Curcio v. Comm'r

• Decision Date: 09 August 2012
• Docket Number: Docket Nos. 10–3578–ag(L), 10–3585–ag(CON), 10–5004–ag(CON), 10–5072–ag(CON).
• Parties: Mark CURCIO, Barbara Curcio, Amy L. Smith, Samuel H. Smith, Jr., Stephen Mogelefsky, Roberta Mogelefsky, Ronald D. Jelling, Lorie A. Jelling, Petitioners–Appellants, v. COMMISSIONER of INTERNAL REVENUE, Respondent–Appellee.
• Court: U.S. Court of Appeals — Second Circuit

689 F.3d 217

110 A.F.T.R.2d 2012-5527

Mark CURCIO, Barbara Curcio, Amy L. Smith, Samuel H. Smith, Jr., Stephen Mogelefsky, Roberta Mogelefsky, Ronald D. Jelling, Lorie A. Jelling, Petitioners–Appellants,

v.COMMISSIONER of INTERNAL REVENUE, Respondent–Appellee.

Docket Nos. 10–3578–ag(L), 10–3585–ag(CON), 10–5004–ag(CON), 10–5072–ag(CON).

United States Court of Appeals,Second Circuit.

Argued: Jan. 5, 2012.

Decided: Aug. 9, 2012.

Joseph M. Pastore III, Smith, Gambrell & Russell, LLP (Ira B. Stechel, John T. Morin, Jennifer L. Marlborough, Wormser, Kiely, Galef & Jacobs LLP, on the brief), New York, NY, for Petitioners–Appellants.

Randolph L. Hutter, Attorney, Tax Division, Department of Justice, Appellate Section (Gilbert S. Rothenberg, Acting Deputy Assistant Attorney General, Thomas J. Clark, Attorney, Tax Division, on the brief), Washington, D.C., for Commissioner of Internal Revenue.

Before: WINTER, HALL, and CHIN, Circuit Judges.

CHIN, Circuit Judge:

In these consolidated cases, petitioners were owners of four small businesses that enrolled in purported life insurance plans for employees. Only the four principal owners and a stepson, however, were covered under the plans. The contributions to the plans—amounting to hundreds of thousands of dollars—were claimed as tax deductions by the businesses.

The Commissioner of Internal Revenue (the “Commissioner”) concluded that these contributions should not have been deducted because, inter alia, they were not “ordinary and necessary” business expenses within the meaning of the Tax Code. Disallowing the deductions resulted in additional pass-through income to petitioners on which they had not paid taxes. Accordingly, the Commissioner issued notices of deficiency to petitioners and assessed accuracy-related penalties.

Petitioners' cases were consolidated and tried before the United States Tax Court in March 2009. After trial, the tax court ruled in favor of the Commissioner, finding that petitioners owed deficiency payments and accuracy-related penalties. Petitioners appealed. We affirm.

BACKGROUND

The following facts are drawn from the tax court's findings and the record on appeal, including stipulations of the parties, documentary evidence, and testimony of petitioners and their witnesses.

A. The Benistar Plan

The Benistar 419 Plan (the “Plan”) was established in 1997 by Daniel E. Carpenter. It was designed to be a multiple-employer welfare benefit plan under 26 U.S.C. § 419A(f)(6). The “Plan provides death benefits funded by individual life insurance policies for a select group of individuals chosen by the Employer to participate in the Plan.” (Ex. 33–J (Benistar Plan Brochure)) (A 1824). The only benefits “claimed to be provided by or through [the Plan] are pre-retirement death benefits for covered employees of participating employers.” (First Stip. of Facts ¶ 41).

Businesses that enroll in the Plan contribute to a trust account maintained by the Plan. The Plan uses these contributions to acquire one or more life insurance policies on the lives of employees covered by the Plan; it withdraws funds from the trust account to pay the premiums on these policies. Each covered employee determines the type of insurance that the Plan will purchase on his behalf. Furthermore, the Plan allows participating businesses to choose the number of years for which contributions to the Plan will be required to fully pay for the death benefit or benefits provided through the Plan. The Plan is listed as the beneficiary on each insurance policy and passes on the death benefit to the covered employee.

The Plan also allows participating businesses to withdraw from, or terminate, participation at any time. Upon termination, the Plan can distribute the underlying policies to the insured employees. Until mid–2002, an underlying policy could be distributed at no cost to the covered employee. From mid–2002 to mid–2005, the Plan required that the covered employee be charged 10% of the “cash surrender value” in exchange for the underlying policy. (Carpenter Exam. at 274–76). Starting in mid–2005, the Plan purportedly began to charge covered employees the “fair market value” of the underlying policy upon termination. ( Id. at 125).¹

The Plan advertises several “advantages,” including (1) “Virtually Unlimited Deductions for the Employer”; (2) “Benefits can be provided to one or more key Executives on a selective basis”; (3) “No need to provide benefits to rank and file employees”; and (4) “Funds inside the BENISTAR 419 Plan accumulate tax-free.” (Ex. 33–J) (A 1825). Carpenter testified that “the beauty” of the Plan “is that you can put away extra money in good times and though the premium is not due, you can put away excess amounts of money, get a tax deduction today, and we don't put the premium in for years to come.” (Carpenter Dep. at 262).

