                         T.C. Memo. 1997-525



                       UNITED STATES TAX COURT



         VERL W. AND FRANCES M. HADERLIE, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 8856-96.                 Filed November 19, 1997.



     Verl W. and Frances M. Haderlie, pro sese.

     Michael W. Lloyd, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:    Respondent determined a $10,049 deficiency

in petitioners' 1991 income tax that is attributable to one

adjustment.1   That adjustment pertains to a scheme where


     1
       An automatic computational adjustment was also made to
petitioners' claimed Schedule A medical deduction due solely to
the increase in adjusted gross income and a corresponding
increase in the threshold for the medical deduction.
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petitioner Verl W. Haderlie applied for an insurance policy, paid

the $40,653 premium, and $40,653 was returned to him by the

procuring insurance agent.   The insurance agent promoted the

transaction because he received about 118 percent of $40,653 from

the insurance company as an inducement to sell its policies.

Respondent determined that the above-described circumstances

resulted in income to petitioners measured by the cost of the

insurance coverage or the $40,653 premium.

     We first addressed this type of scheme or transaction in

Wentz v. Commissioner, 105 T.C. 1 (1995), and held that the

taxpayer/insured realized income in the amount of the insurance

premium kickbacks from the insurance agent.    Petitioners here

argue that the circumstances of their case vary from Wentz v.

Commissioner, supra, in a manner that would change the outcome.

                         FINDINGS OF FACT

     Petitioners had their legal residence in Idaho Falls, Idaho,

at the time their petition was filed.    Verl W. Haderlie

(petitioner) is a high school graduate and has been involved in

the business of hauling milk by truck.    During 1991, petitioner

was involved in the technical aspects of the process of producing

milk, including the identification and cure of bacterial

problems.   From this activity and a small farming operation,

petitioner earned somewhat less than $50,000 for the 1991 taxable

year.
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     Through a colleague, petitioner learned about Daniel Schwab

(Schwab), an insurance agent who was offering $1,250,000 of life

insurance for a "minimum premium".      After advising the colleague

of his interest, petitioner received a telephone call from

Schwab.   Schwab confirmed that he was offering $1,250,000 of life

insurance for a "minimum premium" and that petitioner would need

a physical exam, paid for by Schwab, and after 1 year, petitioner

could either extend or cancel the policy.     At the time of the

conversation with Schwab, petitioner already owned a whole life

insurance policy with coverage in the range of $100,000 to

$150,000.   At the same time, petitioner believed that his need

for life insurance coverage was in the $300,000 to $500,000

range.

     Thereafter, petitioner met with Schwab, who promoted a

$1,250,000 policy with Royal Maccabees Life Insurance Co.

(Royal), and petitioner agreed to apply for a policy.     Schwab

then accompanied petitioner to a medical center where a physical

exam was administered to petitioner.     Petitioner, during 1991,

remitted separate checks in the amounts of $3,500 and $40,653

made payable to Stable Reserve, Inc. (Stable Reserve), and Royal,

respectively.   Stable Reserve was Schwab's straw entity used as a

conduit for the insurance scheme.    At the same time, Schwab

remitted a $40,653 check to petitioner.     In 1992, Schwab remitted

a $3,500 check to petitioner.   Schwab's $40,653 check to
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petitioner was drawn on an account in the name of "Stable

Reserve, Inc."   Petitioner instructed Schwab to delay the deposit

of petitioner's $40,653 premium check to Royal for a few days in

order to permit petitioner's deposit of the $40,653 Stable

Reserve check from Schwab to fund petitioner's check.

     In addition to remitting the two checks, petitioner signed a

document that contained the recitation that the $40,653 check

payment to him from Stable Reserve (Schwab) was a nonrecourse

loan.   Petitioner and Schwab understood that the signed document

reciting the existence of a nonrecourse loan was prepared and

executed in the event that the Internal Revenue Service looked

into their insurance transaction and that the document had no

substance or effect.   Beginning in 1991, petitioner and his

beneficiary(ies) had the benefit of $1,250,000 in life insurance

coverage from Royal.   The coverage was under a universal life

policy, which differs from a whole life policy in that a

universal life policy more closely reflects current interest

rates thereby improving the accumulation of cash value.    The

$40,653 premium paid by petitioner was competitive with the

premium charged by insurance companies other than Royal.    Schwab,

in turn, was entitled to a commission approximating 118 percent

of the $40,653 1-year's premium on petitioner's Royal life

insurance policy.
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     The Royal insurance arrangement was transacted in Idaho

Falls, Idaho.    Schwab was licensed to conduct insurance business

in Wyoming, but not in Idaho.   Royal was licensed to do business

in Idaho.   Rebating by an insurance agent violates Idaho

insurance law.   An insurance company is permitted to rebate part

or all of an insurance premium under the law of Idaho.    So long

as petitioner made no misrepresentation in applying for the

insurance with Royal, the rebating aspect, although in violation

of Idaho law insofar as the rebate was made by Schwab, would not

invalidate the insurance coverage between Royal and petitioner.

