Curcio v. Comm'r of Internal Revenue

10-3578-ag(L)
Curcio v. Comm'r of Internal Revenue

UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT

August Term 2011

(Argued: January 5, 2012 Decided: August 9, 2012)

Docket Nos. 10-3578-ag(L), 10-3585-ag(CON), 10-5004-ag(CON),
10-5072-ag(CON)

MARK CURCIO, BARBARA CURCIO, AMY L. SMITH, SAMUEL H. SMITH, JR.,
STEPHEN MOGELEFSKY, ROBERTA MOGELEFSKY, RONALD D. JELLING, LORIE A.
JELLING,

Petitioners-Appellants,

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent-Appellee.

ON APPEAL FROM UNITED STATES TAX COURT

Before:
WINTER, HALL, and CHIN, Circuit Judges.

Appeal from orders and decisions of the United

States Tax Court (Cohen, J.) finding deficiencies in

petitioners' income tax payments and assessing accuracy-

related penalties under 26 U.S.C. § 6662.
 AFFIRMED.

JOSEPH M. PASTORE III, Smith, Gambrell &
Russell, LLP (Ira B. Stechel, John
T. Morin, Jennifer L. Marlborough,
Wormser, Kiely, Galef & Jacobs LLP,
on the brief), New York, New York,
for Petitioners-Appellants.

RANDOLPH L. HUTTER, Attorney, Tax Division,
Department of Justice, Appellate
Section (Gilbert S. Rothenberg,
Acting Deputy Assistant Attorney
General, Thomas J. Clark, Attorney,
Tax Division, on the brief),
Washington, D.C., for Commissioner
of Internal Revenue.

CHIN, Circuit Judge:

In these consolidated cases, petitioners were

owners of four small businesses that enrolled in purported

life insurance plans for employees. Only the four principal

owners and a stepson, however, were covered under the plans.

The contributions to the plans -- amounting to hundreds of

thousands of dollars -- were claimed as tax deductions by

the businesses.

The Commissioner of Internal Revenue (the

"Commissioner") concluded that these contributions should

not have been deducted because, inter alia, they were not

-2-
"ordinary and necessary" business expenses within the

meaning of the Tax Code. Disallowing the deductions

resulted in additional passthrough income to petitioners on

which they had not paid taxes. Accordingly, the

Commissioner issued notices of deficiency to petitioners and

assessed accuracy-related penalties.

Petitioners' cases were consolidated and tried

before the United States Tax Court in March 2009. After

trial, the tax court ruled in favor of the Commissioner,

finding that petitioners owed deficiency payments and

accuracy-related penalties. Petitioners appealed. We

affirm.

BACKGROUND

The following facts are drawn from the tax court's

findings and the record on appeal, including stipulations of

the parties, documentary evidence, and testimony of

petitioners and their witnesses.

A. The Benistar Plan

The Benistar 419 Plan (the "Plan") was established

in 1997 by Daniel E. Carpenter. It was designed to be a

-3-
multiple-employer welfare benefit plan under 26 U.S.C.

§ 419A(f)(6). The "Plan provides death benefits funded by

individual life insurance policies for a select group of

individuals chosen by the Employer to participate in the

Plan." (Ex. 33-J (Benistar Plan Brochure)) (A 1824). The

only benefits "claimed to be provided by or through [the

Plan] are pre-retirement death benefits for covered

employees of participating employers." (First Stip. of

Facts ¶ 41).

Businesses that enroll in the Plan contribute to a

trust account maintained by the Plan. The Plan uses these

contributions to acquire one or more life insurance policies

on the lives of employees covered by the Plan; it withdraws

funds from the trust account to pay the premiums on these

policies. Each covered employee determines the type of

insurance that the Plan will purchase on his behalf.

Furthermore, the Plan allows participating businesses to

choose the number of years for which contributions to the

Plan will be required to fully pay for the death benefit or

benefits provided through the Plan. The Plan is listed as

-4-
the beneficiary on each insurance policy and passes on the

death benefit to the covered employee.

The Plan also allows participating businesses to

withdraw from, or terminate, participation at any time.

