Curcio v. Comm'r of Internal Revenue

10-3578-ag(L)
Curcio v. Comm'r of Internal Revenue
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
August Term 2011
(Argued: January 5, 2012 Decided: August 9, 2012)
Docket Nos. 10-3578-ag(L), 10-3585-ag(CON), 10-5004-ag(CON),
10-5072-ag(CON)
MARK CURCIO, BARBARA CURCIO, AMY L. SMITH, SAMUEL H. SMITH, JR.,
STEPHEN MOGELEFSKY, ROBERTA MOGELEFSKY, RONALD D. JELLING, LORIE A.
JELLING,
Petitioners-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.
ON APPEAL FROM UNITED STATES TAX COURT
Before:
WINTER, HALL, and CHIN, Circuit Judges.
Appeal from orders and decisions of the United
States Tax Court (Cohen, J.) finding deficiencies in
petitioners' income tax payments and assessing accuracy-
related penalties under 26 U.S.C. § 6662.
AFFIRMED.
JOSEPH M. PASTORE III, Smith, Gambrell &
Russell, LLP (Ira B. Stechel, John
T. Morin, Jennifer L. Marlborough,
Wormser, Kiely, Galef & Jacobs LLP,
on the brief), New York, New York,
for Petitioners-Appellants.
RANDOLPH L. HUTTER, Attorney, Tax Division,
Department of Justice, Appellate
Section (Gilbert S. Rothenberg,
Acting Deputy Assistant Attorney
General, Thomas J. Clark, Attorney,
Tax Division, on the brief),
Washington, D.C., for Commissioner
of Internal Revenue.
CHIN, Circuit Judge:
In these consolidated cases, petitioners were
owners of four small businesses that enrolled in purported
life insurance plans for employees. Only the four principal
owners and a stepson, however, were covered under the plans.
The contributions to the plans -- amounting to hundreds of
thousands of dollars -- were claimed as tax deductions by
the businesses.
The Commissioner of Internal Revenue (the
"Commissioner") concluded that these contributions should
not have been deducted because, inter alia, they were not
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"ordinary and necessary" business expenses within the
meaning of the Tax Code. Disallowing the deductions
resulted in additional passthrough income to petitioners on
which they had not paid taxes. Accordingly, the
Commissioner issued notices of deficiency to petitioners and
assessed accuracy-related penalties.
Petitioners' cases were consolidated and tried
before the United States Tax Court in March 2009. After
trial, the tax court ruled in favor of the Commissioner,
finding that petitioners owed deficiency payments and
accuracy-related penalties. Petitioners appealed. We
affirm.
BACKGROUND
The following facts are drawn from the tax court's
findings and the record on appeal, including stipulations of
the parties, documentary evidence, and testimony of
petitioners and their witnesses.
A. The Benistar Plan
The Benistar 419 Plan (the "Plan") was established
in 1997 by Daniel E. Carpenter. It was designed to be a
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multiple-employer welfare benefit plan under 26 U.S.C.
§ 419A(f)(6). The "Plan provides death benefits funded by
individual life insurance policies for a select group of
individuals chosen by the Employer to participate in the
Plan." (Ex. 33-J (Benistar Plan Brochure)) (A 1824). The
only benefits "claimed to be provided by or through [the
Plan] are pre-retirement death benefits for covered
employees of participating employers." (First Stip. of
Facts ¶ 41).
Businesses that enroll in the Plan contribute to a
trust account maintained by the Plan. The Plan uses these
contributions to acquire one or more life insurance policies
on the lives of employees covered by the Plan; it withdraws
funds from the trust account to pay the premiums on these
policies. Each covered employee determines the type of
insurance that the Plan will purchase on his behalf.
Furthermore, the Plan allows participating businesses to
choose the number of years for which contributions to the
Plan will be required to fully pay for the death benefit or
benefits provided through the Plan. The Plan is listed as
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the beneficiary on each insurance policy and passes on the
death benefit to the covered employee.
The Plan also allows participating businesses to
withdraw from, or terminate, participation at any time.
