Jeffrey J. Furnish v. Commissioner

PURSUANT TO INTERNAL REVENUE CODE
SECTION 7463(b),THIS OPINION MAY NOT
BE TREATED AS PRECEDENT FOR ANY
OTHER CASE.
T.C. Summary Opinion 2013-81UNITED STATES TAX COURT
JEFFREY J. FURNISH, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 25690-11S. Filed October 23, 2013.
Jeffrey J. Furnish, pro se.
Erik W. Nelson, for respondent.
SUMMARY OPINION
GUY, Special Trial Judge: This case was heard pursuant to the provisions
of section 7463 of the Internal Revenue Code in effect when the petition was
filed.1 Pursuant to section 7463(b), the decision to be entered is not reviewable by
1
Section references are to the Internal Revenue Code (Code), as amended
(continued...)
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any other court, and this opinion shall not be treated as precedent for any other
case.
Respondent determined a deficiency of $22,444.52 in petitioner’s Federal
income tax for 2009 and an accuracy-related penalty of $4,488.90 pursuant to
section 6662(a). Petitioner filed a timely petition for redetermination with the
Court pursuant to section 6213(a).
After concessions,2 the issue remaining for decision is whether petitioner
received a constructive distribution of $49,255.24 as reported by Northwestern
Mutual Life Insurance Co. (NML) on Form 1099-R, Distributions From Pensions,
Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.3
1
(...continued)
and in effect for 2009, and Rule references are to the Tax Court Rules of Practice
and Procedure.
2
Respondent concedes that petitioner is not liable for (1) so much of the
deficiency as relates to an adjustment to itemized deductions of $492.55, and (2)
an accuracy-related penalty under sec. 6662(a).
3
Petitioner included the $49,255.24 that NML reported on Form 1099-R in
his taxable income for 2009. Although respondent assessed the tax attributable to
the Form 1099-R income, petitioner has not paid it. Respondent concedes that he
erroneously added $49,255.24 to petitioner’s taxable income a second time in
computing the tax deficiency of $22,444.52.
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Background
Some of the facts have been stipulated and are so found. The stipulation of
facts, the supplemental stipulation of facts, and the accompanying exhibits are
incorporated herein by this reference. At the time the petition was filed, petitioner
resided in Oregon.
I. Petitioner’s Life Insurance Policies
Petitioner is an actuary. In 1972, at the age of 20 and while he was still a
college student, petitioner purchased a “65 LIFE” insurance policy from NML
(1972 policy). The 1972 policy provided a basic death benefit of $20,000 and
required an annual premium payment of $340. Petitioner also agreed to pay $4.20
per year to NML for a waiver of the annual premium in the event of his disability
and $27.17 per year for the option to purchase additional insurance without a
further medical exam.
In 1974 petitioner purchased an “EXTRA ORDINARY LIFE” insurance
policy from NML (1974 policy). The 1974 policy provided a basic death benefit
of $35,000 and an additional death benefit of $15,000 for the first 34 years the
policy remained in force. In addition to an annual premium of $462, petitioner
agreed to pay $8.50 per year for a waiver of the annual premium in the event of his
disability.
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Both policies allowed petitioner to participate in any annual dividends that
NML might declare. When petitioner applied for the policies, he elected to have
NML dividends applied to purchase “fully paid-up” additional insurance.
Both policies offered petitioner the options of (1) obtaining policy loans
from NML, and (2) paying annual premiums through premium loans from NML
against the cash value of the policies. Both policies provided that policy and
premium loans would accumulate compound interest at 6% annually.
Petitioner testified that he recalled paying at least four of the first seven
annual premium payments due on the policies. Thereafter, he elected to pay the
annual premiums through premium loans from NML. The parties did not offer
any evidence regarding policy loans that petitioner obtained from NML.
The record includes a few of petitioner’s annual policy statements.
Petitioner’s annual policy statements for the 1972 policy for 2006, 2008, and 2009
reflect the following:
2006 2008 2009
Total death benefit $65,229.00 $70,123.00 $72,431.00
Total loans 26,960.86 33,188.38 35,544.54
Net death benefit 38,268.14 36,934.62 36,886.46
Total cash value 30,292.61 34,669.47 36,897.98
Net cash value 3,331.75 1,481.09 1,353.44
Dividends 1,107.50 1,271.85 1,204.92
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The annual policy statements summarized above uniformly indicate that
petitioner’s basic insurance coverage was $22,000, whereas the underlying life
insurance policy indicates that petitioner’s basic insurance coverage was $20,000.
