Pierce v. Comm'r of Internal Revenue
| Decision Date | 07 March 1962 |
| Docket Number | Docket No. 70676. |
| Citation | 37 T.C. 1039 |
| Parties | AMOR F. PIERCE AND IDA MAE PIERCE, PETITIONERS, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Thaddeus Rojek, Esq., for the petitioners.
Charles F. Quinlan, Esq., for the respondent.
Held, certain amounts paid in 1954 to an insurance company in the form of interest on purported annuity contract loans are not deductible. Knetsch v. United States, 364 U.S. 361, followed.
The respondent has determined a deficiency in petitioners' income tax for the calendar year 1954 in the amount of $11,502.18. The sole issue is whether petitioners may deduct as interest a payment made in 1954 in the amount of $24,718 to the All Service Life Insurance Corporation of Phoenix, Arizona.
The facts stipulated by the parties are incorporated herein by this reference. In addition, the record in Estate of Charles G. Polacek, Deceased, Carolyn M. Polacek, Executrix, and Carolyn M. Polacek v. Commissioner of Internal Revenue, Docket No. 83919, is incorporated herein by stipulation of the parties.
Petitioners, husband and wife, residing at 15547 Valley Vista Boulevard, Van Nuys, California, filed a timely joint income tax return for the calendar year 1954, prepared on the cash basis, with the district director of internal revenue, Los Angeles, California. Amor F. Pierce will hereinafter be referred to as petitioner.
Sometime prior to December 13, 1954, petitioner and All Service Life Insurance Corporation of Phoenix, Arizona, hereinafter referred to as All Service, agreed that petitioner and All Service would enter into certain transactions in December of 1954 which, in form, were as set forth in the paragraphs that follow.
On December 13, 1954, petitioner applied to All Service for the issuance of six deferred annuity contracts. The consideration specified for each contract was $100,000, payable in six annual installments of $16,666.67, or a total for the six contracts of $100,000 per annual installment.
All Service accepted petitioner's nonrecourse 6-percent demand promissory note in the face amount of $100,000 on December 13, 1954, as payment on the first annual consideration.
On December 13, 1954, All Service accepted petitioner's application and issued to him six deferred annuity contracts, each dated December 1, 1954, and numbered A-356 through A-361. Petitioner's daughter, 10 years of age at the time, was designated as the annuitant in three of the contracts and petitioner's son, 1 year of age at the time, was designated as the annuitant in the other three contracts. Annuity payments under each contract are to begin on the contract anniversary date at which the named annuitant's age at nearest birthday is 65 years. Petitioner is the contract owner and death benefit beneficiary in each contract.
On December 13, 1954, All Service agreed to lend petitioner a total of $117,441 pursuant to six contract loan agreements, each in the amount of $19,573.50. As sole security for the loans, petitioner assigned the six annuity contracts to All Service. Petitioner was able to borrow $117,441 on the annuity contracts on December 13, 1954, because the contracts provided that the net loan value shall be computed ‘as of the end of any period through which interest on such loan and all prior loans have been paid in advance.’ Since petitioner agreed to pay interest on the loans for 6 years in advance, the net loan value was computed as of the end of the 6th year, i.e., as of December 1, 1960.
On December 28, 1954, All Service delivered its check in the amount of $17,441 to Farmers and Stockmens Bank in Phoenix, Arizona, for credit to petitioner's account, which had been opened for the purpose of this transaction. The balance of the loan was applied by All Service against, and in discharge of, the $100,000 nonrecourse demand note which petitioner had delivered in payment of the first annual consideration. The note was returned to petitioner with an acknowledgment thereon by All Service of payment as of December 28, 1954.
On December 28, 1954, petitioner paid to All Service the sum of $24,718 as interest of the loan of $117,441 for 6 years in advance, at the rate of 3.75 percent per annum, with interest paid for more than 1 year in advance discounted at the rate of 2.75 percent per annum, compounded annually. Petitioner paid $17,441 of such interest by a group of six checks drawn on his account at the Farmers and Stockmens Bank, thereby offsetting the deposit of the same day from the All Service loan and reducing his balance in such account to $1. The remaining $7,277 was paid by petitioner's checks on two California banks.
