                        T.C. Memo. 2007-360



                      UNITED STATES TAX COURT



V.R. DEANGELIS M.D.P.C. & R.T. DOMINGO M.D.P.C., V.R. DEANGELIS
     M.D.P.C., TAX MATTERS PARTNER, ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos.   10634-05, 10635-05,   Filed December 5, 2007.
                   10636-05, 10637-05,
                   10638-05.



     1
       Cases of the following petitioners are consolidated
herewith: Vincent and Jeanette DeAngelis (collectively,
DeAngelises), docket No. 10635-05; Rodolfo and Bernadette Domingo
(collectively, Domingos), docket No. 10636-05; Keith and Kathleen
Durante (collectively, Durantes), docket No. 10637-05, and
Anthony J. and Mary Ann Capizzi (collectively, Capizzis), docket
No. 10638-05. While the parties sometimes refer to the name
“DeAngelis” as “De Angelis”, we consistently refer to that name
as “DeAngelis”. We also note that the first word in the name of
each relevant professional corporation is a complete word but
that the parties sometimes refer to the word by its initial
letter. With the exception of the caption and of the
partnership, V.R. DeAngelis M.D.P.C. & R.T. Domingo M.D.P.C.,
whose name is actually spelled using only the initial letter of
the first word of each professional corporation referenced
therein, we refer to each professional corporation by using its
full first word.
                                - 2 -


     John T. Morin and Ira B. Stechel, for petitioners.

     Peter James Gavagan, Peggy J. Gartenbaum, and Thomas A.

Dombrowski, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     LARO, Judge:   These cases are consolidated for purposes of

trial, briefing, and opinion.   Each couple consists of a medical

doctor and his wife, and each doctor is the sole owner of an S

corporation that was a partner in the partnership V.R. DeAngelis

M.D.P.C. & R.T. Domingo M.D.P.C. (VRD/RTD).   These cases concern

amounts paid in 1993 and 1994 by the S corporations to VRD/RTD

and its ensuing contributions of those amounts to the Severance

Trust Executive Program Multiple Employer Supplemental Benefit

Plan and Trust (STEP), a plan that was promoted to wealthy

professionals as a welfare benefits fund that was part of a 10-

or-more-employer plan described in section 419A(f)(6).2   STEP

used the contributions to purchase and pay the premiums on six

whole life insurance policies, five of which were each written

with respect to one or both spouses of each couple (with the



     2
       Unless otherwise indicated, section references are to the
applicable versions of the Internal Revenue Code, Rule references
are to the Tax Court Rules of Practice and Procedure, and dollar
amounts are rounded to the dollar. We use the term “plan” for
convenience and do not suggest that any part of the STEP plan is
a bona fide plan for Federal income tax purposes.
                               - 3 -

exception of the Capizzis, who had no policy insuring either of

their lives) and were each payable to the beneficiaries of the

insured’s choosing in the event of the insured’s death.    The

sixth life insurance policy was written on the life of Kerry

Quinn (Ms. Quinn), an employee of VRD/RTD who was its office

manager.

     For each subject year, respondent determined in the notice

of final partnership administrative adjustment (FPAA) that

VRD/RTD could not deduct the $585,000 it paid in that year to

STEP as contributions to a welfare benefits fund.   The FPAA

stated in part that the payments were not ordinary and necessary

business expenses under section 162(a).

     Respondent determined in the notices of deficiency that the

individual petitioners had the following deficiencies in their

1993 and 1994 Federal income taxes:

           Individual Petitioners      1993         1994

                DeAngelises         $246,768    $208,447
                Domingos             185,422     184,932
                Durantes              29,174      42,020
                Capizzis               1,957       1,546

The deficiencies generally are based on two determinations.

First, respondent determined that the payments that the S

corporations made to VRD/RTD for contribution to the STEP plan

were not deductible by the S corporations because they were not

ordinary and necessary business expenses under section 162(a).

Respondent accordingly increased the net amount of passthrough
                               - 4 -

income received by each doctor from his S corporation.    Second,

respondent determined that each doctor received income under

section 61(a) in the amount of the life insurance premiums that

were paid by his S corporation on his behalf.

      We decide whether the S corporations and VRD/RTD were

entitled to deduct the payments related to the STEP plan as

ordinary and necessary business expenses under section 162(a).

We hold they were not to the extent that the payments related to

the life insurance written on a life of someone other than Ms.

Quinn.3   We also decide whether each doctor realized income in

the amount of the life insurance premiums that were paid by his S

corporation on his behalf.   We hold he did not.

                         FINDINGS OF FACT

I.   Preliminaries

      Some facts were stipulated.   The stipulated facts and the

exhibits submitted therewith are incorporated herein by this

reference.   We find the stipulated facts accordingly.   VRD/RTD

had a legal address in the State of New York when its petition

was filed.   The individual petitioners resided in the State of

New York when their petitions were filed.




      3
       We understand respondent to have conceded that the
payments are deductible to the extent they relate to the
insurance written on the life of Ms. Quinn.
                                  - 5 -

II.   Individual Petitioners

      A.     Overview

      Petitioner doctors are Vincent DeAngelis (Dr. DeAngelis),

Rodolfo Domingo (Dr. Domingo), Keith Durante (Dr. Durante), and

Anthony J. Capizzi (Dr. Capizzi) (collectively, doctors).     During

1993 and 1994, each doctor wholly owned an S corporation that

employed the doctor to provide his medical and surgical services

for VRD/RTD.      Each S corporation was a professional corporation

(PC), the sole employee of which was its owner.     The names of the

PCs of Drs. DeAngelis, Domingo, Durante, and Capizzi were Vincent

R. DeAngelis M.D.P.C., Rodolfo T. Domingo M.D.P.C., Keith Durante

M.D.P.C., and Anthony J. Capizzi M.D.P.C., respectively.

      Each doctor and his wife filed a joint Form 1040, U.S.

Individual Income Tax Return, for each of the years 1993 and

1994.      Each couple’s returns reported compensation received from

the doctor’s PC during those years.4




      4
       We use the term “compensation” to refer to wages,
salaries, and the like. Unlike petitioners, we do not consider
the term “compensation” to include the doctors’ distributive
shares of income from their PCs. See sec. 61(a)(1), (13)
(distinguishing as separate items of gross income "Compensation
for services, including fees, commissions, fringe benefits, and
similar items" from "Distributive share of partnership gross
income"); cf. Campbell v. Commissioner, 943 F.2d 815, 822 (8th
Cir. 1991), affg. in part and revg. in part on other grounds T.C.
Memo. 1990-162. Nor (as discussed below) does the STEP plan
define the term “compensation” to include such distributive
shares.
                                - 6 -

     B.   Dr. DeAngelis

     During 1993, 1994, and 1995, Dr. DeAngelis’s PC reportedly

paid Dr. DeAngelis compensation of $928,000, $581,000, and

$60,000, respectively.    The DeAngelises’ corresponding Federal

income tax returns included those amounts in gross income.    Dr.

DeAngelis’s PC did not reportedly pay Dr. DeAngelis any

compensation thereafter.

     C.   Dr. Domingo

     During 1993, 1994, 1995, and 1996, Dr. Domingo’s PC

reportedly paid Dr. Domingo compensation of $753,000, $452,976,

$485,843, and $62,000, respectively.    The Domingos’ corresponding

Federal income tax returns included those amounts in gross

income.   Dr. Domingo’s PC did not reportedly pay Dr. Domingo any

compensation thereafter.

     D.   Dr. Durante

     During 1993, 1994, 1995, and 1996, Dr. Durante’s PC

reportedly paid Dr. Durante compensation of $136,000, $240,000,

$283,919, and $208,079, respectively.    The Durantes’

corresponding Federal income tax returns included those amounts

in gross income.   During 1998 through 2003, Dr. Durante’s PC

reportedly paid Dr. Durante compensation of $289,398, $340,527,

$258,393, $250,604, $258,208 and $240,000, respectively.    The

Durantes’ corresponding Federal income tax returns included those

amounts in gross income.    The record does not allow the Court to
                                  - 7 -

find the amount of compensation (if any) that Dr. Durante’s PC

reportedly paid Dr. Durante in 1997.

       E.   Dr. Capizzi

       During 1993 and 1994, Dr. Capizzi’s PC reportedly paid Dr.

Capizzi compensation of $609,000 and $719,001, respectively.      The

Capizzis’ corresponding Federal income tax returns included those

amounts in gross income.     During 1996 through 2003, Dr. Capizzi’s

PC reportedly paid Dr. Capizzi compensation of $336,240,

$240,070, $272,043, $294,601, $293,331, $190,271, $194,130 and

$148,423, respectively.     The Capizzis’ corresponding Federal

income tax returns included those amounts in gross income.     The

record does not allow the Court to find the amount of

compensation (if any) that Dr. Capizzi’s PC reportedly paid Dr.

Capizzi in 1995.

III.    VRD/RTD

       A.   General Information

       VRD/RTD was formed as a partnership on July 1, 1982, under

the laws of New York.     VRD/RTD provided medical and surgical

services to its patients through the doctors and operated under

the name “South Shore Surgical Specialists”.     VRD/RTD reported

its income and expenses for Federal income tax purposes using the

cash receipts and disbursements method.     VRD/RTD filed 1993 and

1994 Forms 1065, U.S. Partnership Return of Income, for its

taxable years ended December 31, 1993 and 1994, respectively.
                                - 8 -

     B.    Partners and Employees

     During 1993 and 1994, the five partners of VRD/RTD were the

four PCs of the doctors and a fifth PC owned by another doctor,

Edgar Borrero (Dr. Borrero).    The senior partner of VRD/RTD was

Vincent R. DeAngelis M.D.P.C.    The partners’ percentages of

profits, losses, and ownership of capital for 1993 were as

follows:

             Partner                Beginning of Year    End of Year

  Vincent R. De Angelis M.D.P.C.         35.09%              25%
  Rodolfo T. Domingo M.D.P.C             25.81               23
  Anthony J. Capizzi M.D.P.C.            20.58               24
  Edgar Borrero M.D.P.C.                 18.52               18
  Keith Durante M.D.P.C.1                    0               10
     1
      Keith Durante M.D.P.C. became a partner of VRD/RTD on or
   about July 1, 1993.

The partners’ percentages of profits, losses, and ownership of

capital for 1994 were as follows:

             Partner                Beginning of Year     End of Year

  Vincent R. De Angelis M.D.P.C          25%                 34%
  Rodolfo T. Domingo M.D.P.C.            23                  17
  Anthony J. Capizzi M.D.P.C.            24                  20
  Edgar Borrero M.D.P.C.                 18                  17
  Keith Durante M.D.P.C.                 10                  12

     During 1993 and 1994, VRD/RTD employed nurses, office staff,

and an office manager (i.e., Ms. Quinn).       VRD/RTD had at least 29

employees during 1993 and at least 34 employees during 1994.

