First Nat'l Bank & Trust Co. v. Commissioner

FIRST NATIONAL BANK AND TRUST COMPANY OF MINNEAPOLIS AS REPRESENTATIVE OF THE ESTATE OF EDWARD STARR JUDD, DECEASED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. First Nat'l Bank & Trust Co. v. Commissioner Docket No. 91229. United States Board of Tax Appeals 39 B.T.A. 134; 1939 BTA LEXIS 1065; January 19, 1939, Promulgated *1065 Where decedent was insured under a policy designated as "group life insurance" upon which premiums were paid by the organization with which he was associated and of which he was a director, held, upon consideration of the surrounding circumstances and of the characteristics of the policy, that the premiums were paid indirectly by the decedent and the insurance proceeds are includable in his estate under section 302(g), Revenue Act of 1926. John W. Windhorst, Esq., and Leland W. Scott, Esq., for the petitioner. W. R. Lansford, Esq., for the respondent. OPPER *135 The respondent originally determined a deficiency of $112,618.72 in estate taxes, but the issue here involves only $2,640 of this deficiency. Edward Starr Judd, hereinafter referred to as decedent, died on November 30, 1935. The respondent included in his gross estate $10,000 as the proceeds of a life insurance policy, which was paid to decedent's wife. Petitioner, as executor of decedent's estate, questions whether such proceeds were properly included. FINDINGS OF FACT. The facts are found as stipulated by the parties, the following being a summary thereof: The insurance*1066 policy involved was designated "Group One Year Renewable Term Policy" and insured each member of the permanent staff of the Mayo Clinic whose salary was $3,500 or over. The underlying policy was taken out in 1925 and was renewable annually upon payment of premiums, which were subject to alteration by the company because of changes in its premium schedules or in the group insured. The "Employer" under the policy was "Mayo Clinic" of Rochester, Minnesota. Each person insured thereunder had the power to designate and to change from time to time his beneficiary. Each was also entitled to certain disability benefits and, upon separation from the employ of the Clinic, to have issued to him an individual policy without evidence of insurability. In accordance with the underlying policy an individual certificate was issued to each insured, including the decedent, stating the amount of his coverage and his rights under the policy, as well as endowment benefits under an accompanying certificate. Displayed prominently on a page containing the pictures of the two Mayo brothers and facsimile signatures of the board of governors, of whom decedent was one, is the statement that "This protection*1067 is provided by the Mayo Clinic in appreciation of your cooperation and in recognition of your contribution to the perpetuation of its purposes and ideals." The policy contained the following provisions as to coverage: The amount of insurance, as to each Employee insured hereunder, shall be equal to the annual salary if that be an exact multiple of $1000. otherwise the next higher multiple of $1000. not in any case to exceed $10,000. * * * The premium due on the date of issue of this Policy shall be the aggregate of the premiums determined by applying the Initial Schedule of Premiums as shown in Section 4 hereof, to the amount of insurance issued, at the respective ages of the Employees on whom insurance is effected. * * * Thereafter annual premiums, per thousand dollars of insurance, for all Employees insured or becoming insured hereunder shall, irrespective of age, *136 be at such average rate until such time as such average premium rate is recomputed, as hereinafter provided. Upon any renewal of this Policy or whenever, at any time, the terms of this Policy shall be modified; then either the Employer or the Company may require a recomputation, in accordance with*1068 the method applicable at date of issue, of the average annual premium rate per thousand dollars of insurance according to the Schedule of Premiums then applicable, and such recomputed average premium rate per thousand dollars of insurance, shall, irrespective of age, be charged hereunder for the balance of that policy year and thereafter until again so recomputed. During all of the period here involved, namely 1925 until decedent's death, November 30, 1935, all the properties operated by the Mayo Clinic were owned by and leased from the Mayo Properties Association, a charitable and educational nonprofit corporation, the Clinic itself owning nothing but its profits, which were subject to the dispositions hereinafter set out. The Clinic was operated under three successive agreements during that period to each of which decedent was a party. Without setting them out in full, it is sufficient to state that the first, which was in effect from 1919 to 1929, created a partnership composed of the decedent and four other individuals to operate under the name of "Mayo Clinic." Each partner was to receive a