provided to each employee [wa]s computed under a formula that precludes
individual selection.” See sec. 1.79-1(a)(4), Income Tax Regs. (emphasis added).
Petitioners were entitled to a death benefit of $12.5 million. Each petitioner
enjoyed the same benefit, even though petitioner husband was seven years older
than his wife and earned a salary four times higher. The four rank-and-file em-
ployees were entitled to no death benefits under the Legacy Plan (only to a
$10,000 AD&D benefit) and were entitled under the Flex Plan to a modest death
benefit of $10,000. - 17 -
[*17] Petitioners have not explained what computational formula--based on age,
compensation, or other objective criteria--could produce a distribution of benefits
that looks like this. Even if there were some “theoretical possibility” that this dis-
parity could have resulted without individual selection, the formula “did not in fact
preclude individual selection.” See Whitcomb v. Commissioner, 81 T.C. 505, 519
(1983), aff’d, 733 F.2d 191 (1st Cir. 1984). It seems obvious that the discrimina-
tory pattern displayed by the S Corp.’s selection of benefits reflected “individual
selection” by or on behalf of petitioners. See Towne v. Commissioner, 78 T.C.
791, 798 (1982) (holding that an insurance policy was not part of a group-term
insurance plan because it individually selected the company’s president to receive
$500,000 of excess coverage). Moreover, the Policy insuring petitioners’ lives
took into account their personal risk characteristics, including their nonsmoker
status. See Our Country Home Enters., Inc., 145 T.C. at 42.
The second prong of the test for a compensatory arrangement requires that
the employer or other service recipient pay, “directly or indirectly, all or any por-
tion of the [life insurance] premiums.” Sec. 1.61-22(b)(2)(ii)(B), Income Tax
Regs. During 2006-2010 the S Corp. made contributions in excess of $1.8 million
to the Legacy Trust, which used those contributions to pay premiums of $884,534 - 18 -
[*18] on the Policy insuring petitioners’ lives. The S Corp. was petitioners’
employer and it paid (through the Legacy Trust) all of the premiums on the Policy.
Petitioners contend that the second prong is unsatisfied because the Legacy
Trust did not pay these premiums immediately upon receipt of the S Corp.’s con-
tributions, but several months or years later, after commingling the cash with cash
supplied by other participating employers. This argument ignores the language of
the regulation, which states that an employer can effect premium payments “di-
rectly or indirectly.” Ibid. By supplying the Legacy Trust with the cash to pay the
premiums, the S Corp. paid those premiums indirectly. The regulations contem-
plate exactly this sort of indirect payment by providing that the employer will be
treated as the owner of a life insurance contract that is actually owned (for exam-
ple) by a welfare benefit fund. See id. para. (c)(1)(iii)(C), Income Tax Regs. In
such cases, the employer will typically supply to the fund (or to its associated
trust) the cash with which to pay the premiums, as happened here.
The third prong of the test for a compensatory arrangement requires either
that the employee have an “interest in the policy cash value of the life insurance
contract” or that the beneficiary of the death benefit be “designated by the employ-
ee” or be a person whom the employee “would reasonably be expected to desig-
nate as the beneficiary.” Id. para. (b)(2)(ii)(C). The latter requirement is clearly - 19 -
[*19] met here. Petitioners admit that they named the Legacy Trust (and later the
Flex Trust) as the beneficiary of the $12.5 million death benefit under the Policy.
And the Legacy Trust was obligated to pay that $12.5 million death benefit to the
beneficiary or beneficiaries whom petitioners had designated. As we concluded in
Our Country Home Enters., Inc., the fact that the “proceeds from the life insurance
policies are funneled through the * * * [welfare benefit] Plan to each of the ulti-
mate recipients does not blur our view (or our conclusion) that each of those recip-
ients is the beneficiary of the death benefit” for purposes of the split-dollar regu-
lations. 145 T.C. at 44-45.3
In sum, we conclude that the arrangement at issue satisfied all three criteria
required to create a compensatory arrangement under the regulations. We ac-
cordingly hold that the Policy issued on petitioners’ lives incident to their partici-
pation in the Legacy/Flex Plan was part of a compensatory split-dollar life insur-
ance arrangement under section 1.61-22(b)(2), Income Tax Regs.
3 Petitioners assert that, because the Legacy/Flex Trust was not related to them, they could not gain from naming it the beneficiary of the death benefit. As noted in the text, we rejected this same argument in Our Country Home Enters., Inc., 145 T.C. at 44-45. Petitioners effectively designated the recipients of the death benefit because they were assured that the Legacy/Flex Trust would imme- diately pay the death benefit to the beneficiary or beneficiaries whom petitioners had named. - 20 -
[*20] C. Unreported Income
The Federal income tax consequences of a split-dollar life insurance ar-
rangement are generally determined through one of two regimes: the economic
benefit regime or the loan regime. See Our Country Home Enters., Inc., 145 T.C.
at 49-50. Compare sec. 1.61-22(a)(2), (b)(3)(i), Income Tax Regs., with sec.