Upon termination, the Plan can distribute the underlying

policies to the insured employees. Until mid-2002, an

underlying policy could be distributed at no cost to the

covered employee. From mid-2002 to mid-2005, the Plan

required that the covered employee be charged 10% of the

"cash surrender value" in exchange for the underlying

policy. (Carpenter Exam. at 274-76). Starting in mid-2005,

the Plan purportedly began to charge covered employees the

"fair market value" of the underlying policy upon

termination. (Id. at 125).1

The Plan advertises several "advantages,"

including (1) "Virtually Unlimited Deductions for the

Employer"; (2) "Benefits can be provided to one or more key

Executives on a selective basis"; (3) "No need to provide

1 Carpenter explained that the "fair market value"
of the policy is equal to its "cash value." (Carpenter
Exam. at 238).

-5-
benefits to rank and file employees"; and (4) "Funds inside

the BENISTAR 419 Plan accumulate tax-free." (Ex. 33-J)

(A 1825). Carpenter testified that "the beauty" of the Plan

"is that you can put away extra money in good times and

though the premium is not due, you can put away excess

amounts of money, get a tax deduction today, and we don't

put the premium in for years to come." (Carpenter Dep. at

262).

B. Curcio and Jelling

Petitioners Marc Curcio and Ronald D. Jelling each

own 50% of three car dealerships: Dodge of Paramus, Inc.

("Dodge"), Chrysler Plymouth of Paramus, Inc. ("Chrysler

Plymouth"), and JELMAC LLC ("JELMAC").

In or about 2001, Curcio and Jelling decided to

enter into a buy-sell agreement.2 The buy-sell agreement

contemplated that if one partner died, the other would buy

the deceased partner's 50% stake in the businesses. When

the buy-sell agreement was executed, it set the value of the

2
The agreement was not actually executed until
2003.

-6-
businesses at $12,000,000. To fund the purchase if it

became necessary, each partner agreed to take out an

insurance policy on the other's life. In other words, each

partner would list the other as the beneficiary of his death

benefit and the death benefit would be used to purchase the

deceased partner's share of the businesses.

Instead of purchasing life insurance policies

directly, however, Curcio and Jelling decided to insure

themselves through the Plan. Accordingly, Dodge enrolled in

the Plan on December 28, 2001. Curcio and Jelling were the

only covered employees. They did not choose to insure any

of the other 75 people employed by Dodge. Neither Chrysler

Plymouth nor JELMAC enrolled, nor were any of their

employees, other than Curcio and Jelling, covered.

Curcio and his insurance agent, Robert Iandoli,

selected a whole life policy with a $9,000,000 death

benefit. Jelling and his insurance agent, Alan Solomon,

chose two policies -- one whole life policy and one

universal (or adjustable) life policy -- totaling

approximately $9,000,000 in coverage. Curcio paid a

-7-
$200,000 annual policy premium to the Plan. Jelling paid

the same.

Although Dodge was the only entity to enroll in

the Plan, Dodge was not always the only entity to contribute

to the Plan. In fact, all three Curcio/Jelling business

entities contributed to the Plan, with whichever entity

having the highest cash balance at the end of the year doing

so. Dodge contributed $400,000 in 2001 and 2002. JELMAC

contributed $400,000 in 2003 and Chrysler Plymouth

contributed $400,000 in 2004. Each business claimed a tax

deduction for the entirety of its contribution. Jelling

testified that he considered the contributions "as a funding

for our buy sell agreement." (Jelling Exam. at 581).

Curcio and Jelling had asked their accountant,

Stuart Raskin, about the deductibility of the contributions.

Raskin consulted with his partners and, based on a letter

from the law firm Edwards & Angell, LLP, concluded that a

deduction was proper.3 Raskin advised Curcio and Jelling

3
At the request of Carpenter, Edwards & Angell
issued a series of letters opining on whether contributions
to the Plan were deductible and met the requirements of

-8-
that the deduction was proper, but also communicated that

this opinion was derived solely from the Edwards & Angell

letter, and not from any independent research or

investigation. Furthermore, Raskin did not offer Curcio or

Jelling any assurances that the I.R.S. would approve the

deductions. Neither Raskin, nor anyone at his firm, was an

expert in welfare benefit plans.