As of the end of 1954, according to the books and records of All Service, the net cash value of the six annuity contracts was $5,520. Such net cash value was determined by subtracting $97,127 (the difference between the $117,441 indebtedness on the contracts and the $20,314 refundable portion of the prepaid interest) from the $102,647 cash surrender value of the contracts. Petitioner's out-of-pocket cost for the six annuity contracts as of the same time was $7,277, the difference between the $24,718 payment made as interest and the $17,441 borrowed from All Service. But for tax considerations, petitioner's purported investment in the six annuity contracts resulted in a net economic loss of $1,757 ($5,520 net cash value minus $7,277 net cost) in 1954.
On their joint Federal income tax return for the calendar year 1954, petitioners claimed a deduction in the amount of $24,718 as interest paid to All Service. The respondent has disallowed this deduction.
The events which have occurred, in form, with respect to the six annuity contracts since the taxable year in issue are set forth in the paragraphs that follow.
In each of the following 5 years (December 17, 1955; December 12, 1956; December 8, 1957; December 3, 1958; December 7, 1959), additional new loans were made with the annuity contracts being assigned as the sole collateral security therefor and $100,000 of the proceeds of such contract loans was applied each year either to the payment of promissory notes which had been tendered in payment of the annual consideration then due or directly to the payment of the annual consideration then due. The remaining balance of the loan proceeds was delivered to petitioner or to his bank for credit to his account. In each of the years from 1955 through 1959 petitioner paid interest on the then existing indebtedness for 1 additional year in advance and on the newly created indebtedness for 5 or 6 years in advance. As of the end of the year 1959, the total understanding indebtedness created by the previously described transactions was $734,702.04.
In December 1960, an additional new loan in the amount of $20,202 was made with the six annuity contracts being assigned as the sole collateral security. Consequently, the total outstanding indebtedness secured by the six annuity contracts as of the end of 1960 was $754,904.04. As of the same time, petitioner had paid interest on the then outstanding indebtedness in advance through and to December 1, 1965. The net cash value of the six annuity contracts, including the net refundable interest paid in advance on contract loans, was $30,878 as of the end of 1960.
Petitioner's participation in the transactions with All Service from 1954 through 1960 may be summarized as follows:
+------------------------------------------------------------------+
¦ ¦Amount paid¦Net proceeds¦Out-of-pocket¦Yearly ¦Yearly ¦
+-----+-----------+------------+-------------+------------+--------¦
¦Year ¦as interest¦of loans ¦costs ¦increase net¦economic¦
+-----+-----------+------------+-------------+------------+--------¦
¦ ¦ ¦ ¦ ¦cash values ¦loss ¦
+-----+-----------+------------+-------------+------------+--------¦
¦1954 ¦$24,718 ¦$17,441 ¦$7,277 ¦$5,520 ¦$1,757 ¦
+-----+-----------+------------+-------------+------------+--------¦
¦1955 ¦29,243 ¦20,669 ¦8,574 ¦6,697 ¦1,877 ¦
+-----+-----------+------------+-------------+------------+--------¦
¦1956 ¦27,104 ¦19,145 ¦7,959 ¦4,674 ¦3,285 ¦
+-----+-----------+------------+-------------+------------+--------¦
¦1957 ¦27,104 ¦19,145 ¦7,959 ¦3,285 ¦4,674 ¦
+-----+-----------+------------+-------------+------------+--------¦
¦1958 ¦38,670 ¦27,396 ¦11,274 ¦5,154 ¦6,120 ¦
+-----+-----------+------------+-------------+------------+--------¦
¦1959 ¦43,580 ¦30,906 ¦12,674 ¦5,474 ¦7,200 ¦
+-----+-----------+------------+-------------+------------+--------¦
¦1960 ¦26,421 ¦20,202 ¦6,219 ¦74 ¦6,145 ¦
+-----+-----------+------------+-------------+------------+--------¦
¦Total¦216,840 ¦154,904 ¦61,936 ¦30,878 ¦31,058 ¦
+------------------------------------------------------------------+
On September 16, 1959, pursuant to a joint motion filed by the parties, the present case was continued...
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