Crawford Fitting Co. v. United States

Decision Date16 January 1985
Docket NumberNo. C82-3008.,C82-3008.
Citation606 F. Supp. 136
PartiesCRAWFORD FITTING COMPANY, Plaintiff, v. UNITED STATES of America, Defendant.
CourtU.S. District Court — Northern District of Ohio

Ernest P. Mansour, David B. Cathcart, Mansour, Gavin, Gerlack & Manos Co., L.P.A., Cleveland, Ohio, for plaintiff.

Jason P. Green, Trial Atty., Tax Div., Dept. of Justice, Washington, D.C., Thomas Bauer, Asst. U.S. Atty., Akron, Ohio, for defendant.

MEMORANDUM OPINION

DOWD, District Judge.

This is an income tax refund suit brought by the taxpayer and plaintiff, Crawford Fitting Company, arising from the disallowance of an expense deduction to plaintiff of $20,485.00 for an "insurance premium" paid to a captive insurance company, the Constance Insurance Company. The disallowance of the deduction resulted in an income tax deficiency of $9,423.00 owed by the plaintiff to the defendant. Plaintiff contends that its payment of the insurance premium was deductible as an ordinary and necessary business expense under § 162(a) of the 1954 Internal Revenue Code. Defendant, however, argues that the taxpayer may not deduct the payment as an insurance premium where the risk of loss has not been shifted from or distributed beyond the plaintiff's economic family to an unrelated insurer. Accordingly, defendant argues that the payment made by the plaintiff to the Constance Insurance Company was a contribution of capital to Constance, and therefore, not a deductible premium.

I. PROCEDURAL HISTORY

Plaintiff paid the deficiency assessed against it, filed a timely refund claim, and then timely filed the instant action. Plaintiff sets forth one count in its complaint, in which it states that the government's disallowance of a business deduction in the amount of $20,485.00 for an insurance premium, resulting in the assessment of $9,243.00, plus interest and penalties, against it, and collection of the same, was erroneous and illegal. Plaintiff argues that it has overpaid its liabilities for income taxes for the year of 1978, and is therefore entitled to recover from the defendant the sum of $9,243.00, plus penalties and interest. The matter is now before the Court on a stipulation of facts by the parties, as follows:

II. FINDINGS OF FACT

By agreement of parties, a stipulation of facts was entered into the record as follows. All references to exhibits submitted by the parties are omitted.

1. Crawford Fitting Company (hereinafter referred to as "Crawford"), along with Nupro Company, Whitey Company and Cajon Company (hereinafter referred to as "manufacturing companies"), manufacture valves and fittings which are used in numerous applications. Among other applications, these valves and fittings are used in nuclear power plants, petrochemical plants, offshore oil rigs, scientific research and the space program.

2. There are seperately sic incorporated companies (hereinafter referred to as "support companies") that provide parts and/or services to the manufacturing companies.

3. Eastern Swagelok, Western Swagelok and Central Swagelok (hereinafter referred to as "regional warehouses") are separately incorporated regional warehouses which purchase products from the manufacturing companies. They are owned as follows:

                A.  Eastern—Fred A. Lennon            60%
                            Catherine Lennon Lozick         40%
                B.  Western— Fred A. Lennon           50%
                            Alice P. Lennon                 50%
                C.  Southern— Fred A. Lennon          54.5%
                             Catherine Lennon Lozick        45.5%
                D.  Central—Fred A. Lennon            55.6%
                            Catherine Lennon Lozick         44.4%
                

4. The regional warehouses, support and manufacturing companies are referred to hereinafter as the Crawford Companies.

5. The regional warehouses resell the products to a number of independently owned and operated Crawford distributors, The domestic distributors are exclusive dealers of Crawford.

6. Mr. Fred A. Lennon is the sole owner of Crawford. Mr. Lennon also has interests in various other corporations that provide parts and/or services to the manufacturing companies as set forth in Exhibit I. Alice P. Lennon is the wife of Mr. Lennon, Catherine Lozick is his daughter and John P. Lennon is his son.

7. The Crawford Companies had the need for a large amount of product and general liability insurance, which, by the year in issue, became very expensive.

8. Prior to establishing its own insurance company, the quotes the Crawford Companies received for insurance was generally an up front cash premium of $850,000.00 to obtain the first one million dollars of coverage. Constance was created because the Crawford Companies were unable to secure insurance at a reasonable price and without substantial limitations on the types and amounts of risk.

