In Uncategorized on 12/16/2015 at 18:47

Though I never saw him play (I was only four years old when he died, and he had long since left baseball), he was a legend. Babe Ruth called him the greatest pitcher he ever faced. The Babe also said he lost a heartbreaking number of games by one or two runs, because he played on a mediocre team for most of his twenty-one years as a pitcher.

I said today would blog a case lost by a colleague. He’s a good lawyer, and a good guy, who has lost some tough cases.

So here’s Jeremiah J. O’Connor and Mary K. O’Connor, 2015 T. C. Memo. 244, filed 12/16/15.

It’s a SDLIA (a Split-Dollar Life Insurance Arrangement, where an employer makes insurance premium payments on behalf of an employee, who seeks deferred income; see my blogpost “The Split,” 8/29/12 ) that comes unglued when they all come unglued in 2002.

Jere was a hardware dealer with a Sub S, and parked some cash with a trustee of what purported to be a 419 Plan. Except IRS issued proposed regs blowing up same, so word went out to the splitters to bail and pay tax on the accumulated cash values of the blown-up, rolled-out insurance policies.

Jere tried bailing in 2002 by shifting policy from one trust (blown up) to another (presumably not blown up) and calling it a Section 1035 policy swap. And also claiming he never got his hands on the policy, so he never had incidents of ownership sufficient to render the accumulated cash taxable to him. Or if he did, he argues, it was in another (now closed) year and not the year stated in the deficiency.

A good three-deep defense.

Doesn’t work. Judge Halpern: “Pursuant to section 402(b)(1), employer contributions to a nonexempt employee trust are included in the employee’s gross income to the extent that the employee’s interest in such contributions is substantially vested (within the meaning of section 1.83-3(b), Income Tax Regs.) at the time the contributions are made. See sec. 1.402(b)-1(a)(1), Income Tax Regs. If an employee’s rights under a nonexempt employee trust become substantially vested during a taxable year of the employee, and the taxable year of the trust ends with or within such year, the value of the employee’s interest in the trust on the date of such vesting is included in the employee’s gross income for that taxable year.” 2015 T. C. Memo. 244, at p. 21.

So it’s our old friend “substantial risk of forfeiture,” and here there isn’t, because at the roll-out Jere gets to choose where the policy is to go, including but not limited to himself, (via change-of-ownership forms in blank), and more than that, can change the beneficiary. Jere doesn’t need a duplicate original of the policy.

And the transfer didn’t take place in the closed year (which immediately preceded the year at issue), because the incoming trustee refused to indemnify the outgoing trustee for past shenanigans, and therefore didn’t accept the policy, until the year at issue. Jere twice had to try to get the policy moved to his chosen trustee.

Finally, there was no exchange of policies, so Section 1035 is out. There was no old policy and no new policy, it was the same old, same old. “Rather, the same policy was merely transferred from one owner to another, the only issue being whether Mr. O’Connor, who had a right to keep the policy instead of opting to have it transferred to the … Plan, had income arising out of that right. The foregoing transaction simply is not covered by section 1035, as there must be an actual or, at least, a constructive exchange of one policy for another.” 2015 T. C. Memo. 244, at p. 28. (Citation omitted).

Jere never told his CPA about the warnings he got from the roller-out trustee, so even though his CPA said do a trustee-to-trustee, there’s no evidence his CPA knew about the Section 83 or the Section 402(b)(1) implications. 20% chop, although IRS bases its chop on a lower number than the stipulated deficiency.

I can only suggest that my colleague may have been called into this mess long after the damage was done, and was down two runs in the top of the ninth. A scenario with which Walter Johnson must have been very familiar.

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