                             T.C. Memo. 2018-155



                        UNITED STATES TAX COURT



 RUBEN DE LOS SANTOS AND MARTHA DE LOS SANTOS, Petitioners v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 5458-16.                         Filed September 18, 2018.



      David M. Henderson, for petitioners.

      Elizabeth S. McBrearty, David Weiner, and Angela B. Reynolds, for

respondent.



                          MEMORANDUM OPINION


      LAUBER, Judge: With respect to petitioners’ Federal income tax for 2011

and 2012, the Internal Revenue Service (IRS or respondent) determined deficien-

cies of $588,637 and $615,546, respectively. It also determined accuracy-related

penalties under section 6662A, which covers “reportable transaction understate-
                                         -2-

[*2] ments,” and alternatively under section 6662(a).1 Currently before the Court

are the parties’ cross-motions for partial summary judgment.

      Petitioner husband was the sole shareholder of an S corporation that em-

ployed him and his wife. It made contributions of $1.8 million to an employee

welfare benefit plan, which purchased a life insurance policy with a face value of

$12.5 million covering petitioners’ lives. The question presented is whether this

arrangement generated current taxable income for petitioners as a “split-dollar”

life insurance arrangement under section 1.61-22(b), Income Tax Regs.

      The arrangement here resembles the split-dollar arrangement we considered

in Our Country Home Enters., Inc. v. Commissioner, 145 T.C. 1 (2015). Reaching

similar conclusions here to those we reached there, we will grant respondent’s mo-

tion for partial summary judgment and deny petitioners’ cross-motion.

                                     Background

      There is no dispute as to the following facts, which are drawn from the par-

ties’ motion papers, the stipulation of facts, and the exhibits attached thereto. Peti-

tioners resided in Texas when they petitioned this Court.




      1
        All statutory references are to the Internal Revenue Code (Code) in effect
for the years at issue, and all Rule references are to the Tax Court Rules of Prac-
tice and Procedure. We round all monetary amounts to the nearest dollar.
                                         -3-

[*3] Petitioner husband is a medical doctor. During the tax years at issue he was

the sole shareholder of Dr. Ruben De Los Santos MD, PA, an S corporation incor-

porated in Texas (S Corp.) The S Corp. employed Dr. De Los Santos and his wife,

who served as the office manager for the medical practice, as well as four other

individuals. Petitioners received annual salaries of $216,000 and $54,000, respec-

tively. Petitioner husband also included in his income, as the sole shareholder of

the S Corp., 100% of its items of income and expense. See sec. 1366.

A.    The Legacy/Flex Plan

      In July 2004 Legacy Benefit Plans, LLC, an Illinois company (LBP), estab-

lished the Legacy Employee Welfare Benefit Plan (Legacy Plan). The Legacy

Plan was a purported multiple-employer welfare benefit plan under section

419A(f)(6). At all relevant times LBP was the sponsor and administrator of the

Legacy Plan.

      An employer elected to participate in the Legacy Plan by adopting a welfare

benefit plan pursuant to the terms of a master plan. The Legacy Plan offered liv-

ing benefits, including disability benefits, and death benefits. The latter were ulti-

mately payable, upon the death of a covered employee, to that person’s spouse or

designated beneficiary.
                                        -4-

[*4] Participating employers selected the types of benefits to be provided to their

employees. No employee had any right to withdraw from, borrow against, or sur-

render his interest in the Legacy Plan. An employee covered by the Legacy Plan

designated the beneficiary or beneficiaries who would receive death benefits to

which that employee was entitled.

      The Legacy Plan was funded by employer contributions to the Legacy Em-

ployee Welfare Benefit Trust (Legacy Trust). LBP determined the amount of such

contributions through a rate chart, which took into account common risk factors

such as age, gender, number of covered dependents, and benefit terms. The em-

ployees themselves made no contributions to the Legacy Trust and otherwise made

no financial commitment to the Legacy Plan. At no time was the Legacy Trust

recognized by the IRS as tax-exempt under section 501(a).

      All employer contributions to the Legacy Trust were irrevocable and were

thereafter inaccessible by the participating employer and its creditors. Participat-

ing employers and their creditors had no access to the income or assets (including

insurance contracts) held by the Legacy Trust. In no event could the assets held

by the Legacy Trust be used for any purpose other than funding benefits for par-

ticipating employees and their beneficiaries or defraying expenses of plan ad-
                                        -5-

[*5] ministration. The Legacy Trust invested the contributed funds in multiple

asset classes, including cash, stock, bonds, and life insurance contracts.