salary of not to exceed $100,000, to be fixed by the partnership at the beginning*1069 of each year. The articles of partnership contained the following formula for the computation and distribution of the net income of the partnership: ARTICLE 10. Net Income Defined. From the gross cash receipts incoming in any one year from the operation of the partnership (whether earned or charged in that calendar year or any preceding year) shall be, at the end of each month, deducted and paid all losses, taxes, charges and wages (other than rent to be paid for the Mayo Clinic Property, which is to be a percentage of the net income), fixed salaries, including the payment to a partner retired or the legal representative of a deceased partner for a limited period after his death or retirement, as is hereinafter provided, (but not including the salaries of the partners), expenditures for buildings, improvements, additions, betterments and equipment, and all contributions, donations and gifts, and all reasonably necessary expenses and liabilities of every kind and nature arising out of the operation of such partnership, which may be due or payable, without regard to when incurred or contracted, and such amount as may be necessary for a fund for the payment, at the end of each*1070 year to members of the Faculty, of a percentage of the earnings as compensation for their services in addition to their fixed salaries, which percentage shall be fixed by the partnership, and the remainder of such gross cash receipts, as aforesaid, shall be, for all purposes herein, the net income of the partnership for such year; liabilities shall include the individual liability of each partner arising through any act or omission of the partnership or any member or members thereof in connection with, or in any way whatsoever, arising out of, the partnership business. *137 ARTICLE 11. Distribution of Net Income. The net income shall be distributed at the end of each month in the following manner and order. 1. The Salaries of the partners shall be paid. 2. One-half of the net income of the partnership shall belong to and be paid to Mayo Properties Association as rent for the Mayo Clinic Properties; provided, however, if the remainder after the salaries of the partners shall have been paid, shall be less than fifty percent of the net income, the remaining net income, if any, after the payment of salaries and rent in each subsequent month shall be paid to said*1071 Mayo Properties Association until all of said unpaid rent, without interest, shall have been paid. 3. A percentage of the remaining net income, if any, may be apportioned among members of the Faculty as bonuses for exceptional, extraordinary or distinguished services, upon such basis as the partnership may determine, and a further percentage may be set aside for new projects for the betterment, improvement, or expansion, or for any object which will be for the benefit of, the Clinic. 4. If there be any of the net income then remaining, it shall belong to and be paid to Mayo Properties Association, and neither the partnership nor any partner shall at any time have any right, title, estate or interest therein. Distribution of net income shall be made each month, as aforesaid, and no partner shall, at any time, assign, hypothecate, pledge, or in any manner transfer any of his salary as such partner. Under this agreement the operation of the Clinic and the management of the properties leased from the Mayo Properties Association was to be conducted by a "Board of Governors" consisting of the members of the partnership and two members of the "Faculty of Medicine of Mayo Clinic" *1072 who were named in the agreement. From 1929 to 1933 the Mayo Clinic operated under a second agreement, which was designated "Articles of Association of the Board of Governors of Mayo Clinic." It provided that the prior partnership was dissolved and the five former partners and the two other members of the former board of governors organized themselves as the "Board of Governors of the Mayo Clinic" for the purpose of conducting and managing the business thereof. The governors were to receive salaries fixed by the board at not less than $25,000 and not more than $75,000 to cover professional and all other services, income tax on the salaries of life governors to be paid by the board. There was no further provision for the disposition of the income of the "association." The agreement states: The Mayo Clinic has long been operated as a partnership, but for the last ten years the partners have voluntarily surrendered their right to participate in the profits and have been paid a fixed amount annually, thus making substantial contributions to Mayo Properties Association, as all surplus over operating expenses becomes its property. It is the intention of the parties that such method*1073 of operation be made permanent. *138 The agreement was "approved, ratified and confirmed" by nine individuals "being all of the members of the Mayo Properties Association", seven of