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[PUBLISH]
IN THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT
________________________
No. 19-12875
________________________
D.C. Docket No. 1:17-cv-00326-ALB-SRW
ALAN C. TURNHAM, M.D., et al.,
Plaintiffs-Appellants,
versus
COMMISSIONER OF INTERNAL REVENUE,
Defendant-Appellee.
________________________
On Appeal from The United States District Court
For the Middle District of Alabama
________________________
(November 6, 2020)
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Before NEWSOM and BRANCH, Circuit Judges, and RAY,* District Judge.
RAY, District Judge:
While the changeover from winter to spring is marked by warmer days and
the greening of landscape, a less desirable indication of the change of seasons is the
obligation to file one’s annual Federal tax return. This duty, though never pleasant,
is a part of our civic and legal responsibility.
In a sense, the Federal tax structure is the ultimate honor system, as it “is based
on a system of self-reporting.” United States v. Bisceglia, 420 U.S. 141, 145 (1975).
In other words, although independent information is often forwarded to the
government by third parties, our system depends upon taxpayers fairly and honestly
informing the government as to both their income for the previous year and any
deductions that would reduce the taxable amount. And, sometimes the law imposes
a duty upon the taxpayer to inform the Internal Revenue Service (“IRS”) when the
taxpayer has taken a tax deduction that is questionable. This appeal presents just
such a case.
The Appellants, a medical doctor and the subchapter S Corporation for which
he works, filed suit against the IRS due to penalties it assessed against them for their
failure to inform the IRS about questionable deductions the Corporation took for
*
The Honorable William M. Ray II, United States District Judge for the Northern District of
Georgia, sitting by designation.
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contributions it made for life insurance benefits. For several years, the Corporation
participated in a multi-employer welfare benefit plan designed to provide pre-
retirement and post-retirement life insurance benefits to covered employees. Multi-
employer plans enable small employers to pool their contributions to purchase
insurance for their employees, often at cheaper rates, and the employers may claim
tax deductions for the contributions if they are otherwise deductible as ordinary and
necessary business expenses under I.R.C. § 162(a). See Curcio v. Commissioner,
T.C. Memo. 2010-115, 2010 WL 2134321, at *13 (2010), aff’d, 689 F.3d 217 (2nd
Cir. 2012). While there generally are limitations on the amount of the deduction
allowed (rules §§ 419 and 419A), those limits do not apply if the plan has 10 or more
participating employers and meets other conditions, such as that the employers
cannot normally “contribute more than 10 percent of the total contributions, and the
plan must not be experience rated with respect to individual employers.” 1 Notice
95-34, 1995-1 C.B. 309, 1995 WL 300780, at *1 (June 5, 1995).
Because the IRS became aware that some financial companies offered multi-
employer welfare benefits plans that included 10 or more employers, but did not
satisfy the other requirements so as to qualify for the full deduction for the
contributions, the IRS issued Notice 95-34 to warn about the types of plans that were
1
Experience rating is a measurement that the insurance industry uses to evaluate the insurance
risk of an employer based on their experience.
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not entitled to the § 419A(f)(6) deduction.2 When a welfare plan is equivalent to the
plans listed in the notice, or at least substantially similar thereto, the affected
taxpayers benefiting from the deductions must put the IRS on notice of the
questionable nature of the claim,3 so as to allow the IRS an opportunity to examine
the same, such as through an audit.
The Appellants, however, gave no such notice to the IRS regarding the
deductions they were claiming for the nearly $837,000 in contributions the
Corporation made to its multi-employer benefit plan for 2009-2011. When it found
out nonetheless, the IRS issued the tax penalties pursuant to statute for Appellants’
failure to file the required notices. 4 The Appellants sued to overturn those penalties,
and the district court granted summary judgment to the IRS. Upon review of the
record that is before us on this appeal, and with the benefit of oral argument, we have
no difficulty in determining that the district court correctly granted summary
judgment to the IRS. The subject plan is at least substantially similar to the type of
2
Tax Problems Raised by Certain Tr. Arrangement Seeking to Qualify for Exemption from Section
419, 1995-1 C.B. 309 (1995) (“Guidance is provided to taxpayers concerning the significant tax
problems raised by certain trust arrangements being promoted as multiple employer welfare
benefit funds exempt from the limits of sections 419 and 419A of the Code. In general, these
arrangements do not satisfy the requirements for exemption under section 419A(f)(6).”).
3
The required disclosure of participation in these transactions must be made on an annual Form
8886 (Reportable Transaction Disclosure Statement). 26 C.F.R. § 1.6011-4(d).
4
See Turnham v. United States, 383 F. Supp. 3d 1288, 1289 (M.D. Ala. 2019) (noting “[t]hat
statute [26 U.S.C. § 6707A] imposes penalties on persons who fail to include information on their
returns ‘with respect to a reportable transaction’”).
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plans that the IRS has indicated do not qualify for the exemption and the
corresponding full deduction. Accordingly, we affirm the district court’s decision
that the IRS was correct to issue the penalties on the ground that the Appellants did
not file the required notice.
The subject employee welfare plan was marketed as the PREPare Plan (the
“Plan”). Participating employers contribute funds to the Affiliated Employers
Health & Welfare Trust (the “Trust”), which then uses these contributions to
purchase and maintain group term life insurance policies and annuity products that
fund the benefits. A participating employer’s contributions to the Trust are divided
into two parts. One portion of the contributions is forwarded by the Trust to the
insurance company, which uses them to pay the premiums required to maintain the
group term life insurance that funds the covered employees’ pre-retirement death
benefits. The second, and indeed the overwhelmingly larger, portion of the
contribution is invested into an annuity contract with the insurance company. Thus,
the Plan provides term life insurance coverage for participating employees until they
retire, and after retirement, the Plan provides them with a certificate of insurance
that is “fully paid-up” (meaning that no further premiums would be owed, ever).
