Todd v. Commissioner of Internal Revenue, 060611 FEDTAX, 26378-06

Docket Nº:26378-06.
Opinion Judge:HAINES, Judge
Attorney:David B. Shiner and Sanjay Shivpuri, for petitioners. Angela B. Friedman, Jason W. Anderson, and David S. Weiner, for respondent.
Case Date:June 06, 2011
Court:United States Tax Court

T.C. Memo. 2011-123




No. 26378-06.

United States Tax Court

June 6, 2011

David B. Shiner and Sanjay Shivpuri, for petitioners.

Angela B. Friedman, Jason W. Anderson, and David S. Weiner, for respondent.



After concessions, the issues for decision are: (1) Whether petitioner Frederick D. Todd II (petitioner) received a taxable distribution of $400, 000 from United Employee Benefit Fund (UEBF) in 2002; (2) alternatively, if petitioner did not receive a taxable distribution from UEBF in 2002, whether petitioner received $412, 973 of discharge of indebtedness income in 2003; (3) whether petitioners are liable for an addition to tax under section 6651(a)(1) for 2003; and (4) whether petitioners are liable for a section 6662 penalty for 2002 or 2003.1

Some of the facts have been stipulated and are so found. The stipulations of facts and the exhibits attached thereto are incorporated herein by this reference. At the time they filed their petition, petitioners resided in Texas.


Petitioner was a practicing neurosurgeon employed by Frederick D. Todd, II, M.D., P.A. (corporation), a Texas corporation of which petitioner was the sole shareholder, director, and president. The corporation also employed a few individuals who worked with petitioner.

On August 18, 1995, petitioner signed an application on behalf of the corporation to become a member of the American Workers Master Contract Group (AWMCG), authorizing AWMCG to represent the corporation in negotiations with the National Production Workers Union Local 707 (Local 707), the union representing the corporation's employees. The corporation agreed to provide eligible employees with a death benefit only (DBO) plan organized through the American Workers Benefit Fund (AWBF), a welfare benefit fund established between AWMCG and Local 707.

The agreement provided that upon a covered employee's death, AWBF would provide the employee's designated beneficiary with an amount equal to eight times the employee's annual income up to $6 million. However, AWBF's obligation to pay a death benefit ceased if the corporation's covered employee was voluntarily or involuntarily terminated or retired; if the corporation ceased making contributions; or if the master contract between the union and the master contract group was not renewed. As an eligible employee of the corporation, petitioner enrolled in the DBO plan, designating petitioner Linda D. Todd as the beneficiary of the $6 million death benefit. A few of petitioner's fellow eligible employees also participated in the DBO plan.

On September 5, 1995, petitioner submitted an application for life insurance to Southland Life Insurance Co. (Southland) on behalf of AWBF. On November 15, 1995, Southland issued a $6 million universal life insurance policy (policy No. 5160) on petitioner's life to AWBF. The annual premium on policy No. 5160 was approximately $100, 000. The policy was owned solely by AWBF to provide insurance to fund the death benefit owed by AWBF to petitioner's wife if petitioner died. The corporation made yearly contributions to AWBF on behalf of petitioner and his fellow covered employees and deducted those payments under section 419A(f)(5). Upon receipt of the corporation's yearly contribution, AWBF paid the premium on policy No. 5160.

On July 21, 1999, petitioner submitted another application for life insurance to Southland. On October 1, 1999, Southland issued a $6 million indexed universal life insurance policy (policy No. 8889) on petitioner's life that required an annual premium of approximately $100, 000. On December 3, 1999, petitioner transferred ownership of policy No. 8889 to AWBF. On January 28, 2000, AWBF rolled policy No. 5160, which had an accumulation value of $315, 773, into policy No. 8889 pursuant to section 1035, resulting in a single $6 million policy on petitioner's life.

On December 18, 2000, AWBF merged into United Employees Benefit Fund (UEBF). UEBF was a welfare benefit fund established between Professional Workers Master Contract Group and the Union of Needletrades, Industrial and Textile Employees, Local 2411 (Local 2411), to provide a DBO plan to eligible employees of participating employers. Before November 2001 petitioner's corporation made yearly contributions to AWBF on behalf of petitioner and his fellow covered employees and deducted those payments as contributions to AWBF. After receiving notice of the transfer of the insurance policies on the lives of the corporation's employees from AWBF to UEBF on November 15, 2001, the corporation made contributions to UEBF, which paid the premiums on the Southland life insurance policies held on the lives of petitioner and his covered employees.

Under article 8 of the UEBF Trust Agreement (trust agreement), the employer and employee trustees had discretionary authority to make loans to a plan participant on a nondiscriminatory basis.2 Upon an application and written evidence of an emergency or serious financial hardship from the eligible employee, the trustees could make a loan up to the amount of the present value of the death benefit.3 David Fensler was a certified employee benefit specialist and was the employer trustee and administrator of both UEBF and AWBF. James Skonicki was the employee trustee of UEBF from before 1998 through 2002. On May 20, 2002, Southland notified petitioner's insurance agent that the maximum available distribution from policy No. 8889 was $400, 000 and that any greater distribution would cause the policy to lapse. On July 11, 2002, petitioner submitted to UEBF an application for a loan of $400, 000 for "unexpected housing costs".

Upon receipt of petitioner's loan application, Mr. Fensler recommended to Mr. Skonicki that the loan4 to petitioner be approved. Neither Mr. Fensler nor Mr. Skonicki made further inquiries into the hardship claimed by petitioner. On August 26, 2002, Mr. Fensler submitted a policy loan request to Southland requesting a loan of $400, 000 on policy No. 8889. However, after receiving the loan check, Mr. Fensler decided that the 4.76-percent interest rate charged by Southland on the loan made the choice of a partial surrender from policy No. 8889 a better prospect.5 On August 30, 2002, petitioner agreed to a distribution, which would reduce the face value of policy No. 8889 to $5, 600, 000. On September 18, 2002, Southland reissued a check for $400, 000 to UEBF representing the distribution from policy No. 8889. Upon receipt of the funds from Southland, UEBF issued a check for $400, 000 to petitioner on September 25, 2002. On October 25, 2002, the corporation made its annual contribution to UEBF for petitioner's DBO plan, and on January 7, 2003, UEBF made a premium payment to Southland on policy No. 8889. After 2003, however, petitioner's corporation stopped making its annual contributions to UEBF on behalf of petitioner's DBO plan, and UEBF ceased premium payments on policy No. 8889.

The trust agreement provided that a loan from UEBF had to be secured by a pledge of the actuarially determined present value of the eligible employee's death benefit and evidenced by an executed promissory note that provided for payments at least quarterly. The trust agreement also required that the loan bear a reasonable rate of interest, taking into account the interest rates charged by persons in the business of lending money for loans which would be made under similar circumstances.

Six months after the $400, 000 check was delivered to petitioner, and after Mr. Fensler provided an amortization schedule, on March 21, 2003, petitioner signed a promissory note to UEBF in the amount of $400, 000. The stated interest on the note was 1 percent, and the note provided...

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