9. Constance Insurance Company (hereinafter referred to as "Constance") was chartered in March of 1978.

10. Constance was created under, and is governed by, the Colorado Captive Insurance Company Act C.R.S. § 10-6-101-130 (1973).

11. Constance has its headquarters in Denver, Colorado.

12. Constance is owned in the following manner:

                Entity  Percentage of Ownership
                Eastern Swagelok                     20%
                Western Swagelok                     20%
                Southern Swagelok                    20%
                Central Swagelok                     20%
                John Fant (A)                         5%
                F.J. Callahan (B)                     5%
                Ernest P. Mansour (C)                 5%
                Norge Tobbe (D)                       5%
                                                    ____
                                                    100%
                

N.J. Tobbe (D) is an assistant secretary of Crawford Fitting, John Fant (A) is an attorney employed by Crawford Fitting Co., F.J. Callahan (B) is the Executive Vice President of Crawford Fitting company, Ernest P. Mansour (C) is a partner in the law firm Mansour, Gavin, Gerlack & Manos Co., L.P.A. Mansour, Gavin, Gerlack & Manos has performed legal services for Crawford Fitting for a number of years.

13. The initial capitalization of Constance was a million dollars which was provided by the shareholders in proportion to their ownership interest.

14. Since the initial capitalization of Constance, there have been no additional capital contributions or sale of stock.

15. Since the initial capitalization of Constance, the only funds which it has obtained have been from insurance premiums paid by the Crawford Companies and Constance's investment income.

16. The Crawford Companies do not directly or indirectly indemnify Constance.

17. Constance was administered in 1978 by an independent group of insurance consultants and actuaries known as Alexander & Alexander who negotiated and drafted the policy on behalf of Constance.

18. Constance, for the period covered by 4-1-78 through 12-31-78, issued Policy # CGL-001, for comprehensive general liability and product liability insurance for the parties listed in Endorsement # 25, Pages 1 and 2. The named insured under the policy included Fred. A. Lennon, A.P. Lennon, J.P. Lennon, C.L. Lozick, Edward A. Lozick, approximately 45 Crawford Companies, the Profit Sharing and/or Pension Trusts and/or Plans of the Crawford Companies.

19. The 115 independent distributors, none of which are owned directly or indirectly by Crawford, are insured under the products liability coverage.

20. Nertz, Inc., is a named insured owned 100% by Ed Lozick. Ed Lozick is married to Catherine Lozick.

21. Ekohwerks Company is a named insured owned by Bernie Gallagher, William Tobbe, E.J. Callahan, Earl Shuffleberg and Steve Matousek.

22. Midwest Bank and Trust Company is the trustee of the Profit Sharing and/or Pension Trusts. Among other investments, the Trusts own and lease real property and screw machines.

23. The policy was drafted by Alexander & Alexander. The terms of the policy were negotiated by Alexander & Alexander on behalf of Constance.

24. All management fees for Alexander & Alexander were paid by Constance.

25. The policy provided coverage in the amount of $1,500,000. Constance retained $100,000 of the risk per occurrence, 100,000 aggregate, and reinsured the balance of $1,400,000 with an unrelated insurance company, The Bermuda Fire & Marine Insurance Co., Limited. Constance paid a premium of $475,000 for the reinsurance. The total premium for the policy for the period April 1, 1978 to April 1, 1979 was $575,000.

26. Risk retention and reinsurance was decided by the Constance Board of Directors based upon Alexander & Alexander's recommendations from its own actuarial experience. The Board of Directors of Constance determined how much of the risk would be retained and how much would be reinsured. This decision was based upon a recommendation of Alexander & Alexander based on their actuarial experience in the field.

27. The amount of the premium charged by Constance was suggested by Alexander & Alexander based on their actuarial information. In addition, the board considered premiums being charged in the industry.

28. Crawford paid $157,028 in premiums to Constance in 1978. The total premium for the policy for the period April 1, 1978 to April 1, 1979 was $575,000. Each company paid its premium to Constance with its own check. In the year ending December 31, 1978, Constance Insurance Company lost $60,490.

29. The United States of America allocated, based upon a method of proration $20,485 to the retained portion of Constance's risk. This resulted in the disallowance to Crawford of an expense deduction in the amount of $20,485 for the period in question.

30. Constance, under the terms of the policy with Crawford, must provide coverage during the policy period for claims made at any time for products manufactured by the Crawford Co. and it is required to defend claims and pay the legal expenses related to them.

31. For risk to be reinsured there has to be a primary insurance policy.

32. Constance paid all liabilities incurred by Crawford within the scope of the policy without any direct or indirect reimbursement from Crawford.

33. The...

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