CIR v. Phillips

• Decision Date: 20 February 1960
• Docket Number: No. 7857.,7857.
• Citation: 275 F.2d 33
• Parties: COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Percy W. PHILLIPS and Betty R. Phillips (Husband and Wife), Respondents.
• Court: U.S. Court of Appeals — Fourth Circuit

275 F.2d 33 (1960)

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Percy W. PHILLIPS and Betty R. Phillips (Husband and Wife), Respondents.

No. 7857.

United States Court of Appeals Fourth Circuit.

Reargued October 14, 1959.

Decided February 20, 1960.

Myron C. Baum, Atty., Dept. of Justice, Washington, D. C. (Chas. K. Rice, Asst. Atty. Gen., Lee A. Jackson and I. Henry Kutz, Attys., Dept. of Justice, Washington, D. C., on brief), for petitioner, and Percy W. Phillips, pro se, and as Atty. for Betty R. Phillips.

Before SOBELOFF, Chief Judge, BOREMAN, Circuit Judge, and HOFFMAN, District Judge.

WALTER E. HOFFMAN, District Judge.

By this appeal we are called upon to consider the tax status of a transaction wherein the taxpayer, admittedly motivated by a desire to minimize taxes, sold an endowment policy twelve (12) days prior to its maturity, and thereafter treated the excess received by him, over and above the cost of said policy, as a capital gain. The Commissioner contends that the questioned transaction was merely a transfer of the right to receive ordinary income taxable as such. The Tax Court concluded the issue favorably to the taxpayer. Percy W. Phillips, (June 30, 1958) 30 T.C. 866.

The taxpayer is an attorney specializing in tax matters. In 1931 The Connecticut Mutual Life Insurance Company insured taxpayer's life for the sum of $27,000. At that time the taxpayer was married and had four children, the oldest being nine years of age, and the youngest of whom was three. On April 18, 1938, pursuant to the provisions of the life insurance policy, taxpayer converted same to a fully paid endowment policy providing for the payment of $27,000 to him on March 19, 1952, if he was living at that time, or to his estate or named beneficiary upon his earlier death. Taxpayer prepaid, on April 18, 1938, the annual premiums of $1,444.78 (including an item of $127.45 for a disability provision) for twenty-one years. Presumably the premiums were prepaid at a discount not revealed by the record.

As of March 7, 1952, the cost of the policy to the taxpayer was $21,360.49, and the cash surrender value was $26,973.78. As noted, twelve days thereafter the policy matured in the face amount of $27,000.00.

On March 7, 1952, taxpayer assigned and transferred all of his right, title and interest in and to said policy to his two partners, Barker and Reid, for a cash consideration of $26,750, which amount was received and deposited in taxpayer's checking account on the same date. The assignment was executed on a form provided by the insurance company and, as we view the case, it is not essential that we refer to the contents thereof. Suffice it to say, it admittedly and irrevocably transferred any and all of taxpayer's interest in the policy.

The subsequent activities of the transferor and transferees are of little moment. The taxpayer invested a large portion of the proceeds of the sale of the policy in securities and, to a lesser extent, in assisting in the financing of a home purchased by his son-in-law; all of which was accomplished prior to the maturity date of the policy. The transferees, Barker and Reid, assigned and transferred their right, title and interest in the policy to a banking institution and, upon maturity of the policy on March 19, 1952, the insurance company paid the financial institution the face amount of the policy ($27,000), plus a dividend of $117.45.

Admittedly, had this policy been surrendered by the taxpayer, either at maturity for its face amount or earlier for its cash surrender value, it would not be considered a sale or exchange and the excess of the proceeds over taxpayer's cost basis would have been taxable as ordinary income. Bodine v. Commissioner, 3 Cir., 103 F.2d 982, certiorari denied 308 U.S. 576, 60 S.Ct. 92, 84 L. Ed. 483; Avery v. Commissioner, 9 Cir., 111 F.2d 19; Blum v. Higgins, 2 Cir., 150 F.2d 471, 160 A.L.R. 1093; cf. Osenbach v. Commissioner, 4 Cir., 198 F.2d 235. By the means of a sale prior to maturity, may the excess of proceeds over cost be considered a capital gain?

In this setting let us examine the facts of this case in the light of the statutes and judicial decisions. It is expressly provided that annuities received under a life insurance or endowment contract are taxable, as to the excess over the aggregate premiums or consideration paid, as a part of gross income. Sec. 22(b) (2) (A), Internal Revenue Code of 1939; 26 U.S.C. § 22 (1952 Ed.). The taxpayer herein is not a dealer in securities or life insurance policies. The policy in controversy provided for annual participation by way of dividends "in the divisible surplus which shall be determined and apportioned by the Company". Unlike the annuity in Arnfeld v. United States, Ct.Cl., 163 F.Supp. 865, certiorari denied 359 U.S. 943, 79 S.Ct. 722, 3 L.Ed.2d 676, which guaranteed a fixed rate of return and contained no life insurance feature,¹ the endowment policy reserve or cash value was always less than the amounts paid into the company. Excluding any dividend or rebate on premiums, the insured could only profit on his investment by dying long prior to the maturity date of the policy. The dividend declared is dependent upon a myriad of economic factors including, among others, the death rate of other policyholders, the yield on investments, government subsidies, bad debts, capital gains and losses, taxes, salaries, fringe benefits for the company's employees, and other items too numerous to mention. In the present day it is, of course, difficult to comprehend that any reliable mutual life insurance company will fail to declare a dividend, but we must determine the question presented without regard to economic conditions now existing.

The taxpayer agreed to and did prepay the premiums for twenty-one years at an annual figure of $1,444.78, or a total of $30,342.48. If we eliminate the premium for the "disability provision", the total payments would aggregate $27,663.93, without consideration of any discount feature for prepayment. The company obligated itself to pay $27,000, or less than the total agreed premium payments. The net premiums prepaid, after deduction for excess premiums refunded annually by way of dividends or rebates on premiums, were $21,360.49.

We have no hesitancy in agreeing with the Tax Court on certain basic principles. The legal right of the taxpayer to decrease the amount of his taxes, or altogether to avoid them, by means which the law permits, cannot be doubted. Gregory v. Helvering, 293 U. S. 465, 55 S.Ct. 266, 79 L.Ed. 596; United States v. Isham, 17 Wall. 496, 506, 21 L.Ed. 728; Superior Oil Co. v. State of Mississippi, 280 U.S. 390, 395, 50 S. Ct. 169, 74 L.Ed. 504; Commissioner of Internal Revenue v. Tower, 327 U.S. 280, 66 S.Ct. 532, 90 L.Ed. 670; Arnfeld v. United States, supra; Paine v. Commissioner, 8 Cir., 236 F.2d 398. If, upon careful scrutiny, the transaction has real substance and is not a sham, it matters not whether the taxpayer's aim was "to avoid taxes, or to regenerate the world". Chisholm v. Commissioner, 2 Cir., 79 F.2d 14, 15, 101 A.L.R. 200. The sale must be real and bona fide with no vestige of control retained over the policy or its transferees by means of utilizing wholly owned corporations and like devices which follow the line of cases relied upon by the Commissioner. The Tax Court held that there had been full compliance with the requirements of a real and bona fide sale, and the fact that the purchase by the transferees may have been one of accommodation does not affect the nature of the transaction as a sale. John D. McKee, et al., Trustees, 35 B.T.A. 239. Disregarding the motive and accommodation factors, as we must for this purpose, it necessarily follows that the Tax Court was correct in concluding that the transaction represented an unequivocal and bona fide sale.

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