VRD/RTD did not directly pay the doctors any compensation during

either subject year.
                                    - 9 -

     C.     Arrangements With PCs

     VRD/RTD entered into arrangements with the PCs for the

provision of the doctors’ medical services.     The doctors

performed their services for the patients of VRD/RTD, and VRD/RTD

billed the patients for the fees due on these services.       VRD/RTD

received payment of the fees, deposited the payments into its

bank account, and reported the payments as income on its Forms

1065.     Dr. Domingo performed services for VRD/RTD through the end

of 1999; afterwards, through 2003, Dr. Domingo continued to work

for his PC performing services for other than VRD/RTD.     Dr.

DeAngelis terminated his services with VRD/RTD on or about

December 31, 2003.

     D.     Partnership Agreement

     The VRD/RTD partnership agreement in effect for the subject

years (partnership agreement) was executed on June 19, 1990.      The

partnership agreement stated that Drs. DeAngelis and Domingo were

employed by their PCs and that any future doctor who wished his

PC to become a partner of VRD/RTD had to be employed by his PC.

The partnership agreement stated that it was anticipated that Dr.

DeAngelis would fully retire from VRD/RTD on July 1, 1994, and

that Dr. Domingo would not retire until 1 year after Dr.

DeAngelis retired.     If Dr. DeAngelis continued working for

VRD/RTD until at least July 1, 1995, the partnership agreement

allowed Dr. Domingo to retire at the same time as Dr. DeAngelis
                              - 10 -

or at any time after July 1, 1996.     The partnership agreement

provided for payments to be made to a doctor’s PC in case the

doctor became disabled.

IV.   STEP

      A.     Overview

      STEP purports to provide eligible employees with severance

benefits, funded entirely by their participating employer through

the purchase of whole life insurance policies, and, if elected,

an employer-provided optional life insurance benefit payable upon

the death of a covered employee or an alternate insured.5    STEP

invested the contributions made to the STEP plan in whole life

insurance policies issued by eight insurance companies; namely,

Metropolitan Life Insurance Co. (MetLife), Allmerica Financial

Life Insurance and Annuity Co., National Life Insurance Co. of

Vermont, Prudential Life Insurance Co. of America, Equitable Life

Assurance Society of the United States, ITT Hartford Life

Insurance Co., New York Life Insurance and Annuity Corp., and

Massachusetts Mutual Life Insurance Co.     The life insurance

policies insured the individuals covered by the STEP plan, and

the STEP plan assets, as reported, consisted largely of the cash

values of those policies.   Insurance agents earned substantial




      5
       An employee’s severance benefits were paid from the cash
value of his or her whole life insurance policy.
                              - 11 -

commissions on the sales of the life insurance policies; e.g.,

$605,053 in 1994.

     Drs. DeAngelis, Domingo, and Durante (collectively,

participating doctors) participated in the STEP plan through

their PCs and VRD/RTD.   Alvin Rapp (Mr. Rapp) was an authorized

insurance agent of MetLife, and he recommended that all

contributions to the STEP plan made on behalf of the

participating doctors be invested in whole life insurance

policies issued by MetLife.   That recommendation was followed.

Each whole life insurance policy related to a participating

doctor required that a payment be made annually on December 28

for the policy year beginning on that date.

     B.   Formation of the STEP Plan

     The originator of the STEP concept was Kenneth L. Katz (Mr.

Katz), an insurance agent credentialed as a chartered life

underwriter and a chartered financial consultant.    In 1988, Mr.

Katz asked his friend, Jeffrey Mamorsky (Mr. Mamorsky), to draft

a plan that could be marketed as a tax-beneficial welfare

benefits fund that complied with section 419A(f)(6).    Mr.

Mamorsky was an attorney practicing primarily in the area of

employee benefits and compensation.    Mr. Mamorsky later also

served as counsel to the STEP plan; in that capacity, Mr.

Mamorsky was available and willing to discuss with covered

employees (at the expense of the STEP plan) the manner in which
                                - 12 -

they should prepare their applications for benefits from the

plan.   The intent of the STEP plan was to create an incentive to

buy, and thus to generate the sale of, whole life insurance

policies through a claim of permissible tax avoidance and the

ability to pay and deduct premiums on the purchased policies

which would eventually be transferred to and owned by the

insureds.    Many participants in the STEP plan believed that the

plan was one of deferred compensation.

     Mr. Mamorsky prepared an initial version of the STEP plan on

or about December 15, 1989, and Mr. Katz began operating the STEP

plan at that time.    Mr. Mamorsky prepared a second version of the

STEP plan in 1990.    Mr. Mamorsky wrote other and all versions of

the STEP plan through June 2001, with an understanding that the

deductibility of contributions was critical both to the

marketability of the STEP plan and to the operation and existence

of STEP.    The various versions of the STEP plan through June 2001

included the following:

   Version   1:   Executed on December 15, 1989
   Version   2:   Version 1 Amended and Restated on July 26, 1990
   Version   3:   Executed on January 30, 1992
   Version   4:   Executed on December 29, 1993
   Version   5:   Executed as of November 1, 1994
   Version   6:   Executed as of February 14, 1997
   Version   7:   Executed as of June 11, 2001
                              - 13 -

The four versions executed in or after 1993 were stated as

effective as of January 1, 1993.6

     C.   Trustees, Administrators, and Sponsors

     Connecticut National Bank was the STEP plan trustee from the

plan’s inception through April 1, 1992.   The successor trustees

were United States Trust Co. of New York (U.S. Trust), Mellon

Trust of New York (Mellon Trust), and STEP Plan Services, Inc.

(SPSI).   U.S. Trust served as trustee from April 1, 1992, through

February 14, 1997; Mellon Trust served as trustee from

February 14, 1997, through February 2002; and SPSI served as

trustee from February 2002 to date.

     STEP, Inc., served as the STEP plan administrator from the

plan’s inception through July 26, 1990.   Teplitzky & Co., L.L.C.

(Teplitzky & Co.), acting primarily through its principal Jeffrey

Teplitzky (Mr. Teplitzky), was the successor plan administrator

from July 26, 1990, through February 7, 2002.   The current plan

administrator is SPSI.   During the relevant time, Daniel E.

Carpenter (Mr. Carpenter) had sole signatory authority on behalf

of SPSI and served as its chairman.




     6
       There is also a 1992 version of the STEP plan for MetLife
and, beginning in February 1997, separate plans and trusts for
the eight insurance companies whose policies were sold through
STEP. According to petitioners, the participating doctors were
covered by version 3 when VRD/RTD adopted the STEP plan on or
about Dec. 20, 1993, and were covered by version 4 as of Dec. 29,
1993.
                                  - 14 -

     STEP, Inc., also served as the STEP plan sponsor from the

plan’s inception until April 1, 1992.       U.S. Trust served as the

successor plan sponsor from April 1, 1992, until February 14,

1997, when first STEP, Inc., and subsequently Teplitzky & Co.

took over as successor plan sponsor.       On February 7, 2002,

Teplitzky & Co. resigned as plan sponsor and appointed SPSI as

the successor plan sponsor.

     During the subject years, Teplitzky & Co., acting as the

STEP plan administrator, ran the daily operation of the STEP

plan.     U.S. Trust, as plan sponsor, interacted with the insurance

companies whose policies were owned by the STEP plan and

conducted the plan’s marketing activities.

     D.     Marketing Documents

     The STEP plan marketing documents set forth detailed

examples of when severance benefits would and would not be paid

under the plan.7    These examples allowed individuals covered by

the plan to time their departures from their businesses and to

phrase their requests for severance benefits so that benefits

would be paid to them under the STEP plan as they anticipated.

The STEP plan marketing documents warned participants that

“Benefits accrued for an employee are forfeited if the employee

does not qualify for benefits under a bona fide severance as



     7
       Upon adopting the plan, each participating employer also
was provided examples of qualifying severance events.
                              - 15 -

determined by STEP’s Independent Fiduciary”.8   The STEP plan

marketing documents advised participating employers that

deductions for contributions to the STEP plan could be ultimately

disallowed but that only taxes and interest, and no additional

amounts such as penalties, would then be due because STEP had

received an “opinion letter” from Mr. Mamorsky stating that it

was “more likely than not” that the deductions would be allowed.

     E.   Independent Fiduciary

     The STEP plan administrator had the sole authority to make

determinations relating to “dismissal”, “Total Disability”, or

“death”, conditions that were prerequisites to the receipt of

benefits from the STEP plan as written.   In making those

determinations, the plan administrator was required to rely on

rules and regulations established by the STEP plan “Independent

Fiduciary”.   Jules Pagano (Mr. Pagano) was the independent

fiduciary of the STEP plan from its inception through February

2002; the STEP plan did not have any independent fiduciary

thereafter.   While serving as independent fiduciary, Mr. Pagano

was authorized to and routinely did provide individuals seeking

to obtain benefits under the plan with personal guidance on how

to frame their requests so that they would receive their

anticipated benefits under the plan as written.   Upon receiving


     8
       In operation, however, forfeitures could occur only when
projected plan assets equaled or exceeded projected plan
liabilities on an employer by employer basis.
                              - 16 -

an actual claim for benefits, Mr. Pagano and the STEP plan

administrator relied upon the documents submitted to them by the

claimant and did not perform an independent investigation or

verification of the claim.   If a participant’s claim for benefits

as submitted did not qualify for benefits under the STEP plan,

the STEP plan allowed the participant to reform his or her claim

in order to receive his or her anticipated benefits.

     F.   Version 4 of the STEP Plan9

     Section 1.11, 1.13, and 1.14 of the STEP plan defines the

terms “Covered Employee”, “Eligible Employee”, and “Employee”.

Section 2.1(c) states that “The Employer shall transmit to the

Plan Administrator written notice of any substantial or unusual

change in a Covered Employee’s Compensation or status (e.g., from

fulltime to parttime) as it occurs, but in any event no later

than 30 days after the change occurs”.   Section 3.1 states that

“A Covered Employee’s Severance Benefit shall be determined in

accordance with the Severance Benefit formula elected in the

Adoption Agreement.   In no event, however, may a Covered

Employee’s Severance Benefit exceed two times his Compensation

paid during the twelve full-month period immediately preceding

his Termination of Employment”.




     9
       In our findings of fact set forth under this subheading,
section references are to version 4 of the STEP plan.
                              - 17 -

     Section 3.3 states that an employer shall elect in the

adoption agreement either a “fixed benefit” or a “flexible

benefit”.   As to a fixed benefit, section 3.3 states that the

benefit payable to a covered employee shall equal the sum of the

future service component for each year of participation plus the

past service component.   The future service component equals for

each year of participation the amount of that year’s

“Compensation [defined as the “amount specified by the Employer

in the Adoption Agreement”] multiplied by the Severance Benefit

percentage elected by the Employer in the Adoption Agreement”.

