Cash Surrender Value
Is Includable in Income
Tax Court Special Trial Judge Robert N. Armen Jr., in an unpublished summary
opinion, has held that Steven and Anna Jensen must include in their 2000 income
the cash surrender value of a whole life insurance policy, minus the investment
in the contract, under section 72(e).
Citations: Steven H. Jensen, et ux. v. Commissioner; T.C. Summary Op.
2004-75; No. 7496-03S
Date:
STEVEN H. AND ANNA J. JENSEN,
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
UNITED STATES TAX COURT
Filed
Steven H. and Anna J. Jensen, pro sese.
Aimee R. Lobo-Berg, for respondent.
[1] ARMEN, Special Trial Judge: This case was heard pursuant to the
provisions of section 7463 of the Internal Revenue Code in effect at the time
that the petition was filed. 1 The decision to be entered is not reviewable by
any other court, and this opinion should not be cited as authority.
[2] Respondent determined a deficiency in petitioners' Federal income tax of
$2,730 for the taxable year 2000.
[3] The issue for decision is whether a distribution of $9,7602
resulting from the surrender of a whole life insurance policy is includable in
petitioners' gross income. We hold that it is.
Background
[4] This case was submitted fully stipulated under Rule 122, and the facts
stipulated are so found. We incorporate by reference the parties' stipulation
of facts and accompanying exhibits.
[5] At the time that the petition was filed, petitioners resided in
[6] Mr. Jensen is a retired certified public accountant and former partner
at the accounting firm of Harden, Swisher, and Jensen. As early as 1956, the
firm had purchased several term life insurance policies, which were cross-owned
by and insured the various partners. Although not clearly explained in the
record, some of the term life insurance policies that insured Mr. Jensen were
converted into a whole life insurance policy bearing No. 264261 (the policy).
The policy was issued on
[7] Sometime in 2000, petitioners surrendered the policy and received a
total distribution in the amount of $33,850. For the taxable year 2000,
Transamerica Occidental Life Insurance Co. (Transamerica) 4 sent petitioners a
Form 1099-R, Distributions From Pensions, Annuities, Retirement or
Profit-Sharing Plans, IRAs, Insurance Contracts, etc., reporting a gross
distribution of $33,850 and a taxable distribution of $12,213. Petitioners
disputed the computation by Transamerica of the taxable gain and requested the
company to reexamine the amount of premiums paid towards the policy.
Transamerica recalculated the cost basis of the policy and sent petitioners a
letter explaining the cost basis determination as follows:
The total dividends earned over the life of the policy are deducted from the
total premiums [$ 50,570.50] to arrive at the cost basis. The total dividends
were $26,481.00. So, the net cost is $24,089.50.
Transamerica then issued to petitioners a corrected Form 1099-R for 2000
reporting the following:
Gross distribution
$33,850
Taxable amount
9,760
Employee contributions or
insurance premiums
Box 7
[8] Petitioners timely filed a joint Federal income tax return for 2000. On
their return, petitioners did not report the gross distribution from
Transamerica and did not include the taxable amount in income.
[9] In the notice of deficiency, respondent determined that petitioners
received a taxable pension in the amount of $9,760, which they failed to report
on their Federal Income Tax return.
[10] Petitioners timely filed a petition with the Court disputing the
determined deficiency.
Discussion
[11] Generally, the Commissioner's determinations are presumed correct, and
the taxpayer bears the burden of proving that those determinations are
erroneous. Rule 142(a); Welch v. Helvering, 290
[12] Gross income includes income from whatever source derived including,
but not limited to, life insurance contracts.6 Sec. 61(a)(10). As relevant to this case, any amount which is
received under a life insurance contract on its complete surrender, and which
is not received as an annuity, shall be included in gross income to the extent
it exceeds the investment in the contract.7 Sec. 72(e)(1)(A),
(5)(A), (E)(ii). The investment in the contract is defined generally as the
aggregate amount of premiums or other consideration paid for the contract less
amounts previously received under the contract, to the
extent such latter amounts were excludable from gross income. Sec. 72(e)(6).
[13] Petitioners do not dispute receiving the $33,850 in 2000 as reported on
both the original and the corrected Form 1099-R. Petitioners, however, contend
that no part of that distribution is taxable because life insurance
distributions are not taxable. In support of their contention, petitioners rely
on an Annual Insurance Policy Statement for the year 2002 from the Department
of Veterans Affairs concerning policy No.