Upon termination, the Plan can distribute the underlying
policies to the insured employees. Until mid-2002, an
underlying policy could be distributed at no cost to the
covered employee. From mid-2002 to mid-2005, the Plan
required that the covered employee be charged 10% of the
"cash surrender value" in exchange for the underlying
policy. (Carpenter Exam. at 274-76). Starting in mid-2005,
the Plan purportedly began to charge covered employees the
"fair market value" of the underlying policy upon
termination. (Id. at 125).1
The Plan advertises several "advantages,"
including (1) "Virtually Unlimited Deductions for the
Employer"; (2) "Benefits can be provided to one or more key
Executives on a selective basis"; (3) "No need to provide
1 Carpenter explained that the "fair market value"
of the policy is equal to its "cash value." (Carpenter
Exam. at 238).
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benefits to rank and file employees"; and (4) "Funds inside
the BENISTAR 419 Plan accumulate tax-free." (Ex. 33-J)
(A 1825). Carpenter testified that "the beauty" of the Plan
"is that you can put away extra money in good times and
though the premium is not due, you can put away excess
amounts of money, get a tax deduction today, and we don't
put the premium in for years to come." (Carpenter Dep. at
262).
B. Curcio and Jelling
Petitioners Marc Curcio and Ronald D. Jelling each
own 50% of three car dealerships: Dodge of Paramus, Inc.
("Dodge"), Chrysler Plymouth of Paramus, Inc. ("Chrysler
Plymouth"), and JELMAC LLC ("JELMAC").
In or about 2001, Curcio and Jelling decided to
enter into a buy-sell agreement.2 The buy-sell agreement
contemplated that if one partner died, the other would buy
the deceased partner's 50% stake in the businesses. When
the buy-sell agreement was executed, it set the value of the
2
The agreement was not actually executed until
2003.
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businesses at $12,000,000. To fund the purchase if it
became necessary, each partner agreed to take out an
insurance policy on the other's life. In other words, each
partner would list the other as the beneficiary of his death
benefit and the death benefit would be used to purchase the
deceased partner's share of the businesses.
Instead of purchasing life insurance policies
directly, however, Curcio and Jelling decided to insure
themselves through the Plan. Accordingly, Dodge enrolled in
the Plan on December 28, 2001. Curcio and Jelling were the
only covered employees. They did not choose to insure any
of the other 75 people employed by Dodge. Neither Chrysler
Plymouth nor JELMAC enrolled, nor were any of their
employees, other than Curcio and Jelling, covered.
Curcio and his insurance agent, Robert Iandoli,
selected a whole life policy with a $9,000,000 death
benefit. Jelling and his insurance agent, Alan Solomon,
chose two policies -- one whole life policy and one
universal (or adjustable) life policy -- totaling
approximately $9,000,000 in coverage. Curcio paid a
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$200,000 annual policy premium to the Plan. Jelling paid
the same.
Although Dodge was the only entity to enroll in
the Plan, Dodge was not always the only entity to contribute
to the Plan. In fact, all three Curcio/Jelling business
entities contributed to the Plan, with whichever entity
having the highest cash balance at the end of the year doing
so. Dodge contributed $400,000 in 2001 and 2002. JELMAC
contributed $400,000 in 2003 and Chrysler Plymouth
contributed $400,000 in 2004. Each business claimed a tax
deduction for the entirety of its contribution. Jelling
testified that he considered the contributions "as a funding
for our buy sell agreement." (Jelling Exam. at 581).
Curcio and Jelling had asked their accountant,
Stuart Raskin, about the deductibility of the contributions.
Raskin consulted with his partners and, based on a letter
from the law firm Edwards & Angell, LLP, concluded that a
deduction was proper.3 Raskin advised Curcio and Jelling
3
At the request of Carpenter, Edwards & Angell
issued a series of letters opining on whether contributions
to the Plan were deductible and met the requirements of
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that the deduction was proper, but also communicated that
this opinion was derived solely from the Edwards & Angell
letter, and not from any independent research or
investigation. Furthermore, Raskin did not offer Curcio or
Jelling any assurances that the I.R.S. would approve the
deductions. Neither Raskin, nor anyone at his firm, was an
expert in welfare benefit plans.
C. Smith
Petitioner Samuel H. Smith was, at all relevant
times, the sole owner of SH Smith Construction, Inc. ("Smith
Construction"). Smith Construction enrolled in the Plan in
2002. Although Smith Construction had 35–40 employees, it
chose to insure only Smith through the Plan. On the
§ 419A. A November 2001 letter stated that it was "more
likely than not" that a court would sustain deductions for
contributions to the Plan. (Ex. 37-J at 2) (A 1959). It
cautioned, however, that neither the Internal Revenue Code
nor the tax regulations provided specific guidance on the
issue. While deductions for life insurance were not per se
improper, the I.R.S. could "challenge the amount deducted."