Petitioner’s annual policy statements for the 1974 policy for 2004, 2006,
and 2009 reflect the following:
2004 2006 2009
Total death benefit $74,734.00 $79,473.00 $87,375.00
Total loans 27,310.19 31,713.11 40,220.59
Net death benefit 47,423.81 47,759.89 47,154.41
Total cash value 29,632.67 34,056.56 41,652.62
Net cash value 2,322.48 2,343.45 1,432.03
Dividends 979.54 1,202.49 1,326.55
In early 2009 NML sent written notification to petitioner that both insurance
policies would lapse unless he made additional premium payments. Petitioner did
not make any additional premium payments, and NML determined that the
insurance policies had lapsed at that time.
II. Form 1099-R
NML issued to petitioner a Form 1099-R for 2009 reporting a gross
distribution of $78,414.14 in respect of the two insurance policies, designating
$49,255.24 as taxable income.
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III. Petitioner’s Tax Return
On or about August 16, 2010, petitioner submitted to the Internal Revenue
Service (IRS) two Forms 1040, U.S. Individual Income Tax Return, for 2009,
along with a written statement. Return “A” did not include the income reported by
NML on Form 1099-R, whereas petitioner reported the income on return “B”.
Petitioner’s written statement described the events leading to the lapse of the
insurance policies and the issuance of Form 1099-R and set forth his claim that it
would be unfair to impose income tax on what he considered an artificial
distribution. The IRS accepted and filed petitioner’s return “B” and assessed the
tax reported on that return.
IV. Subsequent Developments
In late October 2010 petitioner contacted NML and requested a statement
confirming that he did not receive a cash distribution from NML when his
insurance policies lapsed. NML responded to petitioner’s request by letter dated
November 1, 2010, stating:
Dear Mr. Furnish:
Thank you for the opportunity to address your questions about the
taxable gain on your policy. The taxable amount occurred when your
policies lapsed to an Extended Term insurance contract and the
outstanding loan balances were repaid.
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Federal laws define most life insurance distributions as a taxable
* * * [event] once the cost of insurance has been recovered. When a
policy lapses to Extended Term, cash value is released from the
policy to repay the loans. To the extent that loans paid off exceed the
cost of the insurance, a taxable event takes place. If a policy has a
gain, it’s considered taxable as ordinary income and we must report it
in the year the policy terminates for any reason, other than the death
of the insured.
Determining taxable gain is a two-step process. First, we determine
the policy’s cost basis. Here’s the calculation for * * * [the 1972]
policy:
1
Total premiums $12,753.40
2
Total dividends -0.00
Cost basis $12,753.00
1
Total premiums include premiums for basic insurance coverage only.
Premiums paid for additional benefits like waiver of premium and
accidental death benefit aren’t included.
2
Total dividends are dividends used for purposes other than
purchasing additional paid-up insurance. Examples of other purposes
would be dividends used for loan repayment, premium reduction or
received in cash.
Next, we compare the paid off loan amount less the cost basis. Here’s
the calculation for * * * [the 1972] policy:
Policy Loan $11,433.36 Paid Off Loan Amount $36,767.33
Premium Loan +$25,333.97 Cost Basis $12,753.40
$36,767.33 $24,013.93
Here are the calculations for * * * [the 1974] policy:
* * * * * * *
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Policy Loan $ 7,993.26 Paid Off Loan Amount $41,646.81
Premium Loan +$33,653.55 Cost Basis $16,405.50
$41,646.81 $25,241.31
I hope I’ve answered your questions regarding the taxable gain on
your policy. Because I’m not in a position to advise you on tax
matters, you may want to discuss this issue with an attorney,
accountant or the IRS if you have further tax questions.
Petitioner responded to NML’s letter with a request for clarification. NML
responded to petitioner by letter dated November 8, 2010, repeating verbatim the
statements contained in the November 1, 2010, letter but adding the following
statement:
At the time the policy lapsed to Extended Term Insurance in 1999,
any remaining cash value in the policy provided insurance coverage
until March 19, 2010, for * * * [the 1974 policy], and June 4, 2010
for * * * [the 1972 policy]. There were no cash values paid to the
policyowner in 2009 because loans and unpaid loan interest depleted
cash values causing the lapse to Extended Term Insurance.
