McIntyre v. Commissioner

WINIFRED WHEELER MCINTYRE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ROBERT T. WHEELER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. McIntyre v. Commissioner Docket Nos. 103221, 103222. United States Board of Tax Appeals 45 B.T.A. 67; 1941 BTA LEXIS 1176; September 12, 1941, Promulgated *1176 Petitioners' father took out life insurance policies on his own life and, pursuant to his request, the company agreed to pay the proceeds thereof to the insured's mother in monthly installments for ten years certain and during her after lifetime as provided in settlement option C of the policies, and that if she should die before receiving installments for the ten years certain, then upon her death the commuted value of the remaining installments for that period would be paid in one lump sum to the insured's children, share and share alike. Option C provided for monthly payments, the amount thereof varying with the age of the beneficiary at the maturity of the contracts. After the insured died his mother received payments under the contracts, but she died before receiving installments for the full ten-year period and the commuted value of the remaining installments for that period was paid to the insured's son and daughter, the petitioners herein. Held, the payments received by petitioners are exempt from taxation under section 22(b)(1) of the Revenue Act of 1936, and no part thereof is taxable to them as interest. Egbert Robertson, Esq., for the petitioners. *1177 Leonard A. Spalding, Jr., Esq., for the respondent. TURNER *68 The respondent determined deficiencies in income tax for 1937 against Winifred Wheeler McIntyre and Robert T. Wheeler in the respective amounts of $522.62 and $230.81. The only question presented is whether certain payments received by petitioners under life insurance contracts taken out by theif father are exempt from income tax under section 22(b)(1) of the Revenue Act of 1936. FINDINGS OF FACT. Petitioners are residents of Chicago, Illinois, and filed their income tax returns for 1937 with the collector of internal revenue for the first district of Illinois. Robert C. Wheeler, father of the petitioners, during his lifetime took out two life insurance contracts on his own life with the Mutual Benefit Life Insurance Co., policies Nos. 759787 and 759788, photostatic copies of which are a part of the record and by reference are made a part of our findings of fact. Each contract provided that in consideration of an annual premium of $603.50 the company insured the life of Robert C. Wheeler in the amount of $25,000. During his lifetime and on February 24, 1928, the insured requested the*1178 company to pay the proceeds of each policy as follows: If the policies, or either of them, shall mature as death claims during the lifetime of Eustacia C. Wheeler, my Mother, the Company is to pay the proceeds to her in Monthly Instalments for Ten years certain and during her after lifetime as provided in Settlement Option C, as set forth on the other side hereof. If my Mother shall survive me but shall die before all of the Instalments certainly payable have been paid, or if she shall predecease me, the proceeds of the Policies or the commuted value of any Instalments certainly payable remaining unpaid, as the case may be, shall be payable, share and share alike, to such of my Children as shall be then living and to the then living issue, per stirpes, of any of such children as may be then deceased; or, if there be no such Beneficiaries thus living, then payable to my executors, administrators or assigns, and such payment shall discharge the Company from all liability under the Policies. The right of commutation is to be withheld. Robert C. Wheeler died on December 20, 1928, at which time the two insurance policies were in full force and effect. Surviving him were his mother, *1179 Eustacia C. Wheeler, who had attained the age of 75 years, and his son and daughter, the petitioners herein. At the date of his death there were accumulated on the said policies final dividends amounting to $424.18, so that the amount the insurance company would have paid at the date of the death of the insured had such policies been payable in a lump sum was $50,424.18. The installment payments under the contracts were determined under the provisions of option C of the contracts, which contained a tabulation showing the amount payable in monthly installments in lieu of $1,000 payable in one sum, the amounts varying with the *69 age of the beneficiary at the maturity of the policy. It was thus determined that the insured's mother was entitled to receive monthly installments of $8.60 for each $1,000 of insurance, so that the amount of each monthly installment under the contracts was $8.60 times 50.42418, or $433.65. The company thereupon issued its installment certificate, which recited the agreement that the proceeds of death claims under the policies were to be paid to Eustacia C. Wheeler in continuous monthly installments of $433.65 each, and that if she should die before*1180 receiving 120 of such installments, the company would pay the commuted value of the installments certainly payable but remaining unpaid in equal shares to the children of the insured then living. Eustacia C. Wheeler died on December 10, 1936, at which time the petitioners were the only living children of the insured. During her lifetime she received under the two policies 96.59 installments of $433.65 each, or a total of $41,885.92, no part of which was