Docket No. 33780.
Benjamin M. Parker, Esq., for the petitioner. Alben E. Carpens, Esq., for the respondent.
Benjamin M. Parker, Esq., for the petitioner. Alben E. Carpens, Esq., for the respondent.
The petitioner received monthly payments on insurance policies left by her deceased husband. She had the right to a specified rate of interest on the maturity value of the policies and, in addition, the privilege of withdrawing annually 3 per cent of the maturity value. She never made any withdrawals of principal up to and during the taxable years in issue. Respondent determined that the amounts received by the petitioner constituted taxable interest income. Petitioner contends that they are excluded from income by section 22(b)(1) because ‘paid by reason of the death of the insured.‘ Held, having permitted the full amount of the principal to be retained by the insurers, interest paid to the petitioner as primary beneficiary constitutes taxable interest income.
The proceeding involves deficiencies in income tax as follows:
+--------------------+ ¦Year ¦Deficiency ¦ +------+-------------¦ ¦1945 ¦$2,684.98 ¦ +------+-------------¦ ¦1946 ¦2,367.00 ¦ +------+-------------¦ ¦1947 ¦2,344.21 ¦ +--------------------+
The issue involved is whether the amounts of money received by the petitioner during 1945, 1946, and 1947, as primary beneficiary of certain life insurance policies on the life of her deceased husband, were taxable income, or whether they are excluded from gross income by virtue of section 22(b)(1) of the Code.
FINDINGS OF FACT.
The petitioner is an individual, residing in Atlanta, Georgia. She filed her income tax returns for the years 1945, 1946, and 1947 with the collector of internal revenue for the northern district of Georgia.
Oscar R. Strauss was the husband of Rubye R. Strauss, the petitioner, and the father of Oscar r. Strauss, Jr., and Claire Strauss. At the date of his death, July 20, 1939, the following 16 life insurance policies on his life, pertinent to the issue here involved, were in existence:
+-------------------------------------------+ ¦NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY ¦ +-------------------------------------------¦ ¦(hereinafter referred to as Northwestern) ¦ +-------------------------------------------¦ ¦ ¦ ¦ +-------------------------------------------+
Policy No. Face value 435,118 $1,000 518,309 2,500 535,627 1,000 919,198 5,000 919,199 5,000 941,452 2,500
UNION CENTRAL LIFE INSURANCE COMPANY (hereinafter referred to as Union)
Policy No. Face value 604,174 $1,500 557,467 7,500 498,406 6,550 498,756 3,000 516,759 500 604,175 15,000
MASSACHUSETTS MUTUAL LIFE INSURANCE COMPANY (hereinafter referred to as Massachusetts)
Policy No. Face value 610,601 $5,000 609,545 13,000 413,479 5,000 535,712 7,000
During the year 1934, Oscar R. Strauss, the insured, irrevocably named the petitioner as beneficiary and his children as contingent beneficiaries, should his wife predecease him, of all the above policies except one. In that one, Massachusetts Policy No. 610,601, the insured's sister, Erna S. Eiseman, continued as the beneficiary. In 1937, the insured executed further supplementary agreements to all the above policies. The petitioner and her children were then irrevocably named as primary and secondary beneficiaries, respectively, of all the above policies, but specific instructions were given regarding the manner in which the proceeds were to be paid. The test of the supplementary agreements, and policies, insofar as here relevant, follows:
NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
Atlanta, Georgia, June 29, 1937
I, OSCAR R. STRAUSS, the insured under policies Nos. 435118, 518309, 535627, 919198, 919199 and 941452, issued by The Northwestern Mutual Life Insurance Company, hereby request and direct that settlement of the aggregate proceeds of said policies, collectively, shall be made with Rubye R. Strauss, wife and beneficiary, in accordance with the provisions of Option A, so modified that payment shall be made monthly at the minimum rate of $2.45 per $1,000 of the amount so retained, the first payment being due one month after my death, with the privilege of withdrawing $510.00 in any one year until the proceeds of said policies are exhausted. In event of the death of the beneficiary, settlement with Oscar R. Jr. and Claire Strauss, children and contingent beneficiaries, born June 15, 1908 and August 5, 1915, respectively, shall be made in one sum. The right to surrender and withdraw shall be withheld from the beneficiary except as expressly permitted in this request.
