44 T.C. 660 (1965), 2002-63, Kay v. C. I. R.

Docket Nº:2002-63 - 2006-63.
Citation:44 T.C. 660
Opinion Judge:DRENNEN, Judge:
Attorney:Jacob Shearer, for the petitioners. John Schessler, for the respondent.
Case Date:July 28, 1965
Court:United States Tax Court

Page 660

44 T.C. 660 (1965)




Nos. 2002-63 - 2006-63.

United States Tax Court.

July 28, 1965

Jacob Shearer, for the petitioners.

John Schessler, for the respondent.

Held: Petitioner-owners of annual-premium life insurance policies issued prior to August 6, 1963, entitled to deduct interest paid on policy loans issued under self-funding life insurance plan despite fact that petitioners' payments were made to a lending agency which purportedly loaned petitioners money on the security of the policies, and in turn paid the net premiums and interest on the policy loans to the insurance company with funds paid to it by petitioners, purportedly as interest on the loans from the lending agencies to petitioners. Petitioners admit that the purported loans from the lending agency to them were shams and that purported payments of interest thereon are not deductible.

Page 661


In these consolidated cases respondent determined deficiencies in petitioners' income taxes as follows:

Docket Petitioner Fiscal or calendar Deficiency

No. year ended-

2002-63 Murray Kay and Ida Kay Dec. 31, 1959 $768.74

Dec. 31, 1960 777.68

2003-63 Plastic Glide Corp. (formerly Plastiglide Manufacturing July 31, 1959 1,559.45

Corp.) July 31, 1960 3,754.96

Aug. 1, 1960, to Sept. 704.76

30, 1960.

2004.63 Saul Bolton and Ethel Rose Bolton Dec. 31, 1959 3,402.45

Dec. 31, 1960 3,537.60

2005-63 Louis L. Colen, surviving husband, and Estate of Freda Dec. 31, 1959 2,796.76