C. Smith

Petitioner Samuel H. Smith was, at all relevant

times, the sole owner of SH Smith Construction, Inc. ("Smith

Construction"). Smith Construction enrolled in the Plan in

2002. Although Smith Construction had 35–40 employees, it

chose to insure only Smith through the Plan. On the

§ 419A. A November 2001 letter stated that it was "more
likely than not" that a court would sustain deductions for
contributions to the Plan. (Ex. 37-J at 2) (A 1959). It
cautioned, however, that neither the Internal Revenue Code
nor the tax regulations provided specific guidance on the
issue. While deductions for life insurance were not per se
improper, the I.R.S. could "challenge the amount deducted."
(Id. at 3) (A 1960). Furthermore, an October 2003 letter
noted that the determination of whether an expense is
"ordinary and necessary" -- and therefore deductible -- "is
quite subjective and dependent upon a totality of the facts
and circumstances of a particular taxpayer." (Ex. 38-J
at 5) (A 1968).

-9-
insurance application, Smith indicated that the purpose of

the insurance was "retirement planning." (Ex. 116-J at 3)

(A 3125). Smith chose a variable life policy with a death

benefit of $5,000,000 and annual premium payments of

$54,000. In 2003, Smith Construction claimed a $54,000

deduction for its contribution to the Plan.

By September 2005, Smith Construction had paid a

total of $171,500 in premiums, and the policy had an

accumulated cash value of $152,259.

By letter dated September 27, 2005, Smith

requested that Benistar terminate his participation in the

Plan. Moreover, he stated that he "would like to purchase

the policies . . . and take ownership of the[m]." (Ex. 129-

J) (A 3203). The Plan provided that Smith could purchase

his policy by paying "10% of the net cash surrender value of

the policy." (Ex. 175-J (Plan Termination and Policy

Transfer Release Form)) (A 3372). Smith paid $2,970. This

amount, however, equaled 10% of his policy's net cash

surrender value on December 31, 2004, not 10% of the net

cash surrender value in September 2005, when Smith

-10-
terminated his company's participation in the Plan and

requested the transfer. In fact, his policy's net cash

surrender value in September 2005 was $83,158, 10% of which

would be $8,316. In April of 2006, Smith withdrew $77,300

from his policy. In January 2007, Smith borrowed $16,000

from his policy.

Smith testified at trial that he relied on his

accountant's representation that contributions to the plan

were deductible. He could not recall whether this

representation was made orally or by email.

D. Mogelefsky

Petitioner Stephen Mogelefsky is the sole owner of

Discount Funding Associates ("Discount"), a corporation that

provides mortgage broker services. Discount enrolled in the

Plan in late 2002 to obtain life insurance for Mogelefsky

and his stepson, an employee of the company. Mogelefsky

chose a $1,300,000 policy on his own life so that "in case

something happened to [him, his] son could take over the

business." (Mogelefsky Exam. at 621). He also chose a

$350,000 policy to cover his stepson. In December 2003,

-11-
Discount elected to provide Mogelefsky with additional life

insurance benefits in the amount of $1,020,000.

In early 2003, Discount contributed $398,597 to

the Plan. It claimed a deduction for this contribution in

the 2002 tax year. In early 2004, Discount contributed

another $354,821. It claimed a deduction for this amount in

the 2003 tax year.

In March 2006, Mogelefsky and his stepson decided

to withdraw from the Plan. To acquire his first policy,

Mogelefsky paid $28,577. To acquire his second policy,

Mogelefsky paid $14,632. By December 2005, the first policy

had accumulated a cash value of $313,745 and had a net

surrender value of $285,414. When the second policy was

transferred on March 16, 2006, it had accumulated a cash

value of $255,089. In December 2005, its net surrender

value was $145,994.

E. Procedural History

The Commissioner sent notices of deficiency to

Curcio and Jelling on January 23, 2007, and to Smith and

Mogelefsky on June 25, 2007. Specifically, the Commissioner

disallowed the deductions petitioners' business entities had

-12-
taken for contributions to the Plan because, inter alia, the

contributions were not ordinary and necessary business

expenses. Accordingly, the Commissioner found that

petitioners had additional passthrough income on which they

had failed to pay income tax. In addition to the

deficiencies, the Commissioner assessed a 20% accuracy-

related penalty on each petitioner.

In the case of Discount's first contribution, the

Commissioner could not disallow the corresponding deduction

because the statute of limitations on the 2002 tax year had

passed. Instead, the Commissioner found that the

contribution was 2003 income in the form of a constructive

dividend or deferred compensation.

