T.C. Memo. 1997-525
UNITED STATES TAX COURT
VERL W. AND FRANCES M. HADERLIE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8856-96. Filed November 19, 1997.
Verl W. and Frances M. Haderlie, pro sese.
Michael W. Lloyd, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Judge: Respondent determined a $10,049 deficiency
in petitioners' 1991 income tax that is attributable to one
adjustment.1 That adjustment pertains to a scheme where
1
An automatic computational adjustment was also made to
petitioners' claimed Schedule A medical deduction due solely to
the increase in adjusted gross income and a corresponding
increase in the threshold for the medical deduction.
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petitioner Verl W. Haderlie applied for an insurance policy, paid
the $40,653 premium, and $40,653 was returned to him by the
procuring insurance agent. The insurance agent promoted the
transaction because he received about 118 percent of $40,653 from
the insurance company as an inducement to sell its policies.
Respondent determined that the above-described circumstances
resulted in income to petitioners measured by the cost of the
insurance coverage or the $40,653 premium.
We first addressed this type of scheme or transaction in
Wentz v. Commissioner, 105 T.C. 1 (1995), and held that the
taxpayer/insured realized income in the amount of the insurance
premium kickbacks from the insurance agent. Petitioners here
argue that the circumstances of their case vary from Wentz v.
Commissioner, supra, in a manner that would change the outcome.
FINDINGS OF FACT
Petitioners had their legal residence in Idaho Falls, Idaho,
at the time their petition was filed. Verl W. Haderlie
(petitioner) is a high school graduate and has been involved in
the business of hauling milk by truck. During 1991, petitioner
was involved in the technical aspects of the process of producing
milk, including the identification and cure of bacterial
problems. From this activity and a small farming operation,
petitioner earned somewhat less than $50,000 for the 1991 taxable
year.
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Through a colleague, petitioner learned about Daniel Schwab
(Schwab), an insurance agent who was offering $1,250,000 of life
insurance for a "minimum premium". After advising the colleague
of his interest, petitioner received a telephone call from
Schwab. Schwab confirmed that he was offering $1,250,000 of life
insurance for a "minimum premium" and that petitioner would need
a physical exam, paid for by Schwab, and after 1 year, petitioner
could either extend or cancel the policy. At the time of the
conversation with Schwab, petitioner already owned a whole life
insurance policy with coverage in the range of $100,000 to
$150,000. At the same time, petitioner believed that his need
for life insurance coverage was in the $300,000 to $500,000
range.
Thereafter, petitioner met with Schwab, who promoted a
$1,250,000 policy with Royal Maccabees Life Insurance Co.
(Royal), and petitioner agreed to apply for a policy. Schwab
then accompanied petitioner to a medical center where a physical
exam was administered to petitioner. Petitioner, during 1991,
remitted separate checks in the amounts of $3,500 and $40,653
made payable to Stable Reserve, Inc. (Stable Reserve), and Royal,
respectively. Stable Reserve was Schwab's straw entity used as a
conduit for the insurance scheme. At the same time, Schwab
remitted a $40,653 check to petitioner. In 1992, Schwab remitted
a $3,500 check to petitioner. Schwab's $40,653 check to
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petitioner was drawn on an account in the name of "Stable
Reserve, Inc." Petitioner instructed Schwab to delay the deposit
of petitioner's $40,653 premium check to Royal for a few days in
order to permit petitioner's deposit of the $40,653 Stable
Reserve check from Schwab to fund petitioner's check.
In addition to remitting the two checks, petitioner signed a
document that contained the recitation that the $40,653 check
payment to him from Stable Reserve (Schwab) was a nonrecourse
loan. Petitioner and Schwab understood that the signed document
reciting the existence of a nonrecourse loan was prepared and
executed in the event that the Internal Revenue Service looked
into their insurance transaction and that the document had no
substance or effect. Beginning in 1991, petitioner and his
beneficiary(ies) had the benefit of $1,250,000 in life insurance
coverage from Royal. The coverage was under a universal life
policy, which differs from a whole life policy in that a
universal life policy more closely reflects current interest
rates thereby improving the accumulation of cash value. The
$40,653 premium paid by petitioner was competitive with the
premium charged by insurance companies other than Royal. Schwab,
in turn, was entitled to a commission approximating 118 percent
of the $40,653 1-year's premium on petitioner's Royal life
insurance policy.