whom, including the decedent, were also the subscribers to the articles of association. From 1933 until decedent's death a third agreement was in effect, which was also designated as "Articles of Association of the Board of Governors of Mayo Clinic." It was similar to the 1929 agreement, the same seven individuals, including decedent, organizing themselves as the board of governors. Similarly to the previous agreements, this one provided that "Each of the governors shall devote his entire time and give his best skill and attention to the work." The salary of the governors was to be fixed by the fiscal committee of the Mayo Properties Association, but limited to $50,000 per year, and the income taxes on the salaries of life governors were to be paid by the board. The agreement made no further provision for the distribution of income. It states: The Mayo Clinic has long been operated as a partnership, but for more than ten years the partners have voluntarily surrendered their right to participate*1074 in the profits and have been paid a fixed amount annually, thus making substantial contributions to Mayo Properties Association, as all surplus over operating expenses becomes its property. It is the intention of the parties that such method of operation be made permanent. On the effective date of this last agreement, January 1, 1933, a thirty-year lease was executed by the Mayo Properties Association and Mayo Clinic covering the physical properties used by the latter. The lessee agreed to pay as rent its entire "net income", to be computed under a formula similar to that quoted from the first agreement. It is as follows: From the gross cash receipts incoming in any one year from the operation of the Mayo Clinic (whether earned or charged in that calendar year or a preceding year) shall be, at the end of each month, deducted and paid all taxes, charges (except rent for the leased property) and wages, salaries of life governors and income taxes thereon, fixed salaries, including the payment to a member retired as provided in the Articles of Association, expenditures for building, improvements, additions, betterments and equipment, and contributions, donations and gifts, and*1075 all reasonably necessary expenses and liabilities of every kind and nature arising out of the operation of such Mayo Clinic, which may be due or payable, without regard to when incurred or contracted, and the remainder of such gross cash receipts, as aforesaid, shall be, for all purposes herein, the net income of the lessee for such period. It is further understood and agreed that, during the term of this lease, the salaries of the governors, officers and all employes of lessee shall be fixed by the Fiscal Committee of the lessor, but shall not exceed the limitations contained in the articles of association of the lessee. All premiums on the "group policy" were paid by the Mayo Clinic and not directly by the decedent. *139 For the calendar years 1925 to 1932, inclusive, the Mayo Clinic filed its income tax returns as a partnership, which returns were accepted and approved by the Commissioner of Internal Revenue. In computing the distributable income of the partnership for those years the premiums paid by said Mayo Clinic on the "group insurance policy" involved were deducted. During that period the parties to the various agreements governing the Mayo Clinic, including*1076 decedent, included in their net income for Federal income tax purposes the entire amount of their shares of the distributable income revealed by the partnership return. Only a part of this distributable net income was actually received by the parties to the agreement. The remaining portion of the distributable net income was paid to the Mayo Properties Association. For the calendar years 1933 to 1935, inclusive, the Mayo Clinic filed its returns as an association taxable as a corporation, which returns were accepted and approved by the Commissioner. In computing its net income for these years the premiums paid on the "group insurance policy" here involved were deducted. OPINION. OPPER: The question is whether insurance on the life of petitioner's decedent under a so-called group life insurance policy was "taken out by the decedent upon his own life", 1 with the consequence that its proceeds should be included in his estate. It is clear from our decision in , that in order to fall within that language it is not necessary that the policy by procured by the decedent personally nor that he pay the premiums directly. *1077 2 Accordingly, the facts that the policy was applied for by the Mayo Clinic, the organization with which decedent was associated, rather than by decedent, and that the premiums were paid by it are not conclusive. The question still remains whether the premiums were paid "indirectly" 3 by the decedent either on the theory that they were additional compensation to him, which was used by the Mayo Clinic to pay premiums for his account, or that a part of his distributive share in the net profits of a