Lewis v. O'MALLEY

• Decision Date: 17 February 1943
• Docket Number: No. 136.,136.
• Citation: 49 F. Supp. 173
• Parties: LEWIS v. O'MALLEY.
• Court: U.S. District Court — District of Nebraska

49 F. Supp. 173

LEWIS v. O'MALLEY.

No. 136.

District Court, D. Nebraska, Lincoln Division.

February 17, 1943.

William I. Aitken and Woods, Aitken & Aitken, all of Lincoln, Neb., for plaintiff.

Joseph T. Votava, U. S. Atty., of Omaha, Neb., and William B. Waldo, Sp. Asst. to the Atty. Gen., for defendant.

DELEHANT, District Judge.

Originally filed as Case No. 206 in the Omaha Division, this action was later transferred to this division of the court, and upon its complete trial is here for final disposition. The defendant is, and at all times involved, was Collector of Internal Revenue of the Omaha district and this suit was instituted against him as an individual, under 28 U.S.C.A. § 41, for the recovery of $13,690.56 with interest, alleged to have been collected illegally from the plaintiff as a deficiency in his income tax for the year 1936.

Essentially a single transaction, in two connected phases, is involved, and the question for determination is whether it resulted in the receipt during 1936 of taxable income by the plaintiff.

Stripped of its related and subsidiary facts, this is the transaction. The plaintiff, at the time in question was 51 years old, and a married man with several children, and the president and sole manager, and for the practical purposes of this case, the owner of all of the stock, of the Lincoln Hatchery, a Nebraska Corporation, operating a general poultry hatchery business in the city of Lincoln, hereinafter identified as the Hatchery. The exact details of stock ownership will presently be recited, but it may be noted here that the minor holdings of two inactive stockholders may, in the circumstances, be disregarded.

On May 9, 1936, the Hatchery being then in possession of a surplus arising from earnings and profits largely in excess of the disbursement now mentioned, with its check drawn and signed by the taxpayer in favor of Massachusetts Mutual Life Insurance Company for $25,000, paid the insurance company the full premium for a single premium ten-year endowment life insurance policy. In like manner on July 10, 1936, the Hatchery, still being in possession of an adequate surplus, paid the sum of $25,000.04 as the full premium for a single premium ordinary life plan insurance policy. Each policy was issued on the life of the plaintiff, solely upon his individual application, designated "The executors or administrators of the insured" as the beneficiary, and contained a clause granting to the plaintiff the right (subject to any previous assignment), to change the beneficiary. The second policy was issued under an amendment of the application of May 9, 1936, pursuant to an insurance selling usage, whereby, within a limited period after the initial application and medical examination, an additional insurance coverage may be obtained under the same application and examination. As of June 1, 1936, the plaintiff in writing requested the redesignation of beneficiary under the earlier policy in such fashion that in the event of the insured's death the proceeds should be paid, (a) contingent upon the survival during the installment periods of Norman R. Lewis, son of the plaintiff, the sum of $5,000 to the said Norman R. Lewis in monthly installments of $100 and (b) any balance in one sum to the Christian and Missionary Alliance, an incorporated religious society, hereinafter called "The Alliance". The insurance company noted this change of beneficiary upon the face of the policy on June 8, 1936. By endorsement upon the later policy as of July 23, 1936, the designation of beneficiary was changed so that the entire proceeds of the policy as a death claim were made payable to "The Alliance". Eventually the beneficiary under each policy was redesignated as the executors or administrators of the insured, under the earlier policy on July 22, 1938, the later one on September 30, 1940, in each case immediately in advance of the surrender of the policy for its cash value. (vide infra). In form, both policies were individual life insurance policies. In neither of them was there a grant or reservation of any right or interest, either present or prospective, in favor of the Hatchery, which was an utter stranger to the terms of both policies.