UPON THE DEATH of the last survivor of myself, Rubye R., Oscar R. Jr. and Claire Strauss, any proceeds then in the Company's hands on account of said policies, together with any interest due or accrued thereon, shall be payable in one sum of the lawful child or children, if any, of the contingent beneficiaries, share and share alike, the survivors or survivor, or if none survive, then to Emil A. Strauss and Erna S. Eiseman, brother and sister, share and share alike, or the survivor, or if neither survives to the executors, administrators or assigns of the last survivor of Rubye R., Oscar R. Jr. and Claire Strauss.
THE POWER to exercise all rights and privileges specified in and/or conferred upon the insured by the terms of said policies including the policy loan and surrender privileges and the right to change or revoke the designation of beneficiary, contingent beneficiaries, further payees and option settlement, shall, during the lifetime of the insured be vested jointly in Rubye R., Oscar R. Jr. and Claire Strauss, the survivors or survivor, or in the executors, administrators or assigns of the last survivor of them, but no one shall be designated as beneficiary or contingent beneficiary except as permitted by law.
ALL INTEREST PAYMENTS under Option A will be subject to increase by such dividends as may be apportioned by the Company.
THE RIGHTS of the payees herein designated shall be subject and subordinate to any outstanding indebtedness on account of said policies in favor of said Insurance Company.
Witnesses: * * * . . . . (Signed) OSCAR R. STRAUSS
The terms and conditions of the foregoing designation and request are hereby accepted.
Witnesses: * * *
(Signed) RUBYE R. STRAUSS (Signed) OSCAR R. STRAUSS, JR. (Signed) CLAIRE STRAUSS
THE UNION CENTRAL LIFE INSURANCE COMPANY
I hereby give notice of change of beneficiary and election of settlement option under the above described policies and request payment of the net sum payable under the said policies in the event of the death of the insured as follows:
1. The net sum payable under the above numbered policies, treated as one sum, shall be retained by the Company in accordance with the provisions of Settlement Option #3 in said policies, and the interest thereon shall be paid in equal monthly instalments to my wife, RUBYE RICH STRAUSS, as long as she lives, with the privilege of withdrawing not to exceed three percent (3%) of the amount originally payable at maturity, each year in addition to the interest payments above provided for.
2. In the event my said wife predeceases me or survives me but dies while entitled to receive interest as above provided, said net sum or so much thereof as remains unpaid, together with any unpaid interest thereon, shall be paid to my son, Oscar R. Strauss, Jr., born June 15, 1908, and my daughter, Claire Strauss, born August 5, 1915, share and share alike, or to the survivor of them, if either be living, otherwise equally to e then living children of my said son and daughter, if any, otherwise to my brother, Emil A. Strauss, and my sister, Mrs. Morris D. Eiseman (formerly Erna Strauss), share and share alike or to the survivor of them, if either be living, otherwise to the executors or administrators of the survivor of my said wife and me.
3. Rubye Rich Strauss, wife of the insured;
Oscar R. Strauss, Jr., son of the insured, and
Claire Strauss, daughter of the insured;
All join herein for the purpose of consenting to all the terms hereof.
32. Option 3. Retained at Interest. Retained by the Company at three percent interest payable annually during the lifetime of the payee. The principal sum and accrued interest may be withdrawn at any time, on sixty days' notice, unless otherwise specified in electing such option.
MASSACHUSETTS MUTUAL LIFE INSURANCE COMPANY
June 30, 1937
The MASSACHUSETTS MUTUAL LIFE INSURANCE COMPANY is hereby authorized and requested to amend contract on the life of Oscar R. Strauss under Policy No. 413479 as follows:
If the policy shall mature as a death claim, the proceeds shall be retained by the Company, as provided in Option ‘D,‘ and interest thereon paid monthly at such rate, not less than 3%, as may be determined by the Directors, to my wife, Rubye R. Strauss, if living, with the right on the part of said wife, at any time while receiving said interest installments, to make on account of the proceeds then retained by the Company, one withdrawal in each calendar year of an amount not in excess of 3% of the original proceeds at said maturity.