The past service component equals the product of (1) the benefit

percentage elected by the employer in the adoption agreement,

(2) a fraction not to exceed 1, the numerator of which is the

covered employee’s past service and the denominator of which is

10, and (3) the covered employee’s total compensation for the

10 years preceding the year of termination of employment.

     As to a flexible benefit, section 3.3 allows a different

percent of compensation to be elected for each year of service

and states that the formula for computing a severance benefit is

made applicable to the employer’s contribution each year.     In

addition, there is a provision for adjustments each year based on

benefits provided to other employees, forfeitures, investment

earnings, and cost of insurance for the covered employee.
                                - 18 -

     Section 4.1 states that the employer must annually

contribute to the STEP plan such amounts as are calculated by the

plan actuary to provide for severance benefits of its covered

employees.     The total amount to be contributed by all employers

is “based upon reasonable actuarial assumptions and methods

taking into account the experience of the Plan, as an undivided

and unweighted pool with no differentiation as to Covered

Employees (other than those differentiations described below) or

Participating Employers”.     The amount to be contributed by each

employer is to be its allocable portion of the total for all

employers.10    Section 4.1 also states that the employer must

contribute the cost of 1-year term life insurance for any life

insurance benefit elected in the adoption agreement.

     Section 5.2(a) states that a participating employer must pay

the STEP plan the annual cost of equivalent 1-year term insurance

if the employer elects a life insurance benefit for its

employees.     Section 5.2(b) states that an employee may elect

additional life insurance beyond the amount elected by the

employer and that the employer must pay the STEP plan the annual

cost of the equivalent 1-year term insurance and the employee

must reimburse the employer for the additional cost.     Section

5.2(c) states that the insurance benefit payable to the


     10
       In operation, the STEP plan neither employed a plan
actuary nor determined amounts to be contributed by the
employers.
                              - 19 -

beneficiary of a covered employee is equal to the amount elected

by the employer plus the amount elected by the employee.    Section

5.2(f) states that the STEP plan may name the beneficiary, or the

insured may name a beneficiary as long as the employer reimburses

the STEP plan.   Section 5.2(g) states that if the employer does

not pay amounts due on the policy for the death benefit, STEP may

declare the policy lapsed or surrender the policy, or the

beneficiary will be changed to STEP.   Section 5.2(h) states that

if the employer fails to make required payments, the insured may

buy the policy from STEP for the policy value.

     Section 10.4(a) states that an employer can withdraw from

the STEP plan at any time and that the employees will have frozen

benefits equal to the amounts they would have been eligible for

on the dates of withdrawal.   Section 10.5 states that if an

employer fails to make a required contribution, it will be

treated as if it withdrew on that date, and it will be treated

the same as in the case of a withdrawal under section 10.4.

     Section 11.1 and 11.3 allows the plan sponsor to “amend,

modify or delete, in whole or in part, any provision of the Plan,

provided the duties and responsibilities of the Trustee shall not

be altered without its written consent” and states that “no

amendment or reorganization may be made to this Plan which shall

change or alter the fundamental purpose of the Plan expressed in

the preface hereto”.   Section 11.2 allows the plan sponsor to
                               - 20 -

reorganize the participating employers into other or separate

plans.

V.   VRD/RTD’s Introduction to the STEP Plan

      A.   Introduction to the Plan

      In late 1993, Drs. DeAngelis and Domingo were engaged in

estate planning with their accountant, Richard Freeman (Mr.

Freeman), and an estate planning attorney, Victor Finmann (Mr.

Finmann).    Mr. Freeman advised Dr. DeAngelis to acquire

additional life insurance coverage and suggested that he consider

a severance pay plan for VRD/RTD.     Mr. Freeman introduced Dr.

DeAngelis to Mr. Rapp.    Mr. Rapp discussed the STEP plan with Dr.

DeAngelis and Mr. Freeman, characterizing the plan as a way to

receive additional insurance coverage and to provide severance

benefits, both with pretax dollars.     Mr. Rapp recommended to Dr.

DeAngelis that VRD/RTD form a section 419 welfare benefit trust

because, he stated, it would secure immediate Federal income tax

deductions, allow the owner-employees to accumulate significant

wealth on a tax-deferred basis, secure assets with insurance

company guaranties, and protect assets from creditors.      Dr.

DeAngelis discussed the STEP plan with the other doctors, their

wives, Mr. Finmann, and others.    Mr. Finmann advised Dr.

DeAngelis that he was skeptical as to the validity of the STEP

plan, as promoted.
                              - 21 -

     B.   Decision to Join Plan

     On December 20, 1993, Dr. DeAngelis decided on behalf of

VRD/RTD to join the STEP plan and to provide coverage thereunder

for the participating doctors and for Ms. Quinn.   Dr. Borrero

declined to participate in the STEP plan after hearing the

presentation of the representatives of STEP.   Dr. Capizzi

initially expressed an intent to participate in the STEP plan but

subsequently decided not to participate in the plan.

     C.   Illustrations

     In or about late 1993, Mr. Rapp provided Drs. DeAngelis and

Domingo with life insurance policy illustrations reflecting

varying amounts of life insurance benefits and premium costs.

Mr. Rapp informed Dr. Domingo that his projected severance

benefit after 5 years would be $253,000 if he made two annual

contributions of $225,000 and that the projected benefit would

increase annually by approximately $238,000 for each additional

$225,000 contribution that he made annually beginning in year 3.

Mr. Rapp informed Dr. DeAngelis that his projected severance

benefit after 3 years would be $312,000 if he made two annual

contributions of $300,000 and that the projected benefit would

increase by approximately $320,000 for each additional $300,000

contribution that he made annually beginning in year 3.
                               - 22 -

VI.   VRD/RTD’s Adoption of the STEP Plan

      A.   Execution of Adoption Agreement

      On or about December 20, 1993, Dr. DeAngelis executed an

adoption agreement for the STEP plan on behalf of VRD/RTD, making

VRD/RTD a participating employer in the STEP plan effective as of

January 1, 1993.    VRD/RTD consented in the agreement to any

future amendment of the STEP plan.

      VRD/RTD elected in the adoption agreement to provide

severance benefits to its eligible employees in the amount of 10

percent of an employee’s compensation for each year of

participation, with no credit for past service.    VRD/RTD also

elected not to provide the optional life insurance benefit.     Drs.

DeAngelis and Domingo understood that in order for VRD/RTD to

claim deductions for its contributions to STEP they had to couch

any subsequent application for benefits in terms that appeared to

make the severance event nonvolitional.

      B.   Relevant Provisions in the Adoption Agreement

      Eligible employees were defined in the adoption agreement as

all full-time employees, other than controlling owners, who were

21 and had completed 1 year of service and whose job title was

“doctor” or “office administrator/business mgr”.    A “controlling

owner” was defined in the adoption agreement as a person who

owned more than a 25-percent voting interest in the participating

employer, unless four or fewer other persons owned in the
                              - 23 -

aggregate a greater voting interest than the person.    The

adoption agreement stated that the eligible employees were Drs.

DeAngelis, Domingo, Durante, and Capizzi, and Ms. Quinn, and that

Dr. Borrero was an employee who was excluded.11    The adoption

agreement defined the term “compensation” as “Total Compensation

paid during the applicable period, including wages, bonuses and

over time [sic], etc., but not including deferred compensation

other than compensation deferred pursuant to Code Section 401(k).

Compensation shall also include salary reduction contributions

excludable from gross income pursuant to Code Section 125.”

     C.   Other Relevant Provisions

     According to the STEP plan, a covered employee was

purportedly eligible to receive a severance benefit from the plan

upon termination of employment (except for termination for cause)

under the following circumstances:     “dismissal; any termination

of employment unless such termination constitutes a ‘voluntary

separation without good cause’ within the meaning of New York

State Unemployment Insurance Law; total disability; or death.12

The STEP plan stated that benefits would normally start on the

first day of the second month after approval of the claim for


     11
       As noted above, Dr. Capizzi subsequently decided not to
participate in the STEP plan. Ms. Quinn was the only employee of
VRD/RTD who was covered by the STEP plan.
     12
       In operation, the STEP plan paid benefits to participants
even though the covered employee did not fall within one of these
circumstances.
                             - 24 -

benefits, that the usual form of payment would be in equal

monthly installments over 24 months from the date of the

employee’s termination, that the first installment would include

any payments delayed because of processing, and that severance

benefits could not exceed two times the employee’s last 12 months

of compensation before termination of employment.   The STEP plan

did not limit the amount of life insurance benefits that could be

received by a covered employee and stated that the optional life

insurance benefit (if elected) would be received in addition to

the severance benefit if the covered employee died while employed

by the participating employer.   The STEP plan stated that a

participating employer could choose to withdraw from the plan,

that a participating employer could constructively withdraw from

the plan by failing to make an annual contribution or by

violating a plan provision, and that upon withdrawal, any

optional life insurance benefit could be discontinued or

purchased from the plan by the employee or alternate insured at a

cost equal to the policy’s value (defined as the amount that

would be paid upon surrender of the coverage determined before

the application of surrender charges).   The STEP plan stated that

the optional life insurance benefit also could be discontinued if

the covered employee terminated service with the employer, the

employer failed to make a contribution with respect to the

coverage, or the covered employee ceased to be a covered
                                 - 25 -

employee.    According to the STEP plan, any life insurance that

was not purchased could be surrendered by the trustee or

continued with the plan as beneficiary.

VII.   VRD/RTD’s Contributions to STEP

       A.   Forwarding Fees

       The PCs of the participating doctors forwarded to VRD/RTD

amounts required by STEP to pay the premiums due on the whole

life insurance policies written on the lives of the participating

doctors.     The PCs and VRD/RTD referred to these transactions as

“forwarding fees”.      During the subject years, VRD/RTD received

the following amounts of forwarding fees from the PCs:

                   PC                        1993       1994

       Vincent R. DeAngelis M.D.P.C.       $300,000   $300,000
       Rodolfo T. Domingo M.D.P.C.          225,000    225,000
       Keith Durante M.D.P.C.                50,000     50,000
         Total                              575,000    575,000

The PCs deducted these forwarding fees as expenses in the year of

payment.

       VRD/RTD recorded its receipt of the forwarding fees from the

PCs as “Fee Income--DeAngelis PC”, “Fee Income–-Domingo PC”, and

“Fee Income–-Durante PC”, respectively.      VRD/RTD recorded that

these amounts were received from the PCs as pension contributions

with respect to the participating doctors.      VRD/RTD also received

a total of $10,000 in each of the years 1993 and 1994, from the

five PCs that were partners in VRD/RTD.      The $10,000 was

forwarded in each year to the STEP plan to pay the premium due on
                                 - 26 -

the policy insuring the life of Ms. Quinn.    Of the $10,000, Dr.