On December 1, 2010, petitioner wrote to an IRS office in Fresno,
California (presumably an examination unit), stating that he questioned NML’s
calculations underlying the Form 1099-R and that NML had declined to provide
him with a “history of distributions” under his insurance policies because its
electronic records went back only to the mid-1990s and the company was
unwilling to do the research necessary to fully respond to his request.
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During the next several months petitioner engaged in discussions with
various IRS personnel in an effort to resolve the matter in his favor. In September
2011 petitioner attempted to obtain the assistance of the Taxpayer Advocate
Service.
V. Notice of Deficiency
On August 12, 2011, respondent issued to petitioner the notice of deficiency
in dispute. Respondent determined in relevant part that it was appropriate to
include the NML distribution in petitioner’s income and that, as a consequence, he
was liable for alternative minimum tax.
VI. Petition
Petitioner filed a timely petition for redetermination asserting that he should
not be subject to Federal income tax in respect of NML’s “phantom” distribution
of $49,255.24. He also expressed disappointment that he was not given an
opportunity to discuss the matter with the IRS Office of Appeals.4
4
Petitioner nevertheless wrote a letter to the IRS Office of Appeals dated
August 13, 2012, asserting that he did not receive a distribution from NML,
summarizing his efforts to obtain from NML detailed calculations underlying the
Form 1099-R, and expressing doubts about the accuracy of NML’s calculations
supporting its determination that his policies had lapsed during 2009.
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VII. NML Declaration
The record includes a declaration executed by Carol A. Stilwell, NML’s
director of policyowner services and a custodian of the company’s business
records. Ms. Stilwell’s declaration states that petitioner’s 1972 and 1974 policies
terminated on June 4 and March 19, 2010, respectively, with no value. Ms.
Stilwell attached to her declaration separate exhibits which provide the same
narrative statements and calculations in respect of petitioner’s insurance policies
that appeared in NML’s letter to petitioner dated November 1, 2010.
Discussion
The term “gross income” is broadly defined in the Code to include all
income from whatever source derived. Sec. 61(a). An amount received in
connection with a life insurance contract which is not received as an annuity
generally constitutes gross income to the extent that the amount received exceeds
the investment in the insurance contract. Sec. 72(e)(1)(A), (5)(A), (C); Brown v.
Commissioner, 693 F.3d 765, 768 (7th Cir. 2012), aff’g T.C. Memo. 2011-83;
Sanders v. Commissioner, T.C. Memo. 2010-279. The investment in the contract
is defined as the aggregate amount of premiums or other consideration paid for the
contract less aggregate amounts previously received under the contract to the
extent they were excludable from gross income. Sec. 72(e)(6).
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When NML determined that petitioner’s insurance policies had lapsed, it
applied the cash values of the policies to the outstanding balances on petitioner’s
loans. As we have explained in numerous cases, the act of applying the cash value
of a life insurance policy against an outstanding loan is not different from
distributing the proceeds to the taxpayer (including the untaxed inside buildup) to
permit the taxpayer to use the proceeds to pay off the loan. See Feder v.
Commissioner, T.C. Memo. 2012-10, 2012 WL 75114, at *4 (and cases cited
thereat).
A preliminary issue in this case, however, is whether NML correctly
determined that petitioner’s insurance policies had lapsed in 2009. As a general
rule, the taxpayer bears the burden of showing that the Commissioner’s
determination is in error. Rule 142(a). As an exception to this general rule, if a
taxpayer raises a reasonable dispute with respect to a third-party information
return (such as the Form 1099-R in dispute) and has otherwise fully cooperated
with the Commissioner, the burden of production may shift to the Commissioner
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to present reasonable and probative evidence to verify the information return. Sec.
