Lowe v. Comm'r

T.C. Memo. 2011-106

UNITED STATES TAX COURT

FREDRIC J. AND DUSHANKA LOWE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 23670-08. Filed May 19, 2011.

David R. Bosse and Mary L. Harriss, for petitioners.

Kathleen A. Tagni, for respondent.

MEMORANDUM OPINION

LARO, Judge: This case is before the Court on respondent’s

motion for summary judgment filed pursuant to Rule 121.1

Respondent determined a $50,252 deficiency in petitioners’ 2003

1
Section references are to the applicable version of the
Internal Revenue Code, and Rule references are to the Tax Court
Rules of Practice and Procedure. Some dollar amounts are
rounded.
 -2-

Federal income tax and a $10,050 accuracy-related penalty under

section 6662(a). The deficiency largely arises from the

distribution of a cash value life insurance policy (policy) from

a nonexempt employee trust to petitioner Frederic J. Lowe (Mr.

Lowe).2 On November 24, 2010, respondent filed a motion for

summary judgment (motion). On December 10, 2010, petitioners

filed a response to respondent’s motion (response). Respondent’s

motion asks the Court to decide as a matter of law that the value

of the policy is its accumulated value on the date of

distribution determined without regard to surrender charges.

That motion also asks the Court to find petitioners liable for an

accuracy-related penalty under section 6662(a). Petitioners

agree in their response that the material facts of the case are

not in dispute, but they contend that the value of the policy

must be determined by taking surrender charges into account.

We hold that section 402(b)(2) requires that the value of a

life insurance policy distributed from a nonexempt employee trust

is its fair market value as of the date of distribution and may

require that surrender charges be taken into account. For the

reasons discussed below, we find that genuine issues of material

fact remain as to the fair market value of the policy. We will

therefore deny respondent’s motion for summary judgment as to the

2
Respondent also determined computational adjustments to
amounts petitioners claimed as itemized deductions and
exemptions.
 -3-

value of the policy. We find it premature to decide the second

issue of whether petitioners are liable for a section 6662(a)

accuracy-related penalty absent a determination of the fair

market value of the policy. We thus reserve our decision on that

issue.

Background

The background facts are drawn from the pleadings, the

motion, and the response. Petitioners Mr. Lowe and Dushanka Lowe

(Ms. Lowe) are husband and wife who resided in Illinois when

their petition was filed.

Mr. Lowe was an employee and the sole shareholder of Smart

Money Strategies, Inc. (Smart Money), an S corporation. Ms. Lowe

was an employee of Smart Money. In 2002 Smart Money adopted the

National Variable Benefit Plan and Trust as an employee welfare-

benefit plan under sections 419 and 419(A).3 Smart Money’s

stated purpose in adopting the plan was to provide benefits to

certain covered employees as a reward for past and future

faithful service. Petitioners were the only employees covered by

the plan as Smart Money had no other employees. The benefits

provided to petitioners under the plan included death and

severance benefits. Smart Money funded these benefits with a

3
We refer to the welfare benefit plan as the “plan” and the
trust that owned the plan’s assets as the “trust”. The parties
agree that the trust was not exempt from taxation under sec.
501(a).
 -4-

cash value life insurance policy on the life of Mr. Lowe and a

term life insurance policy on the life of Ms. Lowe. The trust

was the named owner of the cash value life insurance policy on

Mr. Lowe’s life.

The policy covering Mr. Lowe was a variable universal life

insurance policy4 that provided Mr. Lowe with a death benefit of

$4,213,485, and carried a planned annual premium of $75,000. The

terms of the policy agreement specified that a surrender charge5

would be levied upon the owner of the policy if the policy was

terminated before a specified date. The policy also specified

that the surrender charge would gradually decline and would be

eliminated 14 years after the policy’s effective date. Ms. Lowe

was the named beneficiary of Mr. Lowe’s policy.

Between 2002 and 2003 Smart Money paid premiums due on the

policy by contributing cash to the trust. In late 2003 Smart

Money terminated its participation in the plan and trust, which

in turn caused ownership of the policy to transfer from the trust

to Mr. Lowe. On the date of distribution, the accumulated value

4
Under a variable universal life policy, the premiums paid
by the policy holder are invested in securities, and the payouts
at death fluctuate with the performance of the investments,
though there usually is a minimum guaranteed death benefit. See
Schwab v. Commissioner, 136 T.C. __, __ (2011) (slip op. at 7);
Cadwell v. Commissioner, 136 T.C. __, __ (2011) (slip op. at 8
n.9).
5
A surrender charge is a fee applied against the value of
the life insurance contract if the contract is terminated within
a period specified in that contract.
 -5-

of the policy without regard to surrender charges was $140,901,

and the value of the policy after surrender charges was zero.