A most interesting aspect of these transactions is that the promoters of the
Plan advised that, with fully paid up certificates of insurance, “a participant could
make an irrevocable assignment of the beneficiary and, by doing so, move the
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insurance out of his estate; alternatively, he could sell the death benefit to a willing
beneficiary or convert the certificate in whole or in part to a health reimbursement
benefit.” Vee’s Marketing, Inc. v. United States, No. 13-CV-481-BBC, 2015 WL
2450497, at *2 (W.D. Wis. May 21, 2015), aff’d, 816 F.3d 499 (7th Cir. 2016). In
other words, potential participants were told that they “would be the beneficial
owner[s] of the paid-up contract and could add it to [their] estate planning trusts, sell
the contract for cash or trade it for medical benefits.” Id. (covered employees
“[could] sell a portion or all of [their] post-retirement coverage to an independent
settlement company in exchange for a lump-sum or stream of income payment.”).
Also important is that the Plan, through the investment company, kept track
of the contributions on an employer-by-employer basis, despite that it purported to
aggregate employer contributions to provide group-based benefits. See Vee’s
Marketing, 2015 WL 2450497, at *2 (noting that the Plan promoter “maintained
records of the contributions by each employer to the Trust, . . . and handled each
participant’s payments separately from those of any other participant”). The Plan
Administrator forwarded employer contributions to the insurance companies with
instructions to apply the premiums to the accounts of specific individually covered
employees; the Trust maintained separate records for each employer, and the insurer
kept detailed accounts of the amounts attributed to each covered employee. The
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insurers also allocated each contribution, per the Plan Administrator, to each
individual employee’s group insurance premium and group annuity account.
Now, it is true that the Plan documents prohibited participants from accessing
funds contributed to the Trust. Yet, it is also undisputed that the Plan Administrator
withdrew funds attributed to a participating employer’s covered employees from a
group annuity contract and then used those funds to pay group term life insurance
for the same employees. This allowed the Plan Administrator to pay an employer’s
current expenses from amounts that the employer had already contributed but had
been invested in an annuity. The point here is that this set up is less like an
independent (and acceptable) multi-employer benefit plan and more like the listed
“reportable transactions” for which the IRS had indicated would not qualify for an
exemption from the deduction limits.
These listed transactions “typically are invested in variable life or universal
life insurance on the lives of the covered employees.” 1995-1 C.B. 309. A universal
life insurance policy is a quasi-insurance product in which the premiums partly fund
death benefits and partly accumulate and earn interest to fund future benefits for the
covered person. See Anderson v. Wilco Life Ins. Co., 943 F.3d 917, 920–21 (11th
Cir. 2019). While the investment scheme here did not use universal life insurance
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products in the literal sense, there really isn’t any difference in practical effect. 5 The
combination of a term life policy with a separate (and much larger) annuity product
provided the same generous excess of funds that a universal life policy would itself
provide. And, there is no dispute that a welfare plan using a universal life policy
would likely not be exempt and the contributions thereto would likely not be fully
deductible.
Another red flag in the subject Plan was the large size of the contributions and
how they were allocated. As to the Appellants, for the three tax years at issue (2009-
2011), only a tiny fraction (roughly 3%) of the nearly $837,000 in contributions was
used to pay the premiums on the group life insurance policy for the Corporation’s
employees. The rest was directed into the group annuity account; yet, the Appellants
claimed a deduction for the entire amount. The result was a significant reduction or
elimination of business income and taxes that would have been due.
In granting summary judgment to the government, the district court properly
recognized the similarities between the facts of this case and those in Vee’s
Marketing, Inc. decided by the Seventh Circuit. That case involved the same Plan at
issue here and for which the Seventh Circuit found that the IRS correctly assessed
penalties for that taxpayer’s failure to give the same type of notice at issue in this
5
See Turnham, 383 F. Supp. 3d at 1292 (“That is how the plan was marketed, and that is how it
appeared to operate in practice”).
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case. See Vee's Mktg., Inc. v. United States, 816 F.3d 499, 501 (7th Cir. 2016). In
both cases, the employer contributions were large compared to the cost of the term
insurance, the Plan invested in the products which amounted to the equivalent of
universal life insurance, the trusts owned the insurance contracts, the trust
administrator advised that employees could get benefits by selling their share of the
annuity cash value, and the Plan maintained a separate accounting of the assets per
employer and reflected that separate accounting in reports. We find the holding in
Vee’s Marketing persuasive in the matter before us.
Having discussed what this case is about, it is important to note that this case
will not decide the ultimate issue as to whether the Appellants were entitled to claim
the questioned deductions; that is the subject of other litigation between the
Appellants and the IRS which is pending in the Tax Court. We do not prejudge who
will prevail in that companion litigation. We find here, however, that as a matter of
law the subject Plan is at a minimum “substantially similar” to the listed transaction
in the IRS Notice, such that the Appellants were required to disclose their
participation in it, as IRS regulations dictated. Because they failed to do so, the IRS
properly issued the penalties against them. Thus, the district court correctly decided
to grant summary judgment to the IRS.
AFFIRMED.
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