                         T.C. Memo. 1998-250



                       UNITED STATES TAX COURT



         CHARLES F. SUTTER AND CHERYL SUTTER, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent


       Docket No. 10357-96.                      Filed July 8, 1998.


       Laura Lee Anderson, for petitioners.

       Michael W. Lloyd, for respondent.


               MEMORANDUM FINDINGS OF FACT AND OPINION


       CARLUZZO, Special Trial Judge:   This case was heard pursuant

to the provisions of section 7443A(b)(3) and Rules 180, 181, and

182.    Section references are to the Internal Revenue Code in

effect for the years 1991 and 1992.     Rule references are to the

Tax Court Rules of Practice and Procedure.

       Respondent determined a deficiency in petitioners' 1991 and

1992 Federal income taxes in the amounts of $1,080 and $1,387,
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respectively.   The issue for decision is whether petitioners

realized and must recognize income upon obtaining coverage under

certain life insurance policies during the years in issue.

                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

Petitioners are husband and wife.   They filed timely joint

Federal income tax returns for the years 1991 and 1992.   At the

time the petition was filed, they resided in Afton, Wyoming.

     Charles Sutter was employed as a police officer by the City

of Santa Monica, California, from 1963 until 1969.    He was next

employed as a police officer by the City of Afton, Wyoming, from

1969 until 1981.   After leaving the Afton police force in 1981,

he began to work for Valley Lumber, a sawmill and lumber company

that was owned by Arthur Schwab.

     Arthur Schwab is the father of Marvin Schwab.    Marvin Schwab

is the father of Daniel Schwab, Vance Schwab, and Lee Schwab.

Charles Sutter first met the Schwabs in 1969 or 1970, when he was

purchasing building materials to remodel his house.   During the

relevant periods, Marvin Schwab, Vance Schwab, and Daniel Schwab

were licensed life insurance salesmen in the State of Wyoming.

They were associated with the Daniel Schwab Agency, which was

located in Afton, Wyoming.   Although Lee Schwab maintained an

office in the same building where the offices of the Daniel
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Schwab Agency were located, he was not directly involved with

that agency.

     Charles Sutter purchased life insurance through Marvin

Schwab before the years in issue.    Although the extent of the

coverage is not exactly clear from the record, it appears that

before 1991, he generally maintained between $25,000 and $50,000

of life insurance.    In 1991, Marvin Schwab approached Charles

Sutter and suggested that he purchase a certain type of life

insurance policy offered by the Royal Maccabees Life Insurance

Co. (the Royal policy).    At the time, Charles Sutter was employed

by Aviat, Inc., and Christen Industries, Inc.    His wages totaled

$16,803.54 for that year.

     The Royal policy was described as a flexible premium

adjustable life insurance policy providing death benefits in the

amount of $250,000.    The first-year premium for the Royal policy

was $7,177.    On direct examination petitioner testified as

follows with respect to the payment of the first-year premium due

on the Royal policy:

          Q. Do you recall how he - - how you would pay for
     the policy?

          A. Yes.

          Q. How was that?

          A. He [Marvin Schwab] said he would give me the
     premium, and I would write back to * * * [Royal
     Maccabees Life Insurance Co.].
                                - 4 -


Marvin Schwab "gave" Charles Sutter the premium by arranging what

was described as "nonrecourse premium financing" through Stable

Reserve, Inc. (Stable), a Utah corporation.    Marvin Schwab,

Daniel Schwab, and Devon Nish owned and controlled Stable.

Charles Sutter received a check from Stable, payable to him in

the amount of the first-year premium.    The check was drawn on

Stable's account, signed by Marvin Schwab.    In turn, a check in

the same amount was drawn on petitioners' personal checking

account, payable to the Royal Maccabees Life Insurance Co.

(Royal).   As part of the transaction, Charles Sutter signed a

"Promissory Note (Interest)" to Stable in the amount of the

first-year premium, payable with interest, but, at the option of

the maker, only from the death benefit proceeds of the Royal

policy.    He was not required to, and did not, submit a financial

statement to Stable before receiving the funds from Stable.