Petitioners received a 2003 Form 1099-R, Distributions From

Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs,

Insurance Contracts, etc., which reported a current year cost of

life insurance protection of $4,426.16. Petitioners reported

that amount on their 2003 Form 1040, U.S. Individual Income Tax

Return (2003 return). Petitioners did not, however, report any

income from the distribution of the policy on their 2003 return.

By notice of deficiency dated June 27, 2008, respondent

determined that petitioners had unreported income equal to

$140,901, or the value of the policy distributed to Mr. Lowe

without regard to the surrender charges. Respondent also

determined that petitioners were liable for an accuracy-related

penalty under section 6662(a).

Discussion

Summary judgment is intended to expedite litigation and

avoid unnecessary and expensive trials. Fla. Peach Corp. v.

Commissioner, 90 T.C. 678, 681 (1988). Either party may move for

summary adjudication upon all or any part of the legal issues in

controversy. Rule 121(a). Full or partial summary judgment is

appropriate where the record shows that there is no genuine issue

as to any material fact and that a decision may be rendered as a

matter of law. Rule 121(b); Craig v. Commissioner, 119 T.C. 252,
 -6-

259-260 (2002). As the moving party, respondent bears the burden

of proving that no genuine issue exists as to any material fact

and that he is entitled to judgment as a matter of law. See

Naftel v. Commissioner, 85 T.C. 527, 529 (1985). In deciding

whether summary judgment is appropriate, we view the factual

materials and the inferences drawn therefrom in the light most

favorable to the nonmoving party. United States v. Diebold,

Inc., 369 U.S. 654, 655 (1962); Dahlstrom v. Commissioner, 85

T.C. 812, 821 (1985). The parties contend that there are no

genuine issues as to any material fact and that a decision may be

rendered as a matter of law. For the reasons discussed below, we

do not agree. Accordingly, we will deny respondent’s motion.

The parties agree that the distribution of the policy from

the trust was a taxable event, but they disagree over the amount

which petitioners were required to report as taxable income on

their 2003 return. Petitioners argue that the value of the

policy distributed to Mr. Lowe should be determined under section

83 and that the value of the policy should be reduced by the

amount of the surrender charges payable upon termination of the

policy. Respondent argues that the value of the life insurance

policy should be determined under sections 402(b)(2) and 72 and

that the value as distributed to Mr. Lowe should be determined

without regard to any surrender charges.
 -7-

We begin with an overview of the relevant sections. Section

83 provides rules for the taxation of property transferred to an

employee in connection with services performed by that employee.

See sec. 1.83-1(a)(1), Income Tax Regs. That section requires a

taxpayer to include in gross income the fair market value of the

property transferred (less any amounts paid for such property) in

the first year in which such property becomes transferable or is

not subject to a substantial risk of forfeiture. Sec. 83(a); see

also Childs v. Commissioner, 103 T.C. 634, 648 (1994), affd.

without published opinion 89 F.3d 856 (11th Cir. 1996). Section

402(b)(2) provides “the amount actually distributed” or made

available to a distributee by a nonexempt employee trust must be

included in the distributee’s gross income pursuant to the

annuity rules of section 72. See also sec. 1.402(b)-1(c)(1),

Income Tax Regs. Section 72 generally requires a distributee to

include in his or her gross income any amount received by the

distributee under a life insurance contract but allows the

taxpayer to recover his or her investment in the contract as a

nontaxable return of capital. See sec. 1.72-1(a), Income Tax

Regs.

I. Nonapplicability of Section 83

Petitioners argue that the distribution of the policy to

them from the trust is a transfer in connection with the

performance of services governed by section 83 and that section
 -8-

402(b)(2) does not apply. We do not agree. It is a basic

principle of statutory construction that where two statutes

overlap in application, the more specific provision takes

precedence over the more general provision. See Bulova Watch Co.

v. United States, 365 U.S. 753, 758 (1961); Wing v. Commissioner,

81 T.C. 17, 30 n.15A (1983). The policy here was transferred to

Mr. Lowe by way of a distribution from a nonexempt employee

trust, a situation specifically contemplated by section 402(b).

Section 83, which addresses the taxation of property transferred

in connection with services, is thus general when compared with

the specific application of section 402(b) to a distribution from

a nonexempt employee trust.

