Santos v. Comm'r
| Decision Date | 12 April 2021 |
| Docket Number | 156 T.C. No. 9,Docket No. 5458-16. |
| Parties | RUBEN DE LOS SANTOS AND MARTHA DE LOS SANTOS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
During 2011 and 2012 P-H was the sole shareholder of an S corporation that employed him and P-W. The S corporation adopted an employee welfare benefit plan that provided benefits to P-H, P-W, and four other employees. Ps received these benefits in their capacity as employees.
The benefit plan, insofar as it afforded life insurance protection to Ps, constituted a compensatory "split-dollar" life insurance arrangement under sec. 1.61-22, Income Tax Regs. De Los Santos v. Commissioner, T.C. Memo. 2018-155. Ps are thus taxable on the economic benefits they realized by participating in the plan. Sec. 1.61-22(d)(1), Income Tax Regs. In the notice of deficiency issued to Ps, R determined that these economic benefits are taxable to Ps as ordinary compensation income.
Ps filed a motion for partial summary judgment contending that, because P-H is a shareholder of the S corporation, the economic benefits he realized are taxable to him as a distribution under I.R.C. sec. 301. Citing sec. 1.301-1(q)(1)(i), Income Tax Regs., Ps contend that economic benefits received by a shareholder pursuant to a split-dollar life insurance arrangement constitute a distribution under I.R.C. sec. 301 regardless of whether the taxpayer receives the benefits in his capacity as an employee or as a shareholder. In support of this position Ps rely on Machacek v. Commissioner, 906 F.3d 429 (6th Cir. 2018), rev'g and remanding T.C. Memo. 2016-55.
Held: Because the compensatory split-dollar life insurance arrangement afforded benefits to P-H in his capacity as an employee of the S corporation, such benefits may not be characterized as a distribution "by a corporation to a shareholder with respect to its stock." See I.R.C. sec. 301(a).
Held, further, for purposes of taxing employee fringe benefits, P-H is treated as a partner of a partnership. See I.R.C. sec. 1372. The economic benefits he realized are therefore taxable under I.R.C. sec. 707(c) as "guaranteed payments" and thus as ordinary income.
David M. Henderson, for petitioners.
David Conrad, David Weiner, and Mayer Y. Silber, for respondent.
LAUBER, Judge: This case involves an S corporation that adopted an employee welfare benefit plan for petitioners and four rank-and-file employees. We have ruled that petitioners' participation in this plan constituted a compensatory "split-dollar" life insurance arrangement under section 1.61-22(b), Income Tax Regs., and that the economic benefits that flowed to petitioners generated current taxable income.1 De Los Santos v. Commissioner (De Los Santos I), T.C. Memo. 2018-155. We left for further proceedings the computation of the exact amounts to be included in petitioners' gross income for each year.
On May 14, 2019, petitioners filed a second motion for partial summary judgment directed to the latter question. They assert that the economic benefits at issue are taxable to petitioner husband as distributions under section 301 because he is a shareholder of the S corporation. Respondent opposes petitioners' motion, contending that the economic benefits are taxable as ordinary income because the split-dollar arrangement was a "compensatory arrangement" that afforded benefits to petitioner husband in his capacity as an employee. Concluding that respondent has the better side of this argument, we will deny petitioners' motion.
Background
The following facts are drawn from the parties' motion papers, the stipulation of facts, and the attached exhibits. Petitioners resided in Texas when they petitioned this Court. Absent stipulation to the contrary, appeal of this case would lie to the U.S. Court of Appeals for the Fifth Circuit. See sec. 7482(b)(1)(A).
Petitioner husband is a medical doctor. During 2011 and 2012 he was the sole shareholder of Dr. Ruben De Los Santos MD, PA, an S corporation organized in Texas (S Corp.). The S Corp. employed petitioner husband and petitioner wife, who served as the office manager for the medical practice, as well as four other individuals. Petitioners received annual salaries of $216,000 and $54,000, respectively. Petitioner husband also included in his income, as the sole shareholder of the S Corp., 100% of its items of income and expense. See sec. 1366.
In 2006 the S Corp. adopted an employee welfare benefit plan to provide its employees with life insurance and other benefits. The S Corp. selected the Legacy Employee Welfare Benefit Plan (Legacy Plan), which was funded by employer contributions to the Legacy Employee Welfare Benefit Trust (Trust).2 The S Corp. participated in the Legacy Plan by agreeing to the terms of a "master plan document," which described the Legacy Plan as a "multiple employer welfare benefit plan" under section 419A(f)(6). To be eligible to receive benefits a person was required to "provide[] services to an Employer." Petitioners were "eligible employees" under the Legacy Plan because they provided services to the S Corp.