Royal was aware of the rebating after petitioner's policy had

been applied for and came into force, and, because of its view

that petitioner had done nothing illegal, Royal did not attempt

to cancel the policy or contact petitioner.   Royal believed that

only Schwab was involved in illegal activity (rebating).    The

rebating by Schwab also violated the terms of the agreement

and/or relationship between Schwab and Royal.

     Petitioner was under the mistaken impression that after the

first year of the Royal policy, he would have been entitled to

reduced coverage for the next year at a $3,500 premium.     Although

petitioner thought the Royal insurance transaction was unusual,

he was not aware of any illegality or irregularity until after

the policy had been allowed to lapse.   Petitioner's Royal policy

was allowed to lapse at the end of the first year, and just prior
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to that time Schwab approached petitioner with another insurance

transaction with Columbus Life Insurance Co. (Columbus).

     The Columbus transaction was for life insurance coverage

beginning during 1993 and was, in most respects, substantially

similar to the Royal transaction.   The Columbus transaction

differed from the Royal transaction as to the amount of coverage

($1,000,000 as opposed to $1,250,000), the absence of a document

indicating a nonrecourse loan, and in the Columbus transaction

petitioner refused to execute a premium check to Columbus.     In

the Columbus transaction, Schwab paid petitioner's premium

directly to Columbus.

     Petitioners did not report any income in connection with the

Royal/Schwab insurance arrangement on their 1991 Federal income

tax return.   Respondent determined that the $40,653 premium (for

1 year) on the Royal life insurance policy was income to

petitioners for 1991.

                               OPINION

     Transactions substantially similar to the one in this case

were considered in Wentz v. Commissioner, 105 T.C. 1 (1995), and

Woodbury v. United States, 72 AFTR 2d 93-6140, 93-2 USTC par.

50,528 (D.N.D. 1993), affd. per curiam without published opinion

27 F.3d 572 (8th Cir. 1994).   In those cases, taxpayers who had

received the benefit of life insurance coverage in situations

where the agent kicked back the premium were found to have income
                                - 7 -


taxable in the year of the transaction in the amount of the

premium that had been paid and kicked back.

     Respondent relies on those cases, arguing that the record in

this case contains no distinction(s) to cause a result different

from the prior cases.    Petitioners, who are pro se, argue that

they should not have to recognize income because of the following

theories:   (1) The "market value was nothing because * * *

[Royal] was not legal in Idaho and neither was * * * [Schwab]”.

(2) Royal was aware of Schwab's illegal rebating scheme and did

nothing because it would have had to pay back the premiums to the

insured, and it was easier for Royal to "let it ride out than pay

back all of the premiums."    We agree with respondent.

     Petitioners' arguments are based on illegality as the reason

why they should not be required to recognize income from the

insurance transaction.    Initially, we note that Royal (insurance

company) was licensed in Idaho, and Schwab (agent) was not

licensed in Idaho.   Petitioners contend that due to either the

illegality of rebating and/or the fact that Schwab was not

licensed to sell insurance in Idaho, the insurance coverage had

no value.   We surmise that petitioners are arguing that the

illegality would have provided Royal with a defense to paying

benefits on the policy in the event that petitioner died while

the policy was in force.    State law and evidence in the record do

not present a defense that Royal could have interposed to a claim
                                 - 8 -


by petitioner’s beneficiary.   A representative of the Idaho

Department of Insurance and a representative of Royal testified

that, short of misrepresentation or wrongdoing by petitioner,

there was no reason why Royal could avoid payment of a claim.

Additionally, the rebating by the agent, although illegal under

State law, did not provide the insurance company with a defense

to a claim on the policy.   There is no evidence of wrongdoing or

any misrepresentation by petitioner.     If there had been some

wrongdoing and/or misrepresentation by petitioner regarding the

policy, Royal may have had a defense to payment on the policy.