6201(d).5
Petitioner contends that he fully cooperated with respondent, that there are
legitimate questions regarding the accuracy of NML’s determination that his
insurance policies lapsed in 2009, and that he tried but failed to persuade NML to
produce the records necessary to verify and substantiate the information reported
in the Form 1099-R. Petitioner asserts that he cannot be certain that his insurance
policies actually lapsed in 2009 without detailed records showing the amounts of
premium loans, the interest computations related to those loans, and NML’s
dividend distributions over the life of the policies--yet NML refused to produce
those records. Petitioner further contends that NML’s letters and annual policy
statements raise more questions than they answer. Specifically, petitioner notes
that (1) NML’s annual policy statements for the 1972 policy make reference to
5
Sec. 6201(d) provides:
In any court proceeding, if a taxpayer asserts a reasonable dispute
with respect to any item of income reported on an information return
filed with the Secretary * * * by a third party and the taxpayer has
fully cooperated with the Secretary (including providing, within a
reasonable period of time, access to and inspection of all witnesses,
information, and documents within the control of the taxpayer as
reasonably requested by the Secretary), the Secretary shall have the
burden of producing reasonable and probative information
concerning such deficiency in addition to such information return.
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basic insurance coverage of $22,000, in contradiction of the 1972 policy which
provides for basic insurance of $20,000, (2) there is no explanation for the
seemingly anomalous decrease in the net cash value of the 1972 policy from
$3,331.75 in 2006 to $1,481.09 in 2008, and (3) NML’s letter to him dated
November 8, 2010, erroneously stated that his insurance policies “lapsed to
Extended Term Insurance in 1999”.6 Petitioner maintains that, considering all the
circumstances, the burden of production shifted to respondent under section
6201(d), and respondent failed to meet his burden under that provision of law.
Respondent contends that petitioner has not raised a reasonable dispute in
respect of the accuracy of the Form 1099-R. Specifically, respondent asserts that
“[b]y petitioner’s own admission, long-term computations such as these can be
complex and difficult to verify in exacting detail without access to copious
records. However, taken on the whole, the computations provided by * * * [NML]
follow a logical pattern explaining petitioner’s situation.”
Contrary to respondent’s position, petitioner raised a reasonable dispute
regarding the accuracy of the Form 1099-R. Although petitioner points to
relatively minor discrepancies in NML’s records, we agree with petitioner that the
6
The record is clear that NML had determined that petitioner’s insurance
policies had lapsed in 2009.
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discrepancies are of such a nature that their cumulative effect, compounded over
the extended terms of the policies in question, would likely be significant and
could very well alter the dates that the insurance policies lapsed.
Respondent also avers that petitioner “did not bring these alleged errors to
respondent’s attention until the day of the trial.” The burden of production shifts
to the Commissioner under section 6201(d) only if the taxpayer fully cooperates
with the Commissioner by providing, within a reasonable period, access to and
inspection of all witnesses, information, and documents within the control of the
taxpayer as reasonably requested. Respondent did not present any evidence that
petitioner failed to respond to reasonable requests for information. Considering
petitioner’s detailed communications with IRS personnel before and after the
notice of deficiency was issued and the fact that he apparently was not given the
opportunity to discuss the matter with the Appeals Office, we conclude that
petitioner fully cooperated with respondent within the meaning of section 6201(d).
As a final matter, respondent contends that he produced “reasonable and
probative information” in support of the Form 1099-R. We disagree. Aside from
the documents that the parties agreed to submit to the Court by way of stipulation,
most of which came from petitioner, the only information that respondent offered
was Ms. Stilwell’s declaration. That declaration merely restates the summary
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information that NML provided to petitioner in its letters dated November 1 and 8,
2010. The declaration does nothing to assuage doubts surrounding the accuracy of
the Form 1099-R.
In sum, on the record presented, we conclude that the burden of production
shifted to respondent under section 6201(d), and respondent failed to produce
reasonable and probative information regarding the accuracy of the Form 1099-R
in dispute. Unlike his approach in similar cases, see Feder v. Commissioner, T.C.
Memo. 2012-10; Sanders v. Commissioner, T.C. Memo. 2010-279, respondent did
not obtain detailed records of petitioner’s premium payments and loan history to
corroborate NML’s Form 1099-R in the face of legitimate questions as to its
accuracy. Absent such information, there is insufficient evidence to verify that
petitioner received the constructive distribution of $49,255.24 that NML reported
to respondent or to otherwise sustain the deficiency in dispute.
To reflect the foregoing,
Decision will be entered
under Rule 155.