(Id. at 3) (A 1960). Furthermore, an October 2003 letter
noted that the determination of whether an expense is
"ordinary and necessary" -- and therefore deductible -- "is
quite subjective and dependent upon a totality of the facts
and circumstances of a particular taxpayer." (Ex. 38-J
at 5) (A 1968).
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insurance application, Smith indicated that the purpose of
the insurance was "retirement planning." (Ex. 116-J at 3)
(A 3125). Smith chose a variable life policy with a death
benefit of $5,000,000 and annual premium payments of
$54,000. In 2003, Smith Construction claimed a $54,000
deduction for its contribution to the Plan.
By September 2005, Smith Construction had paid a
total of $171,500 in premiums, and the policy had an
accumulated cash value of $152,259.
By letter dated September 27, 2005, Smith
requested that Benistar terminate his participation in the
Plan. Moreover, he stated that he "would like to purchase
the policies . . . and take ownership of the[m]." (Ex. 129-
J) (A 3203). The Plan provided that Smith could purchase
his policy by paying "10% of the net cash surrender value of
the policy." (Ex. 175-J (Plan Termination and Policy
Transfer Release Form)) (A 3372). Smith paid $2,970. This
amount, however, equaled 10% of his policy's net cash
surrender value on December 31, 2004, not 10% of the net
cash surrender value in September 2005, when Smith
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terminated his company's participation in the Plan and
requested the transfer. In fact, his policy's net cash
surrender value in September 2005 was $83,158, 10% of which
would be $8,316. In April of 2006, Smith withdrew $77,300
from his policy. In January 2007, Smith borrowed $16,000
from his policy.
Smith testified at trial that he relied on his
accountant's representation that contributions to the plan
were deductible. He could not recall whether this
representation was made orally or by email.
D. Mogelefsky
Petitioner Stephen Mogelefsky is the sole owner of
Discount Funding Associates ("Discount"), a corporation that
provides mortgage broker services. Discount enrolled in the
Plan in late 2002 to obtain life insurance for Mogelefsky
and his stepson, an employee of the company. Mogelefsky
chose a $1,300,000 policy on his own life so that "in case
something happened to [him, his] son could take over the
business." (Mogelefsky Exam. at 621). He also chose a
$350,000 policy to cover his stepson. In December 2003,
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Discount elected to provide Mogelefsky with additional life
insurance benefits in the amount of $1,020,000.
In early 2003, Discount contributed $398,597 to
the Plan. It claimed a deduction for this contribution in
the 2002 tax year. In early 2004, Discount contributed
another $354,821. It claimed a deduction for this amount in
the 2003 tax year.
In March 2006, Mogelefsky and his stepson decided
to withdraw from the Plan. To acquire his first policy,
Mogelefsky paid $28,577. To acquire his second policy,
Mogelefsky paid $14,632. By December 2005, the first policy
had accumulated a cash value of $313,745 and had a net
surrender value of $285,414. When the second policy was
transferred on March 16, 2006, it had accumulated a cash
value of $255,089. In December 2005, its net surrender
value was $145,994.
E. Procedural History
The Commissioner sent notices of deficiency to
Curcio and Jelling on January 23, 2007, and to Smith and
Mogelefsky on June 25, 2007. Specifically, the Commissioner
disallowed the deductions petitioners' business entities had
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taken for contributions to the Plan because, inter alia, the
contributions were not ordinary and necessary business
expenses. Accordingly, the Commissioner found that
petitioners had additional passthrough income on which they
had failed to pay income tax. In addition to the
deficiencies, the Commissioner assessed a 20% accuracy-
related penalty on each petitioner.
In the case of Discount's first contribution, the
Commissioner could not disallow the corresponding deduction
because the statute of limitations on the 2002 tax year had
passed. Instead, the Commissioner found that the
contribution was 2003 income in the form of a constructive
dividend or deferred compensation.
The four cases were consolidated and tried before
the tax court in March 2009.4 On May 27, 2010, the tax
court issued a Memorandum Finding of Facts and Opinion (the
"Memorandum Opinion"). In the Memorandum Opinion, the tax
court agreed with the Commissioner, finding that the
contributions made by petitioners' business entities were
4
Petitioners Barbara Curcio, Amy L. Smith, Lorie A.