      In December 2010 the Legacy Plan was merged into the Legacy Employee

Flex Benefit Plan (Flex Plan). The Legacy Trust thereupon transferred its assets to

the Legacy Employee Flex Benefit Trust (Flex Trust). The Flex Plan enabled par-

ticipating employers to offer their employees a wider range of living benefits, such

as day care and vacation benefits. But the operative provisions of the Flex Plan

and the Flex Trust were otherwise substantially similar to the operative provisions

of the Legacy Plan and the Legacy Trust as described above. For convenience we

will sometimes refer to these entities collectively as the Legacy/Flex Plan and the

Legacy/Flex Trust.

B.    The S Corp.’s Participation in the Legacy/Flex Plan

      In October 2006 the S Corp. elected to participate in the Legacy Plan by ex-

ecuting an adoption agreement with an effective date of November 14, 2006. The

S Corp. selected the benefits to be provided to petitioners and its four other em-

ployees under the Legacy Plan. Petitioners were entitled thereunder to a $12.5

million death benefit, and the S Corp.’s four rank-and-file employees were entitled

to a $10,000 accidental death and dismemberment (AD&D) benefit. Under the

Flex Plan petitioners continued to receive a $12.5 million death benefit; the rank-
                                          -6-

[*6] and-file employees received a $10,000 death benefit and several flexible

benefits, including a critical illness benefit and a prepaid legal benefit.

      The Legacy Plan required that life insurance be purchased to fund the prom-

ised death benefits. In January 2007 the Legacy Trust accordingly purchased a life

insurance policy (Policy) insuring the lives of petitioners. The Policy, issued by

American General Life Insurance Co. (AGLI), was a “flexible premium variable

universal life” policy, with accumulation values based on the investment experi-

ence of a separate fund. The Policy provided base insurance coverage of $12.5

million, equal to the death benefit that the S Corp. had selected for petitioners.

The Legacy Trust (later the Flex Trust) was named as the owner and beneficiary of

the Policy.2

      AGLI considered several risk factors when issuing the Policy, including pe-

titioners’ age and status as nonsmokers. (At the time petitioner husband was age

54 and his wife was age 47.) The policy was a survivor policy, under which AGLI

would pay $12.5 million to the Legacy Trust when the second of petitioners died.




      2
         The original Policy documents list the policy owner as the “Legacy Em-
ployee Benefit Plan and Trust.” But the parties have stipulated that the Legacy
Trust was “the owner and beneficiary” of the Policy when it was issued in 2007.
In October 2011 the Flex Trust was substituted as the policy owner and bene-
ficiary.
                                        -7-

[*7] The Legacy Trust in turn would pay $12.5 million to the beneficiary or

beneficiaries whom petitioners had designated.

      The Legacy Trust invoiced the S. Corp. for the required upfront contribu-

tions. Each invoice showed $100 as the cost of AD&D coverage for the four rank-

and-file employees, with the balance attributable to the cost of the Policy. During

2006-2010 the S Corp. made to the Legacy Trust the following contributions,

which it treated as tax-deductible expenses of the medical practice:

                         Date                 Contribution

                     11/14/2006               $372,446
                     12/05/2007                 372,446
                     10/08/2008                 372,486
                     11/19/2009                 372,485
                     10/27/2010                 372,486
                      Total                   1,862,349

      During 2007-2012 the Legacy Trust (and later the Flex Trust) paid premi-

ums on the Policy as follows:

                         Date              Premium paid

                     02/24/2007                $353,767
                     03/24/2008                 353,767
                     02/20/2010                  75,000
                     02/24/2011                  51,000
                     02/24/2012                  51,000
                      Total                     884,534
                                         -8-

[*8] Because of these premium payments and the investment gains thereon, the

“accumulation value” of the Policy was $640,358 at the end of 2011 and $744,460

at the end of 2012, according to the quarterly statements issued by AGLI.

      If an employer participating in the Flex Plan made all required contributions

before December 1, 2011, and thereafter terminated participation, employees who

were entitled to death benefits would continue to receive that coverage for the rest

of their lives. The S Corp. had made, by October 27, 2010, all contributions re-

quired to fund the promised death benefits. Because subsequent events could not

cause petitioners to lose their entitlement to the $12.5 million death benefit, they

were fully vested in that benefit during the tax years at issue.