1.7872-15(a)(2)(i)(B), Income Tax Regs. The parties agree that the loan regime
does not apply here.
Under the economic benefit regime, the non-owner of the life insurance
contract (here, petitioners) “must take into account the full value of all economic
benefits described in paragraph (d)(2) of this section, reduced by the consideration
paid * * * by the non-owner to the owner for those economic benefits.” Sec.
1.61-22(d)(1), Income Tax Regs. The parties agree that petitioners paid no con-
sideration to the S Corp. for the benefits they received under the Legacy/Flex Plan.
As relevant here, “[t]he value of the economic benefits provided to a non-
owner,” id. para. (d)(2), equals the sum of two amounts. The first amount is the
“cost of current life insurance protection provided to the non-owner.” Id. subpara.
(2)(i). The parties agree that the cost of such current protection was $178 for 2011
and $213 for 2012. - 21 -
[*21] The second amount--the focus of dispute here--is “[t]he amount of policy
cash value to which the non-owner has current access within the meaning of para-
graph (d)(4)(ii) of this section (to the extent that such amount was not actually
taken into account for a prior taxable year).” Id. subpara. (2)(ii). The non-owner
“has current access to that portion of the policy cash value” to which he or she
“has a current or future right” if specified conditions are met. Id. subpara.
(4)(ii)(A). Even if the non-owner cannot extract cash from the policy currently, he
is treated as having “current access” to that portion of the policy cash value to
which he has a future right if such portion “is inaccessible to the owner” of the
policy (i.e., the employer) or is “inaccessible to the owner’s general creditors.” Id.
subdiv. (ii)(B).
Petitioners had a “future right” to the Policy cash value because they had the
exclusive right to designate who would receive death benefits under the Policy.
See Our Country Home Enters., Inc., 145 T.C. at 45-46, 53-54. Moreover, once a
participating employer had made contributions to the Legacy/Flex Trust, those
contributions were irrevocable and were inaccessible to the employer and its credi-
tors. Employers and their creditors likewise had no access to the income or assets
(including insurance contracts) held by the Legacy/Flex Trust. Thus, although
petitioners during 2011-2012 could not withdraw funds from the Policy or the - 22 -
[*22] Legacy/Flex Plan, the Policy cash value, in its entirety, was “inaccessible to
the owner” (i.e., the S Corp.) and was “inaccessible to the owner’s general credit-
ors.” See sec. 1.61-22(d)(4)(ii)(B), Income Tax Regs.4
Although the Legacy/Flex Plan documents make clear that the Policy cash
value was not subject to the claims of any participating employer or its creditors,
petitioners assert that a clawback provision in the bankruptcy code could lead to a
different outcome. Under 11 U.S.C. sec. 548(e)(1) (2012), a bankruptcy trustee
may claw back any transfers made by a debtor within 10 years of the petition date
if the transfer (among other things) was made to a self-settled trust or to a similar
device whose beneficiary was the debtor. This provision is irrelevant here. The
Legacy and Flex Trusts were not self-settled trusts. And the S Corp., the debtor in
the scenario petitioners imagine, was not a beneficiary of the Legacy or Flex Trust.
4 Petitioners insist that they enjoyed no economic benefit beyond the cost of current insurance protection--i.e., $178 for 2011 and $213 for 2012--because they could not withdraw cash from the Policy or from the Legacy/Flex Plan currently. This argument ignores the governing regulation, which explicitly states that a non- owner possessing future rights “has current access to that portion of the policy cash value” that is “inaccessible to the owner” or “inaccessible to the owner’s gen- eral creditors.” Sec. 1.61-22(d)(4)(ii)(B), Income Tax Regs. - 23 -
[*23] We accordingly hold that petitioners had “current access” to the entire cash
value of the Policy during 2011 and 2012. The economic benefit provided to them
during those years was not limited to the cost of current life insurance protection,
but also included the amount of policy cash value to which they had current ac-
cess, “to the extent that such amount was not actually taken into account for a
prior taxable year.” Sec. 1.61-22(d)(2)(ii), Income Tax Regs. We leave to further
proceedings the computation of the exact amounts to be included in petitioners’
gross income for each year, as well as a determination as to whether they are liable
for accuracy-related penalties under section 6662A or 6662(a).
To reflect the foregoing,
An appropriate order will be issued.