37 T.C. 1046 (1962), 82241, Helwig v. C. I. R.

Docket Nº:82241.
Citation:37 T.C. 1046
Opinion Judge:RAUM, Judge:
Party Name:A. A. HELWIG AND EVA S. HELWIG, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Attorney:Monroe F. Marsh, Esq., for the petitioners. Alfred L.Margolis, Esq., for the respondent.
Case Date:March 07, 1962
Court:United States Tax Court

Page 1046

37 T.C. 1046 (1962)

A. A. HELWIG AND EVA S. HELWIG, PETITIONERS,

v.

COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

No. 82241.

United States Tax Court.

March 7, 1962

Monroe F. Marsh, Esq., for the petitioners.

Alfred L.Margolis, Esq., for the respondent.

Held, purported interest payments made in connection with so-called annuity transactions, similar to those involved in Knetsch v. United States, 364 U.S. 361, and Amor F. Pierce, 37 T.C. 1039 (decided this day), are not deductible, notwithstanding the interposition of an immediate bank loan found herein to be lacking in substance.

Respondent has determined a deficiency in petitioners' income tax for the taxable year 1955 in the amount of $23,404.38. The sole remaining issue is whether petitioners may deduct as interest certain payments made in 1955 to the All Service Life Insurance Corporation and to the Farmers and Stockmens Bank, both of Phoenix, Arizona.

FINDINGS OF FACT.

The facts stipulated by the parties are incorporated herein by this reference.

Petitioners, husband and wife, presently residing at 404 North Roxbury Drive, Beverly Hills, California, formerly resided in Chicago, Illinois, and filed a joint income tax return for the calendar year 1955 with the district director of internal revenue at Chicago, Illinois. A. A. Helwig will hereinafter be referred to as petitioner.

In 1955 petitioner was chairman of the board of the Standard Railway Equipment Manufacturing Company with an annual salary of $60,000. He was 63 years old. His net worth amounted to several million dollars.

In December of 1955 petitioner traveled to Phoenix, Arizona, for the purported purpose of arranging to purchase 10 annuity contracts from the All Service Life Insurance Corporation of Phoenix, hereinafter referred to as All Service. The events which, in form, occurred on or about December 29, 1955, are set forth in the paragraphs that follow.

Petitioner applied to All Service for the issuance of 10 retirement life annuity contracts with 10 years' payments certain. The consideration specified for each contract consisted of eight annual premiums of $20,000 each, or an aggregate for the 10 contracts of $200,000 per annual installment.

As payment of the first annual installment, petitioner signed 10 nonrecourse demand promissory notes payable to All Service in the total amount of $200,000.

Page 1047

All Service accepted petitioner's application and issued to him 10 retirement life annuity contracts with 10 years' payments certain, each dated December 20, 1955, and numbered A-426 through A-435. Payments to petitioner as the named annuitant under each contract were to commence on the anniversary of the issue date nearest petitioner's 75th birthday and were to be in the amount of $1,534.32 per contract per month. Petitioner's estate was designated as the death benefit beneficiary in each contract.

All Service agreed to lend petitioner $200,000 pursuant to 10 contract loan agreements, each in the amount of $20,000, signed by petitioner on December 29, 1955. As sole security for the loans, petitioner assigned the 10 annuity contracts to All Service. Each contract loan agreement called for 6 years' interest to be paid 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. The total interest payable to All Service on December 29, 1955, was $42,094.40. All Service applied the proceeds of these contract loans to discharge the $200,000 nonrecourse demand notes which petitioner had signed in payment of the first annual consideration.

On the same day petitioner applied to the Farmers and Stockmens Bank of Phoenix, Arizona, for 10 loans in the amount of $3,488 each or for an aggregate loan of $34,880. The bank made such loans on All Service's contract loan agreement forms and the 10 annuity contracts were designated as the sole security therefor. As in the case of the contract loans made directly with All Service, petitioner agreed to pay the bank 6 years' interest 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. The total interest thus payable to the bank by petitioner amounted to $7,341.20, which petitioner paid to the bank on December 29, 1955, by check drawn on his account at the Continental Illinois National Bank & Trust Co. of Chicago, Illinois.

At the same time petitioner opened a new checking account at the Farmers and Stockmens Bank by depositing a check drawn to his own order on his account at the Continental Illinois National Bank & Trust Co., of Chicago, Illinois, in the amount of $7,700. He instructed the Farmers and Stockmens Bank to deposit the $34,880 proceeds of his loan to this new checking account and then to forward his check on his new account in the amount of $42,094.40, also signed on December 29, 1955, to All Service. The bank complied with petitioner's instructions by depositing petitioner's check in All Service's account at the bank.

Under date of January 4, 1956, Farmers and Stockmens Bank wrote to petitioner to inform him that it had assigned, without recourse,

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his 10 contract loan agreements in the total amount of $34,880 to All Service.

In their joint Federal income tax return for 1955, petitioners claimed deductions for interest paid to All Service in the amount of $42,094.40 and to Farmers and Stockmens Bank in the amount of $7,341.20. The respondent has disallowed these deductions.

All Service was incorporated under the laws of Arizona as a fraternal benefit society on February 13, 1952, and commenced business on March 11, 1952. On December 31, 1952, its total assets consisted of $3,674.75 and its liabilities and reserves amounted to $5,913.73, leaving a deficit of $2,238.98. All Service's balance sheet as of December 31, 1955, showed total assets of $9,267,344.22 (of which $9,038,010.62 consisted of ‘ Policy Loans') and a ‘ Surplus' of $8,000.90 (resulting from the difference between the deficit in ‘ accumulated earnings' of $105,103.07 and ‘ non-ledger assets-contra’ of $113,103.97). From the date of incorporation through December 31, 1956, the net income of All Service resulted solely from the difference in the rate of interest charged on contract loans and the rate of interest allowed on annuity considerations paid. Income from other sources, including the sale of other forms of insurance, was exceeded by the expenses incurred in the production of that income.

Sometime in 1954 representatives of All Service approached officers of the Farmers and Stockmens Bank concerning the establishment of a ‘ loan program’ in which the bank would purportedly make loans to holders of All Service's annuity contracts, on the security of such contracts, for the purpose of paying interest due on contract loans to All Service. Under the plan adopted All Service specifically agreed to accept the assignment of all such loans, by a charge to its account at the bank, 1 working day after the loans were purportedly made by the bank. Since the annuity holder opened up an account at the bank in which he deposited the proceeds of the...

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