In Uncategorized on 06/06/2016 at 16:10

Larita K. Mallory’s cri de cœur doesn’t move Judge Morrison in Kenneth L. Mallory and Larita K. Mallory, 2016 T. C. Memo. 110, filed 6/6/16.

Ken plunked down heavy bucks thirty years ago for a modified single premium variable life insurance policy. You’ll remember these have a stock-market gambler’s-choice feature, whereby if the invested premium makes money, cash surrender and cover go up. But if the investment tanks, you pony up the actuarial value or lose it all.

Ken hit it big, but borrowed big. He was supposed to pay interest on his borrowing, but never did. He testifies his borrowings were all for living expenses.

Ultimately the sum of Ken’s borrowings plus interest accrued but unpaid overtook cash surrender, so the insurer dumped the policy, treated the wiped out debt and interest as a Section 72 distribution, and gave Ken a 1099-R.

Hence Larita’s handwritten note to IRS on the 1099: “Paid hundreds of $.  No one knows how to compute this using the 1099R from Monarch–IRS could not help when called–Pls send me a corrected 1040 explanation + how much is owed.  Thank you.” 2016 T. C. Memo. 110, at p. 6.

Now this gambit might have worked if Ken and Larita filed timely, which they didn’t, and heeded the advice of the Liberty Tax Service person they consulted, who “…told Larita Mallory that she ‘was going to owe a bunch of money’.” 2016 T. C. Memo. 110, at p. 6. And were readers of this my blog.

Remember Jeff Furnish? No?  Well, see my blogpost “Ambiguity is the Best Policy – Redivivus,” 10/23/13. Jeff did it right. Ken and Larita didn’t.

The insurer “…regularly issued Kenneth Mallory several types of statements relating to the policy and the loans, including:  (1) loan activity confirmations for each loan when the loan was made, (2) yearly notices requesting payment of interest and notifying Kenneth Mallory that any unpaid interest would be capitalized, and (3) quarterly reports of the policy debt and the cash value of the policy.  The Mallorys received these statements.” 2016 T. C. Memo. 110, at p. 5.

What Ken and Larita didn’t do was save every statement, find a number-cruncher with a killer instinct, and have said person go over every minute of the last thirty years looking for any discrepancy. It might cost a “bunch of money,” but would likely be cheaper than the chops Ken and Larita got.

Ken and Larita argue the interest should be deductible, but it was personal interest, and falls into none of the categories blessed by Section 163(h).

Section 72(e)(5)(A) sinks the Mallorys. The borrowings were just that, nontaxable.  When the insurer wrote them off, that was income to Ken and Larita. Plus late-filing and the five-and-ten chop.



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