Barrett v. Comm'r of Internal Revenue

• Decision Date: 31 August 1964
• Docket Number: Docket No. 4692-62.
• Citation: 42 T.C. 993
• Parties: W. STANLEY BARRETT AND IRENE B. BARRETT, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

42 T.C. 993

W. STANLEY BARRETT AND IRENE B. BARRETT, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 4692-62.

Tax Court of the United States.

Filed August 31, 1964.

Andrew P. Quinn and Richard F. Canning, for the petitioners.

J. Frost Walker, Jr., for the respondent.

Petitioner surrendered or exchanged 12 endowment policies on their maturity dates for 12 paid-up life insurances policies. Held:

1. Petitioners realized ordinary income in the amount of the excess of the cost of the paid-up life insurance policies over the cost of the endowment policies surrendered.

2. No estoppel exists against respondent because of statements made in a letter sent to one of petitioners from the office of respondent in response to a letter requesting a ruling.

OPINION

SCOTT, Judge:

Respondent determined a deficiency in the income tax of petitioners for the taxable year 1960 in the amount of $9,125 and an addition to the tax under section 6654 of the Internal Revenue Code of 1954 for underpayment of estimated tax in the amount of $83.95.

The two issues raised by the pleadings which remain for decision are:

(1) Whether petitioner W. Stanley Barrett realized long-term capital gain or ordinary income on the surrender or exchange of certain endowment policies at their maturity for paid-up life insurance policies.

(2) Whether respondent is estoppel from taking the position that the gain which petitioners realized on the exchange is taxable as ordinary income because of a letter from respondent's office addressed to one of petitioners in response to a request for a ruling.

All of the facts have been stipulated and are found accordingly.

Petitioners, husband and wife residing in Providence, R.I., filed a joint Federal income tax return for the calendar year 1960 with the district director of internal revenue at Providence, R.I.

W. Stanley Barrett, hereinafter referred to as petitioner, was the owner of and the insured under 12 endowment policies, 8 issued by the Travelers Insurance Co. and 4 by Massachusetts Mutual Life Insurance Co., each maturing during the year 1960.

Each of the policies contained provisions whereunder upon maturity of the policy the insured had the right to elect one of the following modes of settlement: (1) A monthly income payable to the insured during his lifetime; (2) a lump-sum cash payment; (3) a paid-up life insurance policy; (4) a lump-sum cash payment and a paid-up life insurance policy on the life of the insured.

A letter dated June 5, 1959, was drafted by petitioner's counsel, signed by petitioner, and mailed on the same date to the Commissioner of Internal Revenue. This letter set forth certain facts with respect to one of petitioner's insurance policies issued by Massachusetts Mutual Life Insurance Co., and assumptions as to the tax consequences of the various elections if he were living on the date the policy matured as an endowment policy. With respect to the election to accept a paid-up life insurance policy and the election to accept a lump-sum cash payment and a paid-up life insurance policy, the letter stated:

(c) If I accept in lieu of the deferred income a paid-up policy payable at death, I will experience no income and no capital gain because the exchange will be made within the terms of the policy and will not be a matter of negotiation with the insurance company.

(d) If I accept in lieu of the deferred income payable under the policy a cash payment and a paid-up contract payable at death, I will experience a capital gain in an amount equal to the difference between the amount of the cash payment plus the amount it would cost me to purchase such a paid-up policy on the date that the policy becomes an endowment policy and the net amount of the premiums paid (gross premiums paid less dividends received).

The concluding paragraph of this letter stated: ‘I respectfully request a ruling as to the tax consequences of (a), (b), (c) and (d) enumerated above.’

The statements of facts contained in the letter of June 5, 1959, with respect to the policy issued by Massachusetts Mutual Life Insurance Co. apply also to the remaining 11 policies in issue, except for dates and amounts.

Under date of July 15, 1959, a reply from the Office of the Commissioner of Internal Revenue was issued, signed by the Chief, Individual Income Tax Branch. The reply stated in part as follows:

This is in reply to your letter of June 5, 1959, in which you request a ruling relative to the optional provisions incorporated in your insurance policy.

In the absence of a copy of the insurance policy involved, this office is not in a position to make a specific ruling on your question. Your attention is called to section 7 of Rev.Rul. 54-172, C.B. 1954-1, 394, a reprint of which is enclosed.