The four cases were consolidated and tried before

the tax court in March 2009.4 On May 27, 2010, the tax

court issued a Memorandum Finding of Facts and Opinion (the

"Memorandum Opinion"). In the Memorandum Opinion, the tax

court agreed with the Commissioner, finding that the

contributions made by petitioners' business entities were

4
Petitioners Barbara Curcio, Amy L. Smith, Lorie A.
Jelling, and Roberta Mogelefsky are the wives of the
business owners. They were named in this action only
because they filed joint tax returns with their husbands.

-13-
not "ordinary and necessary" business expenses and,

therefore, should not have been deducted. Moreover, it

approved the Commissioner's unique treatment of Discount's

first contribution. Finally, the tax court found that the

improper deductions -– and petitioners' corresponding

underpayment of tax -- were the result of negligence or

disregard for the tax rules and regulations. Accordingly,

the court issued four decisions, ordering due the

deficiencies and penalties assessed by the Commissioner.

Curcio and Jelling appealed on August 24, 2010.

Smith and Mogelefsky appealed on December 2, 2010. The

appeals were consolidated on December 17, 2010.

DISCUSSION

A. Applicable Law

1. Ordinary & Necessary Business Expenses

Section 162(a) of the Internal Revenue Code

provides that a business may deduct "all the ordinary and

necessary expenses paid or incurred" during the taxable year

in carrying out that trade or business. 26 U.S.C. § 162(a).

To qualify as an allowable deduction under § 162(a), an item

must "(1) be paid or incurred during the taxable year, (2)

-14-
be for carrying on any trade or business, (3) be an expense,

(4) be a 'necessary' expense, and (5) be an 'ordinary'

expense." Comm'r v. Lincoln Sav. & Loan Ass'n, 403 U.S.

345, 352 (1971) (some internal quotation marks omitted).

An "ordinary" expense is one that is "normal,

usual, or customary in the type of business involved."

Int'l Trading Co. v. Comm'r, 275 F.2d 578, 585 (7th Cir.

1960) (citing Deputy v. du Pont, 308 U.S. 488, 494-96

(1940)); accord Sharon Herald Co. v. Granger, 195 F.2d 890,

895 (3d Cir. 1952). An expense need not be habitual to be

"ordinary," see Welch v. Helvering, 290 U.S. 111, 113-14

(1933), but the transaction "must be of common or frequent

occurrence in the type of business involved," du Pont, 308

U.S. at 495. A "'necessary'" expense is one that is

"'appropriate and helpful'" for the development of the

taxpayer's business. See INDOPCO, Inc. v. Comm'r, 503 U.S.

79, 85 (1992) (quoting Comm'r v. Tellier, 383 U.S. 687, 689

(1966)).

Put simply, "[e]xpenditures may only be deducted

under § 162 if the facts and the circumstances indicate that

-15-
the taxpayer made them primarily in furtherance of a bona

fide profit objective independent of tax consequences."

Green v. Comm'r, 507 F.3d 857, 871 (5th Cir. 2007) (internal

quotation marks omitted). Purchasing or subsidizing

benefits -- e.g., life insurance -- for employees might fall

into this category to the extent it incentivizes employees

to remain loyal to the business and perform to the best of

their abilities. See Schneider v. Comm'r, 63 T.C.M. (CCH)

1787, at *11 (1992).

2. Deductibility of Welfare Benefit Plan

Contributions

Contributions to welfare benefit plans are not

deductible per se. 26 U.S.C. § 419(a)(1). To be

deductible, such a contribution must qualify under some

other provision of the Code. Id. § 419(a)(1)–(2). In fact,

the I.R.S. has explicitly opined that the deductibility of

contributions to an employee trust for life insurance is

governed by § 162(a) of the Code and § 1.162-10 of the

Regulations. See Rev. Rul. 69-478, 1969-2 C.B. 29

(discussing deductibility of term life insurance for active

-16-
and retired employees); 26 C.F.R. § 1.162-10 (1960)

("Amounts paid or accrued within the taxable year for . . .

medical expense, recreational, welfare, or similar benefit

plan, are deductible under section 162(a) if they are

ordinary and necessary expenses of the trade or business.").

Accordingly, if a welfare benefit plan

contribution is ordinary and necessary, it is deductible.

The deduction, however, is generally limited to "the welfare

benefit fund's qualified cost for the taxable year." 26

U.S.C. § 419(b). This limitation does not apply if the

welfare benefit plan meets certain requirements set forth in

§ 419A(f)(6).