Section 402(b) provides for a variety of Federal income tax

consequences to an employee beneficiary who is a participant in a

plan under section 401(a) when the related trust is not exempt

from taxation under section 501(a). Section 402(b) contains

specific provisions for contributions to and distributions from a

nonexempt employee trust for the benefit of an employee

beneficiary. Section 402(b)(1), which addresses contributions

made by an employer to a nonexempt employee trust on behalf of an

employee, requires the employee to include as gross income the

amount of the contribution in accordance with the provisions of

section 83. Section 402(b)(2), which addresses distributions

from a nonexempt employee trust to an employee beneficiary,
 -9-

requires the employee to include in gross income the amount of

the distribution in accordance with section 72. We find no

ambiguity in section 402(b) and believe that section 402(b)(2)

speaks specifically to the policy distributed to Mr. Lowe.6 We

presume that Congress “says in a statute what it means and means

in a statute what it says” and shall rely on the specific

provision of section 402(b). Conn. Natl. Bank v. Germain, 503

U.S. 249, 253-254 (1992).

Because we have determined that section 402(b)(2) applies to

the policy distributed to petitioners, we only look to section 83

to the extent that section 402(b) requires us to do so. See sec.

1.83-8(a)(4), Income Tax Regs. (“to the extent a transfer is

subject to section 402(b) * * *, section 83 applies to such a

transfer only as provided for in section 402(b)”). Despite

petitioners’ contentions of the applicability of section 83,

section 402(b)(2) does not require that section 83 applies.

Congress was clear that section 83 determines the tax

consequences to an employee beneficiary who receives the benefit

6
We are not persuaded that Smart Money provided the policy
to Mr. Lowe in connection with his performance of services so
that sec. 83 would apply. Petitioners offer no elaboration on
the specific services Smart Money provided or any services Mr.
Lowe provided to Smart Money. In addition, petitioners
characterize the transfer of the policy as a “distribution” from
the plan and trust in both the petition and the memorandum they
filed in support of their response. Such a characterization, we
believe, is not merely a matter of semantics but reflects an
objective characterization of the distribution by petitioners as
to the true nature of what they received from the trust.
 -10-

of a contribution made by an employer to a nonexempt employee

trust. Congress was also clear that section 72 determines the

tax consequences to an employee beneficiary who receives a

distribution from a nonexempt employee trust. This distinction,

we believe, shows that Congress was fully aware of the different

alternatives for taxing distributions from a nonexempt employee

trust and intended that the taxability of a distribution from a

nonexempt employee trust to be determined under section 72. If

Congress had intended for distributions from a nonexempt employee

trust to be determined under section 83, it would have said so,

but Congress did not say so. Consequently, we give effect to

Congress’ unambiguously expressed intent and proceed with our

analysis under sections 402(b)(2) and 72. See Chevron U.S.A.

Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842-843

(1984).

II. Application of Sections 402(b)(2) and 72

Because we have found that section 402(b)(2) controls the

tax consequences of the policy distributed to petitioners, we now

turn our attention to that section to determine the methodology

for determining the value of the policy. Section 402(b)(2)

provides that “the amount actually distributed” or made available

to a distributee by a nonexempt employee trust shall be taxable

in the year distributed or otherwise made available to the
 -11-

beneficiary as provided by section 72. See also sec. 1.402(b)-

1(c)(1), Income Tax Regs.

Section 72(e) prescribes rules for the tax treatment of

amounts received under a life insurance contract which are not

received as annuities. In general, any nonannuity amount

received before the annuity starting date is includable in gross

income to the extent allocable to income on the contract.7 See

sec. 72(e)(2)(B); Matthies v. Commissioner, 134 T.C. 141, 151

(2010). Here, the trust distributed the policy to Mr. Lowe as a

lump sum before the annuity starting date. The cross-reference

of sections 402(b)(2) and 72 thus compels the application of

72(e) to the distribution petitioners received.

Section 72(e)(3)(A) requires that the amount allocable to

income, and thus the amount to be included in gross income,

should not exceed the excess (if any) of “the cash value of the

contract (determined without regard to any surrender charge)

immediately before the amount is received” reduced by the

taxpayer’s “investment in the contract”. The parties agree that

the cash value of the policy determined without regard to

7
Although sec. 72(e)(5) generally supersedes the
applicability of sec. 72(e)(2)(B) with regard to life insurance
contracts, see sec. 72(e)(5)(A), (C), sec. 402(b)(2) provides
that distributions from a nonexempt employee trust before the
annuity starting date shall be included in the gross income of
the distributee without regard to sec. 72(e)(5). Thus, sec.
72(e)(5) is inapplicable to the distributions received by Mr.
Lowe, and sec. 72(e)(2)(B) is the controlling provision for
purposes of income inclusion.
 -12-

surrender charges is $140,901. A taxpayer’s investment in the

contract is defined as the amount of consideration paid for the

contract less amounts previously received under the contract that

were excludable from gross income. See sec. 72(e)(6); Campbell

v. Commissioner, 108 T.C. 54, 61-62 (1997). Because petitioners

did not pay any consideration for the contract, we treat Mr.

