                            T.C. Summary Opinion 2013-81



                           UNITED STATES TAX COURT



                     JEFFREY J. FURNISH, Petitioner v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 25690-11S.                         Filed October 23, 2013.



      Jeffrey J. Furnish, pro se.

      Erik W. Nelson, for respondent.



                                SUMMARY OPINION


      GUY, Special Trial Judge: This case was heard pursuant to the provisions

of section 7463 of the Internal Revenue Code in effect when the petition was

filed.1 Pursuant to section 7463(b), the decision to be entered is not reviewable by

      1
          Section references are to the Internal Revenue Code (Code), as amended
                                                                        (continued...)
                                         -2-

any other court, and this opinion shall not be treated as precedent for any other

case.

        Respondent determined a deficiency of $22,444.52 in petitioner’s Federal

income tax for 2009 and an accuracy-related penalty of $4,488.90 pursuant to

section 6662(a). Petitioner filed a timely petition for redetermination with the

Court pursuant to section 6213(a).

        After concessions,2 the issue remaining for decision is whether petitioner

received a constructive distribution of $49,255.24 as reported by Northwestern

Mutual Life Insurance Co. (NML) on Form 1099-R, Distributions From Pensions,

Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.3




        1
       (...continued)
and in effect for 2009, and Rule references are to the Tax Court Rules of Practice
and Procedure.
        2
       Respondent concedes that petitioner is not liable for (1) so much of the
deficiency as relates to an adjustment to itemized deductions of $492.55, and (2)
an accuracy-related penalty under sec. 6662(a).
        3
       Petitioner included the $49,255.24 that NML reported on Form 1099-R in
his taxable income for 2009. Although respondent assessed the tax attributable to
the Form 1099-R income, petitioner has not paid it. Respondent concedes that he
erroneously added $49,255.24 to petitioner’s taxable income a second time in
computing the tax deficiency of $22,444.52.
                                          -3-

                                     Background

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

facts, the supplemental stipulation of facts, and the accompanying exhibits are

incorporated herein by this reference. At the time the petition was filed, petitioner

resided in Oregon.

I. Petitioner’s Life Insurance Policies

       Petitioner is an actuary. In 1972, at the age of 20 and while he was still a

college student, petitioner purchased a “65 LIFE” insurance policy from NML

(1972 policy). The 1972 policy provided a basic death benefit of $20,000 and

required an annual premium payment of $340. Petitioner also agreed to pay $4.20

per year to NML for a waiver of the annual premium in the event of his disability

and $27.17 per year for the option to purchase additional insurance without a

further medical exam.

       In 1974 petitioner purchased an “EXTRA ORDINARY LIFE” insurance

policy from NML (1974 policy). The 1974 policy provided a basic death benefit

of $35,000 and an additional death benefit of $15,000 for the first 34 years the

policy remained in force. In addition to an annual premium of $462, petitioner

agreed to pay $8.50 per year for a waiver of the annual premium in the event of his

disability.
                                          -4-

      Both policies allowed petitioner to participate in any annual dividends that

NML might declare. When petitioner applied for the policies, he elected to have

NML dividends applied to purchase “fully paid-up” additional insurance.

      Both policies offered petitioner the options of (1) obtaining policy loans

from NML, and (2) paying annual premiums through premium loans from NML

against the cash value of the policies. Both policies provided that policy and

premium loans would accumulate compound interest at 6% annually.

      Petitioner testified that he recalled paying at least four of the first seven

annual premium payments due on the policies. Thereafter, he elected to pay the

annual premiums through premium loans from NML. The parties did not offer

any evidence regarding policy loans that petitioner obtained from NML.

      The record includes a few of petitioner’s annual policy statements.

Petitioner’s annual policy statements for the 1972 policy for 2006, 2008, and 2009

reflect the following:

                                   2006           2008            2009

      Total death benefit      $65,229.00       $70,123.00    $72,431.00
      Total loans               26,960.86        33,188.38     35,544.54
      Net death benefit         38,268.14        36,934.62     36,886.46
      Total cash value          30,292.61        34,669.47     36,897.98
      Net cash value             3,331.75         1,481.09      1,353.44
      Dividends                  1,107.50         1,271.85      1,204.92
                                         -5-

The annual policy statements summarized above uniformly indicate that

petitioner’s basic insurance coverage was $22,000, whereas the underlying life

insurance policy indicates that petitioner’s basic insurance coverage was $20,000.