     In addition to the note, Charles Sutter signed an assignment

of the Royal policy in favor of Stable, but the assignment

document was never forwarded to Royal.    Royal allowed such life

insurance policies to be assigned only with its consent.    Royal

was not aware of, and did not consent to, the above-referenced

assignment.

     Stable offered the type of service provided to Charles

Sutter only to clients or customers of the Daniel Schwab Agency.
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In similar transactions, Stable has never been repaid or demanded

repayment from the makers of the notes.

     Charles Sutter allowed the Royal policy to lapse, as was his

option.   From the outset, he never intended to maintain the

original coverage that the Royal policy provided.    He never paid

any other premiums on the policy, nor did he ever make any

payments on the note.    No demand for payment was ever made by

Stable.

     As the selling agent, Marvin Schwab was entitled to a

commission from Royal equal to 117 percent of the first-year

premium on the Royal policy.    Consistent with its practice, Royal

paid the commission to Marvin Schwab within days after the Royal

policy was purchased.

     During the relevant period and under similar circumstances,

the Daniel Schwab Agency sold 120 life insurance policies similar

to the Royal policy.    The Schwabs were paid substantial

commissions by Royal upon the sales of the Royal policy and the

similar policies.   Upon learning about the similar transactions,

officials from the Wyoming Insurance Department interviewed

Daniel Schwab.   During the interview Daniel Schwab represented

that notes similar to the one described above were necessary in

the event that the Internal Revenue Service questioned the

Federal income tax consequences of the transactions.
                               - 6 -


     The fair market value of the insurance coverage that Charles

Sutter received pursuant to the Royal policy was equal to the

first-year premium.

     Knowing that the Royal policy would lapse, one of the

Schwabs recommended that Charles Sutter purchase another life

insurance policy in 1992.   This time the policy involved was

offered by the Columbus Life Insurance Co. (Columbus).    During

1992, Charles Sutter was employed by Aviat, Inc., and Dory

Logging, Inc.   His wages for that year totaled $20,410.43.   Upon

the recommendation of one of the Schwabs, Charles Sutter

purchased a universal life insurance policy from Columbus that

provided death benefits in the amount of $270,000.    The first-

year premium on this policy was $6,705.60.    The sale of this

policy was an even better deal for the Schwabs than the sale of

the policies described above that were offered by Royal.

Columbus paid the selling agent a commission (including bonus and

other incentives) in excess of 190 percent of the first-year

premium on this type of life insurance policy.    Consequently,

Vance Schwab, who was listed as the selling agent on the Columbus

policy, was paid a commission of $12,791.48 by Columbus on the

sale of the Columbus policy to Charles Sutter in 1992.

     In 1992 the Schwabs sold a life insurance policy to Cheryl

Sutter as well.   At the time she was employed as a cook for the

local school district and by Marc Barrus.    Her wages for that
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year totaled $10,449.48.   Through the Schwabs, she also purchased

a Columbus life insurance policy.   Her policy provided death

benefits in the amount of $125,000.     The first-year premium for

her policy was $2,535.   For selling the policy to her, Vance

Schwab received a commission of $4,538.54 from Columbus.

     Petitioners were offered "premium financing" arrangements

through the Schwabs in connection with the life insurance

policies they obtained from Columbus in 1992.    In this regard

Cheryl Sutter was given a check in the amount of the first-year

premium, drawn on an account of Rocky Mountain Revenue (RMR), a

corporation controlled by Lee Schwab.    In turn, she issued a

check in the same amount from petitioners' personal checking

account payable to Columbus.   She signed a "Promisary [sic] Note

(Interest)" payable to RMR.    Except for the date, maker, holder,

amount, and insurance company involved, the note Cheryl Sutter

signed in connection with her Columbus policy is substantially

identical to the note Charles Sutter signed in connection with

the Royal policy.   Cheryl Sutter allowed her Columbus policy to

lapse after the initial period of coverage, as was her option.