Jelling, and Roberta Mogelefsky are the wives of the
business owners. They were named in this action only
because they filed joint tax returns with their husbands.
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not "ordinary and necessary" business expenses and,
therefore, should not have been deducted. Moreover, it
approved the Commissioner's unique treatment of Discount's
first contribution. Finally, the tax court found that the
improper deductions -– and petitioners' corresponding
underpayment of tax -- were the result of negligence or
disregard for the tax rules and regulations. Accordingly,
the court issued four decisions, ordering due the
deficiencies and penalties assessed by the Commissioner.
Curcio and Jelling appealed on August 24, 2010.
Smith and Mogelefsky appealed on December 2, 2010. The
appeals were consolidated on December 17, 2010.
DISCUSSION
A. Applicable Law
1. Ordinary & Necessary Business Expenses
Section 162(a) of the Internal Revenue Code
provides that a business may deduct "all the ordinary and
necessary expenses paid or incurred" during the taxable year
in carrying out that trade or business. 26 U.S.C. § 162(a).
To qualify as an allowable deduction under § 162(a), an item
must "(1) be paid or incurred during the taxable year, (2)
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be for carrying on any trade or business, (3) be an expense,
(4) be a 'necessary' expense, and (5) be an 'ordinary'
expense." Comm'r v. Lincoln Sav. & Loan Ass'n, 403 U.S.
345, 352 (1971) (some internal quotation marks omitted).
An "ordinary" expense is one that is "normal,
usual, or customary in the type of business involved."
Int'l Trading Co. v. Comm'r, 275 F.2d 578, 585 (7th Cir.
1960) (citing Deputy v. du Pont, 308 U.S. 488, 494-96
(1940)); accord Sharon Herald Co. v. Granger, 195 F.2d 890,
895 (3d Cir. 1952). An expense need not be habitual to be
"ordinary," see Welch v. Helvering, 290 U.S. 111, 113-14
(1933), but the transaction "must be of common or frequent
occurrence in the type of business involved," du Pont, 308
U.S. at 495. A "'necessary'" expense is one that is
"'appropriate and helpful'" for the development of the
taxpayer's business. See INDOPCO, Inc. v. Comm'r, 503 U.S.
79, 85 (1992) (quoting Comm'r v. Tellier, 383 U.S. 687, 689
(1966)).
Put simply, "[e]xpenditures may only be deducted
under § 162 if the facts and the circumstances indicate that
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the taxpayer made them primarily in furtherance of a bona
fide profit objective independent of tax consequences."
Green v. Comm'r, 507 F.3d 857, 871 (5th Cir. 2007) (internal
quotation marks omitted). Purchasing or subsidizing
benefits -- e.g., life insurance -- for employees might fall
into this category to the extent it incentivizes employees
to remain loyal to the business and perform to the best of
their abilities. See Schneider v. Comm'r, 63 T.C.M. (CCH)
1787, at *11 (1992).
2. Deductibility of Welfare Benefit Plan
Contributions
Contributions to welfare benefit plans are not
deductible per se. 26 U.S.C. § 419(a)(1). To be
deductible, such a contribution must qualify under some
other provision of the Code. Id. § 419(a)(1)–(2). In fact,
the I.R.S. has explicitly opined that the deductibility of
contributions to an employee trust for life insurance is
governed by § 162(a) of the Code and § 1.162-10 of the
Regulations. See Rev. Rul. 69-478, 1969-2 C.B. 29(discussing deductibility of term life insurance for active
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and retired employees); 26 C.F.R. § 1.162-10 (1960)
("Amounts paid or accrued within the taxable year for . . .
medical expense, recreational, welfare, or similar benefit
plan, are deductible under section 162(a) if they are
ordinary and necessary expenses of the trade or business.").
Accordingly, if a welfare benefit plan
contribution is ordinary and necessary, it is deductible.
The deduction, however, is generally limited to "the welfare
benefit fund's qualified cost for the taxable year." 26
U.S.C. § 419(b). This limitation does not apply if the
welfare benefit plan meets certain requirements set forth in
§ 419A(f)(6).