C.    Tax Return Filings

      Petitioners timely filed joint Federal income tax returns for 2011 and 2012,

reporting adjusted gross income of $830,370 and $927,797, respectively. They

did not report on these returns any income related to their participation in the

Legacy/Flex Plan. On December 4, 2015, the IRS issued petitioners a timely no-

tice of deficiency for 2011 and 2012, in which it determined deficiencies and pen-

alties on the basis that petitioners had received taxable economic benefits from

their participation in the Legacy/Flex Plan. Petitioners timely petitioned this

Court for redetermination.
                                         -9-

[*9]                                 Discussion

       The purpose of summary judgment is to expedite litigation and avoid un-

necessary and time-consuming trials. See FPL Grp., Inc. & Subs. v. Commission-

er, 116 T.C. 73, 74 (2001). We may grant summary judgment or partial summary

judgment when there is no genuine dispute of material fact and a decision may be

rendered as a matter of law. Rule 121(b); Elec. Arts, Inc. v. Commissioner, 118

T.C. 226, 238 (2002). The parties agree on all material facts relevant to the issues

we must decide, and they have expressed that consensus by filing cross-motions

for partial summary judgment. We conclude that these issues may be adjudicated

summarily.

       Respondent contends that the Policy issued on petitioners’ lives incident to

their participation in the Legacy/Flex Plan was part of a compensatory split-dollar

life insurance arrangement under section 1.61-22(b)(2), Income Tax Regs., and

that petitioners must include in gross income the economic benefits thus conferred

on them. Petitioners do not dispute that economic benefits received from a split-

dollar life insurance arrangement constitute taxable income. Rather, they contend

that their participation in the Legacy/Flex Plan did not involve a split-dollar ar-

rangement.
                                        - 10 -

[*10] A.     Governing Legal Framework

      The term “split-dollar” was originally applied to life insurance arrangements

under which an employer paid part of the premiums on a policy insuring an em-

ployee’s life, with the understanding that the employer would recover part or all of

the premiums from the insurance proceeds. See Rev. Rul. 64-328, 1964-2 C.B. 11,

revoking Rev. Rul. 55-713, 1955-2 C.B. 23. In September 2003 the Department of

the Treasury issued final regulations that define split-dollar life insurance arrange-

ments more comprehensively. T.D. 9092, 2003-2 C.B. 1055; see sec. 1.61-22,

Income Tax Regs. These regulations govern all split-dollar life insurance

arrangements entered into or materially modified after September 17, 2003. Sec.

1.61-22(j), Income Tax Regs.; see Our Country Home Enters., Inc., 145 T.C. at

38-39. The parties agree that these regulations govern the outcome here.

      The regulations generally define a split-dollar life insurance arrangement to

include any arrangement (other than group-term life insurance) between an owner

of a life insurance contract and a non-owner of the contract if certain conditions

are met. Sec. 1.61-22(b)(1), Income Tax Regs. One of these conditions is that one

party must be entitled to recover from the insurance proceeds “all or any portion”

of the premiums previously paid. Id. subpara. (1)(ii). Because the arrangement at

issue here does not meet that condition, respondent does not contend that petition-
                                        - 11 -

[*11] ers’ participation in the Legacy/Flex Plan constituted a split-dollar

arrangement under the general definition set forth in the regulations.

      The regulations set forth a “special rule,” however, that applies “regardless

of whether the criteria of paragraph (b)(1) of this section are satisfied.” Id.

subpara. (2)(i). Under this special rule, an arrangement is treated as a split-dollar

life insurance arrangement if it is either a compensatory arrangement or a share-

holder arrangement. See id. subpara. (2)(ii) and (iii). Because neither party con-

tends that the Legacy/Flex Plan involved a shareholder arrangement, the question

we must decide is whether it constituted a compensatory arrangement.

