Carbine v. Comm'r of Internal Revenue

• Decision Date: 18 September 1984
• Docket Number: Docket No. 26092-81.
• Citation: 83 T.C. 356,83 T.C. No. 23
• Parties: JOHN D. CARBINE and ELEANOR W. CARBINE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

83 T.C. 356

83 T.C. No. 23

JOHN D. CARBINE and ELEANOR W. CARBINE, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 26092-81.

United States Tax Court

Filed September 18, 1984.

T, a minority stockholder of BCA, was not only a guarantor of a note given by BCA to a bank but he had also put up his own securities as collateral. To secure the note further BCA obtained an insurance policy on T's life, and, as owner, assigned it to the bank. As a result of financial difficulties, BCA became unable to pay the premiums in full and meet its other obligations to the bank. T thereupon paid those portions of the premiums in 1977 and 1978 that remained unpaid by BCA. T's purpose in making such payments was to protect his securities which had been put up as collateral with the bank.

HELD, (1) such payments constituted ordinary and necessary non-business expenses within sec. 212(2), I.R.C. 1954; (2) such payments were not ‘personal, living or family expenses‘ the deduction of which is precluded by sec. 262; but (3) T was ‘indirectly‘ a beneficiary of the policy by reason of the protection afforded to his collateralized securities, and sec. 264(a)(1) bars the deductions otherwise allowable under sec. 212(2). Meyer v. United States, 175 F.2d 45 (2d Cir. 1949), followed: HARRY K. MANSFIELD, for the petitioners.

PAUL J. DEE, for the respondent.

OPINION

RAUM, JUDGE:

The Commissioner determined deficiencies in petitioners' Federal income tax in the amounts of $12,937.90 and $2,354.41 for 1977 and 1978, respectively. After concessions, the sole issue for decision is whether petitioners may deduct premiums paid with respect to an insurance policy on the life of petitioner John D. Carbine. The case was submitted on the basis of a stipulation of facts.

Petitioners John D.Carbine (sometimes hereinafter referred to as ‘petitioner‘ or ‘Carbine‘) and Eleanor W. Carbine, husband and wife, resided in Haines City, Florida, when they filed their petition herein. They timely filed joint Federal income tax returns for the calendar years 1977 and 1978 with the Internal Revenue Service at Andover, Massachusetts. These returns list Carbine's occupation as ‘attorney‘ and attached Forms W-2 show his ‘Wages, tips and other compensation‘ (presumably related to his occupation as an attorney) to be $91,347.20 for 1977 and $105,496.85 for 1978.

During the years in issue Carbine resided in Vermont and practiced law in that state. Among other investments, he held a 20 percent stock interest in Burgess-Carbine Associates, Inc. (BCA), a Vermont corporation engaged in the business of a general insurance agency. The other shareholders of BCA, each of whom also owned 20 percent of BCA's stock, were Stephen A. Carbine (Carbine's son), Ronald N. Burgess, Mr. Burgess' mother-in-law, and Mr. Burgess' brother.

On November 28, 1973, BCA obtained a loan commitment from First Vermont Bank and Trust Company (the Bank) for the purpose of financing the purchase of the L.A. Appell Agency (the Agency), an insurance agency then owned by Leonard A. Appell (Appell). The Bank agreed to advance BCA an initial amount of $65,000, with subsequent advances to be made up to a total of $225,000. The commitment provided that an aggregate of $125,000 would be advanced on an unsecured basis (subject to a review of the combined operating figures for BCA and the Agency as of September 30, 1974) with the remainder secured by stocks and bonds. In addition, it specifically required Carbine to guarantee all BCA notes issued under the commitment and to hypothecate the stocks and/or bonds needed to secure the loan.

On December 14, 1973, BCA and Appell entered into an agreement whereby BCA purchased all of the Agency's assets for $250,000.¹ Under the terms of the sales agreement, BCA was required to pay $5,000 of the purchase price immediately and the remainder in equal installments of $20,416.67 on the 10th day of January, April, July, and October of 1974, 1975, and 1976. The Bank disbursed the initial $65,000 loan amount to BCA as follows:

+-------------------------+
                ¦$5,000¦-¦Initial deposit ¦
                +------+-+----------------¦
                ¦20,000¦-¦January 1974    ¦
                +------+-+----------------¦
                ¦20,000¦-¦April 1974      ¦
                +------+-+----------------¦
                ¦20,000¦-¦July 1974       ¦
                +-------------------------+
                

Subsequent to these disbursements, the Bank made several additional advances pursuant to the loan commitment, all of which were evidenced by notes to BCA.