She never paid any other premium on the policy.    She made no

repayments on the note, and repayment was never demanded by RMR.

     In connection with his Columbus policy, Charles Sutter

received a check from one of the Schwabs in the amount of the

first-year premium drawn on an account of Double Diamond
                                - 8 -


Investors (DDI).   In turn, a check in the same amount was issued

from petitioners' personal checking account (signed by Cheryl

Sutter), payable to Columbus.   Charles Sutter signed a "Promisary

[sic] Note (Interest)" payable to DDI.   Except for the date,

maker, holder, and amount, the note he signed in connection with

his Columbus policy is substantially identical to the note signed

by his wife in connection with her Columbus policy.   Charles

Sutter allowed his Columbus policy to lapse after the initial

period of coverage, as was his option.   He never paid any other

premium on the policy.   Shortly after being executed, the note to

DDI was repaid by SBTA, a Wyoming corporation controlled by

Daniel Schwab and Vance Schwab.   Charles Sutter never signed a

note payable to SBTA, or made any payments to SBTA, in connection

with this transaction.

     DDI is an unincorporated business owned and controlled by

Evan and Marie Walton.   Through DDI, the Waltons provided funds

to customers or clients of the Daniel Schwab Agency under

circumstances similar to those described above.   The Waltons

dealt directly with one of the Schwabs and not with either

petitioner, or similarly situated individuals.    In this case, and

in numerous similar transactions, the Waltons were repaid by

SBTA, as expected and in accordance with their arrangements with

the Schwabs.
                                - 9 -


     As in the case of the Royal policy, the Columbus life

insurance policies were assigned to either RMR or DDI, as

appropriate, but the assignment documents were never forwarded to

Columbus.    The fair market values of the insurance coverage that

petitioners received from the Columbus policies in 1992 equaled

the amount of the first-year premiums on the policies.

                               OPINION

     Transactions similar to the ones described above were first

considered by this Court in Wentz v. Commissioner, 105 T.C. 1

(1995), and by other Federal courts in Woodbury v. United States,

72 AFTR 2d 93-6140, 93-2 USTC par. 50,528 (D.N.D. 1993), affd.

per curiam without published opinion 27 F.3d 572 (8th Cir. 1994).

In those cases the taxpayers argued:     (1) The transactions did

not result in taxable income, but rather only reduced the cost of

the life insurance through rebates (this argument was rejected in

those cases and was not advanced by petitioners in this case);

and (2) to the extent that the transactions did result in taxable

income, the measure of income should be the fair market value of

term life insurance that would have provided the same death

benefit.    The Commissioner argued that the fair market value

should be measured by the first-year premiums paid for the type

of life insurance involved.    In those cases, the courts agreed

with the Commissioner.
                               - 10 -


     For their participation in the transaction, in the Wentz

case, 105 T.C. at 11-12, we stated:     "[The taxpayers] were

compensated with the annual benefits of whole life insurance

policies, thus triggering a taxable event."     Relying in part on

Woodbury, we found that the "undeniable accession to wealth,

clearly realized", Commissioner v. Glenshaw Glass Co., 348 U.S.

426, 431 (1955), that the Wentzes enjoyed equaled the amount of

first-year premium.    Unlike petitioners, however, the taxpayers

in Wentz and Woodbury did not execute notes in connection with

the transactions under consideration in those cases.

     In this case petitioners concede on brief that if income has

been realized as a result of the transactions here under

consideration, the proper measure of the income equals the first-

year premium paid in connection with each policy.     Petitioners

argue, however, that the transactions did not result in the

realization of income because they "paid" for the insurance with

nonrecourse notes.    According to petitioners, the notes, which

they contend represent bona fide indebtedness, distinguish their

case from Wentz v. Commissioner, supra, and Woodbury v. United

States, supra.   Respondent argues that the notes do not represent

bona fide indebtedness and should therefore be ignored.

     Respondent finds support for his argument in Haderlie v.