      An arrangement between an owner and a non-owner of a life insurance con-

tract constitutes a compensatory arrangement if three conditions are met. First, the

arrangement must be entered into “in connection with the performance of serv-

ices” and must not be “part of a group-term life insurance plan described in section

79.” Id. subdiv. (ii)(A). Second, the employer or other service recipient must pay,

“directly or indirectly, all or any portion of the premiums” on the policy. Id. sub-

div. (ii)(B). Third, as relevant here, the beneficiary of the death benefit must be

“designated by the employee or service provider” or must be a person “whom the

employee or service provider would reasonably be expected to designate as the

beneficiary.” Id. subdiv. (ii)(C)(1).
                                        - 12 -

[*12] “[T]he person named as the policy owner of [a life insurance] contract gen-

erally is the owner of such contract.” Id. para. (c)(1). However, the regulations

include attribution rules that apply in the case of compensatory arrangements. See

id. subpara. (1)(iii). If the arrangement is entered into in connection with the

performance of services, the employer or other service recipient “is treated as the

owner of the life insurance contract” if the owner is (among other things) a “wel-

fare benefit fund within the meaning of section 419(e)(1).” Id. subdiv. (iii)(C).

      The Federal income tax consequences of a split-dollar life insurance ar-

rangement are generally determined either through the economic benefit provi-

sions of section 1.61-22(d) through (g), Income Tax Regs., or through the loan

provisions of section 1.7872-15, Income Tax Regs. See Estate of Morrissette v.

Commissioner, 146 T.C. 171, 179 (2016); Our Country Home Enters, Inc., 145

T.C. at 49-50. The parties agree that, if we find the Legacy/Flex Plan to involve a

split-dollar life insurance arrangement, the economic benefit provisions will apply

here. Under those provisions, the owner of the life insurance contract is treated as

providing current economic benefits to the non-owner of the policy. See sec. 1.61-

22(d)(1), Income Tax Regs.
                                        - 13 -

[*13] B.     Analysis

      Petitioners first contend that there can be no split-dollar arrangement here

because the Legacy/Flex Plan is not “life insurance.” This contention is mis-

guided. The regulations provide that a compensatory split-dollar arrangement

exists if specified criteria are met with respect to an owner and a non-owner of “a

life insurance contract.” Sec. 1.61-22(b)(2), Income Tax Regs. Petitioners do not

dispute (and they could not plausibly dispute) that the Policy is a “life insurance

contract” as defined by section 7702(a). The Policy was issued by AGLI, a life

insurance company, and provides insurance of $12.5 million on petitioners’ lives.

      Petitioners contend that the Legacy/Flex Plan is not life insurance because it

lacks a sufficient element of risk. But it is irrelevant under the regulations whether

the Legacy/Flex Plan as whole constitutes life insurance. The relevant fact is that

this Plan required that life insurance be purchased to fund the promised death

benefit, and the Trust purchased the Policy for that reason.

      The first step of the analysis requires that we identify the owner of the

Policy under the regulatory attribution rules. The Legacy Trust (later the Flex

Trust) was the named owner of the Policy. But when a split-dollar arrangement is

entered into in connection with the performance of services, the employer “is

treated as the owner of the life insurance contract” if the actual owner is (among
                                        - 14 -

[*14] other things) a “welfare benefit fund within the meaning of section

419(e)(1).” Sec. 1.61-22(c)(1)(iii)(C), Income Tax Regs.

      Section 419(e)(1) defines a welfare benefit fund as a fund that is part of an

employer plan and through which the employer “provides welfare benefits to

employees or their beneficiaries.” Section 419(e)(2) generally defines a welfare

benefit as any benefit other than a benefit covered by section 83(h) (property

transferred in connection with performance of services), section 404 (deferred

payment plan), or section 404A (foreign deferred compensation plan).

      Petitioners do not challenge the status of the Legacy Trust (and later the

Flex Trust) as a welfare benefit fund within the meaning of section 419(e)(1).

Section 419(e)(3) defines a fund to include “any trust, corporation, or other

organization not exempt” from Federal income tax. Neither the Legacy Trust nor

the Flex Trust was tax exempt under section 501(a). Each trust was “part of the

plan of an employer” through which the S Corp. “provide[d] welfare benefits to

employees or their beneficiaries.” See sec. 419(e)(1)(A) and (B). And the benefits

thus provided were welfare benefits because they were not covered by section

83(h), 404, or 404A. See sec. 419(e)(2). For purposes of applying the split-dollar

regulations, therefore, the S Corp. is treated as the owner of the Policy and peti-

tioners are treated as the “non-owners.” See sec. 1.61-22(c)(1) and (2), Income
                                        - 15 -

[*15] Tax Regs.; cf. Our Country Home Enters., Inc., 145 T.C. at 40 (reaching the

same conclusion on the basis of the taxpayer’s concession).