If my said wife is not living at said maturity, or upon her death while receiving interest installments, the proceeds, or any balance thereof then retained by the Company, shall be paid forthwith in equal shares to such of my children, Oscar R. Strauss, Jr. (born June 15, 1908) and Claire Strauss (born August 5, 1915), as may then be living, and to the living lawful issue, per stirpes, of such of said children as may then be deceased, but if neither of my said children, nor any of their lawful issue, shall then be living, said proceeds or balance thereof shall be paid in one sum to the executors or administrators of the last survivor of my said wife and my said children.
All rights, privileges, benefits, options and elections granted to or conferred upon the insured by said policy are hereby vested in my said wife, during her lifetime, and thereafter in my said children, jointly, or the survivor of them, and after the death of my said wife and both of said children, all of the aforesaid rights shall vest in the executors or administrators of the last survivor of said wife and said children, it being intended that I shall have no legal incidents of ownership in said policy.
THE INSURED, with the assent of the assignee, if any, may elect by a writing filed with the Company, with the right of revocation, to have the proceeds of this policy (including paid-up additions and dividend accumulations, if any), if not less than $1,000, paid in equal annual installments according to any one of Options ‘A,‘ ‘B,‘ and ‘C,‘ beginning upon receipt of due proof of the death of the insured, in lieu of payment in one sum, or the insured may in like manner elect to leave the proceeds of this policy with the Company in accordance with Option ‘D‘; and any such election or revocation shall become operative only when indorsed upon the policy, at the Company's Home Office, pursuant to such form of request as the Company may require. No installment under Option ‘A,‘ ‘B,‘ or ‘C‘ may be commuted by any beneficiary, except upon the written authority of the insured filed with the Company. If the insured shall not have made any such election, the beneficiary or beneficiaries entitled to receive said proceeds may, when the same become payable, exercise such right of election. If no beneficiary survives the insured, said proceeds will be paid in one sum to the executors, administrators, or assigns of the insured.
The signatures of the petitioner and her children do not appear on the endorsements to the Massachusetts policies.
The petitioner had the vested rights of an irrevocable beneficiary in the Union policies; and her signature was, therefore, required when the insured executed the supplementary agreements limiting her rights to the proceeds.
Oscar R. Strauss, by the final supplementary agreements to have above 16 policies, intended that his widow, Rubye R. Strauss, have the privilege of withdrawing 3 per cent of the principal per annum and also receive interest on the principal retained by the insurers. The petitioner had no power to modify the supplementary agreements and withdraw more than 3 per cent of the principal per annum.
The petitioner, at no time from the death of her husband on July 20, 1939, through 1945, 1946, and 1947, the taxable years in issue, exercised her privilege of making an annual withdrawal of 3 per cent of the proceeds originally payable at the death of her husband, or of any lesser amounts. The petitioner received the following sums in monthly installments during 1945, 1946, and 1947 pursuant to the provisions of the 16 insurance policies and the supplementary agreements attached thereto:
+-------------------------------------------+ ¦From ¦1945 ¦1946 ¦1947 ¦ +-------------+---------+---------+---------¦ ¦Massachusetts¦$1,614.60¦$1,543.27¦$1,492.20¦ +-------------+---------+---------+---------¦ ¦Northwestern ¦519.55 ¦519.55 ¦505.20 ¦ +-------------+---------+---------+---------¦ ¦Union ¦1,685.28 ¦1,685.28 ¦1,685.28 ¦ +-------------+---------+---------+---------¦ ¦Total ¦$3,819.43¦$3,748.10¦$3,682.68¦ +-------------------------------------------+
Said amounts of money represented interest payments and, possibly, surplus dividends, on the maturity value of the 16 insurance policies which was retained undiminished by the 3 insurance companies. The petitioner did not include any part of said amounts in her gross income in her income tax returns for 1945, 1946, and 1947.
