                    T.C. Summary Opinion 2008-23



                        UNITED STATES TAX COURT



           JOSEPH P. AND MARY A. DYER, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 20860-06S.               Filed March 3, 2008.



     Joseph P. Dyer, pro se.

     Jeffrey S. Luechtefeld, for respondent.



     RUWE, Judge:     This case was heard pursuant to the provisions

of section 74631 of the Internal Revenue Code in effect when the

petition was filed.    Pursuant to section 7463(b), the decision to

be entered is not reviewable by any other court, and this opinion

shall not be treated as precedent for any other case.



     1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue.
                                - 2 -

     Respondent determined a deficiency in petitioners’ 2003

Federal income tax of $4,675.   The only issue we must decide is

whether petitioners received income of $18,171 as a result of the

lapse of a life insurance policy.2

                           Background

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

The parties’ oral stipulation of facts and exhibits is

incorporated by this reference.   When the petition was filed,

petitioners resided in Florida.

     Joseph Dyer (petitioner) was a partner in the law firm of

Siciliano, Ellis, Sheridan, & Dyer (law firm or firm) in 1978.

On May 12, 1978, the firm purchased a life insurance policy

(insurance policy or policy) with petitioner as the insured and

his wife, petitioner Mary Dyer, named as the beneficiary.   The

firm’s partners, including petitioner, had an oral agreement to

insure each of the partners so that, in case one of the partners

died, the proceeds from the insurance covering that partner would




     2
       In their petition, petitioners claim that respondent is
barred by the statute of limitations from assessing a deficiency
against them for 2003. In respondent’s answer, he alleged that
petitioners’ 2003 Federal income tax return was filed on Oct. 14,
2004, and that the notice of deficiency was timely sent to
petitioners by certified mail on July 10, 2006, before the
expiration of the 3-year period for assessment applicable under
sec. 6501(a). Petitioners did not argue this issue at trial.
Accordingly, we find that petitioners conceded the issue, and
respondent timely sent the notice of deficiency in accordance
with the requirements of sec. 6501(a).
                               - 3 -

satisfy the partnership’s obligation to his or her spouse for the

deceased partner’s share of the partnership.

     Initially, the firm paid significant amounts of money to

fund the policy’s premiums.   After 5 years, the firm stopped

paying the premiums and, apparently, the premiums then were paid

by borrowing from the cash value of the policy.   The policy was

issued by Northwestern Mutual Life Insurance Co. (the insurance

company).   The insurance policy remained in effect from 1978

until 2003.   The insurance company never had any direct contact

with petitioners.   Petitioners never received any distribution of

money from the policy, nor did they initiate any borrowing

against the policy.

     Petitioner retired from the firm in 2001, and the firm paid

petitioner for his share of the partnership.

     In a letter dated January 19, 2003, the insurance company

informed the law firm that the policy on petitioner’s life had

lapsed.   The letter was addressed to “Siciliano Ellis Sheridan &

Dyer”, the name of the law firm at the time the policy was

purchased,3 and stated in pertinent part:




     3
       According to petitioner, the firm name was changed in 1980
when “Sheridan” withdrew from the firm to become a judge.
Petitioner also noted that “Siciliano” died in 1985, “Ellis”
retired from the firm in 1999, and petitioner retired in 2001.
                              - 4 -

     Dear Policyowner:

     We have not yet received the current premium for this
     policy and it no longer provides the protection you
     originally wanted.

     The policy lapsed to $40,760 of insurance which will be
     in effect until MARCH 9, 2004.

     When your policy lapsed, loan interest of $21,955.05
     was repaid.

     The policy lapse resulted in taxable income of
     $18,171.23 which we are required by law to report to
     the IRS. A 1099R form will be sent to you in January.
     We are also required to ask that you complete and
     return the enclosed Substitute W9 form to ensure the
     correct reporting of this income.

          However, you can apply to restore full
          protection and policy values and avoid the
          taxable income. To do so, you must take
          these easy steps:

          - Complete and sign the enclosed Request for
          Reinstatement.
          - Return the Request and your payment for the
          Amount Due before FEBRUARY 12, 2003.

     We will do the rest. If the request is approved, you
     will continue to enjoy all the valuable benefits the
     policy was designed to provide.

     We will not be sending you another reminder, so we urge
     you to mail the completed request and your payment
     today. If you have any questions, contact your
     Financial Representative shown below or your Service
     Representative in the Policyowner Services Department
     at the home office.

The firm did not apply to restore the policy and did not make any

further premium payments to prevent the policy from lapsing.
                               - 5 -

     Petitioners filed a joint Federal income tax return for 2003

without reporting income from the policy.   Petitioners never

received a Form 1099-R, Distributions from Pensions, Annuities,

Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts,

etc., from the insurance company.

     Apparently, the insurance company obtained petitioner Mary

Dyer’s Social Security number from the firm’s bookkeeper, but it

never contacted petitioners directly about the situation.   The

insurance company notified the IRS that petitioner Mary Dyer was

the recipient of the income referred to in its letter to the law

firm dated January 19, 2003.   This resulted in an examination of

petitioners’ 2003 return.   In a letter addressed to petitioners

dated May 3, 2006, respondent suggested that petitioners might

qualify to use a Form 8606, Nondeductible IRAs, to show their

cost basis in the “distribution” in question.   The letter also

informed petitioners that respondent had contacted the insurance

company, which verified that it paid income to petitioners.     In a

letter dated May 29, 2006, petitioner described to respondent his

version of the circumstances surrounding the purchase of the

insurance policy.   In the letter, petitioner stated as follows:

     There has never been any distribution and the
     suggestion that we may qualify to use a Form 8606 to
     show our cost basis troubles me because that would
     apply to an annuity. * * * All the premiums were paid
     by the business and were a business deduction by the
     firm under the tax law at that time. The purpose of
     the life insurance was solely to benefit the business.
     * * * Northwestern [the insurance company] always
                                - 6 -

     considered the firm to be the policyholder. (See
     Northwestern’s ltr. of Jan. 19, 2003 when they declared
     the policy to have lapsed.) * * * Northwestern didn’t
     even have our address or social security number and
     apparently called the firm in 2003 to get my wife’s
     social security number. * * *

     On July 10, 2006, respondent issued a notice of deficiency

to petitioners for their 2003 tax year.   Under a section in the

notice titled “Reasons for the Changes”, respondent stated in

pertinent part:

     These paragraphs explain the items listed in Section 1.
     Information Reported to IRS. * * *

     RETIREMENT DISTRIBUTIONS

     We need more information for the distribution shown on
     this notice. We need to know if the income is a
     pension or an annuity, an IRA or lump sum rollover, or
     an employee savings plan. If the income is from a
     pension/annuity or an Employee Savings Plan and you are
     recovering your contributions using the General Rule or
     the Simplified General Rule, please send us a signed
     statement with the date of your first pension payment,
     the amount you receive monthly, and the total amount
     you contribute. If the income is an IRA or lump sum
     and was rolled over, please send us a signed statement
     with the amount of the rollover, the date of the
     distribution and the date of the rollover. If the
     income is an employee savings plan, please send us a
     copy of the document showing the total distribution
     amount you received for 2003, and the nontaxable amount
     of the distribution.

     In a letter sent to the insurance company dated May 22,

2007, respondent requested information relating to the alleged

income and stated as follows:
                                - 7 -

     INFORMATION NEEDED

     Our records show that you issued a Form 1099-R to the
     Social Security Number (SSN) * * * for the tax year
     ending December 31, 2003 to Mary Dyer in the amount of
     $ 18,171. Can you please verify the correctness of
     this amount? Can you please provide a copy of the
     check issued to Mary Dyer for this amount? This
     pertains to Policy Number * * * [the policy at issue].

     In another letter to petitioners dated May 23, 2007,

respondent stated as follows:

     Dear Mr. and Mrs. Dyer

          We have been notified that the United States Tax
     Court has docketed this case. It is to our mutual
     benefit to settle the case without a trial. This
     pertains to the tax year ending December 31, 2003.
     This case is scheduled for trial in Tampa, Florida on
     October 1, 2007.

          The Statutory Notice of Deficiency (SND) dated
     July 10, 2006 proposed an increase to taxable income
     for the failure to report the following income on your
     tax return:

          Taxable annuity income issued in the Social
     Security Number (SSN) of Mrs. Dyer from the
     Northwestern Mutual Life Insurance Company in the
     amount of $ 18,171. * * *

          Information received from Northwestern Mutual Life
     Insurance Company regarding Policy Number * * *
     indicates this policy lapsed and the taxable amount was
     $ 18,171.23. I have enclosed a copy of this
     information. Per Internal Revenue Code Section 72, if
     a loan is still outstanding when the life insurance
     policy is surrendered or allowed to lapse, the borrowed
     amount becomes taxable at the time to the extent the
     loan value exceeds the owner’s basis in the contract,
     as if the borrowed amount was actually received at the
     time of surrender or lapse and used to pay off the
     loan. * * * Please secure a corrected written
     statement from them that would verify the corrected
     taxable income regarding this policy for tax year 2003.
                                - 8 -

          The remaining items proposed in the SND was [sic]
     a computational change to your Schedule A limitation.
     The determination of this issue will depend on the
     final resolution of the annuity income issue.

                             Discussion

     Respondent’s position is based on his receipt of a Form

1099-R from the insurance company.      That Form 1099-R is not in

evidence.   After some confusion, respondent now relies solely on

a theory that petitioners’ “income” is a result of policy loans

made by petitioner Mary Dyer as owner of the policy that were

satisfied when the insurance policy lapsed.      Respondent’s

pretrial memorandum cites Atwood v. Commissioner, T.C. Memo.

1999-61.    Atwood involved taxpayers who had borrowed against the

cash value of the insurance policies that they owned.

     The crux of petitioners’ argument is that they were never

the owners of the insurance policy, that they received no loans

to pay policy premiums, that they never received any payments

from the insurance company, and that they, therefore, never

received any income.   Petitioners support this argument by

pointing out that petitioner’s former law firm paid all the

premiums and purchased the policy solely for the purpose of

paying a surviving spouse for a deceased partner’s share in the

firm.   This is corroborated by the letter from the insurance

company addressed to the law firm dated January 13, 2003, which

refers to the law firm as the “policyowner” of the policy and
                                - 9 -

indicates that any income from the policy’s lapse would be the

firm’s income and that a Form 1099-R would be sent to the firm.

     Section 6201(d) provides as follows:

          SEC. 6201(d). Required Reasonable Verification of
     Information Returns.–-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 under subpart B or C of part
     III of subchapter A of chapter 61 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.

     Petitioners have asserted a reasonable dispute to the item

of income reported to the IRS on the information return and

cooperated fully with respondent’s requests.   Accordingly,

respondent has the burden of producing information to show that

petitioners received income.

     There is no evidence in the record that petitioners received

the income in question.   Indeed, the evidence in the record

indicates that the owner of the policy in question was

petitioner’s former law firm.   Petitioner retired from the firm 2

years before the insurance policy lapsed, and neither he nor his

wife received any payments from the insurance company.

Accordingly, we hold that petitioners are not liable for a
                             - 10 -

deficiency in income tax as determined by respondent for the

taxable year 2003.

     To reflect the foregoing,


                                        Decision will be entered

                                   for petitioners.