B. Curcio and Jelling

Petitioners Marc Curcio and Ronald D. Jelling each own 50% of three car dealerships: Dodge of Paramus, Inc. (“Dodge”), Chrysler Plymouth of Paramus, Inc. (“Chrysler Plymouth”), and JELMAC LLC (“JELMAC”).

In or about 2001, Curcio and Jelling decided to enter into a buy-sell agreement.² The buy-sell agreement contemplated that if one partner died, the other would buy the deceased partner's 50% stake in the businesses. When the buy-sell agreement was executed, it set the value of the businesses at $12,000,000. To fund the purchase if it became necessary, each partner agreed to take out an insurance policy on the other's life. In other words, each partner would list the other as the beneficiary of his death benefit and the death benefit would be used to purchase the deceased partner's share of the businesses.

Instead of purchasing life insurance policies directly, however, Curcio and Jelling decided to insure themselves through the Plan. Accordingly, Dodge enrolled in the Plan on December 28, 2001. Curcio and Jelling were the only covered employees. They did not choose to insure any of the other 75 people employed by Dodge. Neither Chrysler Plymouth nor JELMAC enrolled, nor were any of their employees, other than Curcio and Jelling, covered.

Curcio and his insurance agent, Robert Iandoli, selected a whole life policy with a $9,000,000 death benefit. Jelling and his insurance agent, Alan Solomon, chose two policies—one whole life policy and one universal (or adjustable) life policy—totaling approximately $9,000,000 in coverage. Curcio paid a $200,000 annual policy premium to the Plan. Jelling paid the same.

Although Dodge was the only entity to enroll in the Plan, Dodge was not always the only entity to contribute to the Plan. In fact, all three Curcio/Jelling business entities contributed to the Plan, with whichever entity having the highest cash balance at the end of the year doing so. Dodge contributed $400,000 in 2001 and 2002. JELMAC contributed $400,000 in 2003 and Chrysler Plymouth contributed $400,000 in 2004. Each business claimed a tax deduction for the entirety of its contribution. Jelling testified that he considered the contributions “as a funding for our buy sell agreement.” (Jelling Exam. at 581).

Curcio and Jelling had asked their accountant, Stuart Raskin, about the deductibility of the contributions. Raskin consulted with his partners and, based on a letter from the law firm Edwards & Angell, LLP, concluded that a deduction was proper.³ Raskin advised Curcio and Jelling that the deduction was proper, but also communicated that this opinion was derived solely from the Edwards & Angell letter, and not from any independent research or investigation. Furthermore, Raskin did not offer Curcio or Jelling any assurances that the I.R.S. would approve the deductions. Neither Raskin, nor anyone at his firm, was an expert in welfare benefit plans.

C. Smith

Petitioner Samuel H. Smith was, at all relevant times, the sole owner of SH Smith Construction, Inc. (“Smith Construction”). Smith Construction enrolled in the Plan in 2002. Although Smith Construction had 35–40 employees, it chose to insure only Smith through the Plan. On the insurance application, Smith indicated that the purpose of the insurance was “retirement planning.” (Ex. 116–J at 3) (A 3125). Smith chose a variable life policy with a death benefit of $5,000,000 and annual premium payments of $54,000. In 2003, Smith Construction claimed a $54,000 deduction for its contribution to the Plan.

By September 2005, Smith Construction had paid a total of $171,500 in premiums, and the policy had an accumulated cash value of $152,259.

By letter dated September 27, 2005, Smith requested that Benistar terminate his participation in the Plan. Moreover, he stated that he “would like to purchase the policies ... and take ownership of the[m].” (Ex. 129–J) (A 3203). The Plan provided that Smith could purchase his policy by paying “10% of the net cash surrender value of the policy.” (Ex. 175–J (Plan Termination and Policy Transfer Release Form)) (A 3372). Smith paid $2,970. This amount, however, equaled 10% of his policy's net cash surrender value on December 31, 2004, not 10% of the net cash surrender value in September 2005, when Smith terminated his company's participation in the Plan and requested the transfer. In fact, his policy's net cash surrender value in September 2005 was $83,158, 10% of which would be $8,316. In April of 2006, Smith withdrew $77,300 from his policy. In January 2007, Smith borrowed $16,000 from his policy.

Smith testified at trial that he relied on his accountant's representation that contributions to the plan were deductible. He could not recall whether this representation was made orally or by email.

D. Mogelefsky

Petitioner Stephen Mogelefsky is the sole owner of Discount Funding Associates (“Discount”), a corporation that provides mortgage broker services. Discount enrolled in the Plan in late 2002 to obtain life insurance for Mogelefsky and his stepson, an employee of the company. Mogelefsky chose a $1,300,000 policy on his own life so that “in...