Therefore, in determining the deductibility of a
welfare benefit plan contribution, the threshold question is
whether the contribution is an ordinary and necessary
business expense under § 162(a). Only if a court determines
that the contribution is ordinary and necessary would it
proceed with an analysis under § 419A(f)(6) to determine
whether any limitations on deductibility apply.
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3. Accuracy-Related Penalties
Section 6662 of the Internal Revenue Code provides
for a 20% accuracy-related penalty on any portion of an
underpayment that is attributable to, inter alia,
(1) "[n]egligence or disregard of rules or regulations" or
(2) "[a]ny substantial understatement of income tax." 26
U.S.C. § 6662(b)(1)-(2).
"'[N]egligence' . . . includes any failure to make
a reasonable attempt to comply with the provisions of [the
Code]." Id. § 6662(c). "'[D]isregard' includes any
careless, reckless, or intentional disregard." Id.
Disregard of rules or regulations is careless "if the
taxpayer does not exercise reasonable diligence to determine
the correctness" of his position. 26 C.F.R. § 1.6662-
3(b)(2) (2012). Disregard of rules or regulations is
reckless "if the taxpayer makes little or no effort to
determine whether a rule or regulation exists, under
circumstances which demonstrate a substantial deviation from
the standard of conduct that a reasonable person would
observe." Id.-18-
An understatement is "substantial . . . if the
amount of the understatement for the taxable year exceeds
the greater of -- (i) 10 percent of the tax required to be
shown . . . or (ii) $5,000." 26 U.S.C. § 6662(d)(1)(A). A
taxpayer may avoid some or all of a "substantial
understatement" penalty if (1) there was "substantial
authority" supporting the taxpayer's ability to take the
deduction; or (2) the relevant facts relating to the
deduction were "adequately disclosed in the return" and
there was a "reasonable basis" for the deduction. See id.§ 6662(d)(2)(B). "Substantial authority" exists "only if
the weight of the authorities supporting the treatment is
substantial in relation to the weight of authorities
supporting contrary treatment." 26 C.F.R. § 1.6662-
4(d)(3)(i) (2012).
Finally, "no penalty shall be imposed . . . with
respect to any portion of an underpayment if it is shown
that there was a reasonable cause for such portion and that
the taxpayer acted in good faith with respect to such
portion." 26 U.S.C. § 6664(c)(1). "Generally, the most
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important factor [in determining whether a taxpayer acted
with reasonable cause and in good faith] is the extent of
the taxpayer's effort to assess the taxpayer's proper tax
liability." 26 C.F.R. § 1.6664-4(b)(1).
4. Standard of Review
We review the tax court's legal conclusions de
novo and its factual findings for clear error. Robinson
Knife Mfg. Co. v. Comm'r, 600 F.3d 121, 124 (2d Cir. 2010).
Whether an expense is "ordinary and necessary"
within the meaning of § 162(a) is a "pure question[] of fact
in most instances." Comm'r v. Heininger, 320 U.S. 467, 475
(1943); accord McCabe v. Comm'r, 688 F.2d 102, 104 (2d Cir.
1982). Unless "a question of law is unmistakably involved,"
Heininger, 320 U.S. at 475, we review for clear error the
tax court's determination that an expense was not an
ordinary and necessary business expense, McCabe, 688 F.2d at104–05. Compare Chenango Textile Corp. v. Comm'r, 148 F.2d
296, 298 (2d Cir. 1945) (although tax court cited appellate
court opinions to justify its conclusion, its decision was a
determination of fact) with Heininger, 320 U.S. at 475 (tax
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court mistakenly believed that denial was required as a
matter of law). The tax court's finding is clearly
erroneous only when "the reviewing court on the entire
evidence is left with the definite and firm conviction that
a mistake has been committed." Estate of Stewart v. Comm'r,
617 F.3d 148, 164 (2d Cir. 2010) (internal quotation marks
omitted).
The determination that a taxpayer is liable for an
accuracy-related penalty is also a factual determination
reviewed for clear error. See Nicole Rose Corp. v. Comm'r,
320 F.3d 282, 284-85 (2d Cir. 2003) (citing Goldman v.
Comm'r, 39 F.3d 402, 406 (2d Cir. 1994)).
B. Application
We review three of the tax court's rulings:
first, the tax court determined that contributions to the
Plan were not ordinary and necessary business expenses;
second, the tax court ruled that Discount's first
contribution on behalf of Mogelefsky was taxable as a
constructive distribution; and third, the tax court
concluded that accuracy-related penalties were warranted.