Capizzi’s PC paid $2,400 in 1993 and $2,000 in 1994.     The record

does not allow the Court to find the portion of the $10,000 in

either year that was paid by any of the other PC partners.

     During each of 1993 and 1994, VRD/RTD contributed $585,000

to the STEP plan and recorded each of these contributions as a

“Pension Contribution”.   VRD/RTD’s partnership return reported

the forwarding fees received from the PCs as income and claimed a

corresponding deduction for “Retirement plans, etc.”     VRD/RTD did

not make any further contribution to STEP, and neither STEP nor

any petitioner directly paid any further premium on the subject

life insurance policies after the premiums were paid on

December 28, 1994, for the policy year beginning on that date.

     B.   Issuance of Policies

     When VRD/RTD adopted the STEP plan, all of VRD/RTD’s

contribution to the plan was invested in whole life insurance

policies issued by MetLife and sold by Mr. Rapp.    The particular

policies were selected by the participating doctors in

consultation with Mr. Rapp.   All of the policies were

participating whole life insurance polices, with the additional

feature that extra premiums could be paid to purchase paid-up

additions rider insurance (PUAR).     A PUAR feature, when elected,

essentially prefunds the annual premiums for a policy and
                               - 27 -

accumulates any extra proceeds in the policy until needed to pay

premiums in a later year.

     As of December 28, 1993, MetLife issued the following six

life insurance policies with respect to VRD/RTD’s initial

contribution to the STEP plan:

     Insured            Policy #        Type of Policy     Face Value

  Dr. DeAngelis       931250799PR    Whole life            $2,156,442
  Both DeAngelises    931250800A     Survivor whole life    4,818,200
  Dr. Domingo         931250797PR    Whole life             1,327,656
  Both Domingos       931250798A     Survivor whole life    3,500,000
  Dr. Durante         931250795PR    Whole life             1,804,135
  Ms. Quinn           931250796PR    Whole life               409,184

Four of these policies were individual whole life insurance

policies separately insuring the lives of Ms. Quinn and each of

the participating doctors.   The other two policies were joint and

survivor whole life insurance policies (survivor whole life

policies) or, in other words, life insurance that was not payable

to the beneficiary until the deaths of both insureds.      One

survivor whole life policy insured both DeAngelises (DeAngelises

survivor whole life policy), and the other survivor whole life

policy insured both Domingos (Domingos survivor whole life

policy).   Neither Jeanette DeAngelis nor Bernadette Domingo was

an employee of VRD/RTD, and the survivor whole life insurance

policies were purchased by Drs. DeAngelis and Domingo as part of

their Federal estate tax plans.     On December 28, 1993, Dr.

DeAngelis was 60 years old, Jeanette DeAngelis was 61 years old,

and each of the Domingos was 61 years old.      Also on that date,

Dr. Durante was 37 years old, and Ms. Quinn was 38 years old.
                                  - 28 -

Dr. DeAngelis canceled other life insurance that he personally

owned so that insurance on the lives of him and his wife could be

purchased through the STEP plan with pretax dollars.

     The initial owner of each of the six policies was U.S.

Trust, as trustee of the STEP plan.        When U.S. Trust was replaced

as trustee, the successor trustee was listed as owner.            As

further discussed below, in 2001 STEP transferred to the Domingos

ownership of the two policies written on the lives of one or both

of them; in 2002, STEP transferred to Dr. DeAngelis ownership of

the policy written on his life; and in 2003, STEP transferred

ownership of each of the remaining policies to the insured or

insureds named on the policy.

     The insured doctors designated the beneficiaries for their

policies, and Ms. Quinn designated the beneficiaries for her

policy; the STEP plan trustee was never listed as a beneficiary

of any of the policies.     The beneficiaries of the subject

policies were:

        Insured                  Beneficiary

     Dr. DeAngelis        DeAngelis Family Limited Partnership1
     Both DeAngelises     DeAngelis Family Irrevocable Life Insurance Trust
     Dr. Domingo          Domingo Family Irrevocable Life Insurance Trust
     Both Domingos        Domingo Family Irrevocable Life Insurance Trust
     Dr. Durante          Kathleen Durante
     Ms. Quinn            Mother, 2 sisters, and 3 brothers
          1
             The original beneficiary was Dr. DeAngelis’s wife.
     On or about Sept. 6, 2002, MetLife changed the beneficiary
     to the DeAngelis Family Limited Partnership pursuant to
     the request of Dr. DeAngelis.

Mr. Rapp recommended that the beneficiary of each of the survivor

whole life policies be listed as an insurance trust in order to
                                       - 29 -

minimize the Federal estate tax consequences to the family of the

insured, and Drs. DeAngelis and Domingo followed that

recommendation.       STEP wanted any life insurance benefit to be

paid directly to the personal beneficiary of the insured, rather

than to or through the STEP plan, because STEP did not want the

STEP plan to be overfunded if and when it were to receive that

benefit.

     Two annual premiums were paid on each of the six policies,

one for the policy year beginning December 28, 1993, and the

other for the policy year beginning December 28, 1994.                     As to

each policy, those premiums included the base premiums necessary

to fund the whole life insurance component of the policy and

premiums for PUAR.       These payments were consistent with

illustrated payments contained in correspondence from Mr. Rapp.

The base premiums and PUAR premiums on the policies were as

follows:

      Insured            Policy #        Base Premium         PUAR       Total

   Dr. DeAngelis         931250799PR      $81,596.64    $98,403.36     $180,000
   Both DeAngelises      931250800A       103,762.66     16,237.34      120,000
   Dr. Domingo           931250797PR       53,093.13     52,656.87      105,750
   Both Domingos         931250798A        77,845.00     42,155.00      120,000
   Dr. Durante           931250795PR       21,996.32     28,003.68       50,000
   Ms. Quinn             931250796PR        6,173.67      5,826.33       12,000
     Total                                                              587,750

Premiums were paid in the 2 years as follows:

        Insured                  Policy #              1993            1994

     Dr. DeAngelis            931250799PR        $180,000            $178,625
     Both DeAngelises         931250800A          120,000             120,000
     Dr. Domingo              931250797PR         105,750             104,375
     Both Domingos            931250798A          120,000             120,000
                                   - 30 -

     Dr. Durante              931250795PR      50,000     50,000
     Ms. Quinn                931250796PR      12,000     12,000
       Total1                                 587,750    585,000
             1
           We recognize that VRD/RTD deducted for 1993
    contributions totaling $585,000. In that the premiums paid
    in 1993 totaled $587,750, we are unable to find in the record
    an explanation as to who paid the extra $2,750.

The funds used to pay the premiums attributable to the two

policies written on the lives of one or both of the DeAngelises

came from Dr. DeAngelis’s PC, the funds used to pay the premiums

attributable to the two policies written on the lives of one or

both of the Domingos came from Dr. Domingo’s PC, and the funds

used to pay the premiums for the policy written on the life of

Dr. Durante (Dr. Durante policy) came from his PC.       The funds

used to pay the premiums attributable to the policy written on

the life of Ms. Quinn (Ms. Quinn policy) were taken on some

apportioned basis from all five PCs that were partners in

VRD/RTD.13       In each of those cases, the funds used to pay the

premiums went from each PC to VRD/RTD, from VRD/RTD to the STEP

plan, and from the STEP plan to MetLife.

     C.   Additional Correspondence

     On September 19, 1995, Mr. Katz provided Mr. Freeman with

revised illustrations for the life insurance policies written

with respect to Drs. DeAngelis and Domingo.       Those illustrations



     13
       As discussed above, the record does not allow the Court
to find the specifics of that apportionment other than as to Dr.
Capizzi’s PC.
                                    - 31 -

had been requested by Drs. DeAngelis and Domingo to help them

determine whether they wanted to make any additional

contributions on their policies.        The illustrations assumed that

premiums were paid for only 3 years, 4 years, or 5 years.        Mr.

Katz informed Mr. Freeman that the projected severance benefits

for Drs. DeAngelis and Domingo were approximately the cash values

in their policies.     Mr. Katz informed Mr. Freeman that he was

formulating illustrations for the policies that would show a cash

withdrawal of severance benefits and the premium required to

continue the policies thereafter.        On September 20, 1995, Mr.

Rapp provided Drs. DeAngelis and Domingo with answers from

MetLife and STEP to questions asked by those doctors.

     On or about October 30, 1995, Mr. Katz provided Dr.

DeAngelis with revised illustrations for his insurance policies

showing only 2 years of out-of-pocket premium payments.        Mr. Katz

also provided Mr. Freeman with various other illustrations for

the insurance policies written on the lives of Drs. DeAngelis and

Domingo.

VIII.     Payments of Premiums

        A.   Dr. DeAngelis Policy

        The December 28, 1993 and 1994, premiums of $81,596.64 on

the policy written on the single life of Dr. DeAngelis (Dr.
                                - 32 -

DeAngelis policy) were paid timely,14 and PUAR was purchased with

additional premiums of $98,403.36 in 1993 and $97,028.36 in 1994.

In 1996, the premium due on this policy as of December 28, 1995,

was paid timely with a dividend withdrawal of $16,658.17 and a

portion of a withdrawal of $123,004.98 from the PUAR.15    As to

the withdrawal from the PUAR, $64,938.47 was used to pay the

December 28, 1995, premium on this policy, and $58,066.51 was

used to pay the December 28, 1995, premium on the DeAngelises

survivor whole life policy.    In 1997, the premium due on December

28, 1996, on the Dr. DeAngelis policy was paid timely with a

dividend withdrawal of $15,247.77 and a withdrawal of $66,348.87

from the PUAR.    The premium due on December 28, 1997, was not

paid timely, and the policy lapsed for nonpayment of premiums.

MetLife converted the policy to nonforfeiture extended term

insurance with a face value of $2,192,891 through August 21,

2000, at which time it was set to be depleted of its cash value

and thus to terminate without value.16


     14
       Although the premiums were not actually paid until after
the due dates, we consider them to have been paid “timely”. To
this end, we understand each of the subject insurance policies to
have allowed a grace period after the due date so that a premium
paid during that period would be timely in the sense that the
policy would not lapse.
     15
          A dividend withdrawal relates to a dividend payable on a
policy.
     16
       Extended term insurance is a life insurance policy
nonforfeiture option that may be exercised when the policy lapses
                                                   (continued...)
                              - 33 -

     B.   DeAngelises Survivor Whole Life Policy

     The December 28, 1993 and 1994, premiums of $103,762.66 on

the DeAngelises survivor whole life policy were paid timely, and

PUAR was purchased in each year with additional premiums of

$16,237.34.   In 1996, the premium due on December 28, 1995, was

paid timely with a dividend withdrawal of $11,563.68, a

withdrawal of $34,133.47 from the PUAR, and the above-referenced

$58,066.51 withdrawal from the Dr. DeAngelis policy.   In 1997,

the premium due on December 28, 1996, was paid with a dividend

withdrawal of $12,363 and a policy loan of $91,399.66.    The

premium due on December 28, 1997, was not paid timely, and the

policy lapsed for nonpayment of the premium.   MetLife converted

the policy to participating reduced paid-up insurance with a face

value of $588,731.17

     On or about August 23, 1999, upon the request of Dr.