Colen, deceased, Louis L. Colen, administrator. Dec. 31, 1960 1,863.87

2006-63 Ralph Trustman and Blossom Trustman Dec. 31, 1959 3,260.51

Dec. 31, 1960 3,375.01

Due to certain concessions of the petitioners only a portion of the deficiency in each case is now in dispute. The issue for decision is whether a portion of certain payments made by each of the petitioners each year are deductible as interest paid on insurance policy loans. All of the facts were stipulated and the stipulation of facts, together with the facts contained in the exhibits attached thereto, are incorporated herein by reference. A summary of the facts follows. Petitioners Murray Kay and Ida Kay, husband and wife, Saul Bolton and Ethel Rose Bolton, husband and wife, and Ralph Trustman and Blossom Trustman, husband and wife, reside in Los Angeles, Calif. Louis L. Colen and Freda Colen, deceased, were husband and wife residing in Los Angeles, Calif., in 1959 and 1960. Each husband and wife filed joint Federal income tax returns for the years 1959 and 1960 with the district director of internal revenue, Los Angeles, Calif., on calendar years basis and cash method of reporting. References herein to petitioners, or to the individual petitioners by last name, will be to the corporation and the husband-petitioners, unless otherwise indicated. Plastic Glide Corp. (hereinafter referred to as Plastic Glide) is a California corporation and filed its corporate income tax returns for its fiscal years ended July 31, 1959, July 31, 1960, and September 30, 1960, with the district director of internal revenue in Los Angeles, Calif., on a fiscal year basis and accrual method of accounting. Bolton, Trustman, and Colen were president, secretary, and treasurer, respectively, and each owned 28.45 percent of the stock of Plastic Glide. Kay was an employee of Plastic Glide and owned 9.91 percent of its stock. Sometime during the latter part of 1958, and prior to February 18, 1959, the individual petitioners, for themselves and Plastic Glide, had meetings with an insurance broker representing State Mutual Life Page 662 Assurance Co. of America (hereinafter called State Mutual) to discuss life insurance. The broker suggested a plan for purchasing life insurance, which was referred to as ‘ A Self Funding Loan,‘ using State Mutual's ‘ Equity Building Whole Life’ policies. The broker prepared a chart for each petitioner, including Ida Kay and Plastic Glide, based on a $100,000 policy for each prospective applicant at their respective ages, which reflected the insurance data over a period of 20 years as well as the financial data for that period before and after taxes (using an assumed tax bracket) if the policies were purchased under the self-funding loan plan. In summary, under the self-funding life insurance plan, as described by the broker, arrangements are made with a financial institution to loan to the owner of a life insurance policy an amount equal to 20 annual premiums on the policy, with interest payable annually in advance at rates of 4 5/8 percent to 4 3/4 percent. As security for the loan the lending institution has the owner-borrower buy Government securities in the face amount of the loan. The borrower then pledges and assigns the insurance policy and the Government securities to the lending institution as collateral for the loan. Under the assignment of the insurance policy the lending institution is authorized to borrow on the policy and surrender it for its cash surrender value. Under the collateral agreement the lending institution is also authorized to pledge, hypothecate, transfer, borrow on, or otherwise apply, use, or deal with the collateral pledged. The lending institution guarantees a 2-percent return to the borrower on the securities pledged. Gains or losses on the securities inure to the lending institution. The collateral note given by the borrower to the lending institution is nonnegotiable and the lending institution agrees to look solely to the collateral pledged for payment of principal and interest on the loan in case of default. Upon prepayment of the loan or death of the insured the securities then held as collateral are first applied to liquidate the loan and the balance necessary is paid out of the cash surrender value or death benefits of the insurance policy. The equity of the borrower is the surplus of cash surrender value or death benefits under the policy. The ‘ Equity Builder Whole Life’ policy issued by State Mutual provides a death benefit up to age 65 equal to the face amount of the policy plus the cash values of the policy; thereafter the death benefit is the face amount. The policy pays nonguaranteed dividends. The policy has a cash surrender and loan value equal to the full reserve under the policy as set forth in a schedule therein. The policy provides that the owner shall have the right to obtain a loan for the sole Page 663 purpose of paying premiums on the policy. The policy provides as follows with reference to policy loans: At any time after the first year's premium has been paid on this policy, provided it is not continued as extended insurance, a loan may be obtained from the Company on the sole security of this policy of a sum which, with interest, shall not exceed the loan value at the end of the policy year as shown by the accompanying table and the value of any paid-up additions thereto, less any indebtedness to the Company under this policy, and any unpaid portion of the premium for the then current policy year. * * * Interest on such loans shall be paid at the rate of five per cent (5%) annually, payable at the end of each year * * * . Any interest not paid when due or unpaid when the loan is increased, shall be added to and become a part of the principal of the loan and subject to the same rate of interest. * * * Typical of the charts furnished the petitioners by the insurance broker, illustrating the use of the self-funding loan plan, is the following, which is in condensed form, omitting intervening years: LOUIS L. COLEN- State Mutual Life Assur. Co. of Amer. $100,000 equity builder whole life * * * ann. prem. $4662.75 to age 60- thereafter $4522.75 to age 65- prem. from age 65 $3,858.00 loan $93,000- guaranteed int. rate 4 3/4% for 16 yrs. Thereafter 4 5/8%- security yield 2%

1 2 3 4 5 6

Total Total Amount Net Excess Annual

Year death cash due death cash gross

benefit value lender benefit value interest

1 $102,646 $2,646 $2,646.00 $100,000.00 0 $4,417.50

5 113,269 13,269 13,123.33 100,145.67 145.67 4,417.50

10 126,152 26,152 25,375.83 100,776.17 766.17 4,417.50

15 137,482 37,482 36,286.33 101,195.67 1,195.67 4,417.50

20 145,369 45,369 44,013.37 101,355.63 1,355.63 4,301.25

Averages 100,728.07

7 8 9 10 11 12

Annual Annual Assuming Dividend Net Net

outlay amount

Year securities net gross 70% tax available after freed for

yield interest bracket nontaxable dividend investment


1 $1,766.74 $2,650.76 $795.23 $331.00 $464.23 $4,198.52

5 1,393.72 3,023.78 907.13 471.00 436.13 4,226.62

10 927.45 3,490.05 1,047.02 974.00 73.02 4,589.73

15 461.17 3,956.33 1,186.90 1,314.00 127.10 cr 4,789.85

20 3.30 4,297.95 1,289.39 1,544.00 254.61 cr 477.36

Averages 3,512.59 1,053.77 951.20 102.58 4,532.17


1. Face of policy plus cash value.

2. Guaranteed cash value.

3. Fixed by contract-due lender upon termination.

4. Column 1 minus column 3.

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