Prosser v. Comm'r

• Decision Date: 04 February 2015
• Docket Number: 13–4527–ag CON.,Nos. 13–4526–ag L,s. 13–4526–ag L
• Citation: 777 F.3d 582
• Parties: Robert L. PROSSER, III, Mary C. Prosser, McGehee Family Clinic, P.A., Petitioners–Appellants, v. COMMISSIONER of INTERNAL REVENUE, Respondent–Appellee.
• Court: U.S. Court of Appeals — Second Circuit

777 F.3d 582

Robert L. PROSSER, III, Mary C. Prosser, McGehee Family Clinic, P.A., Petitioners–Appellants

v.COMMISSIONER of INTERNAL REVENUE, Respondent–Appellee.

Nos. 13–4526–ag L

13–4527–ag CON.

United States Court of Appeals, Second Circuit.

Argued: Oct. 8, 2014.

Decided: Feb. 4, 2015.

John T. Morin (Ira B. Stechel, on the brief), Wormser, Kiely, Galef & Jacobs LLP, New York, NY, for Petitioners–Appellants.

Randolph L. Hutter (Tamara W. Ashford, Acting Assistant Attorney General; Thomas J. Clark, on the brief), Tax Division, Department of Justice, Washington, D.C., for Respondent–Appellee.

Before: JACOBS, SACK, and DRONEY, Circuit Judges.

Opinion

DRONEY, Circuit Judge:

Robert and Mary Prosser (“the Prossers”) and the McGehee Family Clinic (“the Clinic,” and collectively “Petitioners”) filed petitions for redetermination in the United States Tax Court challenging the Commissioner of Internal Revenue's (“Commissioner”) determination of tax deficiencies and assessment of penalties against them under § 6662A of the Internal Revenue Code, 26 U.S.C. § 1 et seq. (“I.R.C.”). The Commissioner had determined that Petitioners were deficient based on a contribution by the Clinic to a multiple-employer welfare benefit plan, the Benistar 419 Plan and Trust (“the Benistar Plan” or “the Plan”), which the Commissioner concluded was not an “ordinary and necessary” business expense within the meaning of I.R.C. § 162(a). The Commissioner also determined that the Benistar Plan was “substantially similar” to the listed tax-avoidance transaction described by the Internal Revenue Service (“ IRS”) in I.R.S. Notice 95–34, 1995–1 C.B. 309 (“Notice 95–34 ”).¹ Because the Prossers had an understatement of income on their joint personal return attributable to the Clinic's contribution to the Benistar Plan, the Commissioner assessed an accuracy-related penalty against them under I.R.C. § 6662A, as well as an increased accuracy-related penalty against the Clinic.

Petitioners and other participants in the Benistar Plan who had been assessed similar deficiencies by the Commissioner agreed to be bound by the final resolution of a petition for redetermination in Curcio v. Commissioner, 99 T.C.M. (CCH) 1478, 2010 WL 2134321 (2010). In Curcio v. Commissioner, 689 F.3d 217 (2d Cir.2012), this Court affirmed the Tax Court's decision that employer contributions to the Benistar Plan were not “ordinary and necessary” business expenses within the meaning of the I.R.C. Id. at 225. As a result, the Tax Court in these proceedings upheld the Commissioner's determination of tax deficiencies against Petitioners based on the Clinic's contribution to the Benistar Plan. The only issue in this consolidated appeal² is whether the Tax Court was justified in upholding the Commissioner's imposition of additional accuracy-related penalties under I.R.C. § 6662A, an issue not resolved in the Curcio proceedings.

For the reasons set forth below, we hold that the Benistar Plan is substantially similar to the listed tax-avoidance transaction identified by the IRS in Notice 95–34. We therefore uphold the Commissioner's assessment of accuracy-related penalties against the Prossers and the Clinic under I.R.C. § 6662A. We also hold that Petitioners had adequate notice of the potential for penalties under § 6662A and that the increased penalty rate under § 6662A(c) applies to the Clinic. Accordingly, we AFFIRM the decisions of the Tax Court.

BACKGROUND

I. The Benistar Plan

Petitioners and the Commissioner “stipulated into the record in this case [Curcio 's ] evidence and trial testimony.” McGehee Family Clinic, P.A., v. Comm'r, 100 T.C.M. (CCH) 227, 2010 WL 3583386, at *1 (2010). We therefore rely on Curcio 's factual findings concerning the Benistar Plan.

The Benistar Plan was established in 1997 and was designed to be a multiple-employer welfare benefit plan under I.R.C. § 419A(f)(6). Its stated purpose was to allow employers to provide “death benefits funded by individual life insurance policies for a select group of individuals chosen by the Employer.” Curcio, 689 F.3d at 220 (quoting the Benistar Plan brochure). While I.R.C. § 419 generally imposes limits on the amount an employer can deduct for contributions to a welfare benefit fund, the Benistar Plan was intended to fall within § 419A(f)(6)'s exemption from deduction limits for contributions made to “any welfare benefit fund which is part of a 10–or–more employer plan.” I.R.C. § 419A(f)(6)(A).