reported as taxable income during her life. Upon review of the income tax return filed for her after her death, for the period from January 1 to December 10, 1936, the respondent included in her taxable income, by reason of the installment payments received by her during that period, the sum of $674.82 and determined a deficiency in tax thereon in the sum of $87.73, which deficiency was paid by her executor, and no claim for refund has been filed. In 1937 the company paid to each petitioner the sum of $5,188.09 representing one-half of the commuted value of the remaining installments under said contracts for the certain ten-year period. No part of these amounts was included in the taxable income of either petitioner for 1937. *1181 Of such amounts the respondent included in the income of each petitioner the sum of $793.64, stating that it constituted interest income under article 22(b)(1)-1 of Regulations 94. When insurance proceeds are payable in installments the determination of the amount of such installments is a matter for the insurance company to stipulate in its contracts, and depends upon the rate of interest which the company is willing to consider as likely to be made by it in its transactions, and, since this element is an essential in determining the amount of the periodic payments, any guaranties of such payments provided by the policy implicitly recognize such rate of interest. In determining the amount of settlement where it is to be paid over a term certain, the fundamentals of the mathematics of interest and discount are used, and the determination of the periodic payments is made by considering the lump sum which would have been payable but for the installment arrangement and equating that lump sum to the present or discounted value for the term certain at the rate assumed, and it is a matter of ratio to determine *70 the amount of installment for any particular case from the present*1182 value of $1 of income for the period. If a policy is payable for a ten-year certain period and thereafter during the life of a beneficiary, whichever period is longer, the determination of the amount of the installment involves a certain period of ten years and thereafter a life annuity. This involves an estimate of mortality as distinguished from the more simple determination with a period certain only. The company must decide as to the mortality table which it will assume with respect to the beneficiary, and this is in practice different from the mortality table used in the deteermination of the reserves for the policy proper, contemplating the improved mortality situation from the old tables and differentiating by sex. Having done this, the procedure is the same in respect to discount for individuals expected to be alive in the future. Having a present value of $1 per annum payable over the lifetime of an individual of a given age, but for ten years certain in any event, it is a matter of ratio to determine the appropriate amount of installments for any given sum of insurance proceeds. OPINION. TURNER: The question presented is whether the payments received by the petitioners*1183 under the insurance contracts in question are to be excluded from their income under section 22(b)(1) of the Revenue Act of 1936, which provides as follows: (b) EXCLUSIONS FROM GROSS INCOME. - The following items shall not be included in gross income and shall be exempt from taxation under this title: (1) LIFE INSURANCE. - Amounts received under a life insurance contact 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). In making his determination the respondent relied on article 22(b)(1)-1 of Regulations 94, which constitutes his interpretation of the above statutory provision and provides in part as follows: * * * The amount exempted is the amount payable had the insured or the beneficiary not elected to exercise an option to receive the proceeds of the policy or any part thereof at a later date or dates. If the policy provides no option for payment upon the death of the insured, or provides only for payments in installments, there is exempted only the amount which the insurance company would have*1184 paid immediately after the death of the insured had the policy not provided for payment at a later date or dates. Any increment thereto is taxable. In any mode of settlement the portion of each distribution which is to be so included in gross income shall be determined as follows: * * * (b) Proceeds payable in installments for a fixed number of years. - If the proceeds are payable in installments for a fixed number of years, the amount that would have been payable by the insurance company immediately upon the death *71 of the insured (if payment at a later date had not been provided for) is to be divided by the total number of installments payable over the fixed number of years for which payment is to be made, and the quotient represents the portion of each installment to be excluded from gross income. The amount of each installment in excess of such excluded portion is to be included in gross income. * * * (c) proceeds payable in installments during the life of the beneficiary. - If the proceeds are payable in installments during the life of the beneficiary the amount of each installment that is to be included in gross income will be determined as in paragraph*1185 (b) of this article, except that the number of years to be used in the specified computation will be determined by the life expectancy of the beneficiary, as calculated by the table of mortality