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The Royal insurance arrangement was transacted in Idaho
Falls, Idaho. Schwab was licensed to conduct insurance business
in Wyoming, but not in Idaho. Royal was licensed to do business
in Idaho. Rebating by an insurance agent violates Idaho
insurance law. An insurance company is permitted to rebate part
or all of an insurance premium under the law of Idaho. So long
as petitioner made no misrepresentation in applying for the
insurance with Royal, the rebating aspect, although in violation
of Idaho law insofar as the rebate was made by Schwab, would not
invalidate the insurance coverage between Royal and petitioner.
Royal was aware of the rebating after petitioner's policy had
been applied for and came into force, and, because of its view
that petitioner had done nothing illegal, Royal did not attempt
to cancel the policy or contact petitioner. Royal believed that
only Schwab was involved in illegal activity (rebating). The
rebating by Schwab also violated the terms of the agreement
and/or relationship between Schwab and Royal.
Petitioner was under the mistaken impression that after the
first year of the Royal policy, he would have been entitled to
reduced coverage for the next year at a $3,500 premium. Although
petitioner thought the Royal insurance transaction was unusual,
he was not aware of any illegality or irregularity until after
the policy had been allowed to lapse. Petitioner's Royal policy
was allowed to lapse at the end of the first year, and just prior
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to that time Schwab approached petitioner with another insurance
transaction with Columbus Life Insurance Co. (Columbus).
The Columbus transaction was for life insurance coverage
beginning during 1993 and was, in most respects, substantially
similar to the Royal transaction. The Columbus transaction
differed from the Royal transaction as to the amount of coverage
($1,000,000 as opposed to $1,250,000), the absence of a document
indicating a nonrecourse loan, and in the Columbus transaction
petitioner refused to execute a premium check to Columbus. In
the Columbus transaction, Schwab paid petitioner's premium
directly to Columbus.
Petitioners did not report any income in connection with the
Royal/Schwab insurance arrangement on their 1991 Federal income
tax return. Respondent determined that the $40,653 premium (for
1 year) on the Royal life insurance policy was income to
petitioners for 1991.
OPINION
Transactions substantially similar to the one in this case
were considered in Wentz v. Commissioner, 105 T.C. 1 (1995), and
Woodbury v. United States, 72 AFTR 2d 93-6140, 93-2 USTC par.
50,528 (D.N.D. 1993), affd. per curiam without published opinion
27 F.3d 572 (8th Cir. 1994). In those cases, taxpayers who had
received the benefit of life insurance coverage in situations
where the agent kicked back the premium were found to have income
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taxable in the year of the transaction in the amount of the
premium that had been paid and kicked back.
Respondent relies on those cases, arguing that the record in
this case contains no distinction(s) to cause a result different
from the prior cases. Petitioners, who are pro se, argue that
they should not have to recognize income because of the following
theories: (1) The "market value was nothing because * * *
[Royal] was not legal in Idaho and neither was * * * [Schwab]”.
(2) Royal was aware of Schwab's illegal rebating scheme and did
nothing because it would have had to pay back the premiums to the
insured, and it was easier for Royal to "let it ride out than pay
back all of the premiums." We agree with respondent.
Petitioners' arguments are based on illegality as the reason
why they should not be required to recognize income from the
insurance transaction. Initially, we note that Royal (insurance
company) was licensed in Idaho, and Schwab (agent) was not
licensed in Idaho. Petitioners contend that due to either the
illegality of rebating and/or the fact that Schwab was not
licensed to sell insurance in Idaho, the insurance coverage had
no value. We surmise that petitioners are arguing that the
illegality would have provided Royal with a defense to paying
benefits on the policy in the event that petitioner died while
the policy was in force. State law and evidence in the record do
not present a defense that Royal could have interposed to a claim
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by petitioner’s beneficiary. A representative of the Idaho
Department of Insurance and a representative of Royal testified
that, short of misrepresentation or wrongdoing by petitioner,
there was no reason why Royal could avoid payment of a claim.
Additionally, the rebating by the agent, although illegal under
State law, did not provide the insurance company with a defense
to a claim on the policy. There is no evidence of wrongdoing or
any misrepresentation by petitioner. If there had been some
wrongdoing and/or misrepresentation by petitioner regarding the
policy, Royal may have had a defense to payment on the policy.
