                  T.C. Summary Opinion 2004-75



                     UNITED STATES TAX COURT



          STEVEN H. AND ANNA J. JENSEN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 7496-03S.              Filed May 26, 2004.


     Steven H. and Anna J. Jensen, pro sese.

     Aimee R. Lobo-Berg, for respondent.



     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.


     1
        Unless 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.
                                - 2 -

     Respondent determined a deficiency in petitioners’ Federal

income tax of $2,730 for the taxable year 2000.

     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

     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.

     At the time that the petition was filed, petitioners resided

in Woodburn, Oregon.    References to petitioners individually are

to Mr. Jensen or Mrs. Jensen.

     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 May 1, 1963,

by the Occidental Life Insurance Co. of California on the life of

Mr. Jensen in the face amount of $50,000 naming Mrs. Jensen as




     2
          All amounts are rounded to the nearest dollar.
                               - 3 -

beneficiary.3   During the year in issue, petitioners wholly owned

the policy.

     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:




     3
        A 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.
     4
        At some point in time, Occidental Life Insurance Co. of
California merged with Transamerica Life Insurance Co.
                                - 4 -

     Gross distribution                           $33,850
     Taxable amount                                 9,760
     Employee contributions or insurance premiums 24,089

Box 7 of Form 1099-R indicated that the distribution was a normal

distribution.

     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.

     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.

     Petitioners timely filed a petition with the Court disputing

the determined deficiency.

Discussion

     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 U.S. 111, 115 (1933).5

     Gross income includes income from whatever source derived

including, but not limited to, life insurance contracts.6   Sec.


     5
        We 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).
     6
         The policy satisfies the definition of a life insurance
                                                    (continued...)
                               - 5 -

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).

     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:


     6
      (...continued)
contract. See sec. 7702(a).
     7
        We 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.
                               - 6 -

     This policy was never considered an investment. It has
     NEVER been referred to as a “pension or annuity”.[8]

     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




     8
        Petitioners 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.
     9
        Insurance “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).
     10
        Generally, 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).
                               - 7 -

     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.

     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
                                 - 8 -

petitioners’ gross income.   Accordingly, we sustain respondent’s

determination.

     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.

     Reviewed and adopted as the report of the Small Tax Case

Division.

     To reflect the foregoing,



                                         Decision will be entered

                                 for respondent.
