2) Koresko / PennMont support D.A.R.E. program for children

Neonatology - 3rd Cir affirms that inflated term schemes are ridiculous by John J. Koresko, V, Esq., CPA

In a 1995 article, and then in his two articles published nationally in 2001, and in a recent expert witness report in New Jersey District Court, this author correctly predicted that the inflated term insurance scheme of Neonatology Assoc. v. Com'r, 115 TC No. 5 (2000), designed in part by Chicago actuary CJA Associates and friends, would be affirmed as a nondeductible constructive dividend with negligence penalties, to boot. The Third Circuit affirmed as predicted on July 29, 2002 in a decision that is not yet reported. Neonatology Assoc. et al v. Com'r, No. 01-2862 (3rd Cir. 2002). It is a simple constructive dividend analysis for a court when the taxpayers know they are not buying term insurance and the excess is used to buy "conversion credits," not insurance. A wink and a nod does not work. All marketing materials will end up as evidence. Clients will roll on their advisors when they are in depositions. I hope people wake up. There is no free lunch.

Neonatology involved an alleged VEBA arrangement using a type of insurance called "continuous term." The Tax Court found that the arrangement was neither a VEBA nor other form of welfare plan. The Tax Court also recognized that the product used grossly inflated term insurance rates so that cash would accumulate at insurance companies in "conversion credit accounts." Shareholders of the corporate taxpayers admitted at trial that their intention was to borrow on the policies in retirement years, allegedly on a tax-free basis, and that they thought the money was theirs. The intention was not a welfare benefit, but rather, a corporate bail-out scheme. Since the taxpayer corporations were C Corps., the expenditures were nondeductible constructive dividends, said the Tax Court. The Third Circuit affirmed these findings less than three weeks after oral argument in the case.

Neither the Circuit Court nor Tax Court ever held that only term insurance costs are deductible. The excess over term cost in this case was not deductible because the excess amounts were not paid for insurance. The Courts made clear that conversion credits are not insurance, and amounts paid are not premiums. In the DEFRA House Committee Report from 1984, Congress made clear that the term "qualified direct cost" for purposes of section 419 includes administrative expenses and insurance premiums. There is no case that has ever held that the term insurance premium only includes a term insurance premium. The Schneider case, cited below, attests to that.

While the predictions were right (both before the Tax Court case and the 3rd Cir. decision), the 3d Circuit was much more insulting than I would have predicted. I love these quotes:

"The record amply supports the conclusion that taxpayers paid artificially inflated premiums in a creative bookkeeping ploy conceived by their insurance specialists to exploit what they thought were loopholes in the tax laws. Indeed, we do not see how a court examining this case could conclude otherwise. Charles DeWeese, the Commissioner's expert, testified that amounts paid into the C-group policies exceeded conventional life insurance premiums by nearly 500%."

"The physician-owners caused their corporations to overpay considerably for term life insurance knowing that the money could be rerouted circuitously to their personal coffers with a net tax savings."

"The record also reveals that excess premium amounts did not pay for actual current year life insurance protection but rather paid for conversion credits."

"In reaching our result, we acknowledge that Dr. Hirshkowitz deviated from the thoroughly head-in-the-sand posture of his fellow taxpayers by soliciting his accountant's opinion of the SC VEBA. "

"We recognize that it is axiomatic that taxpayers lawfully may arrange their affairs to keep taxes as low as possible.[FN 19] Nevertheless, at the same time the law imposes certain threshold duties which a taxpayer may not shirk simply by manipulating figures or maneuvering assets to conceal their real character. See Court Holding Co., 324 U.S. at 334, 65 S.Ct. at 708 ("[t]o permit the true nature of a transaction to be disguised by mere formalisms . . . would seriously impair the effective administration of the tax policies of Congress."); see also Saviano v. Comm'r, 765 F.2d 643, 654 (7th Cir. 1985) ("The freedom to arrange one's affairs to minimize taxes does not include the right to engage in [end p. 19] financial fantasies with the expectation that the Internal Revenue Service will play along."). Thus, we conclude that the Tax Court correctly held that the inflated premiums were not allowable corporate business expenses but rather allocations in the nature of dividends and thusly taxable."

"Indeed, Neonatology and Lakewood, by design surrendering any expectation of remuneration, purchased products that generated a considerable economic bounty for their shareholders in the form of conversion credits. Furthermore, nothing in the record illustrates that taxpayers diverted these corporate assets with the requisite "compensatory intent."

"When, as here, a taxpayer is presented with what would appear to be a fabulous opportunity to avoid tax obligations, he should recognize that he proceeds at his own peril."

"In this case, PES devised a program which it marketed as "creating] a tax deduction for the contributions to the employee welfare benefit plan going in and a permanent tax deferral coming out." As highly educated professionals, the individual taxpayers should have recognized that it was not likely that by complex manipulation they could obtain large deductions for their corporations and tax free income for themselves."

"As highly educated professionals, the individual taxpayers should have recognized that it was not likely that by complex manipulation they could obtain large deductions for their corporations and tax free income for themselves."

"[As stated in] Saviano v. Comm'r, 765 F.2d 643, 654 (7th Cir. 1985), "The freedom to arrange one's affairs to minimize taxes does not include the right to engage in [end p. 19] financial fantasies with the expectation that the Internal Revenue Service will play along."

"In reaching our result, we acknowledge that Dr. Hirshkowitz deviated from the thoroughly head-in-the-sand posture of his fellow taxpayers by soliciting his accountant's opinion of the SC VEBA. " [JJK comment: He failed his burden to prove reasonable reliance so as to avoid the penalty.]

CONCLUSIONS:

Said the court: There is no doubt; life insurance is deductible as a component of compensation. Sec. 162, Reg. 1.162-10(a). Schneider v. Com'r, a Tax Court Memorandum Decision that haunts the IRS, was cited favorably:

"Beyond peradventure, employee benefits like life insurance are a form of compensation deductible by the employer. [FN 8] See Treas. Reg. sec. 1.162-10(a) [JJK note: a contribution to a welfare plan is deductible]; see also Joel A. Schneider, M.D., S.C. v. Comm'r, 1992 T.C. Memo. 1992-24, 63 T.C.M. (C.C.H.) 1787 [JJK note: a contribution to a welfare plan to pay conventional insurance premiums of $146,000 per year was deductible]."

Inflated term insurance schemes are not deductible when the intent to distribute money to owner employees is clear. [Sorry, BISYS and CJA]

Loan Bail-out schemes don't work, either. [Sorry, Benistar]. This is quite logical. In Rev. Rul 81-126, 1981-1 CB 206, the IRS held that so-called "loans" from an annuity contract are includable in income. The IRS found no loan where the transaction creates no bona-fide debtor-creditor relationship, and this is especially true where there is no expectation of repayment. The loans were treated as distributions. This stance comports with the IRS' previous position in Rev. Rul 67-248, 1967-2 CB 68. It also follows the observations of the Supreme Court in Orleans Parish v. N.Y. Life Ins. Co., 216 U.S. 517 (1910) (life insurance policy loans). The Tax Court ignored the bona fide nature of the interest on policy loans in Golsen v. Commissioner, 54 TC 742 (1970). The Supreme Court previously affirmed the Third Circuit, refusing to allow interest deductions for policy loans in a transaction without economic substance in KNETSCH v. UNITED STATES, 364 U.S. 361, 81 S. Ct. 132, 5 L. Ed. 2d 128 (1960). ERISA sec. 406 makes a loan between a plan and party in interest a prohibited transaction. If a multiple-employer plan has at least one non-owner employee participant in any employer group, it is subject to ERISA. The definition of welfare plan does not include a "loan plan." ERISA sec. 3(1). Loans cannot be used to defeat the express provisions of the Code relating to taxation of distributions. See, Treas. Reg. sec. 1.501(c)(9)-3(f). Just as in the split-dollar arena, when there is a purported "loan" from a welfare plan (repayable only out of death benefit proceeds), the amount is no longer subject to a substantial risk of forfeiture under sec. 83 and should be taxed.

The constructive dividend (no compensation) argument is enhanced because nobody else was in the "plan." [Sorry, Benistar, BISYS, etc.]. See, Grant-Jacoby v. Com'r, 73 TC 700 (1980) (a plan that only covers highly compensated employees is deferred compensation, not a welfare plan). See also, Citrus Orthopedic Med. Group v. Com'r, 72 TC 461 (1979) (education plan only for owner employee's children was deferred compensation).

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Individuals involved in "depressed cash value" life insurance schemes with welfare and pension plans better take note. The courts WILL look behind the documents to see exactly what the client was promised and whether the arrangement is simply a subterfuge to avoid taxes.

The Third Circuit ruling affirms the doubt about the validity of the Proposed Regulations recently issued by Treasury in connection with Sec. 419A(f)(6). In a follow-up article, the author will demonstrate that those regulations are probably invalid.

Do it right, sleep at night

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The author is a shareholder in the Koresko Law Firm, Bridgeport, PA. He is the author of proposed federal welfare plan legislation. He can be reached at 610-992-2200 or jjkvesq@aol.com.

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Press Release: 6/27/02
BRIDGEPORT, PA - FOR IMMEDIATE RELEASE
MONTGOMERY COUNTY LAW FIRM DONATES VEHICLE TO CHESTER COUNTY ANTI-DRUG PROGRAM

John J. Koresko, Esquire, founder of the Koresko Law Firm and PennMont Benefit Services, and Chester County Sheriff Carolyn Welsh unveiled the official vehicle for the Chester County Drug Awareness and Resistance Education ('DARE") program. At a ceremony presently held on June 26th at the Chester County Courthouse, Koresko presented Sheriff Welsh the keys to a new, bright red, Dodge PT Cruiser, specially painted with the DARE logo and the Stars and Stripes. The vehicle has been named "Betsy" by the Sheriff's staff.

Koresko, who recently renovated and moved his firms into the landmark former Bank building in Bridgeport, is a resident of Tredyffrin Township and supports causes in both Montgomery and Chester Counties. Koresko and his firms provided the funding for the purchase of the vehicle. He has three school-age children.

The distinctive color of the DARE cruiser is designed to attract the attention of children. According to Koresko, "If only one child avoids the horrors of drugs as a result of seeing the car and remembering the message of DARE, then this investment in our kids will be well worth it."

Attorney General Mike Fisher, Republican candidate for governor, accepted the invitation of Koresko and Sheriff Welsh to attend the unveiling ceremony. Attorney General Fisher is a strong advocate of DARE and thanked Koresko and his firms for showing how the private sector can work with government to make a difference in the lives of Pennsylvania's citizens.

For further information, contact 610-992-2200

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