In the face of the apparent individual character of the insurance policies, the plaintiff argues that certain facts show that the transaction was not personal to the plaintiff and resulted in no distribution to him out of the Hatchery's profits. Of these facts the following are admitted, or at least undisputed:

1. On July 9, 1931, the Hatchery, having a substantial then unused cash reserve, purchased from the same insurance company for $20,003.50 a single premium five-year endowment insurance policy upon the plaintiff's life in the sum of $22,120 in which the Hatchery was the sole beneficiary and reserved to itself every right and benefit under the policy, which was thus made a purely corporate transaction. It purchased the insurance as a method of preserving its available cash for recourse, through loan privileges or conversion option, during its seasonal peak financial demands, and, at the same time, obtaining at least a small measure of insurance protection and interest return. From time to time during the life of that policy the Hatchery borrowed different sums of money upon it which were utilized temporarily in its business. In these borrowings some annoyance and inconvenience, alike to the plaintiff and to the Lincoln representative of the insurance company, arose out of the necessity of holding corporate board meetings of the Hatchery and obtaining certificates respecting its minutes and signatures of its officers to the instruments evidencing and securing the loans. On some occasions, in consequence of the delay involved in holding meetings and supplying copies of records, the Lincoln agent of the insurance company advanced to the Hatchery temporary loans out of his personal funds, and on one occasion, himself borrowed money from a bank to enable him to do it. That policy by its terms matured July 9, 1936.

2. Shortly in advance, and in view, of the maturity of the 1931 policy, the Lincoln, Nebraska, general agent for the insurance company discussed with the plaintiff the negotiation of a new policy but suggested to him the writing of individual insurance as a device for the obviation of the inconvenience that had been experienced in the course of borrowings upon the then current policy. It was out of this discussion that the issuance of the earlier of the 1936 policies immediately, and of the later one ultimately, arose.

3. After the issuance of the Hatchery's checks in 1936, each transaction was entered on the books of the Hatchery in precisely the same fashion in which the 1931 transaction had been entered; that is, against the disbursement of the premium checks, entries were made disclosing as an asset of the Hatchery the initial cash surrender value of the policies purchased, and as an insurance expense the difference between the premium checks and that cash surrender value.

4. In connection with the 1936 disbursements, no charges were made upon the Hatchery's books against the personal account of the plaintiff, reflecting either enlarged salary, a loan, a gift, or a distribution to him; no dividend was declared or other resolution for distribution adopted.

5. After the procurement of the 1936 policies, the plaintiff personally and the Hatchery, through the plaintiff as its president, made several financial statements to a bank all of which were consistent particularly in this, that the corporate statements showed the cash surrender values of the policies as corporate assets and the individual statements did not reveal the large insurance holding as the plaintiff's property. Likewise in income tax reports subsequently filed both the Hatchery and the plaintiff consistently treated the cash surrender value of the insurance policies as an asset of the Hatchery.

6. From time to time after the issuance of the 1936 policies, loans were negotiated upon both of them in 1937, and upon the July, 1936, policy in 1940. The May, 1936, policy was converted into cash and surrendered in August, 1938, the July, 1936, policy in October, 1940. These loans were all negotiated and the policy surrenders made by the plaintiff individually; but in each instance cash payments made by the insurance company were made by its check to the plaintiff which he promptly endorsed and delivered to the Hatchery and the only loan repayment was made by a check from the Hatchery direct to the insurance company. All such borrowings were entered in the books of the Hatchery as loans upon the insurance policies. The repayment check was likewise entered there as were the receipts of cash on final surrender of the policies. In consequence of the loans upon, and surrender of, the policies, the plaintiff now has no property in or proceeds from the policies which have been extinguished; and the full cash surrender value of the policies has been returned to the Hatchery.

Pointing to a conclusion adverse to the plaintiff are the following manifest circumstances:

1. The form and contents of the policies themselves as instruments of a character purely personal to the plaintiff.

2. The plaintiff's exercise of his option to change beneficiary, under each policy, almost immediately after its issuance, and in the case of the earlier policy before the later one was issued, in such fashion that a disposition of proceeds as a death claim was provided in a manner intimately personal to the plaintiff and utterly unrelated to the Hatchery.

3. The plaintiff's complete domination through stock ownership of the Hatchery. Its corporate history need not be detailed too specifically. But it was organized by the plaintiff in 1922 as a device for the enlargement of a business theretofore operated by plaintiff individually. Though initially he had a number of stockholders associated with him, he...