DeAngelis (and in connection with a similar request of Dr.



     16
      (...continued)
because of a failure to pay a premium owed on the policy. Under
this option, the cash value of a lapsed policy is used to
maintain the full original death benefit until the cash value is
depleted.
     17
       A reduced paid-up feature is another life insurance
policy nonforfeiture option that may be exercised when the policy
lapses because of a failure to pay a premium owed on the policy.
If such a feature is exercised, the remaining cash value of the
policy is used to purchase a single premium life insurance policy
with a lower death benefit. While the death benefit is reduced,
the cash value in the policy is used up more slowly than under
other nonforfeiture options.
                             - 34 -

Domingo with respect to the Domingos survivor whole life policy),

the DeAngelises survivor whole life policy was reinstated by

MetLife to the full face value and converted retroactively to a

policy with an automatic premium loan (APL) provision.18   That

feature was then applied to pay the premiums of $103,762.66 due

on December 28, 1997 and 1998, through an APL of $207,525.32.

MetLife’s stated reason for reinstating the DeAngelises survivor

whole life policy was that the policy had lapsed because of

“company error”; specifically, MetLife stated, Dr. DeAngelis

wanted loans to be made automatically from the policy to pay the

premiums and was not advised by the broker that the policy was

set up with a nonforfeiture option of reduced paid-up insurance.

The DeAngelises survivor whole life policy lapsed again after the

nonpayment of the premium due on December 28, 1999 (the cash

value in the policy was insufficient to support an APL), and in

October 2000 was converted to participating reduced paid-up

insurance with a face value of $669,547.




     18
       APL provisions allow an insurance company to pay a
premium due on a policy by way of a loan taken out against the
cash value of the policy. The loan is subject to interest
charges and affects the policy’s cash value only as a potential
reduction of that value. The total amount of outstanding loans
on the policy is usually less than the policy’s cash value
because the policy will generally lapse when the total amount of
the loans exceeds that cash value.
                                - 35 -

     C.   Dr. Domingo Policy

     The December 28, 1993 and 1994, premiums of $53,093.13 on

the policy written on the single life of Dr. Domingo (Dr. Domingo

policy) were paid timely, and PUAR was purchased with additional

premiums of $52,656.87 in 1993 and $51,281.87 in 1994.     In 1996,

the premium due on December 28, 1995, was paid timely with a

dividend withdrawal of $10,358.01 and a withdrawal of $42,735.12

from the PUAR.   In 1997, the premium due on December 28, 1996,

was paid timely with a dividend withdrawal of $10,416.38 and a

withdrawal of $42,676.75 from the PUAR.     The premium due on

December 28, 1997, was not paid timely, and the policy lapsed for

nonpayment of the premium.     MetLife continued the policy as

nonparticipating paid-up term insurance with a face value of

$1,377,206 through December 1, 2000, at which time it was set to

be depleted of its cash value and thus to terminate without

value.

     D.   Domingos Survivor Whole Life Policy

     The December 28, 1993 and 1994, premiums of $77,845 on the

Domingos survivor whole life policy were paid timely, and PUAR

was purchased in each year with additional premiums of $42,155.

In 1996, the premium due on December 28, 1995, was paid timely

with a dividend withdrawal of $8,960 and a withdrawal of $68,885

from the PUAR.   In 1997, the premium due on December 28, 1996,

was paid timely with a dividend withdrawal of $9,616, a
                              - 36 -

withdrawal of $21,407 from the PUAR, and a policy loan of

$46,820.   The premium due on December 28, 1997, was not paid

timely, and the policy lapsed for nonpayment of the premium.

MetLife converted the policy to reduced paid-up insurance with a

face value of $511,542.

     On or about October 19, 1999, upon the request of Dr.

Domingo (and in connection with the above-referenced similar

request of Dr. DeAngelis), the Domingos survivor whole life

policy was reinstated by MetLife to the full face value and

converted retroactively to a policy with an APL provision.    That

feature was then applied to pay the premiums of $77,845 due on

December 28, 1997 and 1998, through an APL of $155,690.

MetLife’s stated reason for reinstating the Domingos survivor

whole life policy in 1999 was that the policy had lapsed because

of “company error”; specifically, MetLife stated, Dr. Domingo

wanted loans to be made automatically from the policy to pay

premiums and was not advised by the broker that the policy was

set up with a nonforfeiture option of reduced paid-up insurance.

The Domingos survivor whole life policy lapsed again after the

nonpayment of the premium due on December 28, 1999 (the cash

value in the policy was insufficient to support an APL), and in

2000 was converted to participating reduced paid-up insurance

with a face value of $579,263.
                                  - 37 -

     E.    Dr. Durante Policy

     The December 28, 1993 and 1994, premiums of $21,996.32 on

the Dr. Durante policy were paid timely, and PUAR was purchased

in each year with additional premiums of $28,003.68.      In 1996,

the premium due on December 28, 1995, was paid timely with a

dividend withdrawal of $1,881.58 and a withdrawal of $20,114.74

from the PUAR.     In 1997, the premium due on December 28, 1996,

was paid timely with a dividend withdrawal of $1,618.17 and a

withdrawal of $20,378.15 from the PUAR.      The premium due on

December 28, 1997, was not paid timely, and the policy lapsed for

nonpayment of the premium.      MetLife continued the policy as

nonparticipating paid-up term insurance with a face value of

$1,864,269 through February 1, 2005, at which time it was set to

be depleted of its cash value and thus to terminate without

value.

     F.     Ms. Quinn Policy

     The December 28, 1993 and 1994, premiums of $6,173.67 on the

Ms. Quinn policy were paid timely, and PUAR was purchased in each

year with additional premiums of $5,826.33.      In 1996, the premium

due on December 28, 1995, was paid timely with a dividend

withdrawal of $422.06 and a withdrawal of $5,751.61 from the

PUAR.     In 1997, the premium due on December 28, 1996, was paid

timely with a dividend withdrawal of $337.18 and a withdrawal of

$5,836.49 from the PUAR.       The premium due on December 28, 1997,
                              - 38 -

was not paid timely, and the policy lapsed for nonpayment of the

premium.   MetLife continued the policy as nonparticipating paid-

up term insurance with a face value of $410,881 through May 7,

2003, at which time it was set to be depleted of its cash value

and thus to terminate without value.

IX.   Dispute of Drs. DeAngelis and Domingo

      In 1999, Dr. DeAngelis received a statement from STEP

showing that the death benefit for the DeAngelises survivor whole

life policy had decreased by approximately $3.5 million.   The

statement caused Dr. DeAngelis to write letters to STEP,

Teplitzky & Co., and Mr. Rapp, requesting an explanation for the

decrease in value.   Dr. DeAngelis (and ultimately Dr. Domingo)

also retained an attorney as to this matter.

      On investigation, Dr. DeAngelis concluded that the policies

had lapsed for nonpayment of premiums, contrary to the advice

that he had received at the inception of his participation in

STEP that the policies would be self-sustaining after the making

of the first two contributions.   Because the option on each

policy to pay the annual premiums through an APL had not been

elected on the insurance application form, each of the six

subject policies lapsed as of the end of 1997.

      The failure to make the APL election on the insurance

application forms was partially that of Mr. Rapp, who

misunderstood the expressed intent of Drs. DeAngelis and Domingo
                                 - 39 -

that the APL election be made on their policies.        After the lapse

of the policies, much correspondence on the subject ensued

between Drs. DeAngelis and Domingo and their lawyer, on the one

hand, and MetLife, Mr. Rapp, and/or Teplitzky & Co., among

others, on the other hand, and Drs. DeAngelis and Domingo

threatened to file a lawsuit as to the matter.        Drs. DeAngelis

and Domingo sought from MetLife the reinstatement of their and

Ms. Quinn’s single individual policies as reduced paid-up

insurance retroactively to the original lapse date.

X.   Reinstatement of Policies

      A.   Overview

      On January 24, 2002, Marcia McDermott (Ms. McDermott), an

internal consultant for MetLife, asked MetLife to reinstate the

lapsed policies of Dr. DeAngelis and Ms. Quinn as paid-up

insurance retroactively to the original lapse date, as if the

policies had never lapsed.      Previously, Ms. McDermott had made a

similar request as to the Dr. Domingo policy.        Because Dr.

Durante did not ask Ms. McDermott to seek a similar reinstatement

of the Dr. Durante policy, Ms. McDermott did not ask MetLife to

reinstate the Dr. Durante policy.

      B.   Dr. Domingo Policy

      STEP transferred ownership of the Dr. Domingo policy to Dr.

Domingo in or about November 2001.        Although the policy

technically had no value, Dr. Domingo wanted the policy because
                                 - 40 -

Ms. McDermott had agreed to reinstate the policy as a reduced

paid-up policy retroactive to December 28, 1997.     Subsequently,

pursuant to the request of Dr. Domingo, MetLife changed the Dr.

Domingo policy to reduced paid-up insurance retroactively

effective to December 28, 1997, with a face value of $195,924.

MetLife stated in part that it was making this change because

neither Dr. Domingo nor the STEP plan trustee had received timely

notice of either the lapse of the policy or multidistrict

litigation involving MetLife’s marketing practices; the trustee

had directed MetLife to send all mail to the trustee in care of

the STEP plan administrator.     Following this change, the Dr.

Domingo policy has continued as participating reduced paid-up

insurance.

     From December 28, 1993, through the present, Dr. Domingo

received life insurance coverage of $195,924 to $1,377,206

through the Dr. Domingo policy.     As of December 28, 2005, the

policy’s death benefit and net cash surrender value were

$267,034.57 and $185,025.58, respectively.

     C.   Dr. DeAngelis Policy

     On or about January 24, 2002, the ownership of the Dr.

DeAngelis policy was changed to his name.     Shortly thereafter,

the Dr. DeAngelis policy was changed from nonforfeiture extended

term insurance to participating reduced paid-up insurance

retroactively effective to December 28, 1997, with a face value
                               - 41 -

of $264,809.   MetLife stated in part that it was making this

change because neither Dr. DeAngelis nor the STEP plan trustee

had received timely notice of either the lapse of the policy or

multidistrict litigation involving MetLife’s marketing practices;

the trustee had directed MetLife to send all mail to the trustee

in care of the STEP plan administrator.    Before the formal change

of ownership, Dr. DeAngelis understood that the policy

technically had no value but that MetLife was going to change the

policy to reduced paid-up status retroactively to 1997.    As of

December 28, 2004 and 2005, respectively, the Dr. DeAngelis

policy had a death benefit of $349,286 and $360,559.21 and a net

cash surrender value of $232,215.81 and $244,798.07.

