Cadwell v. Comm'r of Internal Revenue

• Citation: 50 Employee Benefits Cas. 2332,136 T.C. No. 2,136 T.C. 38
• Decision Date: 03 January 2011
• Docket Number: No. 15456–08.,15456–08.
• Parties: G. Mason CADWELL, Jr., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: United States Tax Court

136 T.C. 38
136 T.C. No. 2
50 Employee Benefits Cas. 2332

G. Mason CADWELL, Jr., Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 15456–08.

United States Tax Court.

Jan. 3, 2011.

[136 T.C. 38]

K, an S corporation 100 percent owned by P's spouse, adopted and, through its subsidiary KSM, made contributions to a multiemployer welfare-benefit plan (the plan). Through KSM, K made a contribution to the plan, part of which was used to purchase life insurance coverage for P and K's other employees, and the remainder of which was an excess contribution. The plan was amended and converted to a single-employer plan. The plan's qualification pursuant to sec. 419A(f)(6), I.R.C., is not in issue.

Held: R was not required to send P a “30 day letter”, and the notice of deficiency adequately sets forth R's position in this case and is therefore valid.

Held, further, P's interest in the plan became substantially vested upon the plan's conversion from a multiemployer plan to a single-employer plan. Sec. 1.402(b)–1(b)(1), Income Tax Regs.

Held, further, P must include in gross income the cash value of the life insurance policy on P's life. The value of the life insurance policy is the PERC (premiums, earnings, and reasonable charges) pursuant to Rev. Proc.2005–25, 2005–1 C.B. 962. P has not contended that we should deviate from the safe harbor provision of Rev. Proc.2005–25, supra; thus, P may not reduce the PERC value by the surrender charge under that provision.

Held, further, P must include in his gross income the excess contributions pursuant to sec. 1.402(b)1(b)(1), Income Tax Regs.

Held, further, the current year cost of insurance protection is an accession to wealth which P must include in gross income pursuant to sec. 61(a), I.R.C.

Held, further, where the fair market value of a life

[136 T.C. 39]

insurance policy has been determined using the PERC method, P must include in his gross income as the cost of life insurance protection an amount equal to the sum of mortality charges and other expenses.

Held, further, P is liable for the accuracy-related penalty for a substantial understatement of income tax pursuant to sec. 6662(a) and (b)(2), I.R.C.

Richard H. Morton and Kevin J. Ryan, for petitioner.

Kathleen Tagni, Sherri Wilder, and Betty Clary (specially recognized), for respondent.

OPINION WELLS, Judge:

This case is before the Court on petitioner's motion for summary judgment and respondent's cross-motion for summary judgment pursuant to Rule 121.¹ Respondent determined a deficiency of $33,057 in petitioner's Federal income tax for tax year 2004 and a penalty pursuant to section 6662(a) of $6,611. On August 31, 2009, petitioner filed a motion for summary judgment. On October 5, 2009, respondent filed a response to petitioner's motion for summary judgment and a cross-motion for summary judgment. On October 26, 2009, petitioner filed a motion to amend his petition.² On November 4, 2009, petitioner filed a response to respondent's cross-motion for summary judgment. On November 16, 2009, a hearing was held on the parties' motions. On November 19, 2009, respondent filed a reply to petitioner's response to respondent's motion for summary judgment and an objection to petitioner's motion to amend his petition.

The issues to be decided as a consequence of Petitioner's motion for summary judgment and Respondent's cross-motion for summary judgment are: (1) Whether respondent was required to send a “30 day letter” to petitioner and whether the notice of deficiency adequately sets forth respondent's position in the instant case; (2) whether petitioner must include in gross income the cash value of a life insurance policy held by a multiemployer welfare benefit plan that was converted to a single-employer welfare benefit plan during the year in issue; (3) whether petitioner

[136 T.C. 40]

must include in his gross income payments made by his employer in excess of the cost of current year life insurance protection (excess contribution); (4) whether petitioner must include in his gross income the current year cost of life insurance protection paid by his employer; and (5) whether petitioner is liable for the penalty under section 6662.³

Background

The background facts are drawn from the pleadings, the parties' motions, facts deemed established, and stipulated exhibits, and are not in dispute.⁴

At the time of filing of the petition, petitioner was a resident of North Carolina.

Petitioner is married to Jennifer K. Cadwell (Mrs. Cadwell). Petitioner and Mrs. Cadwell have two daughters, Jennifer Keady Cadwell (Jennifer) and Miranda M. Cadwell (Miranda). For his 2002 through 2004 tax years, petitioner filed Forms 1040, U.S. Individual Income Tax Return, claiming a filing status of married filing separately. For his 2002 through 2004 tax years, petitioner did not report any wages or salaries on line 7 of Form 1040.