The petitioner had permitted the following amounts to remain with the 3 insurers by 1945, 1946, and 1947, due to her decision not to exercise her right to make 3 per cent annual withdrawals.
+-------------------------------------------+ ¦Name ¦1945 ¦1946 ¦1947 ¦ +-------------+---------+---------+---------¦ ¦Massachusetts¦$4,500.00¦$5,400.00¦$6,300.00¦ +-------------+---------+---------+---------¦ ¦Northwestern ¦2,550.00 ¦3,060.00 ¦3,570.00 ¦ +-------------+---------+---------+---------¦ ¦Union ¦5,107.50 ¦6,129.00 ¦7,150.50 ¦ +-------------------------------------------+
Included in the total sums paid to the petitioner by the insurers in 1945, 1946, and 1947, were the following amounts:
+-------------------------------------+ ¦Name ¦1945 ¦1946 ¦1947 ¦ +-------------+-------+-------+-------¦ ¦Massachusetts¦$135.00¦$162.00¦$189.00¦ +-------------+-------+-------+-------¦ ¦Northwestern ¦75.58 ¦90.70 ¦105.82 ¦ +-------------+-------+-------+-------¦ ¦Union ¦153.23 ¦183.87 ¦214.52 ¦ +-------------+-------+-------+-------¦ ¦Total ¦$363.81¦$436.57¦$509.34¦ +-------------------------------------+
These amounts represent the minimum specified rate of interest allocable to the above portions of principal which the petitioner permitted the insurers to retain.
Each year from the time of the death of her husband through the taxable years in issue, the petitioner told her children, the secondary beneficiaries, that she was not withdrawing her annual installment of 3 per cent of the maturity value of the policies because she would like to leave that particular installment in the form of Christmas presents for them. She told the secondary beneficiaries to consider that as a gift. In 1945, the petitioner was 63 years of age.
The petitioner starts her argument by a concession. She admits that she must include in gross income interest payments from the insurance companies on that portion of the total principal which she could have withdrawn, had she wished to exercise her privilege to make 3 per cent annual withdrawals. She argues that this portion of the amounts received from the insurance companies is taxable under the rule enunciated in United States v. Heilbroner, 100 F.2d 379 (C.A. 2, 1938). The theory on which such concession is made is that petitioner constructively received such amounts during each of the years in question.
The amounts here in issue, therefore, are the interest payment by the insurance companies on the balance of the principal which was not yet subject to petitioner's annual 3 per cent right of withdrawal. Respondent contends that they are earnings within the meaning of parenthetical clause of section 22(b)(1), whereas petitioner maintains that they are taxable income because ‘paid by reason of the death of the insured.‘
SEC. 22. GROSS INCOME.(b) EXCLUSION FORM GROSS INCOME.— The following items shall not be included in gross income and shall be exempt from taxation under this chapter:(1) LIFE INSURANCE.— Amounts received under a life insurance contract paid by reason of the death of the insured, whether in a single sum or otherwise (but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income);
The petitioner contends that her basic rights under the policies are so like those of a beneficiary of an insurance policy to whom the proceeds are paid on the installment method, that she merits the same tax treatment. She argues that both she and such a beneficiary have the right to annual installments of principal, plus interest on the total principal not yet distributed. It has been established that when either the insured or the beneficiary elects to have the proceeds paid in installments, the entire amount of such installments is ‘paid by reason of the death of the insured.‘ Katharine C. Pierce, 2 T.C. 832 (1943), affd. 146 F.2d 388 (C.A. 2, 1944); Sidney W. Winslow, Jr., 39 B.T.A. 373 (1939), affd. 113 F.2d 418 (C.A. 1, 1940); Allis v. La Budde, 128 F.2d 838 (C.A. 7, 1942). Even though these installments may include interest payments, ultimately giving the beneficiary a larger amount than the face value of the policies, this interest factor has been held to be excluded from gross income under section 22(b)(1). But, even assuming that petitioner did constructively receive annual installments of principal and that they were permitted to remain with the insurance companies as gifts for her children, her situation is readily distinguishable from the cited cases. The beneficiary to whom the proceeds are paid on the installment method actually receives a mixed installment of principal and interest. It may be inferred that Congress intended to favor the installment method of paying the proceeds to the family of the insured, and, possibly, added the incentive of tax-free interest on such installments. But we cannot believe, in view of the parenthetical clause, that Congress also intended to grant tax exemption to a beneficiary who, in actuality, received only interest and elected to leave the principal undiminished for the secondary beneficiaries.