Employers that were enrolled in the Benistar Plan contributed to a trust account operated by the Plan that was used to pay premiums on life insurance policies for certain employees, which included “one or more key Executives on a selective basis.” Curcio, 2010 WL 2134321, at *2, *5. However, the individual employee participants selected the insurance policies. Employers could also contribute additional amounts above the amount the Benistar Plan required to keep the underlying insurance policy active.Id. at *5. These additional contributions “remain[ed] in the trust account,” were “not used to make additional payments on the underlying insurance policy,” and would have substantial cash value based on the portion of the contributions not necessary for coverage. Id. Claiming that the Plan fell within § 419A(f)(6)' s exemption from deduction limits, the promoters of the Benistar Plan informed participating employers that tax deductions for these contributions which the plan separately recorded for each employer, were “[v]irtually [u]nlimited.” Id.

Employers could terminate their participation in the Benistar Plan at any time. Id. at *6. From mid–2002 to mid–2005, the Benistar Plan distributed the underlying policies of terminated accounts to the insured employees for ten percent of the cash surrender value of the policy. Id. Beginning in mid–2005, the Benistar Plan began to charge covered employees the entire fair market value of their underlying policy when the employer terminated participation. Id. at *7. However, the Benistar Plan did not require this payment immediately, but rather allowed the insured employee to borrow from the trust the cost of the purchase, providing as collateral the insurance policy itself. Id. In lieu of charging interest on the loan, the Benistar Plan charged an insured employee ten percent of the net surrender value of the policy, which had to be prepaid at the time the insured employee requested to withdraw the underlying policy. Id.

To summarize, the Benistar Plan allowed employers to make tax-free contributions for life insurance policies for certain “key” employees, and allowed additional contributions—also tax-free—above what was required to cover the potential death benefits of the policies. Those employees could then “retrieve the value in those policies with minimal expense” after participation in the Benistar Plan was terminated. Id. at *20.

In Curcio, the Tax Court held that contributions to the Benistar Plan by certain other businesses—a construction company, a mortgage broker, and automobile dealerships—were not “ordinary and necessary” business expenses eligible for deduction under I.R.C. § 162(a). Id. The Tax Court explained that taxpayers “used [the] Benistar Plan to funnel pretax business profits into cash-laden life insurance policies over which they retained effective control. As a result, contributions to [the] Benistar Plan are more properly viewed as constructive dividends to petitioners and are not ordinary and necessary business expenses under [§ ] 162(a).” Id. at *13. According to the Tax Court, the Benistar Plan was “a thinly disguised vehicle for unlimited tax-deductible investments.” Id. at *20.

This Court affirmed the Tax Court's decision in Curcio, explaining that “contributions [to the Benistar Plan] were made solely for the personal benefit of petitioners,” and “were a mechanism by which petitioners could divert company profits, tax-free, to themselves, under the guise of cash-laden insurance policies that were purportedly for the benefit of the businesses, but were actually for petitioners' personal gain.” Curcio, 689 F.3d at 226. As a result, we held that the Tax Court was correct in concluding that contributions to the Benistar Plan were not deductible by those businesses, and that the employees in whose name these contributions were made should have listed the contributions as personal income. Id. Penalties under I.R.C. § 6662A, however, were not at issue in Curcio because § 6662A penalties only applied to tax returns filed after October 22, 2004, see American Jobs Creation Act of 2004, Pub.L. No. 108–357, § 812(f), 118 Stat. 1418, 1580, and Curcio involved improper deductions in returns filed prior to October 2004, see Curcio, 689 F.3d at 220–22.³

II. Accuracy–Related Penalties Against Petitioners Under I.R.C. § 6662A

A. Factual Background⁴

Dr. Robert Prosser, a family medicine physician, was the sole owner and an employee of the McGehee Family Clinic, a C corporation⁵ and family medicine practice in McGehee, Arkansas. The Clinic enrolled in the Benistar Plan in May 2001 and first claimed a deduction for a contribution to the Plan on the tax return it filed in 2002. The Clinic then made a $50,000 contribution to the Benistar Plan during its 2004 tax year on behalf of Dr. Prosser, and claimed a $45,833 deduction for that contribution.⁶ Although IRS Form 8886, a “Reportable Transaction Disclosure Statement,” was available to the Clinic, the Clinic did not file any document disclosing its involvement in the Benistar Plan with its tax return for the 2004 tax year. The Prossers did not include the amount of the Clinic's contribution to the Benistar Plan on Dr. Prosser's behalf as income in their joint personal tax return, which they filed in 2005 for the tax year ending December 31, 2004.

On March 21, 2008, the Commissioner sent Notices of Deficiency to the Clinic for deducting its contribution to the Benistar Plan during its 2004 tax year, and to the Prossers for failing to report the...