The record is unclear as to whether Carbine in fact ever hypothecated any securities pursuant to the loan commitment. However, on October 8, 1975, in a transaction independent of that loan, Carbine signed a general hypothecation agreement covering all obligations of BCA to the Bank whenever arising. Pursuant to this latter agreement, Carbine pledged certain securities and insurance policies ² which he owned to the Bank.

In 1976 BCA sold the major part of its assets and its casualty insurance business to Smith-Bell, another insurance agency, for cash and a note. Thereafter, BCA continued to conduct only a small volume of life insurance and pension business.

On November 1, 1976, the outstanding notes of BCA under the 1973 loan commitment were consolidated into a single new seven-year term note of $137,000. Carbine guaranteed this term note as an endorser and, ‘(p)ursuant to (this) * * * term Loan * * * pledged stock owned by him to the Bank to secure BCA's indebtedness‘.³ Under the provisions of this term note, the Bank could dispose of the pledged stock if BCA defaulted on its obligations or if the Bank determined that the collateral available to it had become insufficient to secure BCA's obligations unless additional collateral was deposited or the note was paid down.

On January 24, 1977, BCA obtained an insurance policy on Carbine's life (the policy). The policy listed BCA as its owner and BCA and the First National Bank of Boston, Trustee of the John D. Carbine Trust dated May 19, 1975,⁴ as its beneficiaries. On March 3, 1977, BCA assigned the policy to the Bank as additional security for the term note. BCA also altered the policy's beneficiary designation so as to eliminate any interest of the First National Bank of Boston, Trustee of the John D. Carbine Trust, and so as to provide that the policy's proceeds would continue to be payable to BCA to the extent of any premiums that had become due and been paid at the time of Carbine's death, less any policy indebtedness. The Bank's interest as assignee of the policy does not appear to have been adversely affected.

During 1977 and 1978 BCA encountered financial difficulties and became unable to pay both the amounts owing on the term note to the Bank and the policy's premiums. BCA chose to apply its limited funds first to the payment of the term note ⁵ and then to the payment of some of the premiums. Because nonpayment of the premiums would have allowed the Bank to sell the securities owned by Carbine and held by the Bank under the general hypothecation agreement and the term loan, Carbine personally paid all premiums on the policy which were not paid by BCA. BCA was not obligated to, and did not in fact, reimburse petitioner Carbine for these payments.

Carbine made total premium payments with respect to the policy of $14,486.59 in 1977 and $8,912.73 in 1978. Petitioners treated these amounts as expenses incurred ‘to protect * * * collateral‘ and claimed a deduction under section 212, I.R.C. 1954, for the respective amounts on their 1977 and 1978 Federal income tax returns. In the deficiency notice herein, the Commissioner disallowed these deductions on the ground that petitioners had not established that the amounts were ‘ordinary and necessary business expenses (within section 162(a))‘.

Petitioners never did claim any such section 162(a) ‘business‘ expense deduction; their sole position rests upon section 212(2), and indeed they argue affirmatively, as will hereinafter appear, that the expenses were not incurred in any trade or business conducted by Carbine. Their basic position is that the claimed deduction is allowed by section 212(2) since the payments were made to protect Carbine's securities which had been put up as collateral for the Bank's loan to BCA. The Commissioner now contends (1) that section 212(2) is inapplicable because the payments were not ‘ordinary and necessary‘, (2) that in any event, the deduction is forbidden by section 262 relating to ‘personal, living, or family expenses‘, and (3) that it is also foreclosed by section 264(a)(1) relating to life insurance premiums. We shall proceed to consider each of these points.

1. SECTION 212(2). The pertinent provisions of section 212(2) of the 1954 Code allow a deduction to individuals for all the ‘ordinary and necessary expenses‘ incurred or paid ‘for the management, conservation, or maintenance of property held for the production of income‘. These provisions had their origin in section 23(a)(2) of the 1939 Code, which had been added to that Code in 1942 by section 121 of the Revenue Act of 1942, 56 Stat. 798, 819. Theretofore, deductions for ‘ordinary and necessary‘ expenses were allowed under section 23(a) of the 1939 Code only with respect to the carrying on of a ‘trade or business‘. The 1942 amendment divided the old section 23(a) into two parts, one, section 23(a)(1), dealt with the previously deductible ‘trade or business‘ expenses, now covered by section 162 of the 1954 Code; the other, section 23(a)(2), dealt with a new category of deductions relating to non-trade or non-business expenses, now covered by section 212 of the 1954 Code involved herein. These new provisions were intended to allow deductions in respect of certain income or profit-oriented situations, notwithstanding the absence of a related ‘trade or business‘. But all the other requirements for deductibility of ‘trade or business‘ expenses remained applicable to this new class of non-trade or non-business deductions. See Trust of...