Therefore, in determining the deductibility of a

welfare benefit plan contribution, the threshold question is

whether the contribution is an ordinary and necessary

business expense under § 162(a). Only if a court determines

that the contribution is ordinary and necessary would it

proceed with an analysis under § 419A(f)(6) to determine

whether any limitations on deductibility apply.

-17-
 3. Accuracy-Related Penalties

Section 6662 of the Internal Revenue Code provides

for a 20% accuracy-related penalty on any portion of an

underpayment that is attributable to, inter alia,

(1) "[n]egligence or disregard of rules or regulations" or

(2) "[a]ny substantial understatement of income tax." 26

U.S.C. § 6662(b)(1)-(2).

"'[N]egligence' . . . includes any failure to make

a reasonable attempt to comply with the provisions of [the

Code]." Id. § 6662(c). "'[D]isregard' includes any

careless, reckless, or intentional disregard." Id.

Disregard of rules or regulations is careless "if the

taxpayer does not exercise reasonable diligence to determine

the correctness" of his position. 26 C.F.R. § 1.6662-

3(b)(2) (2012). Disregard of rules or regulations is

reckless "if the taxpayer makes little or no effort to

determine whether a rule or regulation exists, under

circumstances which demonstrate a substantial deviation from

the standard of conduct that a reasonable person would

observe." Id.

-18-
 An understatement is "substantial . . . if the

amount of the understatement for the taxable year exceeds

the greater of -- (i) 10 percent of the tax required to be

shown . . . or (ii) $5,000." 26 U.S.C. § 6662(d)(1)(A). A

taxpayer may avoid some or all of a "substantial

understatement" penalty if (1) there was "substantial

authority" supporting the taxpayer's ability to take the

deduction; or (2) the relevant facts relating to the

deduction were "adequately disclosed in the return" and

there was a "reasonable basis" for the deduction. See id.

§ 6662(d)(2)(B). "Substantial authority" exists "only if

the weight of the authorities supporting the treatment is

substantial in relation to the weight of authorities

supporting contrary treatment." 26 C.F.R. § 1.6662-

4(d)(3)(i) (2012).

Finally, "no penalty shall be imposed . . . with

respect to any portion of an underpayment if it is shown

that there was a reasonable cause for such portion and that

the taxpayer acted in good faith with respect to such

portion." 26 U.S.C. § 6664(c)(1). "Generally, the most

-19-
important factor [in determining whether a taxpayer acted

with reasonable cause and in good faith] is the extent of

the taxpayer's effort to assess the taxpayer's proper tax

liability." 26 C.F.R. § 1.6664-4(b)(1).

4. Standard of Review

We review the tax court's legal conclusions de

novo and its factual findings for clear error. Robinson

Knife Mfg. Co. v. Comm'r, 600 F.3d 121, 124 (2d Cir. 2010).

Whether an expense is "ordinary and necessary"

within the meaning of § 162(a) is a "pure question[] of fact

in most instances." Comm'r v. Heininger, 320 U.S. 467, 475

(1943); accord McCabe v. Comm'r, 688 F.2d 102, 104 (2d Cir.

1982). Unless "a question of law is unmistakably involved,"

Heininger, 320 U.S. at 475, we review for clear error the

tax court's determination that an expense was not an

ordinary and necessary business expense, McCabe, 688 F.2d at

104–05. Compare Chenango Textile Corp. v. Comm'r, 148 F.2d

296, 298 (2d Cir. 1945) (although tax court cited appellate

court opinions to justify its conclusion, its decision was a

determination of fact) with Heininger, 320 U.S. at 475 (tax

-20-
court mistakenly believed that denial was required as a

matter of law). The tax court's finding is clearly

erroneous only when "the reviewing court on the entire

evidence is left with the definite and firm conviction that

a mistake has been committed." Estate of Stewart v. Comm'r,

617 F.3d 148, 164 (2d Cir. 2010) (internal quotation marks

omitted).

The determination that a taxpayer is liable for an

accuracy-related penalty is also a factual determination

reviewed for clear error. See Nicole Rose Corp. v. Comm'r,

320 F.3d 282, 284-85 (2d Cir. 2003) (citing Goldman v.

Comm'r, 39 F.3d 402, 406 (2d Cir. 1994)).

B. Application

We review three of the tax court's rulings:

first, the tax court determined that contributions to the

Plan were not ordinary and necessary business expenses;

second, the tax court ruled that Discount's first

contribution on behalf of Mogelefsky was taxable as a

constructive distribution; and third, the tax court

concluded that accuracy-related penalties were warranted.