V-1207-72-70, which specifically states that "Insurance dividends are not
subject to Federal income tax". Petitioners further contend:
This policy was never considered an investment. It has NEVER been referred
to as a "pension or annuity".[8]
[14] Petitioners have set forth no plausible legal theory to support their
argument that the distribution in issue is nontaxable. Although it is true that
as a general rule, proceeds of life insurance contracts paid by reason of the
death of the insured are excludable from gross income, see sec. 101(a)(1), the
proceeds of the contract in issue were not paid by reason of Mr. Jensen's
death, but rather because of the surrender of that policy. Moreover,
petitioners' reliance on a statement from the Department of Veterans Affairs is
misplaced because such statement does not apply to the policy in this case (No.
264261), and, further, the distribution in issue was not a payment of insurance
dividends,9 nor was it a payment from the
Department of Veterans Affairs.10
[15] The policy in this case was a whole life insurance policy. Generally, a
whole life insurance policy has a cash surrender value that increases over time
as premiums are paid. The cash surrender value can be distributed to the
insured upon the cancellation, surrender, or termination of the policy before
its maturity date. Upon distribution, a taxable gain may result to the extent
that the distribution exceeds the investment in the contract; i.e., the amount
of premiums paid for the contract.
[16] The record is clear that petitioners canceled the policy and received
the cash surrender value of the policy. Transamerica then calculated the
taxable gain on the distribution based on petitioners' cost basis in the
policy. Petitioners were well aware of the fact that the premiums paid affected
their cost basis in the policy and, thus, their taxable gain. In fact, it
appears that petitioners diligently requested Transamerica to recalculate the
taxable gain due to employee contributions that may not have been accounted for
as a result of the conversion of the term life insurance policies into the
policy. Absent exceptions not applicable in the instant case, the law is
well-settled that a distribution upon the complete surrender of a life
insurance contract is includable in gross income to the extent the distribution
exceeds the investment in the contract. Therefore, the distribution of $9,760
is includable in petitioners' gross income. Accordingly, we sustain
respondent's determination.
[17] We have considered all of the other arguments made by petitioners, and,
to the extent that we have not specifically addressed those arguments, we
conclude they are without merit.
[18] Reviewed and adopted as the report of the Small Tax Case Division.
[19] To reflect the foregoing,
[20] Decision will be entered for respondent.
FOOTNOTES
1Unless otherwise indicated, all subsequent section references are
to the Internal Revenue Code in effect for 2000, the taxable year in issue. All
Rule references are to the Tax Court Rules of Practice and Procedure.
2All amounts are rounded to the nearest dollar.
3A complete copy of the policy is not in the record, but the
evidence indicates that the policy provided for annual dividends, premiums
payable during life of insured, and face amount payable at death of insured.
4At some point in time, Occidental Life Insurance Co. of
California merged with Transamerica Life Insurance Co.
5We need not decide whether sec. 7491, concerning burden of
proof, applies to the present case because the facts are not in dispute and the
issue is one of law. See Higbee v. Commissioner, 116
T.C. 438 (2001).
6The policy satisfies the definition of a life insurance
contract. See sec. 7702(a).
7We note that sec. 101(g)(2) provides
that amounts received under a life insurance contract on the life of an insured
who is "chronically ill" may be excluded from gross income. See sec.
7702B(c)(2). Although Mr. Jensen may suffer from certain
health problems, the record does not support a finding that he is chronically
ill.
8Petitioners disagree with respondent's characterization that the
distribution is from a pension or annuity. The fact that
respondent erroneously characterizes the distribution as from a pension or
annuity has no bearing on the resolution of the issue in this case.
Clearly, the distribution resulted from petitioners' surrender of the policy.
9Insurance "dividends", in general, "may be
excluded from income as a reduction of premium, at the time of the periodic
payment of premiums". Estate of Wong Wing Non v.
Commissioner, 18 T.C. 205, 209 (1952).
10Generally, payments of benefits due under any law administered
by the Department of Veterans Affairs are exempt from taxation. See 38 U.S.C
sec. 5301(a)(1) (Supp. III 2003).
END OF FOOTNOTES
Tax Analysts Information
Code Section: Section 72 -- Annuities; Section 61 -- Gross Income
Defined
Geographic Identifier:
Subject Area: Individual income taxation
Litigation and appeals
Author: Armen, Robert N., Jr.
Institutional Author: United States Tax Court
Tax Analysts Document Number: Doc 2004-11253 [PDF]
Tax Analysts Electronic Citation: 2004 TNT 103-7