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We review the first and third rulings for clear error. The
standard of review applicable to the second ruling is less
clear, and the parties have provided no guidance on the
issue. We need not resolve the issue, however, because even
applying de novo review, the tax court's second ruling was
not erroneous.
1. Ordinary and Necessary Business Expenses
The tax court did not clearly err when it found
that the contributions by petitioners' business entities to
the Plan were not ordinary and necessary business expenses.
The record supports the conclusion that the contributions
were not normal, usual, or "helpful for the development of
the [taxpayers'] business," see Tellier, 383 U.S. at 689(internal quotation marks omitted); they were not made in
furtherance of a profit objective or for any viable business
purpose, see Green, 507 F.3d at 871. Rather, the evidence
demonstrates that the contributions were made solely for the
personal benefit of petitioners. The contributions were a
mechanism by which petitioners could divert company profits,
tax-free, to themselves, under the guise of cash-laden
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insurance policies that were purportedly for the benefit of
the businesses, but were actually for petitioners' personal
gain.
Indeed, the Plan was designed to benefit only
owners and their families and not the businesses generally.
Carpenter, who conceived of the Plan, admitted that the Plan
was meant to cover only owners and their families.
Moreover, he testified that "most of the people in the plan
are looking for estate planning advantages." (Carpenter
Dep. at 156). The Plan was essentially touted as a way for
"Key Executives" to avoid paying taxes on business income by
diverting it into a vehicle in which funds could accumulate
tax-free. (See Ex. 33-J (Benistar Plan Brochure) (noting
that "Plan Advantages" included "unlimited deductions,"
"tax-free" accumulation, and "tax-free distribution at a
later date")).
Evidence pertaining to the individual owners also
demonstrates that contributions to the plan were for their
personal benefit, not the benefit of their respective
business entities. Dodge, for example, enrolled in the Plan
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so that Curcio and Jelling could fund the buy-sell agreement
between them. The contributions to the Plan were not made
in furtherance of a business objective, but rather to
relieve Curcio or Jelling from having to use personal funds
to pay for his partner's share of the business in the event
the partner died. See Petersen v. Comm'r, 74 T.C.M. (CCH)
90, 98 (1997). Dodge employed approximately 75 other
people, none of whom were covered under the plan.
Smith admitted that he enrolled his company in the
Plan for the purpose of "retirement planning." (A 3125).
None of the other 35–40 employees of Smith Construction were
covered under the Plan. In late 2005, Smith paid
approximately $3,000 to acquire ownership of his underlying
life insurance policy. At the time, the policy had a cash
value of over $150,000 and a net surrender value of over
$83,000. He subsequently withdrew $77,300 from the policy
and took out a $16,000 loan against it. Therefore, the
record supports the conclusion that Smith's contributions to
the Plan were not business expenses; they funded a life
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insurance policy from which Smith himself later realized a
significant personal monetary benefit.
Mogelefsky's company, Discount, deducted a total
of over $750,000 in Plan contributions for the 2002 and 2003
tax years. In 2006, Mogelefsky paid less than $45,000 in
exchange for ownership of the two underlying insurance
policies. Around the time the policies were transferred,
they had accumulated a total cash value of over $560,000 and
a total net surrender value of over $430,000. Therefore,
the record demonstrates that Mogelefsky, like Smith,
diverted business profits, tax-free, into what eventually
became a personal asset with a significant cash component.
To be sure, paying for life insurance for one's
employees can be an ordinary and necessary business expense
if the purpose is to compensate, incentivize, and retain key
employees. See Schneider, 63 T.C.M. (CCH) 1787, at *11.
But it is neither ordinary nor necessary when the insurance
policies are purchased as investment -- or "estate planning"
(see Carpenter Dep. at 156) -- vehicles for the sole benefit
of the owners of the company. See V.R. DeAngelis v. Comm'r,
-25-
94 T.C.M. (CCH) 526, at *23 (2007) ("While employers are not
generally prohibited from funding term life insurance for
their employees and deducting the premiums . . . as a
business expense . . . , employees are not allowed to
disguise their investments in life insurance as deductible
. . . when those investments accumulate cash value for the
employees personally."), aff'd, 574 F.3d 789 (2d Cir. 2009)
(per curiam).