Keady Ltd. (Keady), is a Pennsylvania S corporation organized during 1998 pursuant to sections 1361–1375. Keady is, and has always been, 100 percent owned by Mrs. Cadwell. Mrs. Cadwell is the sole director of Keady. During 2002 through 2004, Mr. Cadwell served as the secretary of Keady. Keady does not have any minutes of shareholders or directors meetings for 2002 through 2004. During 2002 through 2004, Keady's only income was its share of income (or loss) from KSM, Limited Partnership (KSM), a Pennsylvania limited partnership formed during 1998.

During 2002 through 2004, KSM was owned as follows: 90 percent by Mrs. Cadwell; 5 percent by Keady; 2 percent by petitioner; 1.5 percent by Jennifer; and 1.5 percent by Miranda. Keady is the general partner of KSM.

During December 2002, petitioner and Mrs. Cadwell decided to obtain employee welfare benefits for petitioner, Jennifer, and Miranda through the National Benefit Plan

[136 T.C. 41]

and Trust.⁵ The respective plan documents are hereinafter referred to as the Plan and the respective trust created under the Plan is hereinafter referred to as the Trust. According to its original terms, the Plan was organized as a multiemployer welfare benefit plan pursuant to section 419A(f)(6).⁶ The documents describe the Plan's design and operation. The primary purpose of the Plan is to provide severance and death benefits to eligible employees. According to the Plan, each employer is to bear the full cost of the benefits provided. Assets held by the Trust are protected from the claims of each employer's creditors. Each employer enrolled in the Plan is entitled to elect the amount of benefits to provide and the period over which such benefits become vested. Upon termination of the Plan or employer withdrawal from the Plan, an employee's nonforfeitable benefits are deemed to be 100 percent vested, regardless of the vesting schedule set by the employer. ⁷

Before joining the Plan, a prospective employer provides to the Plan sponsor, Niche Plan Sponsors (Niche), employment information regarding the employees whom the employer chooses to include in the Plan. Niche uses the employer's information to create a package of information that contains a summary of the Plan's benefits to the employer and its employees. According to the summary, petitioner receives $50,000 a year in wages from Keady.

On December 31, 2002, petitioner signed the document adopting the Plan as secretary on behalf of Keady. Petitioner was 64 years old at the time Keady adopted the Plan. The adoption agreement identifies Niche as the Plan sponsor, National Plan Advisory as the Plan Administrator, Wells Fargo Bank as the Plan Trustee, and National Benefit Plan and Trust as the Record Owner of the Trust's assets. Keady elected to cover petitioner, Miranda, and Jennifer with death benefits equal to 20 times the covered employee's compensation, severance benefits equal to 14.847 percent of compensation per year up to 10 years (not to exceed 200 percent), and a modified 4–40 vesting schedule (vesting schedule). Under the vesting schedule, an employee is first vested in severance

[136 T.C. 42]

benefits at 40 percent of the stated benefit after 4 years of employment, with vesting increasing to 100 percent at year 10 of employment.

Life insurance covering petitioner's and his daughters' lives was selected to fund the death and severance benefits payable under the Plan to petitioner and his daughters.⁸ For petitioner, a universal life policy with an initial death benefit of $1 million that also accumulates cash value (hereinafter referred to as the life insurance policy) was selected to fund his benefit. ⁹ The life insurance policy was issued by Lincoln National Life Insurance Co. (Lincoln Life) on December 7, 2002. Petitioner named Miranda and Jennifer as beneficiaries of the life insurance policy. In his life insurance policy application, petitioner listed himself as “Manager” of Keady.

For Miranda and Jennifer, identical 10–year, level term life insurance policies on their lives with death benefits of $300,000 were selected to fund their benefits. The annual combined premiums on those policies totaled $645. On their life insurance applications, Miranda and Jennifer were identified as “Consultants” for Keady.

On December 31, 2002, KSM paid $75,000 by check to Compass Bank,¹⁰ the Plan Trustee, to cover Keady's obligation under the Plan, and $2,050 for the Plan fee. Both checks were drawn on KSM's Centennial Bank account and were signed by petitioner. Lincoln Life credited petitioner's life insurance policy for a payment of $73,000 for the month ending January 6, 2003. Petitioner did not include any income on his 2002 Form 1040 as a result of any life insurance

[136 T.C. 43]

premiums paid by KSM. The payments to the Plan Trustee were not claimed as a deduction on KSM's or Keady's 2002 Federal income tax return. Petitioner's accountant, Robert W. Nicolini, C.P.A. (Mr. Nicolini), was not aware of the payments or that KSM had a bank account with Centennial Bank.

On May 20, 2004, KSM paid $38,800 to 419 Plan Administrators,¹¹...