used by the particular insurance company in determining the amount of the annuity. (d) Proceeds payable for a fixed number of years and for continued life. - If the proceeds are payable in installments for a fixed number of years and for continued life, the amount of each installment that is to be included in gross income will be determined either as provided in paragraph (b) of this article if the fixed number of years for which payment is to be made exceeds the life expectancy of the beneficiary, as calculated by the table of mortality used by the particular insurance company in determining the amount of the annuity; or, as provided in paragraph (c) of this article if such life expectancy exceeds the specified fixed period. If a mode of settlement has been in effect prior to the first taxable year which begins after December 31, 1933 (or after December 31, 1935, in the case of a mode of settlement described in paragraph (d) of this article), the entire amount received and excluded*1186 from gross income in such prior years shall be deducted from the proceeds payable upon the death of the insured; the remainder shall be divided by the number of installments unpaid at the beginning of such taxable year (whether over the remaining portion of the fixed period or over the life expectancy as of that date, depending on the made of settlement adopted); and that quotient shall be the excludible portion of each installment. As soon as the aggregate of the amounts received and excluded from gross income under the methods of computation provided for in this article equals the amount of the proceeds payable upon the death of the insured, the entire amount received thereafter in each taxable year must be included in gross income. The respondent, apparently applying that regulation to the instant facts, held that, of the payments received by the petitioners under the two policies, $793.64 was taxable to each of them as interest. That figure was arrived at by deducting from $41,885.92 (total installments received by Eustacia C. Wheeler during her lifetime) the amount of $674.82 on which tax was paid by her executor, and, by subtracting the remainder, $41,211.10, from the lump*1187 sum face value of the policies ($50,000), leaving $8,788.90 as the net amount of the remaining installments to be received fre from tax; then, by subtracting that amount from the aggregate of the commuted value payments received by the two petitioners ($10,376.18), he arrived at $1,587.28 which was to be treated as taxable interest, one-half to each petitioner, or $793.64. The petitioners contend that the payments in question were amounts received under life insurance contracts paid by reason of the death of the insured and are to be excluded from their gross income under the *72 first part of section 22(b)(1), supra; that the respondent's regulation as applied here has been held by this Board and the courts in substantially similar cases to be in conflict with the revenue act and invalid, Sidney W. Winslow, Jr.,39 B.T.A. 373; affd., 113 Fed.(2d) 418; and Commissioner v. Bartlett, 113 Fed.(2d) 766; and, further, that the respondent's interpretation of the statutory provision, as set forth in his regulations and as applied here, would render the act violative of the Fifth Amendment to the Constitution, since it would*1188 deprive the taxpayers of property without due process of law in that it would impose upon them a tax based upon income received by another, namely, their grandmother, Eustacia C. Wheeler. Under the cases cited, the contentions of the petitioners must be sustained. Furthermore, except for certain of the items in the Bartlett case, it is our opinion that the petitioners here are in an even stronger position. In those cases the petitioners' position was comparable to that of Eustacia C. Wheeler in the instant case, and the respondent argued in those cases that, since the insurance company withheld a portion of the proceeds of insurance and made use of it during the period in which installment payments were being made, a portion of such payments constituted interest for the use of the proceeds withheld. That argument was rejected. Here his argument is even less tenable, because the petitioners were not entitled to any payments whatever until the death of Eustacia C. Wheeler, and, if she had lived long enough to receive installments for ten years certain, they would not have received anything. Upon her death the remaining payments certain were commuted and paid to them in a*1189 lump sum in complete settlement of the obligation. Since it is apparent that no payments were withheld from these petitioners, we think the respondent's contention here is even less meritorious than it was in the cases cited. Even if it be conceded that a portion of the installment payments of this character represented interest, which is contrary to the cases cited, it would seem to us that such interest was eliminated therefrom in the instant case by the very act of commutation. In fact, the respondent's regulation in question does not seem to make provision for the precise factual situation existing in the instant case, and the commutation which was supposed to have been made thereunder appears to be a further extension of the rule there enunciated, which, in our opinion, is unwarranted. We hold that the payments in question received by the petitioners under the life insurance contracts are to be excluded from their income under section 22(b)(1), supra. Decision will be entered under Rule 50.