113 T.C. 254 (T.C. 1999), 5382-97, Winn-Dixie Stores, Inc. and Subsidiaries v. Commissioner of Internal Revenue

Docket Nº:5382-97
Citation:113 T.C. 254, 113 T.C. No. 21
Opinion Judge:RUWE, JUDGE:
Attorney:Michael J. Henke, Tegan M. Flynn, Cary D. Pugh, Thomas Crichton IV, Robert H. Cox, and Thomas P. Marinis, Jr., for petitioner. Nancy B. Herbert, Jeffrey L. Bassin, James D. Hill, and Michelle A. Missry, for respondent.
Judge Panel:Ruwe, Robert P.
Case Date:October 19, 1999
Court:United States Tax Court

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113 T.C. 254 (T.C. 1999)

113 T.C. No. 21




No. 5382-97

United States Tax Court

October 19, 1999

Decision will be entered under Rule 155.


P entered into a leveraged corporate-owned life insurance (COLI) program in which it purchased life insurance on approximately 36,000 of its employees and systematically borrowed against the cash value of the policies to fund the premiums. The COLI program was designed so that annual premiums, fees, and policy loan interest would exceed the projected annual death benefits and net cash value of the policies. The program was designed to generate large amounts of interest on petitioner's policy loans that petitioner intended to deduct for income tax purposes. The income tax savings from the deductions for interest and fees were projected to be substantially in excess of the projected net costs of maintaining the COLI program. In each year of operation, the COLI program projected a pretax loss and an after-tax gain.

Held: P's broad-based leveraged COLI program lacked economic substance and business purpose (other than tax reduction) and is therefore a sham for tax purposes. As a result, interest on P's COLI policy loans is not deductible interest on indebtedness within the meaning of sec. 163, I.R.C. The administrative fees associated with the COLI program are not deductible because they were incurred in furtherance of a sham.

Michael J. Henke, Tegan M. Flynn, Cary D. Pugh, Thomas Crichton IV, Robert H. Cox, and Thomas P. Marinis, Jr., for petitioner.

Nancy B. Herbert, Jeffrey L. Bassin, James D. Hill, and Michelle A. Missry, for respondent.

Ruwe, Robert P.



Respondent determined a deficiency of $ 1,599,176 in petitioner's Federal income tax for its tax year ending June 30, 1993. After concessions, the issue is whether deductions petitioner claimed for policy loan interest and administrative fees associated with certain of petitioner's corporate-owned life insurance (COLI) policies are deductible.

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Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.


Some of the facts have been stipulated and are so found. The stipulations of facts are incorporated herein by this reference. At the time the petition was filed, petitioner was a Florida corporation with its principal office in Jacksonville, Florida.

Petitioner was founded in the 1920's, and its stock is publicly traded on the New York Stock Exchange. Petitioner is a major food retailer made up of self-service food stores which sell groceries, meats, seafood, fresh produce, deli/bakery, pharmaceuticals, and general merchandise items. As of June 30, 1993, petitioner had 1,165 stores in 14 States and the Bahama Islands.

Petitioner is an accrual basis taxpayer, which has adopted a 52- 53 week fiscal year ending on the last Wednesday in June. Petitioner filed a consolidated corporate Federal income tax return for its fiscal year ending June 30, 1993.

As of June 30, 1993, petitioner employed approximately 36,000 full-time and 69,000 part-time employees. Since 1988, all full-time employees who completed 3 months of continuous service have been eligible for a flexible benefits program called " Winn- Flex" . Under Winn-Flex, employees were furnished certain benefits that they received automatically and certain optional benefits among which they could choose. Employees automatically received life insurance and accident and sickness coverage. The optional benefits included a medical plan, dental coverage, vision coverage, supplemental associate life insurance, long-term disability and two flexible spending accounts for health care and dependent care. Petitioner self-insured the medical and life insurance benefits under Winn-Flex while the remaining benefits were insured through third parties.

The life insurance coverage provided by the company under the core Winn-Flex benefit program was in effect only while a worker was a full-time employee. Petitioner provided no postretirement benefits to its employees under Winn-Flex.

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Early retirees covered by the Winn-Flex plan had the option of continued coverage under a separate insurance pool not paid for by petitioner.