      The first prong of the test for a compensatory arrangement requires that the

arrangement between the owner and the non-owner be entered into “in connection

with the performance of services” and not be “part of a group-term life insurance

plan described in section 79.” Sec. 1.61-22(b)(2)(ii)(A), Income Tax Regs.

Petitioners concede that the S Corp. provided them benefits under the Legacy/Flex

Plan “in connection with the performance of services.” However, they contend

that the insurance coverage they received under the Policy was part of a “group-

term life insurance plan.” That is assertedly so because all of the S Corp.’s eligi-

ble employees “received death benefits from the Flex Plan, in varying amounts,”

and because eligibility to receive such benefits “was based solely on factors re-

lated to employment,” such as years of service.

      Petitioners’ argument misses the mark for at least two reasons. First, the

insurance coverage that funds petitioners’ promised death benefits is not group-

term life insurance. See sec. 79(a). The Policy insuring petitioners’ lives covers

them alone, and it does not provide term insurance. Rather, it is a self-described

“flexible premium variable universal life insurance” policy with accumulation

values based on the investment experience of a separate fund. See Norem v.
                                         - 16 -

[*16] Lincoln Ben. Life Co., 737 F.3d 1145, 1147 (7th Cir. 2013) (distinguishing

a “Flexible Premium Variable Life Insurance Policy” from term life insurance).

      Second, “[l]ife insurance is not group-term life insurance for purposes of

section 79” unless “[t]he amount of insurance provided to each employee is com-

puted under a formula that precludes individual selection.” Sec. 1.79-1(a)(4),

Income Tax Regs. This requirement is not satisfied if the formula takes into ac-

count the personal risk characteristics of particular employees. See Our Country

Home Enters., Inc., 145 T.C. at 41-42.

      Eligibility to receive benefits under the Legacy/Flex Plan was open to all six

S Corp. employees. But petitioners have not established that “[t]he amount of in-

surance provided to each employee [wa]s computed under a formula that precludes

individual selection.” See sec. 1.79-1(a)(4), Income Tax Regs. (emphasis added).

Petitioners were entitled to a death benefit of $12.5 million. Each petitioner

enjoyed the same benefit, even though petitioner husband was seven years older

than his wife and earned a salary four times higher. The four rank-and-file em-

ployees were entitled to no death benefits under the Legacy Plan (only to a

$10,000 AD&D benefit) and were entitled under the Flex Plan to a modest death

benefit of $10,000.
                                        - 17 -

[*17] Petitioners have not explained what computational formula--based on age,

compensation, or other objective criteria--could produce a distribution of benefits

that looks like this. Even if there were some “theoretical possibility” that this dis-

parity could have resulted without individual selection, the formula “did not in fact

preclude individual selection.” See Whitcomb v. Commissioner, 81 T.C. 505, 519

(1983), aff’d, 733 F.2d 191 (1st Cir. 1984). It seems obvious that the discrimina-

tory pattern displayed by the S Corp.’s selection of benefits reflected “individual

selection” by or on behalf of petitioners. See Towne v. Commissioner, 78 T.C.

791, 798 (1982) (holding that an insurance policy was not part of a group-term

insurance plan because it individually selected the company’s president to receive

$500,000 of excess coverage). Moreover, the Policy insuring petitioners’ lives

took into account their personal risk characteristics, including their nonsmoker

status. See Our Country Home Enters., Inc., 145 T.C. at 42.

      The second prong of the test for a compensatory arrangement requires that

the employer or other service recipient pay, “directly or indirectly, all or any por-

tion of the [life insurance] premiums.” Sec. 1.61-22(b)(2)(ii)(B), Income Tax

Regs. During 2006-2010 the S Corp. made contributions in excess of $1.8 million

to the Legacy Trust, which used those contributions to pay premiums of $884,534
                                        - 18 -

[*18] on the Policy insuring petitioners’ lives. The S Corp. was petitioners’

employer and it paid (through the Legacy Trust) all of the premiums on the Policy.