partnership or association was applied to the payment of the premiums. *1078 *140 Because of the somewhat involved history of the Mayo Clinic it may not be entirely clear whether the premium on the policy which was in effect at decedent's death was paid by an organization more nearly analogous for tax purposes to a partnership on the one hand or to a corporation on the other. From 1925, when the policy was originally issued, to 1933, decedent and his associates were admittedly partners and filed income tax returns as such. As of January 1, 1933, the articles of association were amended slightly and thereafter returns were made as an association taxable as a corporation. They were so accepted by the respondent. As pointed out by petitioner, the policy in question being a term insurance policy, renewable annually, the specific contract which was in effect at decedent's death was made within the period when corporate returns were being filed. But the fact that an association may be taxable as a corporation under the specific provisions of the revenue act would not necessarily be conclusive on the question whether the respective rights of the associates and particularly their interest in the annual income of the enterprise were those of partners on*1079 the one hand or stockholders holders on the other. Since, however, in our view the same result would follow under either hypothesis, we refrain from a determination on this point. If the organization was in effect a corporation it seems to us the situation is controlled by the language in the Dobrzensky proceeding, supra (p. 311): The directors could not legally give away the corporate property. We will not assume they acted illegally. Decedent had furnished and was even then furnishing the company with his "invaluable advice, counsel and personal influence which would justify a very large compensation" * * *. Then "as some slight evidence of appreciation and recognition of these valuable services" the directorate assumed the costs incidental to * * * its future premiums. We conclude that action constituted not a gift to decedent but compensation paid to him for those services. ; affd., ; ; *1080 . Cf. ; affd., . And, since decedent acquired this policy for such services, that policy must be regarded, in law, as "taken out by the decedent upon his own life." Here also, according to the certificate issued to decedent, his protection under the policy was "provided by the Mayo Clinic in appreciation of your cooperation and in recognition of your contribution to the perpetuation of its purposes and ideals." The language quoted from the Dobrzensky case refers to an individual policy. Consideration of a group policy in the same decision resulted in a determination that it was not to be included in the estate, upon the authority of . *141 4 For the reasons about to be stated, however, we believe the language quoted to be more nearly applicable to the present situation than the decision as to the group policy. *1081 As a preliminary it is to be observed that the mere designation of the policy is of little consequence. In , we said, p. 1222: "There is nothing to justify the petitioner's pleaded contention that this was 'group insurance,' and if it were to be so designated, the designation alone would not warrant the omission of the premiums for [from] petitioner's income. That the purpose, plan and effect was to give petitioner this additional compensation for his services is manifest. The benefit was directed to him, and the corporation received no more benefit than any employer derives when it increases the compensation of its employee." Except for the designation, however, there is little, if anything, to characterize the present policy as true group insurance from decedent's standpoint. Decedent was not only a member of the Mayo Properties Association and a director of the Mayo Clinic, but he and the other directors responsible for their conduct, including the issuance and terms of the policy, were the sole "stockholders" of the latter and preferred beneficiaries under the policy. For it is significant that the policy, with an upper*1082 limit, was proportional in its benefits to the salaries of those insured and that the premiums were based upon their ages. The group involved was a personal service enterprise readily distinguishable from a large industrial corporation. All of the foregoing characteristics have been considered and determined to be consequential in the decision of similar cases. Giving effect to all of them and without attempting to evaluate their separate importance we have arrived at the conclusion above set forth. In , we said: Counsel for the respondent argues that ordinarily group insurance is taken out without the consent and without the knowledge in most cases of the employee, who is not consulted, who does not make the application for the insurance, and who is told about the matter after the thing has been accomplished; that here we have the actual participation by all the employees