Golsen v. CIR, 310-70.

• Decision Date: 18 June 1971
• Docket Number: No. 310-70.,310-70.
• Citation: 445 F.2d 985
• Parties: Jack E. GOLSEN and Sylvia H. Golsen, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

445 F.2d 985 (1971)

Jack E. GOLSEN and Sylvia H. Golsen, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

No. 310-70.

United States Court of Appeals, Tenth Circuit.

June 18, 1971.

Julian P. Kornfeld, of Andrews, Mosburg, Davis Elam, Legg & Kornfeld, Oklahoma City, Okl., for appellants.

Johnnie M. Walters, Asst. Atty. Gen. (Joseph M. Howard, Bennet N. Hollander and William S. Estabrook, Attys., Tax Div., Dept. of Justice, on the brief), for appellee.

Before LEWIS, Chief Judge, and McWILLIAMS and DOYLE, Circuit Judges.

WILLIAM E. DOYLE, Circuit Judge.

This is an action in which the plaintiffs-appellants sought an income tax refund in the amount of $2,918.15 growing out of an assessed deficiency for the taxable year 1962. The item in dispute is tax assessed on what purports to be an interest payment to Western Security Life Insurance Company. The taxpayers deducted this interest in the amount of $12,441.40. The Commissioner disallowed the interest deduction whereupon this action was commenced. The Tax Court upheld the Commissioner, thus determining that the interest deduction was not proper under 26 U.S.C. § 163(a).¹

The case before us revolves around the issuance on January 31, 1962, by Western Security Life Insurance Company to the Golsens life insurance in the face amount of $1,000,000 consisting of twenty "executive special" policies, each having a face amount of $50,000 and an effective date of December 28, 1961. They named Jack E. Golsen as insured, and Mrs. Golsen as beneficiary; their three children are contingent beneficiaries. The "executive special" policies appeared on their faces to be whole life policies, providing for aggregate premiums of $68,180 a year for the first twenty years and $18,180 a year thereafter.

The "executive special" policies implemented an insurance program embodying the following principal elements:

1. The insured first "borrowed" from Western the entire amount of the first year cash value, which he used simultaneously to pay the greater part of the first year's premium.

2. He, at the same time, "borrowed" a much larger sum from Western. With most of the proceeds of the "loan" he simultaneously established a so-called "prepaid premium fund" in the amount of the present value of the aggregate annual premiums for the following four years, discounted at an annual rate of three percent. Western undertook to pay interest on the "prepaid premium fund" at the rate of three percent a year, and that fund, when supplemented by the interest increments paid by Western, were sufficient at each of the next four anniversary dates of policies to pay the annual aggregate premium of $68,180.

3. At the beginning of the first year, the insured simultaneously paid in advance that year's four percent "interest" on the sums he had "borrowed."

4. As the "prepaid premium fund" was reduced each year thereafter by the purported payment of premiums therefrom for such year, the insured was in turn to "replenish" the fund by a "prepayment" in respect of the premiums to become due four years thereafter. The amount thus added to the fund each year was $60,577.90, which, at three percent compound interest, was expected to increase to $68,180 four years thereafter and accordingly be sufficient to pay the premiums falling due at that time.

5. Each year after the issuance of the policies, the insured would "borrow" the full amount of the increase in the loan value of the policies for that year, and he would simultaneously use part of the proceeds of such "loan" to pay the full amount of $60,577.90 to be added to the "prepaid premium fund" and would use the balance to pay part of the annual "interest" charges on his growing indebtedness to Western.

6. After the first year, no part of the insured's out-of-pocket costs would be allocable to premiums, and, as a consequence of treating the "interest" as deductible, the insured's actual cost of the insurance purchased by him would either be comparatively nominal or result in a net profit to him. The insured was never to be personally liable on any of his "loans", and the policies would never in fact have any cash surrender value as a result of the "loans."