Commissioner, T.C. Memo. 1997-525.      Like petitioners, the

Haderlies were clients of the Schwabs and were induced by them to
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purchase a life insurance policy from Royal under circumstances

more or less identical to those involved in this case.   In that

case we described Stable as the Schwabs' "straw entity" and

referred to the taxpayers' note to Stable as "illusory".    We

found that the taxpayers were enriched to the extent that they

received the benefit of a year's worth of life insurance coverage

at no cost, and relying upon Wentz v. Commissioner, supra, and

Woodbury v. United States, supra, held that they realized taxable

income to the extent of the first-year premium attributable to

the life insurance policy there involved.

     Although the parties disagree on various points in this

case, the critical dispute between them focuses upon the bona

fides of the indebtedness represented by the notes signed by

petitioners.   Petitioners claim that the notes were in all

respects valid, although they concede that the underlying debts

represented by the notes became uncollectible when the related

insurance policies lapsed.   Respondent, relying upon Haderlie v.

Commissioner, supra, argues that the notes were illusory.

According to respondent, there was no valid indebtedness between

the holders and either petitioner.

     We agree with respondent, particularly with respect to the

DDI note.   At the time that the DDI note was executed Charles

Sutter had no intention to repay the indebtedness it represented,

and the Waltons had no intention to collect from Charles Sutter.
                             - 12 -


Consequently, for Federal income tax purposes there was no debt

between the Waltons and Charles Sutter.   See Beaver v.

Commissioner, 55 T.C. 85 (1970).   Pursuant to the apparent

arrangement among Charles Sutter, the Waltons, and the Schwabs,

the DDI note was to be repaid not by Charles Sutter, but by the

Schwabs, or an entity controlled by the Schwabs.   This is in fact

what happened not only in this case, but with other customers of

the Schwabs as well who received funds from DDI.   As far as

Charles Sutter was concerned, the DDI note was a nullity.

Disregarding the DDI note, it follows from our holding in Wentz

v. Commissioner, supra, see also Haderlie v. Commissioner, supra,

that the fair market value of the life insurance coverage Charles

Sutter received from Columbus, measured by the amount of the

first-year premium for that insurance, must be included in

petitioners' income for 1992, and we so hold.

     Respondent's argument that the Stable and RMR notes were

also illusory is likewise persuasive.   There is credible evidence

in the record that those notes were afterthoughts, designed not

to represent legitimate debt between the makers and holders, but

to disguise transactions that would otherwise lead to the Federal

income tax consequences that are involved in this proceeding.

The manner in which the Schwabs orchestrated each transaction

through entities that they controlled, coupled with the extent of

the compensation they received from the insurance companies,
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supports respondent's contention in this regard.   Except for the

insurance companies, all parties to the transactions profited;

the Schwabs received commissions in excess of the amounts

dispersed through their controlled entities; petitioners received

life insurance coverage at no cost for a limited period.    No one

seemed particularly concerned about whether the debts would be

satisfied.   Under the circumstances, the legitimacy of the debt

evidenced by each note has not been established.

     Our conclusion in this regard is bolstered by the following:

(1) At the option of the makers, the notes were payable only from

the death benefit proceeds of the life insurance policies, a

contingency that made collectibility uncertain, at best; (2)

there was never an intent by the makers to continue full coverage

under the life insurance policies beyond the initial periods,

rendering the notes uncollectible after those periods; and (3)

the holders never took the necessary steps to validate the

assignments in order to protect the collateral, actions that we

expect would routinely be taken by legitimate creditors.

     Consequently, we find that the insurance coverage that

Charles Sutter received under the Royal policy in 1991 and the

insurance coverage that Cheryl Sutter received under the Columbus

policy in 1992 were obtained in return for notes that did not

represent bona fide indebtedness.   It follows that petitioners

realized and must recognize income during those years to the
                              - 14 -


extent of the fair market value of the insurance coverage

provided by those policies, measured by the amount of the first-

year premiums.   Respondent's determination in this regard is

therefore sustained.

     To reflect the foregoing,

                                      Decision will be entered

                                 for respondent.