The only wrongdoing was a rebating of the premium to petitioner

by Schwab.

     Under Idaho's insurance statutes, unauthorized rebating by

an insurance agent is illegal.    See Idaho Code sec. 41-1314

(1991).   In this case, rebating also violated the terms of the

agreement and contractual relationship between the insurer and

the agent, but has no direct effect on the insured.    Royal might

have had recourse to recover the rebated portion of the premium

(in this case the entire first year premium) from Schwab, but

that does not change the fact that petitioner had the benefit of

1 year's universal life insurance coverage, along with an option

to renew.    As discussed in Wentz v. Commissioner, supra, even if

petitioner had become uninsurable during the year, he could have
                                - 9 -


continued the Royal policy by payment of the premium for each

successive year.

     Petitioners also discuss the fact that they were financially

unable to afford the $40,653 annual premium and that they had to

wait until Schwab's rebate check was credited to petitioner's

bank account before their equal-in-amount premium check to Royal

could be honored.   In that regard, petitioners argue that their

maximum insurance coverage needs were no more than a few hundred

thousand, if they could afford it.      It is irrelevant that the

insurance transaction entered into by petitioner was beyond his

needs or means.    Our focus must be on the benefit or enrichment

petitioners received.   Although the transaction with Royal,

through Schwab, may have been "too good to be true," petitioners

were willing to engage in the transaction because they received a

benefit.   They did not become involved with Schwab out of

disinterested generosity.    Instead, they willingly applied for a

$1,250,000 policy with Royal knowing that they would receive the

benefit of that coverage for a year without any cost.      In order

to obtain that benefit, petitioner signed various documents, took

a physical, and made representations that he was applying for and

accepting $1,250,000 of coverage.    In exchange for that

performance, petitioner received $40,653 from Schwab and/or the

benefit of $40,653 of insurance without payment.      Either way,

petitioners were enriched.
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     It is somewhat ironic that if Royal had offered and/or

authorized its agent (Schwab) to offer petitioner 1 year of

insurance coverage at no cost as an inducement to continue the

coverage in the future, the tax consequences might have been

different.   In that type of circumstance, courts have held that

the "reduced" price or rebate is not taxable to the consumer.

See, e.g., Pittsburgh Milk Co. v. Commissioner, 26 T.C. 707

(1956).   Here, however, the insurance company was not offering a

price reduction or rebate.   Instead, the agent, without the

insurer's approval or agreement, devised an illegal scheme to

take advantage of his contractual relationship with the insurer.

The agreement between the insurer and the agent was for the agent

to receive about 118 percent of the first year’s premium as a

commission for selling the policy.     In turn, the agent paid

petitioner the amount of the premium, in exchange for

petitioner’s applying for the insurance coverage.     As a result,

the agent received about 118 percent of 1 year's premium, and

petitioner received the benefit of 1 year's insurance coverage.

Although petitioner may not have understood the technical

distinction between a rebate and a kickback, he was aware that

his payment to the insurance company was repaid to him by the

agent in exchange for his performance.

     We can empathize with petitioners to the extent they relied

on Schwab, did not wish to do anything improper, and never
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anticipated that their involvement would subject them to a tax

burden or possible financial hardship.    Their actions, however,

are well documented, and the tax burden that results in these

circumstances has been considered, analyzed, and explained by

this and other courts.   Petitioner signed an illusory document

reciting that a nonrecourse loan existed in the event that the

Internal Revenue Service looked into their insurance transaction.

Under these circumstances we do not see petitioner as an

unwitting participant.   We also note that petitioners became

involved with Schwab in a subsequent and similar insurance

coverage scheme.   In the subsequent transaction, petitioner had

become leery, refusing to sign any documents or to remit checks

to the insurance company in exchange for a check from Schwab.     In

the subsequent transaction, Schwab paid the insurance company,

and petitioner applied for the insurance and was subjected to a

physical exam in order to be entitled to the insurance coverage.

In either situation, petitioner had to apply for insurance, take

a physical exam, and manifest to the insurer his intent to apply

for insurance.   In exchange for those actions or consideration,

petitioners received the benefit of $1,250,000 of insurance

coverage, which was ultimately paid for by the agent, Schwab.

     To reflect the foregoing,

                                      Decision will be entered for

                                 respondent.