-21-
We review the first and third rulings for clear error. The

standard of review applicable to the second ruling is less

clear, and the parties have provided no guidance on the

issue. We need not resolve the issue, however, because even

applying de novo review, the tax court's second ruling was

not erroneous.

1. Ordinary and Necessary Business Expenses

The tax court did not clearly err when it found

that the contributions by petitioners' business entities to

the Plan were not ordinary and necessary business expenses.

The record supports the conclusion that the contributions

were not normal, usual, or "helpful for the development of

the [taxpayers'] business," see Tellier, 383 U.S. at 689

(internal quotation marks omitted); they were not made in

furtherance of a profit objective or for any viable business

purpose, see Green, 507 F.3d at 871. Rather, the evidence

demonstrates that the contributions were made solely for the

personal benefit of petitioners. The contributions were a

mechanism by which petitioners could divert company profits,

tax-free, to themselves, under the guise of cash-laden

-22-
insurance policies that were purportedly for the benefit of

the businesses, but were actually for petitioners' personal

gain.

Indeed, the Plan was designed to benefit only

owners and their families and not the businesses generally.

Carpenter, who conceived of the Plan, admitted that the Plan

was meant to cover only owners and their families.

Moreover, he testified that "most of the people in the plan

are looking for estate planning advantages." (Carpenter

Dep. at 156). The Plan was essentially touted as a way for

"Key Executives" to avoid paying taxes on business income by

diverting it into a vehicle in which funds could accumulate

tax-free. (See Ex. 33-J (Benistar Plan Brochure) (noting

that "Plan Advantages" included "unlimited deductions,"

"tax-free" accumulation, and "tax-free distribution at a

later date")).

Evidence pertaining to the individual owners also

demonstrates that contributions to the plan were for their

personal benefit, not the benefit of their respective

business entities. Dodge, for example, enrolled in the Plan

-23-
so that Curcio and Jelling could fund the buy-sell agreement

between them. The contributions to the Plan were not made

in furtherance of a business objective, but rather to

relieve Curcio or Jelling from having to use personal funds

to pay for his partner's share of the business in the event

the partner died. See Petersen v. Comm'r, 74 T.C.M. (CCH)

90, 98 (1997). Dodge employed approximately 75 other

people, none of whom were covered under the plan.

Smith admitted that he enrolled his company in the

Plan for the purpose of "retirement planning." (A 3125).

None of the other 35–40 employees of Smith Construction were

covered under the Plan. In late 2005, Smith paid

approximately $3,000 to acquire ownership of his underlying

life insurance policy. At the time, the policy had a cash

value of over $150,000 and a net surrender value of over

$83,000. He subsequently withdrew $77,300 from the policy

and took out a $16,000 loan against it. Therefore, the

record supports the conclusion that Smith's contributions to

the Plan were not business expenses; they funded a life

-24-
insurance policy from which Smith himself later realized a

significant personal monetary benefit.

Mogelefsky's company, Discount, deducted a total

of over $750,000 in Plan contributions for the 2002 and 2003

tax years. In 2006, Mogelefsky paid less than $45,000 in

exchange for ownership of the two underlying insurance

policies. Around the time the policies were transferred,

they had accumulated a total cash value of over $560,000 and

a total net surrender value of over $430,000. Therefore,

the record demonstrates that Mogelefsky, like Smith,

diverted business profits, tax-free, into what eventually

became a personal asset with a significant cash component.

To be sure, paying for life insurance for one's

employees can be an ordinary and necessary business expense

if the purpose is to compensate, incentivize, and retain key

employees. See Schneider, 63 T.C.M. (CCH) 1787, at *11.

But it is neither ordinary nor necessary when the insurance

policies are purchased as investment -- or "estate planning"

(see Carpenter Dep. at 156) -- vehicles for the sole benefit

of the owners of the company. See V.R. DeAngelis v. Comm'r,

-25-
94 T.C.M. (CCH) 526, at *23 (2007) ("While employers are not

generally prohibited from funding term life insurance for

their employees and deducting the premiums . . . as a

business expense . . . , employees are not allowed to

disguise their investments in life insurance as deductible

. . . when those investments accumulate cash value for the

employees personally."), aff'd, 574 F.3d 789 (2d Cir. 2009)

(per curiam).