      Petitioner’s annual policy statements for the 1974 policy for 2004, 2006,

and 2009 reflect the following:

                                  2004           2006          2009

      Total death benefit       $74,734.00     $79,473.00   $87,375.00
      Total loans                27,310.19      31,713.11    40,220.59
      Net death benefit          47,423.81      47,759.89    47,154.41
      Total cash value           29,632.67      34,056.56    41,652.62
      Net cash value              2,322.48       2,343.45     1,432.03
      Dividends                     979.54       1,202.49     1,326.55

      In early 2009 NML sent written notification to petitioner that both insurance

policies would lapse unless he made additional premium payments. Petitioner did

not make any additional premium payments, and NML determined that the

insurance policies had lapsed at that time.

II. Form 1099-R

      NML issued to petitioner a Form 1099-R for 2009 reporting a gross

distribution of $78,414.14 in respect of the two insurance policies, designating

$49,255.24 as taxable income.
                                        -6-

III. Petitioner’s Tax Return

      On or about August 16, 2010, petitioner submitted to the Internal Revenue

Service (IRS) two Forms 1040, U.S. Individual Income Tax Return, for 2009,

along with a written statement. Return “A” did not include the income reported by

NML on Form 1099-R, whereas petitioner reported the income on return “B”.

Petitioner’s written statement described the events leading to the lapse of the

insurance policies and the issuance of Form 1099-R and set forth his claim that it

would be unfair to impose income tax on what he considered an artificial

distribution. The IRS accepted and filed petitioner’s return “B” and assessed the

tax reported on that return.

IV. Subsequent Developments

      In late October 2010 petitioner contacted NML and requested a statement

confirming that he did not receive a cash distribution from NML when his

insurance policies lapsed. NML responded to petitioner’s request by letter dated

November 1, 2010, stating:

      Dear Mr. Furnish:

      Thank you for the opportunity to address your questions about the
      taxable gain on your policy. The taxable amount occurred when your
      policies lapsed to an Extended Term insurance contract and the
      outstanding loan balances were repaid.
                                   -7-

Federal laws define most life insurance distributions as a taxable
* * * [event] once the cost of insurance has been recovered. When a
policy lapses to Extended Term, cash value is released from the
policy to repay the loans. To the extent that loans paid off exceed the
cost of the insurance, a taxable event takes place. If a policy has a
gain, it’s considered taxable as ordinary income and we must report it
in the year the policy terminates for any reason, other than the death
of the insured.

Determining taxable gain is a two-step process. First, we determine
the policy’s cost basis. Here’s the calculation for * * * [the 1972]
policy:
             1
                 Total premiums              $12,753.40
             2
                 Total dividends                  -0.00
                 Cost basis                  $12,753.00
1
 Total premiums include premiums for basic insurance coverage only.
Premiums paid for additional benefits like waiver of premium and
accidental death benefit aren’t included.
2
 Total dividends are dividends used for purposes other than
purchasing additional paid-up insurance. Examples of other purposes
would be dividends used for loan repayment, premium reduction or
received in cash.

Next, we compare the paid off loan amount less the cost basis. Here’s
the calculation for * * * [the 1972] policy:

Policy Loan   $11,433.36           Paid Off Loan Amount     $36,767.33
Premium Loan +$25,333.97           Cost Basis               $12,753.40
              $36,767.33                                    $24,013.93

Here are the calculations for * * * [the 1974] policy:

                      *    *   *   *     *     *    *
                                        -8-

      Policy Loan   $ 7,993.26            Paid Off Loan Amount       $41,646.81
      Premium Loan +$33,653.55            Cost Basis                 $16,405.50
                    $41,646.81                                       $25,241.31

      I hope I’ve answered your questions regarding the taxable gain on
      your policy. Because I’m not in a position to advise you on tax
      matters, you may want to discuss this issue with an attorney,
      accountant or the IRS if you have further tax questions.

Petitioner responded to NML’s letter with a request for clarification. NML

responded to petitioner by letter dated November 8, 2010, repeating verbatim the

statements contained in the November 1, 2010, letter but adding the following

statement:

      At the time the policy lapsed to Extended Term Insurance in 1999,
      any remaining cash value in the policy provided insurance coverage
      until March 19, 2010, for * * * [the 1974 policy], and June 4, 2010
      for * * * [the 1972 policy]. There were no cash values paid to the
      policyowner in 2009 because loans and unpaid loan interest depleted
      cash values causing the lapse to Extended Term Insurance.