Under the Legacy Plan as adopted by the S Corp., petitioners were entitled to a $12.5 million death benefit, and the four rank-and-file employees were entitled to a $10,000 death benefit and certain flexible benefits. To fund the promised death benefits the Legacy Plan required the purchase of life insurance. The Trust accordingly purchased a life insurance policy (Policy) insuring petitioners' lives. The Policy was a "flexible premium variable universal life" policy with accumulation values based on the investment experience of a separate fund. The Policy provided base insurance coverage of $12.5 million, equal to the death benefit that the S Corp. had selected for petitioners. The Policy was a "survivor policy," under which the insurer would pay $12.5 million to the Trust when the second of petitioners died. The Trust in turn was required to pay $12.5 million to whatever beneficiaries petitioners had designated.
During 2006-2010 the S Corp. paid $1,862,349 to the Trust, treating these contributions as tax-deductible expenses of the medical practice. These contributions were sufficient to fund the $12.5 million death benefit promised to petitioners. During 2007-2012 the Trust paid aggregate premiums of $884,534 on the Policy. Because of these premium payments and the investment gains thereon, the "accumulation value" of the Policy was $640,358 at year-end 2011 and $744,460 at year-end 2012.
Petitioners timely filed joint Federal income tax returns for 2011 and 2012. They did not report on these returns any income related to their participation in the Legacy Plan. On December 4, 2015, the IRS issued petitioners a timely notice of deficiency, determining that the economic benefits they received under the Legacy Plan were currently taxable to them as ordinary income. Petitioners timely petitioned this Court for redetermination.
In 2017 the parties filed cross-motions for partial summary judgment on the question whether petitioners' participation in the Legacy Plan constituted a "split-dollar life insurance arrangement" under section 1.61-22(b)(2), Income Tax Regs. Respondent contended that the S Corp. had adopted a "compensatory" split-dollar arrangement because the Legacy Plan was "entered into in connection with the performance of services." See id. subdiv. (ii)(A). Petitioners "concede[d] that * * * [the S Corp.] did provide welfare benefits to * * * [them] in exchange for the performance of services," and they acknowledged that their eligibility to receive benefits "was based solely on factors related to employment." But they asserted that the arrangement did not meet other requirements of the regulations. See id. subdiv. (ii)(B) and (C).
Agreeing with respondent, we held that the benefit plan constituted a compensatory split-dollar life insurance arrangement and that the economic benefits flowing to petitioners therefrom generated current taxable income. De Los Santos I, T.C. Memo. 2018-155. We left for further proceedings the computation of the exact amounts to be included in petitioners' gross income for each year, as well as a determination as to their liability for penalties. Petitioners have filed a second motion for partial summary judgment directed to the gross income question.
Discussion
The purpose of summary judgment is to expedite litigation and avoid costly, unnecessary, and time-consuming trials. See FPL Grp., Inc. & Subs. v. Commissioner, 116 T.C. 73, 74 (2001). We may grant summary judgment regarding an issue as to which there is no genuine dispute of material fact and a decision may be rendered as a matter of law. Rule 121(b); Elec. Arts, Inc. & Subs. v. Commissioner, 118 T.C. 226, 238 (2002). The sole question presented at this stage of the proceedings is whether the economic benefits that petitioner husband received from the compensatory split-dollar life insurance arrangement are taxable as ordinary income or as a distribution under section 301. The parties agree on all material facts relevant to this issue, and we conclude that it may be adjudicated summarily.
In 2003 the Department of the Treasury (Treasury) issued final regulations addressing the taxation of split-dollar life insurance arrangements. T.D. 9092, 2003-2 C.B. 1055. Split-dollar life insurance arrangements of the sort involved here fall into one of two categories--"compensatory arrangements" or "shareholder arrangements." Sec. 1.61-22(b)(2)(ii) and (iii), Income Tax Regs. In both types the "owner" of the life insurance contract pays the premiums, and the "non-owner" has a current interest in the policy.
The difference between these two types of arrangements is the underlying economic relationship. In a "compensatory arrangement," the arrangement "is entered into in connection with the performance of services" by a...
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