We are furnishing you the following general information with the understanding that it does not constitute a specific ruling.

The Internal Revenue Service has held that if an insured exercises his right under an option to receive a paid-up life insurance policy in lieu of a cash payment, he in effect exchanges one kind of a policy for another and under certain circumstances realizes taxable gain as a result of such exchange. A policy is considered surrendered for a different type of policy when a supplementary insurance contract is issued or the original policy is amended or endorsed in such a manner that the policyholder is insured under a different type of policy. Revenue Ruling 54-264, C.B. 1954-2, 57. Under the provisions of section 1.1035-1(c) of the Income Tax Regulations, any gain or loss will be recognized in a transaction involving the exchange of an endowment contract or an annuity contract for a life insurance contract.

If the insured surrenders an endowment policy, pursuant to an election, in exchange for cash and a paid-up life insurance policy, he realizes taxable income. The amount of such taxable income is the excess of (1) the cash plus the value of the policy received over (2) the premiums paid, reduced by any dividends paid or credited to the policy holder. The phrase ‘value of the policy received’ means the same price that any person of the same age, sex and condition of health as the taxpayer would have to pay for a similar policy with the same company on the date the policy is surrendered. The cash surrender value of the policy is not to be used for this purpose. This principle applies to any type of endowment policy or life insurance policy surrendered in exchange for cash and a different type of policy.

If you still desire a specific ruling, please furnish the information requested as explained in section 7 of the reprint of Rev. Rul. 54-172.

Subsequent to receipt of the respondent's letter dated July 15, 1959, petitioner consulted his counsel, who examined the letter and advised him.

Petitioner's counsel submitted a memorandum to petitioner under date of January 6, 1960, enclosing a summary of the estimated taxes payable under the various options of petitioner's endowment policies which were to mature in 1960. The memorandum attached was a tabulation dated December 31, 1959, entitled ‘Summary re Endowment Policies.’ The tabulation showed computations of tax under designations ‘Lump-sum,’ ‘Paid-up Policy,‘ and ‘Cash and Paid-up Policy.’ Under the designations ‘Lump-sum’ and ‘Cash and Paid-up Policy’ the amounts on which tax was computed were shown as ‘Ordinary Income’ and tax was computed at 60 percent thereof. Under the designation ‘Paid-up Policy’ the amounts on which tax was computed were shown as ‘Capital Gain’ and tax was computed at 25 percent.

Effective upon maturity of each of the endowment policies here in issue, and within the taxable year 1960, petitioner elected with respect to each such policy to surrender that policy and did so surrender each such policy to the respective insurance company, and effective on the respective maturity date of each such policy received from the respective insurance company, a paid-up life insurance policy. Petitioners reported the resulting gain on their joint income tax return for 1960 as a long-term capital gain as follows:

+-----------------------------------------------------------------------------+
                ¦Replacement cost of paid-up life insurance policies received in   ¦$72,184.14¦
                ¦exchange for endowment policies                                   ¦          ¦
                +------------------------------------------------------------------+----------¦
                ¦Cost of endowment policies (premiums paid less dividends credited)¦49,948.47 ¦
                +------------------------------------------------------------------+----------¦
                ¦                                                                  ¦          ¦
                +------------------------------------------------------------------+----------¦
                ¦                                                                  ¦          ¦
                +------------------------------------------------------------------+----------¦
                ¦Gain                                                              ¦22,235.67 ¦
                +-----------------------------------------------------------------------------+
                

Respondent in his notice of deficiency determined that the $22,235.67 gain computed by petitioner on surrender of the endowment policies constituted ordinary income instead of long-term capital gain and recomputed petitioners' income tax accordingly under the provisions of section 72(e)(3) of the Internal Revenue Code of 1954,¹ providing for a limitation of tax on receipt of a lump sum under an annuity, endowment, or life insurance contract.

Petitioners in their petition assigned as errors respondent's determination that the gain realized by petitioners upon the exchange of the endowment policies was taxable as ordinary income rather than capital gain and respondent's refusal to concede that he was estopped from taking the position that such gain is taxable as ordinary income in view of a letter issued to petitioners. In his opening statement when the stipulation of facts...