      On December 1, 2010, petitioner wrote to an IRS office in Fresno,

California (presumably an examination unit), stating that he questioned NML’s

calculations underlying the Form 1099-R and that NML had declined to provide

him with a “history of distributions” under his insurance policies because its

electronic records went back only to the mid-1990s and the company was

unwilling to do the research necessary to fully respond to his request.
                                          -9-

      During the next several months petitioner engaged in discussions with

various IRS personnel in an effort to resolve the matter in his favor. In September

2011 petitioner attempted to obtain the assistance of the Taxpayer Advocate

Service.

V. Notice of Deficiency

      On August 12, 2011, respondent issued to petitioner the notice of deficiency

in dispute. Respondent determined in relevant part that it was appropriate to

include the NML distribution in petitioner’s income and that, as a consequence, he

was liable for alternative minimum tax.

VI. Petition

      Petitioner filed a timely petition for redetermination asserting that he should

not be subject to Federal income tax in respect of NML’s “phantom” distribution

of $49,255.24. He also expressed disappointment that he was not given an

opportunity to discuss the matter with the IRS Office of Appeals.4




      4
      Petitioner nevertheless wrote a letter to the IRS Office of Appeals dated
August 13, 2012, asserting that he did not receive a distribution from NML,
summarizing his efforts to obtain from NML detailed calculations underlying the
Form 1099-R, and expressing doubts about the accuracy of NML’s calculations
supporting its determination that his policies had lapsed during 2009.
                                        - 10 -

VII. NML Declaration

      The record includes a declaration executed by Carol A. Stilwell, NML’s

director of policyowner services and a custodian of the company’s business

records. Ms. Stilwell’s declaration states that petitioner’s 1972 and 1974 policies

terminated on June 4 and March 19, 2010, respectively, with no value. Ms.

Stilwell attached to her declaration separate exhibits which provide the same

narrative statements and calculations in respect of petitioner’s insurance policies

that appeared in NML’s letter to petitioner dated November 1, 2010.

                                     Discussion

      The term “gross income” is broadly defined in the Code to include all

income from whatever source derived. Sec. 61(a). An amount received in

connection with a life insurance contract which is not received as an annuity

generally constitutes gross income to the extent that the amount received exceeds

the investment in the insurance contract. Sec. 72(e)(1)(A), (5)(A), (C); Brown v.

Commissioner, 693 F.3d 765, 768 (7th Cir. 2012), aff’g T.C. Memo. 2011-83;

Sanders v. Commissioner, T.C. Memo. 2010-279. The investment in the contract

is defined as the aggregate amount of premiums or other consideration paid for the

contract less aggregate amounts previously received under the contract to the

extent they were excludable from gross income. Sec. 72(e)(6).
                                        - 11 -

      When NML determined that petitioner’s insurance policies had lapsed, it

applied the cash values of the policies to the outstanding balances on petitioner’s

loans. As we have explained in numerous cases, the act of applying the cash value

of a life insurance policy against an outstanding loan is not different from

distributing the proceeds to the taxpayer (including the untaxed inside buildup) to

permit the taxpayer to use the proceeds to pay off the loan. See Feder v.

Commissioner, T.C. Memo. 2012-10, 2012 WL 75114, at *4 (and cases cited

thereat).

      A preliminary issue in this case, however, is whether NML correctly

determined that petitioner’s insurance policies had lapsed in 2009. As a general

rule, the taxpayer bears the burden of showing that the Commissioner’s

determination is in error. Rule 142(a). As an exception to this general rule, if a

taxpayer raises a reasonable dispute with respect to a third-party information

return (such as the Form 1099-R in dispute) and has otherwise fully cooperated

with the Commissioner, the burden of production may shift to the Commissioner
                                       - 12 -

to present reasonable and probative evidence to verify the information return. Sec.

