Corporation Denied Deductions for Contributions to Welfare Benefit Plan; No Constructive Receipt of Income on Termination of Insurance Policies; Penalties Imposed (White, TCM)

A married couple’s corporation’s deduction of contributions to a purported welfare benefit plan was disallowed. The husband was a doctor and the wife a nurse, and they owned a corporation that purchased a welfare benefit plan. The corporation made contributions to the plan over several years, for which the taxpayers claimed deductions. The plan used the contributions to purchase life insurance policies on the taxpayers and their two children. After several years, the initial plan terminated, and the taxpayers transferred the insurance policies to a new plan.

Generally, employers are not prohibited from funding term life insurance for employees and deducting the premiums as business expenses. However, they may not disguise investments in life insurance as deductible benefit plan expenses when the investments accumulate cash value for the employees personally, as was the case here. The taxpayers had the ability to void their participation in either the initial or successor plan, and to have the underlying insurance policies returned to them. Therefore, the corporation’s contributions to the plans were payments on behalf of the taxpayers personally, and not ordinary and necessary business expenses deductible under Code Sec. 162.

In addition, the corporation had earnings and profits of at least the amount of the contributions made by the corporation to the plans. Therefore, those contributions were constructive dividends taxable to the taxpayers under Code Sec. 301(c).

The IRS argued that the taxpayers constructively received income under Code Sec. 402(b) when the initial plan terminated, since they had the right to distribution of the policies at that time. However, the taxpayers had always had the right to distribution of the policies, and did not gain any new rights in the policies when the plan terminated. Therefore, termination of the plan did not result in taxable income in the amount of the accumulated cash value of the policies.

Finally, the taxpayers caused the corporation to improperly deduct a large amount of money used to purchase cash-accumulating whole life insurance policies that could later be distributed to the taxpayers for free or for a small fraction of the value of the insurance policy. The amount of tax understated by the taxpayers exceeded the greater of 10 percent of the amount of tax required to be shown or $5,000. This justified imposition of an accuracy-related penalty under Code Sec. 6662(a) based on substantial understatement of income tax. The taxpayers did not act with reasonable cause and good faith because they relied on advice from persons involved in selling them the plan, rather than on independent financial advisors. In addition, there was no substantial authority for the taxpayers’ position to mitigate the penalty imposed on the taxpayers.

J.W. White, TC Memo. 2012-104, Dec. 59,020(M)

Other References:

Code Sec. 162

CCH Reference – 2012FED ¶8520.517

CCH Reference – 2012FED ¶8522.386

Code Sec. 301

CCH Reference – 2012FED ¶15,305.18

Code Sec. 402

CCH Reference – 2012FED ¶18,209.107

Code Sec. 6662

CCH Reference – 2012FED ¶39,652.63

CCH Reference – 2012FED ¶39,652.80

Tax Research Consultant

CCH Reference – TRC BUSEXP: 3,100

CCH Reference – TRC BUSEXP: 3,152

CCH Reference –
TRC CCORP: 6,300

CCH Reference –
TRC CCORP: 6,308

CCH Reference – TRC COMPEN: 12,102

CCH Reference – TRC PENALTY: 3,108

CCH Reference – TRC PENALTY: 3,116.10


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