Since 1980, petitioner has also maintained a program to provide death, disability, and retirement benefits to a limited number of full-time management level employees. This program was known as the " Management Security Program" (MSP). During the fiscal year ending in 1993, 615 of petitioner's employees were covered under the MSP. In order to provide funds for specific benefits for each manager, petitioner purchased flexible premium adjustable life insurance policies on each manager (MSP policies) from American Heritage Life Insurance Co. (AHL). The MSP policies are individual policies and not group contracts. The death benefits under the individual MSP policies were tailored to cover petitioner's costs for preretirement deaths of the covered individual and to cover costs of postretirement benefits. Petitioner's practice of purchasing MSP policies on the lives of its managers began long before 1993.

During 1992 and early 1993, Wiedemann & Johnson (WJ) and The Coventry Group (Coventry) formed a joint venture (WJ/Coventry) and approached petitioner with a proposal for the purchase by petitioner of individual excess interest life insurance policies on the lives of petitioner's employees. AIG Life Insurance Company (AIG) was to be the underwriter for the proposed policies. In a letter dated January 12, 1993, Mr. Alan Buerger, chairman of Coventry, confirmed a meeting on January 14, 1993, with Mr. Richard D. McCook, petitioner's financial vice president. Included with the letter was a memorandum from Mr. Buerger and Mr. Bruce Hlavacek, chairman and chief executive officer of WJ, proposing that petitioner purchase a " broad-based COLI pool" .

The memorandum provided an overview section which generally described a broad-based COLI pool as consisting of a group of corporate-owned life insurance (COLI) policies covering a wide cross-section of a corporation's employees. Petitioner was the proposed beneficiary of the COLI policies to be written on the lives of petitioner's employees. WJ/Coventry's proposal focused on two issues raised by petitioner in a prior meeting. These two issues were described as " (i) achieving positive earnings in every year; and (ii) providing an exit if

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the tax laws change or Winn-Dixie's appetite for interest deductions declines."

The memorandum summarized the tax aspects of leveraged COLI with the following captioned diagram:

[diagram omitted]1 - Winn-Dixie makes deposits and pays loan interest to insurance carrier.

2 - Winn-Dixie receives withdrawals, loans and death proceeds from the insurance carrier. 3 - Winn-Dixie receives a tax deduction for loan interest paid.

The memorandum next explained the difference between the proposed broad-based COLI pool and petitioner's then existing leveraged COLI program being used to fund the MSP. The memorandum stated:

Winn-Dixie is familiar with leveraged COLI and particularly with the tax arbitrage created when deductible policy loan interest is paid to finance non-taxable policy gains. Winn-Dixie's existing leveraged COLI policies provide this arbitrage and, having been purchased before passage of the 1986 Tax Reform Act, provide it beyond the $ 50,000 cap applicable to newer policies.

A broad-based COLI Pool applies the same principle in ways that are effective under current law. But, where each of the existing policies was designed to fund a specific executive's benefit under the MSP, the Pool that we have illustrated would cover 38,000 employees at all levels of Winn-Dixie's workforce.

With respect to obtaining the employees' consent to purchase the COLI policies on their lives, the memorandum stated:

We usually recommend that a company adopt or expand employee death benefits when installing a COLI Pool. This provides an immediate and meaningful benefit for employees, and it helps to provide a logic and incentive for obtaining employees' consent to being insured. The benefit may

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depend on the size of the pool and the amount of the insurance purchased on each employee. A death benefit in the range of $ 5,000 to $ 15,000 is typical for the Pools presented here. After an employee leaves the company, the benefit is normally reduced or discontinued. With normal rates of retirement and attrition, only a small proportion of the participants will receive a benefit. As a result, the cost of providing the benefit is insignificant.

The memorandum also expressed an opinion on the tax issues raised by the proposed COLI pool, the legislative status of leveraged COLI, and exit strategies available to petitioner in the event that the tax laws change:

What tax issues are raised by the COLI Pool?

Deductibility of Interest. Because the COLI Pool involves systematic borrowing of increases in the policies' cash value, a deduction for interest to carry policy loans is allowed only if at least four of the first seven annual premiums are paid in cash. In addition, a deduction is allowed for interest on only the first $ 50,000 debt to carry policies on any one employee. The COLI Pool proposed here is designed to satisfy the 4-out-of-7 rule, and the financial illustrations take into account the $ 50,000 cap on loans for which interest deductions are allowed. * * * What is the legislative status of leveraged COLI? In the past few years, Rep. Barbara Kennelly (D-Conn.) and Senator David Pryor (D-Ark.) have introduced bills that would impose new restrictions on the deductibility of interest paid on loans from COLI...

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