Indeed, this case falls into the latter category.

Petitioners' business entities employed scores of other

individuals, but with the exception of Mogelefsky's stepson,

none was offered life insurance coverage under the Plan.

Petitioners cannot claim that they enrolled in the Plan to

incentivize or retain themselves as employees, as they were

the owners of the businesses.

We do not hold that purchasing a life insurance

policy with a cash component can never be an ordinary and

necessary business expense. Such a determination is fact

intensive and must be made on a case by case basis. In this

case, however, where petitioners could withdraw from the

-26-
Plan at any time and obtain personal control over cash-laden

policies, and where other evidence in the record

demonstrates that the taxpayers contributed to the Plan

solely for their personal benefit, the tax court did not

clearly err in finding that the contributions were not

ordinary and necessary business expenses.

Petitioners argue that all contributions to a plan

satisfying the requirements of § 419A(f)(6) are deductible

in their entirety, without regard to whether those

contributions are ordinary and necessary business expenses.

(Pet. Br. at 57; Pet. Reply Br. at 6). Petitioners,

however, cite no authority for this position and it is

belied by the statutory scheme. Section 419(a) states that

plan contributions "shall not be deductible" unless they

would otherwise be deductible under another section of the

Tax Code, such as § 162(a). Section 419(b) provides that if

a contribution is deductible under another section of the

Code, such a deduction is limited to the fund's qualified

cost for the taxable year. Section 419A(f)(6), upon which

petitioners rely, only supplies an exemption -- if certain

-27-
requirements are met -- to § 419(b)'s limit on

deductibility. It does not provide that such contributions

are deductible in the first instance.5

Thus, the threshold question is whether plan

contributions are deductible under another section of the

Code -- here, § 162(a). Because we find no clear error in

the tax court's ruling that the plan contributions were not

deductible under § 162(a) -- i.e., they were not ordinary

and necessary business expenses –- we do not reach the issue

of whether the Plan meets the requirements of § 419A(f)(6).6

5
Under petitioners' reading of the statute, a
company enrolled in a plan that satisfies the requirements
of § 419A(f)(6) could contribute and deduct the entire
amount of its profits, avoiding its entire tax burden.
Obviously, this was not what Congress contemplated.
6
On appeal, petitioners argue that if their entire
contributions cannot be deducted, they should at least be
able to deduct an amount equal to the annual "qualified
cost" of the welfare benefit fund. See 26 U.S.C. § 419(b),
(d). It does not appear, however, that petitioners raised
this argument below, and thus we do not consider it.

-28-
 2. The Tax Court's Treatment of Discount's

Contributions Was Not Improper

Discount –- on behalf of Mogelefsky -- made its

first contribution to the Plan in early 2003, for which it

claimed a deduction on its 2002 tax return. It made a

second contribution to the Plan in early 2004, for which it

claimed a deduction on its 2003 tax return. The

Commissioner disallowed the 2003 deduction on the ground

that the second contribution was not an ordinary and

necessary business expense, creating additional passthrough

income for Mogelefsky in 2003. The Commissioner, however,

did not have jurisdiction over the 2002 deduction, as the

statute of limitations had run on the 2002 tax year.

Instead of disallowing the 2002 deduction, the Commissioner

classified the first contribution as "constructive dividend

income" or "deferred compensation" to Mogelefsky in the 2003

tax year. (A 1317). The tax court affirmed, finding that

the first contribution was a constructive distribution.

Petitioners contend that the manner in which the

tax court treated Discount's two contributions was

-29-
inconsistent and resulted in "double taxation." (Pet. Br.

at 78). Moreover, they argue that the 2003 "distribution"

accrued to Mogelefsky in the 2002 tax year, so it should not

have been counted as income for 2003. (Id. at 75-78).

Petitioners' argument is without merit.

Mogelefsky was not taxed twice on either of the two

contributions. The tax court treated Discount's second

contribution (for which a deduction was claimed in the 2003

tax year) like the contributions made by the other

petitioners' business entities. It found that the

contribution was not an ordinary and necessary business

expense, disallowed the deduction, and included the amount

as taxable passthrough income to Mogelefsky. The record

does not reflect that this contribution was taxed at any

other point.