     D.   Ms. Quinn Policy

     On January 3, 2003, Dr. DeAngelis formally terminated

VRD/RTD’s participation in STEP.    At that time, Dr. DeAngelis

offered on behalf of VRD/RTD to purchase from the STEP plan the

DeAngelises survivor whole life policy, the Dr. Durante policy,

and the Ms. Quinn policy.    Dr. DeAngelis offered to purchase

these policies at a cost of 10 percent of each policy’s cash

value, payable as a withdrawal from the policy’s cash value.

     On July 28, 2003, STEP assigned the ownership of the Ms.

Quinn policy to Ms. Quinn.    No severance event had occurred under

the STEP plan to permit this assignment.    In connection with the

assignment, Ms. Quinn executed a claim settlement and release
                                - 42 -

form, backdated to January 3, 2003, the day of VRD/RTD’s formal

termination of its participation in the STEP plan.

     On August 7, 2003, STEP informed Ms. Quinn that it had asked

MetLife to change the ownership of the Ms. Quinn policy from the

STEP trustee to Ms. Quinn and that any action to reinstate the

policy had to be made by Ms. Quinn.      One day later, MetLife

informed SPSI that it had received STEP’s request to change the

ownership of the Ms. Quinn policy but MetLife’s records indicated

that the policy had expired and was no longer in force.      At the

request of Dr. DeAngelis, the Ms. Quinn policy was changed by

MetLife later in 2003 to reduced paid-up insurance retroactively

effective to December 28, 1997, with a face value of $34,135.      On

September 30, 2003, MetLife confirmed to Ms. Quinn that she was

the owner of the Ms. Quinn policy and that the policy was being

continued as reduced paid-up insurance in the amount of $34,135,

which would increase as dividends were credited to the policy.

     On or after January 16, 2004, Ms. Quinn surrendered the Ms.

Quinn policy to MetLife and received a check from MetLife in the

amount of $15,573.69.   MetLife processed the check on January 27,

2004.   From December 28, 1993, through January 16, 2005, Ms.

Quinn received life insurance coverage of $34,135 to $410,881

through the Ms. Quinn policy.
                               - 43 -

XI.   Survivor Whole Life Policies

      A.   Domingos Survivor Whole Life Policy

      On December 10, 2001, STEP assigned the ownership of the

Domingos survivor whole life policy to Dr. Domingo.    As of

December 28, 2001, the Domingos survivor whole life policy had a

total death benefit of $596,009.81, less an outstanding policy

loan of $220,206.85, for a net death benefit of $375,802.96.      As

of the same date, the Domingos survivor whole life policy had a

cash surrender value of $224,475.17, less the outstanding policy

loan of $220,206.85, for a net cash surrender value of $4,268.32.

As of November 2006, the Domingos survivor whole life policy had

a cash value base of $277,316.37, a cash value of additional

insurance of $21,380.58, an existing loan of $279,056.26, and

loan interest due of $13,793.75, for a net cash surrender value

of $5,846.94.    From December 28, 1993, through the present, the

Domingos received life insurance coverage of between $511,542 and

$3,500,000 through the Domingos survivor whole life policy.

      B.   DeAngelises Survivor Whole Life Policy

      On July 28, 2003, STEP assigned the ownership of the

DeAngelises survivor whole life policy to the DeAngelises.     No

severance event had occurred under the STEP plan to permit this

assignment.    In connection with the assignment, Dr. DeAngelis

also executed a claim settlement and release form backdated to

January 3, 2003.
                                  - 44 -

       As of various times, the policy’s death benefit and net cash

surrender value were as follows:

          As of            Death Benefit   Net Cash Surrender Value

         3/1/1999          $595,195.38          $186,974.68
       12/28/1999         4,663,784.34           220,495.10
       12/28/2000           678,528.13           236,229.57
       12/28/2001           688,464.08           253,038.08
         2/5/2003           699,316.63           272,153.06
        3/31/2003           669,547.00           274,537.72
       12/28/2004           713,391.54           305,930.83
       12/28/2005           719,830.71           324,053.39

XII.    Dr. Durante Policy

       As of March 1, 1999, the cash surrender value of the Dr.

Durante policy was $52,982.52.      As of December 31, 2001, the cash

surrender value of the policy was $23,508.43.      As of February 25,

2003, the cash surrender value of the Dr. Durante policy was

$21,811.95.       As of each of these dates, the death benefit payable

under the policy was $1,864,269.

       On July 28, 2003, STEP assigned the ownership of the Dr.

Durante policy to Dr. Durante.      No severance event had occurred

under the STEP plan to permit this assignment.      In connection

with the assignment, Dr. Durante also executed a claim settlement

and release form backdated to January 3, 2003.

       On August 4, 2003, the cash surrender value of the Dr.

Durante policy was $17,635.98, and the death benefit was

$1,864,269.       The Dr. Durante policy had no value once it expired

on February 1, 2005.      From December 28, 1993, through February 1,
                                   - 45 -

2005, Dr. Durante received life insurance coverage of $1,804,135

to $1,864,269 through the Dr. Durante policy.

XIII.     Acquisition of STEP

        STEP was acquired from Teplitzky & Co. in February 2002 by

STEP Acquisition Group, Inc.        Afterwards, SPSI offered

participants three options.        Option A was “To continue

participation in the STEP Plan & Trust as the Plan is now and as

it is amended from time to time.”        Option B was “To terminate our

participation in the STEP Plan & Trust and to have 80% of the

potential severance benefit paid out to each of our employees

over a 24 month period.”        Option C was “To terminate our

participation in the STEP Plan and rollover 90% of the potential

severance benefit to purchase new insurance policies to provide

death benefit protection in the BENISTAR 419 Plan and Trust.”

The STEP plan does not provide for any of these options.         On June

28, 2002, Dr. DeAngelis signed a STEP “Option Selection Form”

stating that VRD/RTD had decided “To continue participation in

the STEP Plan & Trust as the Plan is now and as it is amended

from time to time.”

XIV.     Recordkeeping for the STEP Plan

        STEP maintained its records of employer contributions;

insurance policy premiums; potential severance benefits; policy

values; termination, surrender, or withdrawal dates; forfeitures;

severance payments; “frozen” potential severance benefits; and
                              - 46 -

surrenders and withdrawals on an employee-by-employee basis

within each employer group, further segregated by each of the

eight insurance companies participating in the STEP plan.    STEP

maintained its books and records first by insurance company,

second by employer group, and finally by each individual

employee.   Forms 5500-C/R, Return/Report of Employee Benefit

Plan, filed by the STEP plan were generally broken down by

insurance company, employer group, and employee.   Forms W-2, Wage

and Tax Statement, were issued to participants with separate

employer identification numbers for each life insurance company.

     Each insurance policy was essentially a separate account for

the covered employee on whose life the policy was written.     The

account included all of the employer’s contributions for that

employee, was increased by all of the income earned as a result

of those contributions, was reduced by all insurance company

charges to provide the life insurance benefits for only that

employee, and was used as the base from which to calculate the

purported severance benefits of that employee.   A severance

benefit that was paid out to an employee was typically not equal

to what had been paid in by way of employer contributions.     The

employer contribution was invested by STEP, and the assets grew.

     VRD/RTD’s contributions were invested in the individual

insurance policies of the participating doctors and Ms. Quinn.

The contributions for each policy were accounted for separately.
                              - 47 -

Dividends were credited to the policy, and insurance charges were

taken out of each of the policies to pay for the cost of

providing the covered employee with life insurance coverage.

STEP applied a factor to the cash value of the life insurance

policy on the covered employee’s life in order to compute the

benefit payable to the employee.   The insurance policies (or the

cash derived therefrom) were distributed to VRD/RTD’s

participating employees without regard to STEP’s purported

computation of the allowable amounts of severance benefits.

XV.   Dr. Domingo’s Receipt of Plan Benefits

      On April 3, 1997, Dr. Domingo wrote to Mr. Katz requesting a

“legal opinionated [sic] letter” regarding his “intent to retire

within the time period of 3 years” for “business reasons and for

continuity of our surgical group.”     Dr. Domingo requested that

any response be sent to him “Personal and Confidential.”     Mr.

Katz relayed Dr. Domingo’s letter to Mr. Pagano.     On May 1, 1997,

Mr. Pagano advised Dr. Domingo that he would receive full

benefits under the STEP criteria of “good cause” and “genuine

business purpose” if he resigned after being asked to retire.

Mr. Pagano advised Dr. Domingo that he would not qualify for

benefits if he agreed to work for VRD/RTD in a different

capacity.

      On March 21, 2001, Dr. Domingo informed Teplitzky & Co. that

on January 1, 1999, he “retired completely from my surgical
                              - 48 -

practice” and wanted to know about the severance monetary

benefits available to him.   On March 28, 2001, Teplitzky & Co.

informed Dr. Domingo that he needed to establish a severance

event in order to qualify for benefits under the plan and had to

establish to the satisfaction of the plan’s independent fiduciary

that the termination was for good cause within the meaning of New

York State Unemployment Insurance Law.   Teplitzky & Co. enclosed

examples of “good cause” under New York law and advised Dr.

Domingo to call Mr. Mamorsky if he had any questions.

     On June 17, 2001, Dr. Domingo relayed to the STEP plan

administrator his revised request for severance benefits,

including a formal “Request for Benefit Payments” and an attached

“Reason for Termination of Service”.   The revised claim removed

all reference to his prior statement that he had “completely

retired” from his surgical practice.   The revised claim stated

that on October 5, 1998, VRD/RTD asked him to terminate his

association with the group effective January 1, 1999, because his

financial contribution to the group was not satisfactory.     Dr.

Domingo claimed that his compensation for the last 12-month

period before his termination of service was $323,334.

     On July 16, 2001, VRD/RTD mailed to Teplitzky & Co. an

“Employer Request for Payment of Benefits” for Dr. Domingo

listing the date of severance as January 1, 1999, and stating

that the compensation paid to Dr. Domingo for the last 12-month
                             - 49 -

period before termination of employment was $323,334.   Attached

to the request was the same “Reason for Termination of Service”

that Dr. Domingo had attached to his benefit request.   Both forms

were signed by Dr. DeAngelis on June 30, 2001.   Before that

request, neither VRD/RTD nor Dr. Domingo notified STEP that Dr.

Domingo had stopped providing services to VRD/RTD on January 1,

1999.

     On August 10, 2001, Teplitzky & Co. forwarded Dr. Domingo’s

claim for severance benefits to Mr. Pagano, asking Mr. Pagano if

he agreed or disagreed with the claim.   On September 4, 2001, Mr.

Pagano informed Teplitzky & Co. that he had reviewed Dr.

Domingo’s claim for severance benefits and that he confirmed that

it was an “induced termination due to non renewal of contract”

which would be a qualifying event for severance benefits under

the STEP plan.