6201(d).5

      Petitioner contends that he fully cooperated with respondent, that there are

legitimate questions regarding the accuracy of NML’s determination that his

insurance policies lapsed in 2009, and that he tried but failed to persuade NML to

produce the records necessary to verify and substantiate the information reported

in the Form 1099-R. Petitioner asserts that he cannot be certain that his insurance

policies actually lapsed in 2009 without detailed records showing the amounts of

premium loans, the interest computations related to those loans, and NML’s

dividend distributions over the life of the policies--yet NML refused to produce

those records. Petitioner further contends that NML’s letters and annual policy

statements raise more questions than they answer. Specifically, petitioner notes

that (1) NML’s annual policy statements for the 1972 policy make reference to


      5
          Sec. 6201(d) provides:

      In any court proceeding, if a taxpayer asserts a reasonable dispute
      with respect to any item of income reported on an information return
      filed with the Secretary * * * by a third party and the taxpayer has
      fully cooperated with the Secretary (including providing, within a
      reasonable period of time, access to and inspection of all witnesses,
      information, and documents within the control of the taxpayer as
      reasonably requested by the Secretary), the Secretary shall have the
      burden of producing reasonable and probative information
      concerning such deficiency in addition to such information return.
                                        - 13 -

basic insurance coverage of $22,000, in contradiction of the 1972 policy which

provides for basic insurance of $20,000, (2) there is no explanation for the

seemingly anomalous decrease in the net cash value of the 1972 policy from

$3,331.75 in 2006 to $1,481.09 in 2008, and (3) NML’s letter to him dated

November 8, 2010, erroneously stated that his insurance policies “lapsed to

Extended Term Insurance in 1999”.6 Petitioner maintains that, considering all the

circumstances, the burden of production shifted to respondent under section

6201(d), and respondent failed to meet his burden under that provision of law.

      Respondent contends that petitioner has not raised a reasonable dispute in

respect of the accuracy of the Form 1099-R. Specifically, respondent asserts that

“[b]y petitioner’s own admission, long-term computations such as these can be

complex and difficult to verify in exacting detail without access to copious

records. However, taken on the whole, the computations provided by * * * [NML]

follow a logical pattern explaining petitioner’s situation.”

      Contrary to respondent’s position, petitioner raised a reasonable dispute

regarding the accuracy of the Form 1099-R. Although petitioner points to

relatively minor discrepancies in NML’s records, we agree with petitioner that the



      6
       The record is clear that NML had determined that petitioner’s insurance
policies had lapsed in 2009.
                                        - 14 -

discrepancies are of such a nature that their cumulative effect, compounded over

the extended terms of the policies in question, would likely be significant and

could very well alter the dates that the insurance policies lapsed.

      Respondent also avers that petitioner “did not bring these alleged errors to

respondent’s attention until the day of the trial.” The burden of production shifts

to the Commissioner under section 6201(d) only if the taxpayer fully cooperates

with the Commissioner by providing, within a reasonable period, access to and

inspection of all witnesses, information, and documents within the control of the

taxpayer as reasonably requested. Respondent did not present any evidence that

petitioner failed to respond to reasonable requests for information. Considering

petitioner’s detailed communications with IRS personnel before and after the

notice of deficiency was issued and the fact that he apparently was not given the

opportunity to discuss the matter with the Appeals Office, we conclude that

petitioner fully cooperated with respondent within the meaning of section 6201(d).

       As a final matter, respondent contends that he produced “reasonable and

probative information” in support of the Form 1099-R. We disagree. Aside from

the documents that the parties agreed to submit to the Court by way of stipulation,

most of which came from petitioner, the only information that respondent offered

was Ms. Stilwell’s declaration. That declaration merely restates the summary
                                       - 15 -

information that NML provided to petitioner in its letters dated November 1 and 8,

2010. The declaration does nothing to assuage doubts surrounding the accuracy of

the Form 1099-R.

      In sum, on the record presented, we conclude that the burden of production

shifted to respondent under section 6201(d), and respondent failed to produce

reasonable and probative information regarding the accuracy of the Form 1099-R

in dispute. Unlike his approach in similar cases, see Feder v. Commissioner, T.C.

Memo. 2012-10; Sanders v. Commissioner, T.C. Memo. 2010-279, respondent did

not obtain detailed records of petitioner’s premium payments and loan history to

corroborate NML’s Form 1099-R in the face of legitimate questions as to its

accuracy. Absent such information, there is insufficient evidence to verify that

petitioner received the constructive distribution of $49,255.24 that NML reported

to respondent or to otherwise sustain the deficiency in dispute.

      To reflect the foregoing,


                                                Decision will be entered

                                       under Rule 155.