The tax court treated Discount's first

contribution (for which a deduction was claimed in the 2002

tax year) as a "distribution"7 to Mogelefsky, to be taxed

7
This Court has affirmed the treatment of welfare
benefit plan contributions as "distribution[s] of corporate
profits" where, as here, the contributions were used to

-30-
under 26 U.S.C. §§ 1366-68. See also 26 U.S.C. § 301(c).8

Because Discount claimed a deduction in the 2002 tax year

for the amount of this contribution -- and that deduction

has not been disallowed -- Mogelefsky has not been taxed

twice on the amount of the contribution.

Petitioners have not pointed to any authority

prohibiting the Commissioner from recognizing these two

contributions under separate sections of the Tax Code.

purchase life insurance policies with large cash components
that were accessible to the insured. See DeAngelis, 94
T.C.M. (CCH) 526, at *25.
8
Under § 1368, a distribution is not included in
income if the taxpayer has sufficient "basis" in his
corporation against which he can apply the distribution. 26
U.S.C. § 1368(b)(1). Under such circumstances, his basis is
reduced by the amount of the distribution, id.
§ 1367(a)(2)(A), increasing the amount of his tax burden
when he sells his shares in the corporation. On the other
hand, to the extent there is insufficient basis against
which the distribution may be applied, the distribution is
to be treated as a gain from the sale of property. Id.
§ 1368(b)(2).

In Mogelefsky's case, the record did not reflect
his basis in Discount. Therefore, the tax court treated the
entire distribution as being "in excess of basis" and taxed
it as gain from the sale or exchange of property. See id.

-31-
 Furthermore, the tax court did not err in finding

that the distribution accrued to Mogelefsky in 2003 --

rather than 2002 -- because that is when it was

"unqualifiedly made subject to [his] demands." See 26

C.F.R. § 1.301-1(b). Indeed, while Discount may have

committed to making the contribution in 2002, it did not

actually transfer the money to the Plan until 2003. It was

only at that point that Mogelefsky could have terminated

Discount's participation in the Plan and obtained the policy

along with its cash component.

3. Accuracy-Related Penalties

Finally, we affirm the imposition of accuracy-

related penalties. Specifically, the tax court did not

clearly err in finding that petitioners were "negligent" and

acted in "disregard" of the tax rules and regulations.

Section 162(a) of the Tax Code is clear: To deduct a

business expense, that expense must be "ordinary and

necessary." 26 U.S.C. § 162(a). It is also clear that

neither § 419 nor § 419A provides an independent ground for

deducting welfare benefit plan contributions. See 26 U.S.C.

-32-
§ 419 ("Contributions paid or accrued by an employer to a

welfare benefit fund . . . shall not be deductible under

this chapter [unless] they would otherwise be deductible

. . . ."). Petitioners' respective decisions to deduct the

Plan contributions in the face of such clear statutory

language could reasonably be classified as negligent

behavior.9

Petitioners argue that they relied in "good faith"

on the advice of their accountants. Reliance on

professional advice, however, is not, by itself, an absolute

defense to negligence. Freytag v. Comm'r, 89 T.C. 849, 888-

89 (1987). Indeed, there was little reason for petitioners

to believe that their accountants were authorities on the

tax treatment of welfare benefit plan contributions or that

they had sufficiently researched the issue. The accountants

9
Part of Mogelefsky's accuracy-related penalty was
assessed on a constructive-dividend theory, but the tax
court did not disaggregate that aspect of the deficiency
when imposing penalties. Mogelefsky, however, does not
provide any argument on appeal that he should not have been
assessed an accuracy-related penalty for failing to report
Discount's 2003 contribution as a constructive dividend to
him. We therefore do not need to consider the matter. See
Norton v. Sam's Club, 145 F.3d 114, 117 (2d Cir. 1998).

-33-
for Curcio, Jelling, and Mogelefsky told them that they had

solely relied on the Edwards & Angell letter.

Moreover, the record does not reflect that

petitioners conducted an investigation sufficient to avail

themselves of a "good faith" defense. See 26 C.F.R.

§ 1.6664(c). Had petitioners reviewed the Edwards & Angell

letters upon which their accountants so heavily relied, they

would have learned that Edwards & Angell made no guarantees

as to the deductibility of Plan contributions. In fact, the

letters specifically warned that the Commissioner could

disallow petitioners' deductions based on a finding that the

amount of the contributions was not ordinary and necessary.

CONCLUSION

For the reasons stated above, the decisions of the

tax court are affirmed.

-34-