     On September 20, 2001, Teplitzky & Co. notified Dr. Domingo

that his severance benefit had been approved in the estimated

amount of $233,661 and offered Dr. Domingo the opportunity to

“purchase” the Domingos survivor whole life policy, coverage of

which was $587,232, for $5,496.   On September 25, 2001, Dr.

Domingo wrote to Teplitzky & Co. asking for answers to certain

questions he had about his benefits and his life insurance

policies, including a question as to why he had to pay so much to

purchase the Domingos survivor whole life policy.   On September
                              - 50 -

28, 2001, Teplitzky & Co. responded to Dr. Domingo’s questions,

indicating, among other things, that the purchase price for his

policy was determined by subtracting from the $217,305 cash

surrender value of the policy the maximum loan that could be

taken of $211,809, leaving a balance in the policy of $5,496.     On

October 9, 2001, Ms. McDermott confirmed in writing to Dr.

Domingo that MetLife would be willing to change the policy on his

life to reduced paid-up status retroactively effective to the

date when a request to make such a change could have been timely

made.   Ms. McDermott also informed Dr. Domingo that the policy

was still “technically an asset of the severance plan” so it

would be a “good idea” to get the policy from the plan before the

change was made.   Ms. McDermott attached a letter showing that

the policy is presently of “no value to the plan” to assist Dr.

Domingo in getting the policy.

     On October 14, 2001, Dr. Domingo advised Teplitzky & Co.

that he wished to purchase the Domingos survivor whole life

policy.   One day later, Dr. Domingo sent to Mellon Trust a $2,000

check from Rodolfo T. Domingo M.D.P.C. and a $3,496 check from

the Domingo Family Limited Partnership as requested by the STEP

plan administrator to purchase the Domingos survivor whole life

policy.   On October 24, 2001, Teplitzky & Co. applied for a

policy loan on and requested a change in ownership of the

Domingos survivor whole life policy.   The policy loan was used to
                                   - 51 -

pay to Dr. Domingo his requested severance benefits totaling

approximately $220,000.

XVI.    Dr. DeAngelis’s Receipt of Plan Benefits

        Dr. DeAngelis filed a claim for severance benefits with STEP

in November 2002.        In connection therewith, Dr. DeAngelis on

November 19, 2002, signed a “Request for Payment of Benefits”

stating that he was terminating his services because of “prostate

cancer, with symptoms which interfere with employee’s ability to

perform surgery” and that his compensation for the 12-month

period before his termination of service was approximately

$350,000.     Dr. DeAngelis underwent radiation and incurred

radiation colitis to try to treat his prostate cancer and

continued to work until December 31, 2003.

        Wayne Bursey (Mr. Bursey), the president of SPSI, approved

the claim.        Mr. Bursey was concerned about the possibility of

future litigation between Dr. DeAngelis and STEP, insofar as Drs.

DeAngelis and Domingo had threatened suit against the prior plan

administrator but had never instituted any such litigation.

                                   OPINION

I.     Overview

        We are faced once again with an issue arising from a plan

designed aggressively to bolster the sale of insurance products

through a claim of permissible tax savings.        Cf. Neonatology

Associates, P.A. v. Commissioner, 115 T.C. 43, 99 (2000), affd.
                               - 52 -

299 F.3d 221 (3d Cir. 2002).   Respondent determined that neither

the PCs’ payments to VRD/RTD related to the STEP plan nor

VRD/RTD’s ensuing contributions to the STEP plan were deductible

under section 162(a) as ordinary and necessary business expenses

and that the amounts of the payments were includable in the

doctors’ gross income under section 61(a).     Respondent argues

that the payments were made for the doctors’ personal benefit.

Petitioners argue that the payments and contributions are

deductible under section 1.162-10(a), Income Tax Regs., as

“Amounts paid or accrued within the taxable year for dismissal

wages” and, thus, that the payments are not includable in the

doctors’ gross income.   We agree with respondent’s determination

on the disallowed deductions but disagree with respondent’s

determination on the inclusion in income.     We set forth our

analysis below primarily in two sections.     The first section sets

forth our opinion of the credibility of the witnesses.       The

second section sets forth our opinion on the substantive issues

at hand.

II.   Credibility of the Witnesses

      A.   Expert Witnesses

      At trial, each party called an expert witness in support of

their and his respective positions.     Petitioners called

Michael L. Frank (Mr. Frank), and the Court recognized him as an

expert on experience rating and risk sharing.     Mr. Frank is an
                              - 53 -

actuary who graduated from the University of Michigan in 1987 and

has worked in the insurance industry ever since.    He currently

works for his own company in part (1) advising employers on the

purchase of insurance, (2) consulting on employee benefits and

the plans related thereto, (3) brokering and underwriting

insurance, and (4) helping insurance and other companies

underwrite insurance.   His credentials include that he is

licensed to sell life and other forms of insurance in 18 States,

that he is an associate of the Society of Actuaries, that he is a

member of the American Academy of Actuaries, and that he is a

fellow of the Conference of Consulting Actuaries.    Petitioners

retained him less than 3 months before trial to testify as an

expert in this proceeding.   Mr. Carpenter, with whom Mr. Frank

has had a longstanding working and personal relationship,

recommended him.

     Respondent called Charles C. DeWeese (Mr. DeWeese) at trial

to testify as an expert, and the Court recognized Mr. DeWeese as

an expert on multiple-employer benefit plans, insurance

experience rating, and individual life insurance policies.    Mr.

DeWeese is an independent consulting actuary who graduated from

Yale University in 1968 and has worked in the insurance industry

ever since.   His credentials include that he has been a fellow of

the Society of Actuaries since 1972, a member of the American

Academy of Actuaries since 1974, and a fellow of the Conference
                               - 54 -

of Consulting Actuaries since 1987.     Various courts, including

this one, have previously recognized Mr. DeWeese as an expert on

subjects similar to those relevant herein, and he has repeatedly

testified as an expert on those subjects, including twice in this

Court.    See Neonatology Associates, P.A. v. Commissioner, supra

at 85-86; Booth v. Commissioner, 108 T.C. 524, 573 (1997).

     The Court has broad discretion to evaluate the cogency of an

expert’s analysis.    See Neonatology Associates, P.A. v.

Commissioner, supra at 85.    Sometimes, an expert will help us

decide a case.    See, e.g., id.; Booth v. Commissioner, supra at

573; Trans City Life Ins. Co. v. Commissioner, 106 T.C. 274, 302

(1996).    Other times, he or she will not.   See, e.g., Estate of

Scanlan v. Commissioner, T.C. Memo. 1996-331, affd. without

published opinion 116 F.3d 1476 (5th Cir. 1997); Mandelbaum v.

Commissioner, T.C. Memo. 1995-255, affd. without published

opinion 91 F.3d 124 (3d Cir. 1996).     Aided by our common sense

and our perception of the expert during his or her testimony, we

weigh the helpfulness and persuasiveness of an expert’s testimony

in the light of his or her qualifications and with due regard to

all other credible evidence in the record.     See Neonatology

Associates, P.A. v. Commissioner, supra at 84-85.     We may embrace

or reject an expert’s opinion in toto, or we may pick and choose

the portions of the opinion to adopt.     See Helvering v. Natl.

Grocery Co., 304 U.S. 282, 294-295 (1938); IT&S of Iowa, Inc. v.
                              - 55 -

Commissioner, 97 T.C. 496, 508 (1991).     We are not bound by an

expert’s opinion and will reject an expert’s opinion to the

extent that it is contrary to the judgment we form on the basis

of our understanding of the record as a whole.    See IT&S of Iowa,

Inc. v. Commissioner, supra at 508.

     In making our findings of fact and reaching our decisions

herein, we have given little weight to the testimony of Mr.

Frank.   Although the Court recognized Mr. Frank as an expert on

the stated subjects, we were and remain troubled that Mr. Frank

has a longstanding and continuing working and personal

relationship with Mr. Carpenter and other entities and persons

with financial and/or other direct interests in the resolution of

these cases.   See Neonatology Associates, P.A. v. Commissioner,

115 T.C. at 86 (stating that “An expert witness loses his or her

impartiality when he or she is too closely connected with one of

the parties” and holding that such an expert is of limited value

to the Court).   In fact, during trial, we were forced to admonish

Mr. Frank that he should not be improperly communicating with one

or more of the just-referenced persons and petitioners’ counsel.

In addition to that stated relationship, we also on the basis of

our observation of Mr. Frank’s candor, sincerity, and demeanor

perceived him to be of little help to the Court in deciding these

cases.   As to Mr. DeWeese, we have respected his testimony and

given that testimony appropriate weight.    When Mr. DeWeese
                             - 56 -

previously testified before this Court, the Court on each

occasion found him to be reliable, relevant, and helpful on the

areas that were the subject of his expertise.   See id. at 85-86;

Booth v. Commissioner, supra at 573.   We find him likewise

helpful in these cases.

     B.   Fact Witnesses

     At trial, petitioners called five witnesses to testify as to

the facts of these cases; respondent called three such witnesses.

Petitioners’ fact witnesses were Drs. DeAngelis and Domingo and

Messrs. Mamorsky, Bursey, and Teplitzky.   Respondent’s fact

witnesses were Dr. Borrero, Mr. Mamorsky, and Ms. McDermott.19

On the basis of our perception of the witnesses and our review of

the record as a whole, we do not find much of the testimony of

the fact witnesses to be helpful as to the critical facts

underlying the issues at hand.   See generally Neonatology


     19
       For completeness, we note that respondent also called Mr.
Carpenter to testify at an evidentiary hearing held immediately
before trial. Petitioners had moved the Court approximately 1
month before trial to issue an order generally disqualifying Mr.
DeWeese from testifying as an expert witness in this proceeding
and had attached to their motion an affidavit of Mr. Carpenter
setting forth serious allegations questioning the objectivity of
Mr. DeWeese. In respondent’s response to that motion (as
supplemented by petitioners to address in part a question by the
Court as to why petitioners had not filed their motion earlier),
respondent raised serious issues of truthfulness on the part of
Mr. Carpenter and requested in part that the Court hold an
evidentiary hearing so that respondent could question Mr.
Carpenter as to his actions connected with this proceeding and
the subject matter thereof. The Court granted respondent’s
request. The Court ultimately denied petitioners’ motion as
supplemented.
                                - 57 -

Associates, P.A. v. Commissioner, supra at 84 (discussing the

standards that the Court applies to evaluate the testimony of

trial witnesses).     We rely mainly on the testimony of Mr. DeWeese

and the voluminous record built by the parties through their

comprehensive stipulation of facts and exhibits.