It is our opinion that the total amount of the payments received by the petitioner during the taxable years 1945, 1946, and 1947 from the insurers falls within the parenthetical clause of section 22(b)(1) and is, therefore, taxable income. The principal consideration, as we see it, is that the proceeds of the policies have been retained and held intact by the insurers while interest thereon was paid to the primary beneficiary. Section 22(b)(1) was amended in 1934, by changing the phrase ‘whether in a single sum or in installments‘ to read ‘whether in a single sum or otherwise.‘ The House and Senate Committee Reports, at that time, state that ‘This change * * * makes it clear that the proceeds of a life-insurance policy payable by reason of the death of the insured in the form of an annuity are not includible in gross income.‘ (Ways and Means Committee Report No. 704, p. 21, Finance Committee Report No. 558, p. 23, 73d Cong., 2d Sess.) This section can apply, however, only where proceeds of a life insurance policy are being so paid. Here, no part of the proceeds has been paid to the petitioner, up to and during the years in issue, as an annuity or otherwise. Such proceeds have been ‘held by the insurer under an agreement to pay interest thereon.‘ The payments in issue, therefore, come literally within the parenthetical clause of section 22(b)(1). In view of the clear words of such clause and the obvious intent of Congress, we are not at liberty to use the theory of constructive receipt to circumvent such words or intent.
The petitioner puts great emphasis on statements in United States v. Heilbroner, supra, that payments to the primary beneficiary were taxable earnings because said amounts were ‘solely for the use of money ultimately payable without depletion to designated beneficiaries, and were fairly within the meaning of the word 'interest’.‘ She attempts to distinguish her situation by her unexercised right to diminish the principal by annual withdrawals of 3 per cent. The mere possibility that the petitioner might choose, at some time in the future, to exercise her limited right of withdrawal is not an adequate distinction. In fact, she might never choose to exercise this limited right of withdrawal and yet would have us hold that it renders interest payments received by her nontaxable. The parenthetical clause states that ‘if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income.‘ The Code clearly speaks in the present tense and is not concerned here with future alterations of the arrangement between the insurer and the beneficiary whereby the principal may be diminished. During the taxable years in question, the entire principal was retained by the insurers. Interest payments thereon must accordingly be governed by the parenthetical clause. This conclusion is in accord with the interpretation of this clause given by the Senate Finance Committee at the time of its enactment:
In order to prevent an exemption of earnings, where the amount payable under the policy is placed in trust, upon the death of the insured, and earnings thereon paid, the committee amendment provides specifically that such payments shall be included in gross income. (Report of the Senate Finance Committee, Rept. No. 52, p. 20, to accompany H.R. 1 of the 69th Cong., 1st Sess.)
The question as to whether the petitioner constructively received 3 per cent of the principal annually need not be determined here. Even if 3-per cent payments were constructively received annually, they were not ‘installment payments which pro tanto diminished the total amounts payable under the policies.‘ See Commissioner v. Bartlett, 113 F.2d 766 (C.A. 2, 1940). The determining fact here is that the entire principal was allowed to be retained undiminished by the insurers. It is not material whether the petitioner's failure to exercise her annual right of withdrawal resulted in an annual gift to her children, the secondary beneficiaries.
Nor need we determine whether that portion of the amounts paid by the insurers to the petitioner, above the interest rate specified in the supplementary agreements, represented surplus dividends. It is settled law that surplus dividends are not exempt from gross income under section 22(b)(1), Katharine C. Pierce, supra; United States v. Heilbroner, supra. The entire amounts paid to the petitioner during 1945, 1946, and 1947 constitute taxable income, whether paid as interest or as surplus dividends.
Reviewed by the Court.
Decision will be entered for the respondent.