Lowe’s investment in the contract (i.e., his basis) as zero.

Thus, the maximum amount that petitioners would be required to

include as gross income under section 72(e)(3) is the cash value

of the policy without regard to surrender charges, or $140,901.

Respondent would have us stop our analysis after a plain

reading of section 72 and conclude that the value of the policy

for purposes of section 402(b) is the cash value of the policy

without regard to surrender charges. But section 402(b)(2) does

not require that we read section 72 in isolation. The cross-

reference of section 402(b)(2) requires only that we use section

72 as a guide to allocating the value of the policy between

taxable income and a nontaxable return of the investment in the

contract (i.e., petitioners’ return of capital). Section

402(b)(2) provides that the “amount actually distributed” to the

distributee is taxable under section 72. The “amount actually

distributed” is thus the amount petitioners are required to

include in their gross income, subject to the limitation imposed

by section 72(e)(3)(A).
 -13-

We recently analyzed the interplay of sections 402(b)(2) and

72 in the context of distributions from a nonexempt trust in

Schwab v. Commissioner, 136 T.C. __ (2011). We believe our

reasoning in Schwab is directly on point to the instant case and

apply its reasoning herein. We observed that “amount actually

distributed” under section 402(b)(2) is not synonymous with the

accumulated cash value of the policy. Like petitioners, the

taxpayers in Schwab received distributions of life insurance

policies from a nonexempt employee trust and challenged the

Commissioner’s determination that the values of those policies

should be determined without regard to surrender charges. We

held that for the purposes of section 402(b)(2), the phrase

“amount actually distributed” means the fair market value of what

was actually distributed.

We reasoned in Schwab that the regulations under section

402(a) (prescribing rules for distributions from exempt employee

trusts) and section 402(b)(2) (prescribing rules for

distributions from nonexempt employee trusts) provide differing

interpretations of the phrase “amount actually distributed”. We

were cognizant of our decision in Matthies v. Commissioner,

supra, in which we held that a distribution of a life insurance

policy from an exempt employee trust should be determined without

regard to surrender charges. But we noted that the regulations

under section 402(a) require a taxpayer to include as the “amount
 -14-

actually distributed” the “entire cash value” of the life

insurance policy, see sec. 1.402(a)-1(a)(2), Income Tax Regs.,

whereas the regulations under section 402(b)(2) indicate by way

of an example that the amount to be included as gross income is

the “entire value” of the contract, see sec. 1.402(b)-1(c),

Income Tax Regs. We deemed this distinction not insignificant.

We concluded that while the “entire cash value” of a life

insurance policy is determined without regard to surrender

charges, the “entire value” of a life insurance policy is

determined by its fair market value, which may include surrender

charges. We thus rejected the simple proposition that surrender

charges should never count or that they should always count,

instead reading section 402(b) to require a court to consider the

payment of surrender charges as part of a more general inquiry

into the policy’s fair market value.8

But we also recognized in Schwab that the fair market value

of an insurance contract can be a “slippery concept”, the

determination of which requires further analysis. See Schwab v.

Commissioner, supra at __ (slip op. at 8). On the facts in

Schwab, we were persuaded that the only value the taxpayers

received from the distributions of their policies was a small

amount of insurance coverage attributable to premiums their

employer previously paid. We also had in the record the base

8
The Commissioner moved the Court to reconsider our Opinion
in Schwab, and we denied that motion.
 -15-

rates for the guaranteed maximum monthly cost of insurance rates

and were able to make a tentative effort at calculating the fair

market values of what the taxpayers actually received.

The facts of the instant case are virtually identical to

those presented in Schwab. The policies were variable universal

life insurance policies with steep premiums, and both were

distributed from nonexempt employee trusts in late 2003. Both

policies carried surrender charges that rendered the accumulated

value of the policy zero or less than zero. In Schwab we decided

that the fair market values of the policies the taxpayers

received were less than their accumulated values. Here, we are

unable to determine the fair market value of Mr. Lowe’s policy

because the record does not allow us to do so. Accordingly, we

will deny respondent’s motion for summary judgment.

An appropriate order will

be issued denying respondent’s

motion for summary judgment.