Indeed, this case falls into the latter category.
Petitioners' business entities employed scores of other
individuals, but with the exception of Mogelefsky's stepson,
none was offered life insurance coverage under the Plan.
Petitioners cannot claim that they enrolled in the Plan to
incentivize or retain themselves as employees, as they were
the owners of the businesses.
We do not hold that purchasing a life insurance
policy with a cash component can never be an ordinary and
necessary business expense. Such a determination is fact
intensive and must be made on a case by case basis. In this
case, however, where petitioners could withdraw from the
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Plan at any time and obtain personal control over cash-laden
policies, and where other evidence in the record
demonstrates that the taxpayers contributed to the Plan
solely for their personal benefit, the tax court did not
clearly err in finding that the contributions were not
ordinary and necessary business expenses.
Petitioners argue that all contributions to a plan
satisfying the requirements of § 419A(f)(6) are deductible
in their entirety, without regard to whether those
contributions are ordinary and necessary business expenses.
(Pet. Br. at 57; Pet. Reply Br. at 6). Petitioners,
however, cite no authority for this position and it is
belied by the statutory scheme. Section 419(a) states that
plan contributions "shall not be deductible" unless they
would otherwise be deductible under another section of the
Tax Code, such as § 162(a). Section 419(b) provides that if
a contribution is deductible under another section of the
Code, such a deduction is limited to the fund's qualified
cost for the taxable year. Section 419A(f)(6), upon which
petitioners rely, only supplies an exemption -- if certain
-27-
requirements are met -- to § 419(b)'s limit on
deductibility. It does not provide that such contributions
are deductible in the first instance.5
Thus, the threshold question is whether plan
contributions are deductible under another section of the
Code -- here, § 162(a). Because we find no clear error in
the tax court's ruling that the plan contributions were not
deductible under § 162(a) -- i.e., they were not ordinary
and necessary business expenses –- we do not reach the issue
of whether the Plan meets the requirements of § 419A(f)(6).6
5
Under petitioners' reading of the statute, a
company enrolled in a plan that satisfies the requirements
of § 419A(f)(6) could contribute and deduct the entire
amount of its profits, avoiding its entire tax burden.
Obviously, this was not what Congress contemplated.
6
On appeal, petitioners argue that if their entire
contributions cannot be deducted, they should at least be
able to deduct an amount equal to the annual "qualified
cost" of the welfare benefit fund. See 26 U.S.C. § 419(b),
(d). It does not appear, however, that petitioners raised
this argument below, and thus we do not consider it.
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2. The Tax Court's Treatment of Discount's
Contributions Was Not Improper
Discount –- on behalf of Mogelefsky -- made its
first contribution to the Plan in early 2003, for which it
claimed a deduction on its 2002 tax return. It made a
second contribution to the Plan in early 2004, for which it
claimed a deduction on its 2003 tax return. The
Commissioner disallowed the 2003 deduction on the ground
that the second contribution was not an ordinary and
necessary business expense, creating additional passthrough
income for Mogelefsky in 2003. The Commissioner, however,
did not have jurisdiction over the 2002 deduction, as the
statute of limitations had run on the 2002 tax year.
Instead of disallowing the 2002 deduction, the Commissioner
classified the first contribution as "constructive dividend
income" or "deferred compensation" to Mogelefsky in the 2003
tax year. (A 1317). The tax court affirmed, finding that
the first contribution was a constructive distribution.
Petitioners contend that the manner in which the
tax court treated Discount's two contributions was
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inconsistent and resulted in "double taxation." (Pet. Br.
at 78). Moreover, they argue that the 2003 "distribution"
accrued to Mogelefsky in the 2002 tax year, so it should not
have been counted as income for 2003. (Id. at 75-78).
Petitioners' argument is without merit.
Mogelefsky was not taxed twice on either of the two
contributions. The tax court treated Discount's second
contribution (for which a deduction was claimed in the 2003
tax year) like the contributions made by the other
petitioners' business entities. It found that the
contribution was not an ordinary and necessary business
expense, disallowed the deduction, and included the amount
as taxable passthrough income to Mogelefsky. The record
does not reflect that this contribution was taxed at any
other point.
