Whitcomb v. C.I.R., 83-1847

• Decision Date: 10 May 1984
• Docket Number: No. 83-1847,83-1847
• Citation: 733 F.2d 191
• Parties: 84-1 USTC P 9472 Arthur K. WHITCOMB and Lena R. Whitcomb, Arthur Whitcomb, Inc. and Subsidiaries, Petitioners, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent, Appellee.
• Court: U.S. Court of Appeals — First Circuit

Page 191

733 F.2d 191

84-1 USTC P 9472

Arthur K. WHITCOMB and Lena R. Whitcomb, Arthur Whitcomb Inc. and Subsidiaries, Petitioners, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent, Appellee.

No. 83-1847.

United States Court of Appeals First Circuit.

Argued April 6, 1984.

Decided May 10, 1984.

Chester M. Howe, Boston, Mass., with whom Gaston Snow & Ely Bartlett, Boston, Mass., was on brief, for appellants.

Joan I. Oppenheimer, Atty., Tax Div., Washington, D.C., with whom Glenn L. Archer, Jr., Asst. Atty. Gen., Michael L. Paup, Atty., Tax Div., and Ann Belanger Durney, Atty., Tax Div., Dept. of Justice, Washington, D.C., were on brief, for appellee.

Before BOWNES, ALDRICH and BREYER, Circuit Judges.

BOWNES, Circuit Judge.

Petitioners-appellants, Arthur Whitcomb, Inc., and Subsidiaries (Company), appeal a decision from the United States Tax Court, 81 Tax Court 505 (1983), holding that the Company was not entitled to a deduction for the cost of life insurance premiums on a policy covering the Company's former president, Arthur K. Whitcomb. The Tax Court determined income tax deficiencies of $2,624 and $18,242 for 1974 and 1975 for the Company, and $2,877.52 and $17,115.55 for Arthur and Lena Whitcomb. The individual taxpayers, Arthur and Lena Whitcomb, have conceded tax liability and the only issue is the Company's liability.

The issue on appeal is whether the Tax Court erred in finding that the premiums the Company paid for term life insurance on Arthur Whitcomb after his retirement were not compensation for services to the Company and, therefore, not deductible.

We affirm.

The Facts

The Company originated in 1946 when Whitcomb formed Arthur Whitcomb, Inc., naming himself president and treasurer. Arthur Whitcomb, Inc., is a general management company, overseeing other corporations formed by Whitcomb in New Hampshire and Vermont. These corporations produce and sell building supplies, sand, gravel, concrete, and concrete building blocks, as well as rent heavy construction equipment. Some of the corporations were Arthur Whitcomb, Inc., subsidiaries while others were affiliates.

In 1974 and 1975, the common stock of the Company was owned exclusively by members of the Whitcomb family who held, directly, or indirectly, the stock of the other corporations in approximately the same proportions as they did the parent company holdings.

At age sixty-four, in October, 1971, Arthur Whitcomb retired from the Company with a $21,000 annual pension. After his retirement, Whitcomb spent about six months a year in Florida, where he operated Miramar Lakes, Inc., a sand and gravel business he started in 1971 or 1972. For the years 1972 through 1975, the remaining six months were spent in New Hampshire working for the Company. James Wirths, comptroller of the Company, testified that during this time Whitcomb was very active in the Company, shouldered the same responsibilities that he had carried prior to his retirement, was still considered the boss despite the fact that his son, Robert, had been president of the Company since 1971 and that Arthur Whitcomb's services were worth $40,000 a year to the Company. Whitcomb was not carried on the books as an employee, nor was he ever paid any salary after his retirement.

Prior to Whitcomb's retirement, the Company initiated a group term life insurance plan for its active, full-time employees, which was in effect from December 27, 1968, to November 1, 1974. The Company purchased the insurance policy from Mutual Benefit Life Insurance Company. Whitcomb was not covered under this insurance plan.