The table which is set forth below shows the approximate figures as to some of the more important elements of Golsens' life insurance program.²

As each year's $68,180.00 premium is paid out of the prepaid premium fund, the cash (or loan) value of the policy increases and the value of the death benefit increases. In fact, examination of column (1) indicates that the cash value increases by an increasing amount which after the third policy year exceeds the amount of the $68,180.00 annual premium. Whether these substantial amounts of cash value increases are due to an amount of "implicit interest" paid to the policyholder on the cash value on deposit with the insurance company was not determined by the Tax Court. The Tax Court did determine that "the so-called annual premium on the "executive special" policies was set at an artificially high level so as to create an abnormally high cash value in order to facilitate or make possible the purported lending transaction * * *." Golsen v. Comm'r, 54 T.C. 742, at 17 (filed April 9, 1970). In any event, Golsen did not declare as income or pay taxes on any portion of the increases in cash value over and above the amount of his premium payments, nor did he declare as income or pay taxes on any of the 3 percent annual interest which the insurance company paid on the "prepaid premium fund." Yet, he was able to "borrow" each year against the full amount of both funds and, of course, he deducted the amount of interest which he paid on these "loans."

Golsen's annual loans (in the amounts of the cash value increases shown in column (1) above) were just sufficient to replenish the "prepaid premium fund and to pay approximately half of the "interest" charges on his "loans." (Column 3.) Thus, his out-of-pocket expenses were also approximately one-half of his so-called "interest" charges, and the tax savings realized by deducting the "interest" charges against his other income were (assuming a 52 percent tax bracket) just enough to generally offset the amount of his out-of-pocket expenses. It is also no coincidence that Golsen's annual out-of-pocket expense or net cash flow was found by the Tax Court to be "merely the amount that was actuarially required to pay for or support the insurance benefits available under the policies when stripped of their cash surrender values." Id. at 18. It was upon this basis that the Tax Court found that in reality "such `interest' payments in fact represent the cost to the insured of the insurance benefits provided by the `executive special' policies under the prearranged plan and do not represent payment for the use of borrowed funds."³ Thus, the Tax Court found that the superstructure of "loans" and "interest payments" surrounding the basic insurance transaction was sham and lacked economic substance, and that therefore the "interest payments" did not qualify as deductions pursuant to 26 U.S.C. § 163(a), as payment for the use of borrowed funds.

We agree with the Tax Court that the loan and interest transactions involved with this insurance plan lacked economic substance. The loan and interest transactions have no purpose other than the conversion of payments for insurance coverage into interest payments for tax purposes. As stated by the Tax Court,

Golsen\'s "loans" were secured solely by the policies themselves and the so-called premium prepayment fund, without any personal liability on his part; the "loans" could be cancelled at any time without any cash payment, merely by appropriate offsetting book entries, and the full amount of the so-called premium prepayment fund was in fact thus "charged off" on Western\'s books on January 26, 1967, accompanied by a corresponding entry reducing Golsen\'s "indebtedness" by the amount allocable to such "fund."

In denying the Golsens' claim for refund, the Tax Court held that it was bound by the decision of this Court in Goldman v. United States, 403 F.2d 776 (10th Cir.1968), because the appeal from the Tax Court's decision could only be brought in this Court.

In Goldman we considered an insurance-loan program which was written by the same company, Western Security, and which had attributes similar to those present in the instant case. Involved were interest payments to Western Security which, as here, exceeded the rate paid by the insurance company on the surrender value. It was the interest transaction which was the predominant aspect and which led this Court to conclude: (403 F.2d at 778)

The policy itself clearly reflects that the interest on the loans was 4% and the annual yield or increase in policy value was at the rate of 3%. The annual loss of 1%, when the record reveals the taxpayer was not pressed for cash, indicates a lack of economic substance in these transactions.

The Court in Goldman was guided by the decision of the Supreme Court in Knetsch v. United States, 364 U.S. 361, 81 S.Ct. 132, 5 L.Ed.2d 128 (1960), in which the insurance program was devoid of substance. There it was said:

* * * For it is patent that there was nothing of substance to be realized by Knetsch from this transaction beyond a tax deduction. What he was ostensibly "lent" back was in reality only the rebate of a substantial part of the so-called "interest" payments. The $91,570 difference retained by the company was its fee for providing the facade of "loans" whereby the petitioners sought to reduce their 1953 and 1954 taxes in the total sum of $233,297.68. There may well be single premium annuity arrangements with nontax substance which create an "indebtedness" for the purposes of § 23(b) of the 1939 Code and § 163(a) of the 1954 Code. But this one is a sham.

The Tax Court rejected Campbell v. Cen-Tex, 377 F.2d 688 (5th Cir.1967), which it also deemed to be directly in point, "despite some...