The tax court treated Discount's first
contribution (for which a deduction was claimed in the 2002
tax year) as a "distribution"7 to Mogelefsky, to be taxed
7
This Court has affirmed the treatment of welfare
benefit plan contributions as "distribution[s] of corporate
profits" where, as here, the contributions were used to
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under 26 U.S.C. §§ 1366-68. See also 26 U.S.C. § 301(c).8
Because Discount claimed a deduction in the 2002 tax year
for the amount of this contribution -- and that deduction
has not been disallowed -- Mogelefsky has not been taxed
twice on the amount of the contribution.
Petitioners have not pointed to any authority
prohibiting the Commissioner from recognizing these two
contributions under separate sections of the Tax Code.
purchase life insurance policies with large cash components
that were accessible to the insured. See DeAngelis, 94
T.C.M. (CCH) 526, at *25.
8
Under § 1368, a distribution is not included in
income if the taxpayer has sufficient "basis" in his
corporation against which he can apply the distribution. 26
U.S.C. § 1368(b)(1). Under such circumstances, his basis is
reduced by the amount of the distribution, id.§ 1367(a)(2)(A), increasing the amount of his tax burden
when he sells his shares in the corporation. On the other
hand, to the extent there is insufficient basis against
which the distribution may be applied, the distribution is
to be treated as a gain from the sale of property. Id.
§ 1368(b)(2).
In Mogelefsky's case, the record did not reflect
his basis in Discount. Therefore, the tax court treated the
entire distribution as being "in excess of basis" and taxed
it as gain from the sale or exchange of property. See id.
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Furthermore, the tax court did not err in finding
that the distribution accrued to Mogelefsky in 2003 --
rather than 2002 -- because that is when it was
"unqualifiedly made subject to [his] demands." See 26
C.F.R. § 1.301-1(b). Indeed, while Discount may have
committed to making the contribution in 2002, it did not
actually transfer the money to the Plan until 2003. It was
only at that point that Mogelefsky could have terminated
Discount's participation in the Plan and obtained the policy
along with its cash component.
3. Accuracy-Related Penalties
Finally, we affirm the imposition of accuracy-
related penalties. Specifically, the tax court did not
clearly err in finding that petitioners were "negligent" and
acted in "disregard" of the tax rules and regulations.
Section 162(a) of the Tax Code is clear: To deduct a
business expense, that expense must be "ordinary and
necessary." 26 U.S.C. § 162(a). It is also clear that
neither § 419 nor § 419A provides an independent ground for
deducting welfare benefit plan contributions. See 26 U.S.C.
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§ 419 ("Contributions paid or accrued by an employer to a
welfare benefit fund . . . shall not be deductible under
this chapter [unless] they would otherwise be deductible
. . . ."). Petitioners' respective decisions to deduct the
Plan contributions in the face of such clear statutory
language could reasonably be classified as negligent
behavior.9
Petitioners argue that they relied in "good faith"
on the advice of their accountants. Reliance on
professional advice, however, is not, by itself, an absolute
defense to negligence. Freytag v. Comm'r, 89 T.C. 849, 888-
89 (1987). Indeed, there was little reason for petitioners
to believe that their accountants were authorities on the
tax treatment of welfare benefit plan contributions or that
they had sufficiently researched the issue. The accountants
9
Part of Mogelefsky's accuracy-related penalty was
assessed on a constructive-dividend theory, but the tax
court did not disaggregate that aspect of the deficiency
when imposing penalties. Mogelefsky, however, does not
provide any argument on appeal that he should not have been
assessed an accuracy-related penalty for failing to report
Discount's 2003 contribution as a constructive dividend to
him. We therefore do not need to consider the matter. See
Norton v. Sam's Club, 145 F.3d 114, 117 (2d Cir. 1998).
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for Curcio, Jelling, and Mogelefsky told them that they had
solely relied on the Edwards & Angell letter.
Moreover, the record does not reflect that
petitioners conducted an investigation sufficient to avail
themselves of a "good faith" defense. See 26 C.F.R.
§ 1.6664(c). Had petitioners reviewed the Edwards & Angell
letters upon which their accountants so heavily relied, they
would have learned that Edwards & Angell made no guarantees
as to the deductibility of Plan contributions. In fact, the
letters specifically warned that the Commissioner could
disallow petitioners' deductions based on a finding that the
amount of the contributions was not ordinary and necessary.
CONCLUSION
For the reasons stated above, the decisions of the
tax court are affirmed.
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