In 1973, the Company determined that on Whitcomb's death his estate tax liability would be approximately one million dollars, and realized that his estate would not have the liquidity necessary to pay the estate tax. It, therefore, purchased a separate one million dollar whole life insurance policy on Whitcomb with the Company as the named beneficiary. The annual premium was $69,500. On Whitcomb's death, the Company planned to use the policy proceeds to redeem Whitcomb's stock from the estate thus giving it the funds necessary to pay the estate tax. At no time did the Company claim that this policy was part of the group term plan, nor did it attempt to deduct the premium as a business expense for personal services actually rendered, 26 U.S.C. Sec. 162(a)(1).

In 1974 the Company decided to change its insurance coverage on Whitcomb for three reasons: to reduce the cost of the annual premium; to render the cost of the premiums deductible; and to preclude the amount of the premiums being included as income to Whitcomb. It, therefore, obtained, on November 1, 1974, a one million dollar term life insurance policy from the Provident Life and Accident Insurance Company, designating Whitcomb's son and daughter as the beneficiaries. The change from whole life to term insurance reduced the annual premium from $69,500 to $34,000. By eliminating itself as the designated beneficiary, the Company believed the premium could be deducted because 26 U.S.C. Sec. 264 no longer applied. ¹ The Company purported to include the policy in a "Plan of Group Life Insurance for Eligible Employees" adopted on November 1, 1974. This would have the effect of eliminating the cost of the premiums as income to Whitcomb under 26 U.S.C. Sec. 79(b)(1). ²

The plan covered five categories of employees, but Whitcomb was the only employee that qualified under category D, "Active full-time President, or retired President with at least 25 years of service with the Company." All employees, except Whitcomb, were insured by the Paul Revere Life Insurance Company, successor to Mutual Benefit.

On November 19, 1974, Whitcomb assigned all of his interest in the Provident policy to his son and daughter as tenants in common. In November, 1980, the Company cancelled the million dollar term life policy because of the increased liquidity of Whitcomb's assets and the questionability of the deductibility of the premiums by the Company.

The Deductibility of the Premium Payments

The question is whether the payment of the 1974 and 1975 term life insurance premiums were deductible under 26 U.S.C. Sec. 162(a)(1) ³ as "compensation for personal services actually rendered." Petitioner makes two arguments: one, that the Tax Court erred in framing the issue in terms of whether the payments were made as an "intent to compensate"; two, that the payments were in fact compensation for services rendered and the Tax Court's finding to the contrary was clearly erroneous.

The regulations and case law interpreting section 162(a)(1) set forth two requirements that must be satisfied before the deduction will be allowed. First the compensation must be intended to be payment for the services performed. Second, it must be reasonable. Treas.Reg. Sec. 1.162-7(a); see Paula Construction Company v. Commissioner of Internal Revenue, 58 T.C. 1055, 1058-59 (1972), aff'd without published opinion, 474 F.2d 1345 (5th Cir.1973); Electric & Neon, Inc. v. Commissioner, 56 T.C. 1324, 1340 (1970), aff'd without published opinion, 496 F.2d 876 (5th Cir.1974); Drexel Park Pharmacy, Inc. v. Commissioner of Internal Revenue, 48 T.C.M. (P-H) p 81,416 at 79,2096 (T.C.1981). Only the first requirement is at issue here.

Petitioner cites no cases holding that "intent to compensate" is not the key factor in determining whether the payments were made as compensation for personal services actually rendered. It seems to argue that intent should only be considered where the taxpayer erroneously characterizes the payments and then claims they were for compensation. The law is otherwise:

It is now settled law that only if payment is made with the intent to compensate is it deductible as compensation. Charles McCandless Tile Service v. United States, 422 F.2d 1336, 1339 (Ct.Cl.1970); Northlich, Stolley, Inc. v. United States, supra [177 Ct.Cl. 435, 368 F.2d] at 278 [1966]; Irby Construction Co. v. United States, , 290 F.2d 824, 826 (Ct.Cl.1961); Electric & Neon, Inc., supra at 1340; Klamath Medical Service Bureau, 29 T.C. 339, 347 (1957), affd. 261 F.2d 842 (C.A. 9, 1958), certiorari denied 359 U.S. 966 [79 S.Ct. 877, 3 L.Ed.2d 834] (1959); Twin City Tile & Marble Co., 6 B.T.A. 1238, 1247 (1927),...