III.    Substantive Issues at Hand

       A.   Disallowance of Deductions

       Section 162(a) generally provides that “There shall be

allowed as a deduction all the ordinary and necessary expenses

paid or incurred during the taxable year in carrying on any trade

or business”.     A taxpayer such as VRD/RTD or one of the PCs must

meet five requirements in order to deduct an item under this

section.     The taxpayer must prove that the item claimed as a

deductible business expense:     (1) Was paid or incurred during the

taxable year; (2) was for carrying on its trade or business;

(3) was an expense; (4) was a necessary expense; and (5) was an

ordinary expense.20    See Commissioner v. Lincoln Sav. & Loan

Association, 403 U.S. 345, 352 (1971); Welch v. Helvering,

290 U.S. 111, 115 (1933); see also Rule 142(a)(1).     A

determination of whether an expenditure satisfies each of these




       20
       While sec. 7491(a) places the burden of proof upon the
Commissioner in certain cases, the Court has decided in an
unpublished order that sec. 7491(a) has no applicability to these
cases.
                              - 58 -

requirements is a question of fact.    See Commissioner v.

Heininger, 320 U.S. 467, 475 (1943).

     Petitioners argue that section 162(a) allowed VRD/RTD and

the PCs to deduct the amounts related to the STEP plan because

those amounts represented “dismissal wages” paid to a “welfare or

similar benefit plan” within the scope of section 1.162-10(a),

Income Tax Regs.   We disagree.   While the STEP plan may have been

cleverly designed to appear to be a welfare benefits fund and

marketed as such, the facts of these cases establish that the

plan was nothing more than a subterfuge through which the

participating doctors, through VRD/RTD, used surplus cash of the

PCs to purchase cash-laden whole life insurance policies

primarily for the benefit of the participating doctors

personally.   While employers are not generally prohibited from

funding term life insurance for their employees and deducting the

premiums on that insurance as a business expense under section

162(a), employees are not allowed to disguise their investments

in life insurance as deductible benefit-plan expenses when those

investments accumulate cash value for the employees personally.

See Neonatology Associates, P.A. v. Commissioner, supra at 88-89.

     The insurance premiums at hand pertained to the

participating doctors’ personal investments in whole life

insurance policies that primarily accumulated cash value for

those doctors personally.   VRD/RTD’s contributions to the STEP
                                - 59 -

plan were used to pay the initial year’s cost of providing life

insurance for each participating doctor and to create an

investment fund for the insured within his whole life insurance

policy (or policies in the cases of Drs. DeAngelis and Domingo).

That fund, when enhanced with expected future dividends, was

calculated to be sufficient to pay for the future years’ costs of

life insurance protection and to provide for cash values

sufficient to allow for a distribution of cash to the insured

doctor whenever he opted to claim that he was involuntarily

terminated from his business.    As to each investment fund (and as

to each insurance policy in general), the insured doctor regarded

that fund (and policy) as his own, as did the STEP plan trustee,

the STEP plan administrator, and MetLife.   Very little (if any)

value in one participating doctor’s fund was available to pay to

another insured, and any distribution of cash from the STEP plan

to a participating doctor was directly related to the cash value

of his policy.   In many instances, a participating doctor dealt

with his own insurance agent in selecting and purchasing the

policy on his life, received illustrations on an assortment of

life insurance investments that could be made through the STEP

plan, determined the amount of his investment in his life

insurance policy, selected the form of the insurance policy to be

issued for him (e.g., single whole life versus survivor whole

life), and selected his policy’s face amount.   In the latter
                              - 60 -

regard, we note our finding on the basis of the credible evidence

in the record that Drs. DeAngelis and Domingo, when dealing with

Mr. Rapp, MetLife, and the insurance policies in general, were

not acting as agents of VRD/RTD but were acting in their

individual capacities.   We also note our finding that Dr. Durante

was not acting as an agent of VRD/RTD with respect to his policy.

     The use of whole life insurance policies and the direct

interactions between the participating doctors and the STEP plan

representatives support our finding that the participating

doctors in their individual capacities fully expected to get

their promised benefits and that any receipt of those benefits

was not considered by anyone connected with the life insurance

transaction to rest on any unexpected or contingent event.     Each

whole life insurance policy upon its issuance was in and of

itself a separate account of the insured doctor, and the insured

(rather than the STEP plan) dictated and directed the funding and

management of the account and bore most risks incidental to the

account’s performance.   The STEP plan in essence and in operation

was simply an aggregation of separate plans for the participating

doctors and not, as petitioners claim, one single plan in which

various employers participated.   The cash value in a

participating doctor’s policy was both intended to be and

actually returned to the insured doctor, net of reductions for

the cost of current insurance coverage and other de minimis
                             - 61 -

amounts that were payable for charges related to the policies or

otherwise incidental to the participation in the STEP plan.    In

fact, upon learning that their policies had lost the value that

they expected to receive, Drs. DeAngelis and Domingo pursued

recovery of those losses both directly and aggressively with

their insurance agent and with the STEP plan representatives and

caused the policies written on their lives to be transferred to

them (and the Ms. Quinn policy to be transferred to her) as they

had expected from the start of their investment in the STEP plan.

As to the DeAngelises survivor whole life policy and the Domingos

survivor whole life policy, the retroactive reinstatement and

conversion of those policies to APL also rebuts petitioners’

claim that each insurance policy was truly an asset of the STEP

plan which the plan had the unfettered right to benefit from, to

liquidate, or to dispose of; to the contrary, the cash value

theoretically belonging to the STEP plan was converted into death

benefits for Drs. DeAngelis and Domingo even though VRD/RTD had

stopped making contributions years before the conversion.

     We also note the events leading up to the initial purchase

of the whole life insurance policies.   Through the partnership

agreement executed on June 19, 1990, Drs. DeAngelis and Domingo

had expressed their intent to retire in the near future.    Yet, in

connection with the planning of their personal estates and their

consideration of ways to reduce the application to their estates
                               - 62 -

of the Federal estate tax, Dr. DeAngelis caused VRD/RTD to join

the STEP plan on December 30, 1993.     Drs. DeAngelis and Domingo

were told that their 1993 and 1994 payments to the STEP plan

would suffice to fund the future costs of providing life

insurance benefits for the remainder of their lives and to

provide future distributions of cash to them at the time of their

choosing.   From the beginning of their decision to participate in

the STEP plan, the participating doctors were most concerned

about the amounts of, and their ability to receive, their

expected benefits from STEP.    In fact, Drs. DeAngelis and Domingo

requested calculations and illustrations showing how much they

would receive depending upon the number of years that

contributions were made to the STEP plan.    Drs. DeAngelis and

Domingo also wrote to Mr. Katz for assurance that they would

receive their benefits and requested a written opinion from the

plan sponsor about how to characterize their planned departures

from their practices so as to meet the terms of the STEP plan as

written.    STEP advised the participating doctors on what to say

in order to get their promised benefits, and STEP assured the

doctors that a protocol was in place to ensure that they would

get their money as intended.    Because each of the participating

doctors’ PCs funded its own employee’s benefits under the STEP
                              - 63 -

plan, STEP was at no significant loss in allowing each PC to

remove from the plan the money it invested therein.21

     Petitioners rely erroneously on Booth v. Commissioner,

108 T.C. 524 (1997), in arguing that these cases turn primarily

not on the application of section 162(a) but on the question of

whether the STEP plan meets the requirements of section

419A(f)(6).   As discussed herein, our decisions in these cases

turn on our factual evaluation of the relationship between the

participating doctors and their whole life insurance policies

without any regard to the STEP plan’s qualification under section

419A(f)(6), and we decide on the basis of the credible evidence

in the record before us that those doctors upon investing in the

STEP plan had the primary right to receive the value reflected in

the insurance policies written on their lives.   We note in this

regard that the Court in Booth v. Commissioner, supra, did not

decide the issue under section 162(a) that we decide today.

     In sum, we find that the PCs’ payments to VRD/RTD were

distributions to the doctors personally and that neither those

payments nor VRD/RTD’s ensuing contributions to STEP were

ordinary and necessary business expenses under section 162(a)



     21
       We also are mindful that the provisions in the STEP plan
were routinely not followed; e.g., Dr. Domingo received a
“severance” benefit even though he informed the STEP plan
administrator that he had “completely retired”, a situation that
even the author of the STEP plan admitted was not an eligible
event under the STEP plan as written.
                                 - 64 -

(except to the extent they relate to payments of premiums on the

Ms. Quinn policy as discussed supra note 3).        Accord Neonatology

Associates, P.A. v. Commissioner, 115 T.C. 43 (2000).

Consequently, we hold that those amounts are not deductible under

section 162(a) by either the PCs or VRD/RTD.22

     B.    Inclusion in Income

     Respondent determined that the amounts of the life insurance

premiums that were paid by each doctor’s PC on his behalf are

includable in the doctor’s gross income under section 61(a) as

“accessions to wealth, clearly realized, and over which the

taxpayers have complete dominion.”        See Commissioner v. Glenshaw

Glass Co., 348 U.S. 426, 431 (1955).       We disagree that those

amounts are includable in the doctors’ gross income.       While the

payments of the premiums were indeed accessions to the doctors’

wealth, our decision on this issue does not rest simply on that

finding.    Instead, our decision turns on our finding that the

doctors’ PCs were S corporations and that the payment of the

premiums by the PCs was essentially a distribution to the doctors

of corporate profits rather than a payment that the PCs made to

the doctors with a compensatory intent.       See Neonatology



     22
       Although the PCs may arguably be entitled to deduct the
costs of the current life insurance protection purchased through
the STEP plan, see Neonatology Associates, P.A. v. Commissioner,
115 T.C. 43 (2000), petitioners have not requested any such
deductions, and the record does not allow the Court to find the
amounts of any such deductions.
                              - 65 -

Associates, P.A. v. Commissioner, supra at 91-92, 95-96; see also

Neonatology Associates, P.A. v. Commissioner, 299 F.3d at

231-232.   In accordance with the Federal income tax law

applicable to S corporations, most particularly sections 1367 and

1368, our disallowance of the deductions claimed by the PCs has

the effect of increasing pro tanto the net income of those PCs,

with corresponding increases to the doctors’ distributive shares

of that income.   That being so, the payments of the premiums are

not taxed a second time to the doctors.23   Cf. Neonatology

Associates, P.A. v. Commissioner, 115 T.C. at 95-96 (tax at the

shareholder-level was appropriate where the employer was a C

corporation).



     We have considered each argument made by petitioners for

holdings contrary to those expressed herein and have rejected all

arguments not discussed herein as irrelevant or without merit.

We also have considered each argument made by respondent for a

holding contrary to that expressed herein as to the inclusion in




     23
        In other words, we regard each distribution as a tax-free
recovery of adjusted basis, taking into account the increase in
basis resulting from the disallowance of deductions claimed by
the PC.
                               - 66 -

income and have rejected all arguments not discussed herein as

irrelevant or without merit.   Accordingly,


                                         Decisions will be entered

                                    under Rule 155.
