In Uncategorized on 08/02/2011 at 17:39

Or, Documentation is the Name of the Game

 Once again Tax Court stresses the old rule: Documentation isn’t the most important thing, it’s the only thing. Thus spake Judge Wherry in James and Deborah Ledger, 2011 T.C. Mem. 183, filed 8/2/11.

Jimmy took out an endowment insurance policy in the early Seventies that paid off in the year at issue to the extent of $40K after the investment in the contract was deducted. Jimmy took out more than a dozen loans against the policy over the years, and claimed he paid tax on the proceeds each time, but introduced no evidence to show he’d ever paid any tax.

The insurance company paid off the loans at maturity of the policy via a bookkeeping entry, and sent Jimmy the net proceeds; he got the proceeds, but the 1099-R the insurer mailed him showing the $40K payout, Jimmy claims he never got. No matter, says Judge Wherry, the parties stipulated it was sent and the amount it showed, 2011 T.C. Mem. 183, at p. 3, footnote 2.

Our old friend Section 72(e) makes all insurance payouts other than annuities gross income, to the extent the payout exceeds investment in the contract (as defined in the statute). Judge Wherry lays it all out thus: “The term ‘investment in the contract’ is defined under section 72(e)(6) as ‘(A) the aggregate amount of premiums or other consideration paid for the contract before such date, minus(B) the aggregate amount received under the contract before such date, to the extent that such amount was excludable from gross income’.

“For Federal income tax purposes, loans against a life insurance contract’s cash value are treated as true loans from the insurance company to the policyholder with the policy serving as collateral. See Minnis v. Commissioner, 71 T.C. 1049, 1054(1979); Sanders v. Commissioner, T.C. Memo. 2010-279; Atwood v. Commissioner, T.C. Memo. 1999-61. Thus, using the policy’s proceeds to satisfy the loans has the same effect as paying the proceeds directly to the policyholder. See Atwood v. Commissioner, supra.” 2011 T.C. Mem. 183, at pp. 5-6.

See also my blogpost “A Dangerous Thing”, posted 4/13/11, wherein I describe how an attorney with an LL.M. in Taxation came a cropper on this principle.

Jimmy may have conflated taxes he paid on dividends on the policy with taxes he never paid on loans against the policy. “Mr. Ledger testified at trial that he had already ‘paid taxes’ on any money he took out of the policy, specifically any dividends that were issued to him. Mr. Ledger also testified at trial that he does not ‘know the difference between a dividend or calling the insurance company and say [sic], I need another $3,000 for the kids school and they sent it to me.’” 2011 T.C. Mem. 183, at p.6.

Not good enough, Jimmy, says Judge Wherry. You never proved what taxes you paid, if any. And your want of knowledge of the difference between a loan and a dividend will not help you.

Bottom line–As the old advertising slogan for the finance company said, “Never borrow money needlessly, but when you must, borrow confidently…” but keep meticulous records.

Leave a Reply

Please log in using one of these methods to post your comment: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: