Docket No. 31660.
Max H. Zabronsky, Esq., for the petitioner. Arthur L. Nims, Esq., for the respondent.
In order to induce Standard to furnish merchandise on credit, petitioner had to agree on July 1, 1936, to pay premiums and interest on a $60,000 life insurance policy assigned to Standard by Hale. Hale, a bankrupt corporation run by many of the same officers and employees now with petitioner, had been indebted to Standard for $60,102.14. Subsequently, Hale paid about 20 per cent of its debts to its creditors, including Standard, and Standard contracted to remit to petitioner insurance proceeds in excess of $48,081.47, the unpaid indebtedness of Hale without interest. Accordingly, shortly after August 1946, Standard remitted to petitioner $12,151.33. Held, that because of the applicability of section 24(a)(4) of the Internal Revenue Code, premiums paid are not deductible expenses. Held, further, that the proceeds of the insurance policy are includible in gross income only to the extent of the excess above the consideration and premiums paid on the policy under section 22(b)(2) of the Code which, in this case, was nothing. Max H. Zabronsky, Esq., for the petitioner. Arthur L. Nims, Esq., for the respondent.
In his deficiency notice respondent determined the following tax deficiencies for the taxable years ended June 30, 1946 and 1947:
+------------------------------------------------------+ ¦ ¦ ¦Declared value¦ ¦ +-------------+----------+--------------+--------------¦ ¦Date ¦Income tax¦excess-profits¦Excess profits¦ +-------------+----------+--------------+--------------¦ ¦ ¦ ¦tax ¦tax ¦ +-------------+----------+--------------+--------------¦ ¦June 30, 1946¦$550.50 ¦$206.43 ¦$1,259.16 ¦ +-------------+----------+--------------+--------------¦ ¦June 30, 1947¦7,151.98 ¦ ¦ ¦ +-------------+----------+--------------+--------------¦ ¦Total ¦7,702.48 ¦206.43 ¦1,259.16 ¦ +------------------------------------------------------+
The only contested adjustments are explained by respondent as follows:
* * * It is held that life insurance premiums of $3,127.80 and $1,790.40 paid during the fiscal years ended June 30, 1946 and June 30, 1947, respectively, are not allowable deductions under section 23(a) of the Internal Revenue Code.
* * * It is also held that the amount of $12,151.33 which was received from the Standard Furniture Company in the fiscal year ended June 30, 1947, represents taxable income and is not excludible under section 22(b)(1) of the Internal Revenue Code.
Petitioner made the following assignment of error to the adjustments above:
Such premium payments are ordinary and necessary business expenses and are properly deductible from gross income under Section 23(a) of the Internal Revenue Code, because taxpayer agreed to make those payments in order to be able to obtain merchandise for its business, obtain adequate credit and conduct its business. Taxpayer had no interest whatever in the life insurance policy upon which it paid the premiums.
The sum of $12,151.33 received by taxpayer from Standard Furniture Company does not constitute taxable income. * * *
The uncontested adjustments will be given effect under Rule 50.
FINDINGS OF FACT.
Most of the facts have been stipulated and are found accordingly.
The petitioner Desks, Inc., is a corporation organized under the laws of the State of New York, with its principal office and place of business in New York, New York. The tax returns for the fiscal years ended June 30, 1946, and June 30, 1947, were filed with the collector for the second district of New York.
Standard Furniture Company, hereinafter called Standard, a corporation organized under the laws of New York has been engaged in the manufacture of wooden office desks, tables, etc., at Herkimer, New York. Hale Desk Co., Inc., hereinafter called Hale, a corporation organized a considerable time prior to the year 1931, was engaged in the retail furniture business and purchased merchandise from Standard. Charles F. Chauvin, hereinafter called Chauvin, was at all times herein material the president of Hale and the owner, with his wife, of 5,800 out of 10,840 outstanding shares of Hale stock.
On February 14, 1931, a life insurance policy bearing No. 7,230,965 was issued by the Prudential Insurance Company of America on the life of Chauvin in the face amount of $100,000 naming Hale as beneficiary. On February 24, 1936, the $100,000 insurance policy was rewritten to one policy in the face amount of $60,000, and two policies in the face amount of $20,000 each. Chauvin acquired the ownership of the two $20,000 policies, in which his estate and his wife Lillian Chauvin were named beneficiaries respectively. The proceeds and premiums of these two policies are not in issue here.
In November 1934, Hale executed a promissory note payable to Standard in the amount of $60,102.14 for merchandise purchased on credit during the period January 1933 to November 1933. On February 24, 1936, Hale assigned the $60,000 life insurance policy, hereinafter called the insurance policy, to Standard. As of June 25, 1936, the cash surrender value of the life insurance policy was $2,910, against which there was an outstanding loan of $1,877.86, including interest. Standard had paid total premiums on said life insurance policy in the amount of $1,492 on November 11, 1935, and $1,742.05 on March 7, 1936.
On July 14, 1936, Hale filed a voluntary petition in bankruptcy in which it listed total assets of approximately $47,000 and total liabilities of approximately $81,000, which included the debt owed to Standard. Desks, Inc., the petitioner herein, was incorporated on June 25, 1936, by Chauvin and several other employees of Hale with Chauvin as president. Petitioner, like Hale, was engaged in the retail furniture business.
On July 1, 1936, petitioner entered into an agreement in writing with Standard whereby Standard agreed to consign on credit merchandise not exceeding $40,000 to petitioner under certain conditions. The agreement could be terminated upon 5 days' written notice by either party. In order to obtain this credit, petitioner had to agree to a provision requiring it, regardless of termination, to pay premiums and interest on the $60,000 insurance policy as follows:
10. In consideration of the terms and covenants herein contained, and to induce the First Party (Standard) to enter into this consignment agreement and to forward to the Second Party (petitioner), merchandise under this consignment agreement up to an amount not exceeding in the invoice price the sum of $40,000.00, the Second Party hereby agrees to pay any and all premiums, dues and assessments due and to become due on and after January 1, 1937 on a life insurance policy numbered 7230965 and dated February 14, 1931, issued by the Prudential Insurance Company on the life of Charles F. Chauvin, the president of the Second Party, and heretofore assigned to the First Party; the Second Party further agrees to pay any and all interest due and to become due from the date hereof on the loan from said insurance company secured by said life insurance policy; the Second Party agrees to pay said premiums and said interest on said loan during the lifetime of said Charles F. Chauvin, and the termination of this consignment agreement by either party shall in no way relieve the Second Party from the covenant and agreement herein contained to pay said premiums and said interest, but said obligation to pay said premiums and said interest will remain with the same force and effect as though this consignment agreement had not been terminated as to its other provisions.
In the latter part of 1939, there was paid by the trustee in bankruptcy of Hale a 20.3 per cent first and final dividend whereby Standard received the sum of $12,200.73. Petitioner entered into a written agreement with Standard on December 14, 1939, whereby it was agreed that petitioner should receive or have credited to its account with Standard the proceeds of the insurance policy in excess of $48,081.47, being the remaining unpaid debt of Hale without interest. This contract provided in part:
WHEREAS, Desks, Inc., claims that equitably it is entitled to the excess, if any, by which the amount of the proceeds of said policy may exceed the indebtedness due to the Standard Furniture Company which the assignment of said policy was intended to secure, now, therefore;
The parties hereto hereby mutually agree that upon said policy being paid upon the death of said Charles F. Chauvin, there shall be first paid to said Standard Furniture Company, the amount of Forty-eight thousand eighty-one and forty-seven one-hundredths Dollars ($48,081.47), being the amount due to it, without interest, and that any excess above that amount shall be retained by said Standard Furniture Company and credited upon the indebtedness due it from said Desks, Inc., for goods on consignment from the Standard Furniture Company to said Desks, Inc., except that any excess above the total amount so due for such goods on consignment, shall be paid over by said Standard Furniture Company to said Desks, Inc.
Pursuant to the agreement dated July 1, 1936, petitioner paid the annual premiums on the insurance policy beginning January 1, 1937, and continuing to the date of death of the insured. These payments aggregated approximately $31,732.20. In addition thereto, petitioner paid on the loan secured by the said policy interest of $859.40 and the principal of $1,948.58, making petitioner's total payments approximately $34,540.18. Petitioner claimed these payments as deductions on its income tax returns for the respective years in which the payments were made.
Chauvin died in August 1946. The Prudential Insurance Company of America thereupon paid the proceeds of the insurance policy to Standard in the amount of $60,232.80. Standard remitted $12,151.33 to the petitioner, the amount in excess of $48,081.47 pursuant to the December 14, 1939, agreement and did not intend thereby to make a gift. At no time was the petitioner, Desks, Inc., named in the policy as owner or beneficiary. The Commissioner has added to the net income as disclosed by petitioner's return for its fiscal year ended June 30, 1947, the foregoing sum of $12,151.33 and has not reduced it any by deducting premiums which petitioner paid during the lifetime of decedent Chauvin to keep the policy in force.
There are two questions raised in this proceeding: (1) are the life insurance premiums allowable deductions under section 23(a) of the Code, and (2) is $12,151.33 received from the insurance proceeds in the fiscal year ended June 30, 1947, taxable income in its entirety.
Hale became indebted to Standard for $60,102.14 and assigned to Standard a $60,000 life insurance policy on Chauvin, Hale's president. Hale went into bankruptcy, and some of its officers and employees formed petitioner corporation, which engaged in the same business. In order to induce Standard to furnish merchandise on credit, petitioner on July 1, 1936, agreed to pay the insurance policy's premiums and interest, regardless of the termination of the consignment provisions. This was an arm's length enforceable contract and without it, Standard would never have extended further credit to petitioner, because of its credit experience with Hale.
In the latter part of 1939, Hale's trustee in bankruptcy paid a 20.3 per cent first and final dividend to creditors, whereby Standard received $12,200.73. At this time petitioner was still a customer of Standard and, in accordance with its 1936 contract, paying the premiums on the insurance policy. A second agreement was executed on December 14, 1939, whereby Standard agreed to remit to petitioner the insurance policy proceeds in excess of $48,081.47. Hale's remaining, outstanding principal indebtedness without interest.
Petitioner contends that there was no consideration for this second agreement, and it constitutes a gratuity by Standard. Under the original 1936 contract, petitioner could have terminated its consignment purchases on 5 days' notice and was not required to purchase any minimum amount. Petitioner was apparently a regular customer of Standard from 1936 through 1947, and relied on this second agreement for over six years. To follow petitioner's contention ignores the arm's length nature of this continuing business relationship. Cf. Williston on Contracts, rev. ed. 1936, vol. 1, sec. 137A, p. 485, sec. 144, p. 514, sec. 139, p. 494. Moreover, the express language of the 1939 contract states that it arises out of an equitable claim of petitioner, which is settled thereby. An equitable obligation can be as binding and enforceable as a legal obligation. The settlement of a disputed claim furnishes adequate consideration by itself. Cf. Williston, supra, sec. 130 at p. 445, sec. 147, p. 520.
In fact, Standard felt bound by this agreement and accordingly remitted to petitioner $12,151.33, its share of the insurance proceeds. We hold that under the 1939 agreement, petitioner had a contractual enforceable right in the insurance proceeds.
Petitioner contends that it is entitled to deduct premiums in 1946 and 1947 as an ordinary and necessary business expense to obtain adequate credit. However, even though an item is an ordinary and necessary business expense under section 23(a)(1)(A), if the provisions of section 24(a)(4) are met, the deduction is not allowed. Section 24(a)(4) of the Internal Revenue Code provides:
SEC. 24. ITEMS NOT DEDUCTIBLE.
(a) GENERAL RULE.— In computing net income no deduction shall in any case be allowed in respect of
(4) Premiums paid on any life insurance policy covering the life of any officer or employee, or of any person financially interested in any trade or business carried on by the taxpayer, when the taxpayer is directly or indirectly a beneficiary under such policy;
We find that in order to obtain credit originally, petitioner had to obligate itself in the 1936 contract to pay the insurance policy's premiums and interest. But under the 1939 contract which was in force and effect during the two taxable years which we have before us, petitioner became a beneficiary of the $60,000 insurance policy to the extent of the excess above $48,081.47.
In J. H. Parker, 13 B.T.A. 115, premiums were not deductible even though the taxpayer was not named beneficiary, and there was only a mere possibility of the taxpayer's being a beneficiary under a creditors' agreement. Similarly, premiums on an insurance policy held as security for a loan by a taxpayer's creditor were not deductible. Rieck v. Heiner, 25 F.2d 453, certiorari denied 277 U.S. 608; Edwin M. Klein, 31 B.T.A. 910, 919, affd. 84 F.2d 310. Petitioner's interest in the instant case is more direct. We hold that petitioner is ‘directly or indirectly a beneficiary‘ under section 24(a)(4) and the premiums are not deductible as ordinary and necessary business expenses. On this issue respondent is sustained.
Petitioner contends that the $12,151.33 received from the proceeds of the insurance policy is a gift, while respondent determined it was ordinary income. Standard paid this sum to petitioner pursuant to a written contract and did not intend to make a gift. Therefore, the $12,151.33 could not be a gift for tax purposes, which requires an intent on the part of the donor to make a gift. David Herbert Botchford, 29 B.T.A. 656, affd. 81 F.2d 914; Willis L. Garey, 16 B.T.A. 274.
The proceeds of a life insurance paid by reason of the insured's death are exempt from taxation generally. Section 22(b)(1), Internal Revenue Code. However, when the policy has been transferred for a valuable consideration, the amounts by which the insurance proceeds exceed the consideration and premiums paid are included in gross income. Section 22(b)(2), Internal Revenue Code.
Under the 1939 contract, petitioner received an interest in the insurance proceeds. The consideration for this interest was a valuable one and an intangible benefit of its business dealings with Standard. These business dealings encompassed petitioner's purchasing merchandise from Standard on consignment and payment of insurance proceeds and interest on the insurance policy. Cf. St. Louis Refrigerating & Cold Storage Co. v. United States, 162 F.2d 394.
From January 1937 until Chauvin's death in August 1946, petitioner paid premiums of approximately $31,732.20. However, petitioner claimed as deductions on its returns all those premiums. Under our decision on Issue 1, the deduction of premiums paid subsequent to the 1939 contract were improperly claimed as deductions. But these premiums are, nevertheless, still to be excluded from the insurance policy proceeds in determining the amount included in gross income. In Stroud & Co., 45 B.T.A. 862, 868, we said the following:
The respondent has added to the net proceeds of the policies, after deducting their cost, the sum of $6,120.64 representing premiums paid by the New Jersey company during 1932 to 1935, inclusive, and also $149.18, so paid by it in 1936. Apparently he seeks to justify his action on the ground that such amounts were claimed and allowed as deductions in previous years.
We find no statutory authority for respondent's action in adding the premiums to petitioner's gross income. Section 22(b)(2) specifically states that the actual value of the consideration and the amount of premiums and other sums subsequently paid by the transferee shall be exempt under section 22(b)(1). The premiums here were paid by the transferee (the petitioner's predecessor) and hence serve to increase the exemption.
As we said in Charles E. Lambeth, supra, ‘we are not dealing with the ordinary case but with the proceeds of life insurance contracts in respect of which Congress has seen fit to legislate specifically.‘ We also observed:
The fact that the petitioner might be permitted a deduction in some year by reason of the worthlessness of the corporate stock does not change the situation, for Congress has seen fit to deal specifically with the proceeds of life insurance and we must apply the statute as it is enacted.
In the case at bar no reference is made in the statute to deductions claimed or allowed relating to such ‘premiums and other sums subsequently paid by the transferee‘ either during the taxable year or theretofore. The language of the statute is clear and unambiguous. We must apply it as we find it. Therefore, the amount of the premiums aggregating $6,269.82 should be deducted from the $105,220.30, computed by the respondent to be the taxable gain on the life insurance proceeds.
As we have already pointed out, petitioner claims that none of the $12,151.33 should be included in petitioner's income for 1947 because it represented a gift from Standard to petitioner. That contention we have not sustained.
Petitioner contends in the alternative, however, that:
If it should be held that petitioner had a beneficial interest in the policy of life insurance, then the amount of $12,151.33 received by petitioner from Standard Furniture Co. would not be subject to tax, because the premiums paid by petitioner from 1936 to 1947 amounted to approximately $37,000 and far exceeded the recovery by petitioner. This is so even though petitioner deducted the premium payments from its gross income.
As we have pointed out elsewhere petitioner did not acquire a beneficial interest in the insurance policy until the latter part of 1939 and therefore only premiums which it paid thereafter would represent cost to it of its interest in the policy, yet it is perfectly clear from the facts which have been stipulated that the annual premiums which petitioner paid to keep the policy in force after it acquired a beneficial interest in the policy in 1939 exceeded by a substantial amount the $12,151.33 which petitioner collected out of the proceeds of the policy upon Chauvin's death in 1946. The effect of our holding therefore is that none of the $12,151.33 insurance proceeds is includible in petitioner's income because the cost to petitioner of recovering this amount was greater than the amount itself.
Decision will be entered under Rule 50.