insured, who were also directors as well as the beneficiaries; that the employees on whom the policies were taken out made out the applications, had knowledge of what *142 was being done, and gave their consent to what was done; and that the*1083 amount of the insurance (the face value of the policy) obviously was set by the individuals, since they were directors of the corporation and the minutes show that the directors passed on such insurance. It was also urged upon us on behalf of the respondent that group insurance could not be compared to the situation existing in the instant proceeding, since it would appear that the corporation was practically a personal service corporation, where the activities of the stockholders, and especially the activities of petitioner, produced the income and that such a situation is not at all analogous to one where insurance is taken out for thousands of employees who know nothing about it * * *. We agree with counsel for respondent that the situation here is quite different from the one contemplated by that portion of Article 33, Regulations 62, relative to premiums paid on group insurance policies * * *. And in , we said: "The fact the payments to all of the employees were based upon the amount of their salaries, carries with it a strong indication that the payments were in consideration of past services * * *." *1084 Some of the cases cited consider whether such premiums are additional compensation, taxable as such to the employee. While this precise question is not before us, the applicable reasoning is comparable (see ), and the absence of any estate tax regulation 5 as to group insurance makes this if anything a stronger case for the respondent than the Adams and Danforth proceedings. It follows that nothing in the Ballinger or Dobrzensky decisions, where some or all of these facts were absent, is inconsistent with our conclusion in this proceeding that if the organization with which decedent was associated is to be regarded as a corporation the proceeds of the policy before us should be included in his estate. If, on the other hand, the organization was a partnership for some part or all of the critical period, the argument that decedent indirectly paid the premiums is even stronger. For whatever voluntary arrangement with respect to*1085 the disposition of the net profits might have been made by the partners, their right to receive the income in the first instance and their interest in the partnership property and profits can only result in the conclusion that payments made by the partnership were no more than agency transactions in which the funds were actually the property of the partner benefited. ; . And, while not conclusive, 6 it is of some significance that for the greater part of this period tax returns were being filed by decedent as a partner and income tax was being paid on his proportionate share *143 of the partnership profits, an amount which was, according to the stipulation, reduced by the premiums paid for the "group policy." 7 We accordingly conclude that the policy was taken out by decedent on his own*1086 life because it was procured and paid for at least indirectly by him. Reviewed by the Board. Decision will be entered for the respondent. LEECH concurs only in the result. Footnotes 1. Section 302(g), Revenue Act of 1926. ↩ 2. See also ; 711, where the court said: "The manifest purpose of that provision is to include in the decedent's estate for purposes of the tax the proceeds of all insurance on his life receivable under policies acquired through expenditure by him." This case was cited with approval in . ↩ 3. Regulations 80 (1934 Ed.), art. 25: "Insurance is deemed to be taken out by the decedent in all cases, whether or not he makes the application, if he pays the premiums either directly or indirectly.↩ * * *" (Emphasis added.) The Supreme Court in , held a similar regulation to have been "approved by Congress." 4. In that case "this Board construed the quoted words [of the statute] literally." . In , we expressed our unwillingness "to ignore the intent of the statute or to nullify it by mere technical construction." On appeal, this position was sustained, the court there saying (: "The statute readily could be evaded if a policy, under which the beneficiary may be changed, could be taken out by a corporation or firm on the life of an official or member of that corporation or firm, and the latter could acquire the policy and have a new beneficiary designated, with the result of excluding from his gross estate the amount in excess of $40,000 receivable by the beneficiary under the policy * * *." ↩ 5. Cf. Regulations 86, art. 22(a) 3 - "* * * Premiums paid by an employer on policies of group life insurance covering the lives of his employees, are not income to the employees." ↩ 6. Cf. . ↩ 7. This treatment was apparently accepted by respondent, perhaps upon an interpretation of his regulations. Regulations 65 and 69, art. 293; Regulations 74 and 77, art. 283; Regulations 86, art. 24 - 3. ↩