The only wrongdoing was a rebating of the premium to petitioner
by Schwab.
Under Idaho's insurance statutes, unauthorized rebating by
an insurance agent is illegal. See Idaho Code sec. 41-1314
(1991). In this case, rebating also violated the terms of the
agreement and contractual relationship between the insurer and
the agent, but has no direct effect on the insured. Royal might
have had recourse to recover the rebated portion of the premium
(in this case the entire first year premium) from Schwab, but
that does not change the fact that petitioner had the benefit of
1 year's universal life insurance coverage, along with an option
to renew. As discussed in Wentz v. Commissioner, supra, even if
petitioner had become uninsurable during the year, he could have
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continued the Royal policy by payment of the premium for each
successive year.
Petitioners also discuss the fact that they were financially
unable to afford the $40,653 annual premium and that they had to
wait until Schwab's rebate check was credited to petitioner's
bank account before their equal-in-amount premium check to Royal
could be honored. In that regard, petitioners argue that their
maximum insurance coverage needs were no more than a few hundred
thousand, if they could afford it. It is irrelevant that the
insurance transaction entered into by petitioner was beyond his
needs or means. Our focus must be on the benefit or enrichment
petitioners received. Although the transaction with Royal,
through Schwab, may have been "too good to be true," petitioners
were willing to engage in the transaction because they received a
benefit. They did not become involved with Schwab out of
disinterested generosity. Instead, they willingly applied for a
$1,250,000 policy with Royal knowing that they would receive the
benefit of that coverage for a year without any cost. In order
to obtain that benefit, petitioner signed various documents, took
a physical, and made representations that he was applying for and
accepting $1,250,000 of coverage. In exchange for that
performance, petitioner received $40,653 from Schwab and/or the
benefit of $40,653 of insurance without payment. Either way,
petitioners were enriched.
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It is somewhat ironic that if Royal had offered and/or
authorized its agent (Schwab) to offer petitioner 1 year of
insurance coverage at no cost as an inducement to continue the
coverage in the future, the tax consequences might have been
different. In that type of circumstance, courts have held that
the "reduced" price or rebate is not taxable to the consumer.
See, e.g., Pittsburgh Milk Co. v. Commissioner, 26 T.C. 707
(1956). Here, however, the insurance company was not offering a
price reduction or rebate. Instead, the agent, without the
insurer's approval or agreement, devised an illegal scheme to
take advantage of his contractual relationship with the insurer.
The agreement between the insurer and the agent was for the agent
to receive about 118 percent of the first year’s premium as a
commission for selling the policy. In turn, the agent paid
petitioner the amount of the premium, in exchange for
petitioner’s applying for the insurance coverage. As a result,
the agent received about 118 percent of 1 year's premium, and
petitioner received the benefit of 1 year's insurance coverage.
Although petitioner may not have understood the technical
distinction between a rebate and a kickback, he was aware that
his payment to the insurance company was repaid to him by the
agent in exchange for his performance.
We can empathize with petitioners to the extent they relied
on Schwab, did not wish to do anything improper, and never
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anticipated that their involvement would subject them to a tax
burden or possible financial hardship. Their actions, however,
are well documented, and the tax burden that results in these
circumstances has been considered, analyzed, and explained by
this and other courts. Petitioner signed an illusory document
reciting that a nonrecourse loan existed in the event that the
Internal Revenue Service looked into their insurance transaction.
Under these circumstances we do not see petitioner as an
unwitting participant. We also note that petitioners became
involved with Schwab in a subsequent and similar insurance
coverage scheme. In the subsequent transaction, petitioner had
become leery, refusing to sign any documents or to remit checks
to the insurance company in exchange for a check from Schwab. In
the subsequent transaction, Schwab paid the insurance company,
and petitioner applied for the insurance and was subjected to a
physical exam in order to be entitled to the insurance coverage.
In either situation, petitioner had to apply for insurance, take
a physical exam, and manifest to the insurer his intent to apply
for insurance. In exchange for those actions or consideration,
petitioners received the benefit of $1,250,000 of insurance
coverage, which was ultimately paid for by the agent, Schwab.
To reflect the foregoing,
Decision will be entered for
respondent.