      Petitioners contend that the second prong is unsatisfied because the Legacy

Trust did not pay these premiums immediately upon receipt of the S Corp.’s con-

tributions, but several months or years later, after commingling the cash with cash

supplied by other participating employers. This argument ignores the language of

the regulation, which states that an employer can effect premium payments “di-

rectly or indirectly.” Ibid. By supplying the Legacy Trust with the cash to pay the

premiums, the S Corp. paid those premiums indirectly. The regulations contem-

plate exactly this sort of indirect payment by providing that the employer will be

treated as the owner of a life insurance contract that is actually owned (for exam-

ple) by a welfare benefit fund. See id. para. (c)(1)(iii)(C), Income Tax Regs. In

such cases, the employer will typically supply to the fund (or to its associated

trust) the cash with which to pay the premiums, as happened here.

      The third prong of the test for a compensatory arrangement requires either

that the employee have an “interest in the policy cash value of the life insurance

contract” or that the beneficiary of the death benefit be “designated by the employ-

ee” or be a person whom the employee “would reasonably be expected to desig-

nate as the beneficiary.” Id. para. (b)(2)(ii)(C). The latter requirement is clearly
                                        - 19 -

[*19] met here. Petitioners admit that they named the Legacy Trust (and later the

Flex Trust) as the beneficiary of the $12.5 million death benefit under the Policy.

And the Legacy Trust was obligated to pay that $12.5 million death benefit to the

beneficiary or beneficiaries whom petitioners had designated. As we concluded in

Our Country Home Enters., Inc., the fact that the “proceeds from the life insurance

policies are funneled through the * * * [welfare benefit] Plan to each of the ulti-

mate recipients does not blur our view (or our conclusion) that each of those recip-

ients is the beneficiary of the death benefit” for purposes of the split-dollar regu-

lations. 145 T.C. at 44-45.3

      In sum, we conclude that the arrangement at issue satisfied all three criteria

required to create a compensatory arrangement under the regulations. We ac-

cordingly hold that the Policy issued on petitioners’ lives incident to their partici-

pation in the Legacy/Flex Plan was part of a compensatory split-dollar life insur-

ance arrangement under section 1.61-22(b)(2), Income Tax Regs.




      3
        Petitioners assert that, because the Legacy/Flex Trust was not related to
them, they could not gain from naming it the beneficiary of the death benefit. As
noted in the text, we rejected this same argument in Our Country Home Enters.,
Inc., 145 T.C. at 44-45. Petitioners effectively designated the recipients of the
death benefit because they were assured that the Legacy/Flex Trust would imme-
diately pay the death benefit to the beneficiary or beneficiaries whom petitioners
had named.
                                       - 20 -

[*20] C.     Unreported Income

       The Federal income tax consequences of a split-dollar life insurance ar-

rangement are generally determined through one of two regimes: the economic

benefit regime or the loan regime. See Our Country Home Enters., Inc., 145 T.C.

at 49-50. Compare sec. 1.61-22(a)(2), (b)(3)(i), Income Tax Regs., with sec.

1.7872-15(a)(2)(i)(B), Income Tax Regs. The parties agree that the loan regime

does not apply here.

      Under the economic benefit regime, the non-owner of the life insurance

contract (here, petitioners) “must take into account the full value of all economic

benefits described in paragraph (d)(2) of this section, reduced by the consideration

paid * * * by the non-owner to the owner for those economic benefits.” Sec.

1.61-22(d)(1), Income Tax Regs. The parties agree that petitioners paid no con-

sideration to the S Corp. for the benefits they received under the Legacy/Flex Plan.

      As relevant here, “[t]he value of the economic benefits provided to a non-

owner,” id. para. (d)(2), equals the sum of two amounts. The first amount is the

“cost of current life insurance protection provided to the non-owner.” Id. subpara.

(2)(i). The parties agree that the cost of such current protection was $178 for 2011

and $213 for 2012.
                                        - 21 -

[*21] The second amount--the focus of dispute here--is “[t]he amount of policy

cash value to which the non-owner has current access within the meaning of para-

graph (d)(4)(ii) of this section (to the extent that such amount was not actually

taken into account for a prior taxable year).” Id. subpara. (2)(ii). The non-owner

“has current access to that portion of the policy cash value” to which he or she

“has a current or future right” if specified conditions are met. Id. subpara.

(4)(ii)(A). Even if the non-owner cannot extract cash from the policy currently, he

is treated as having “current access” to that portion of the policy cash value to

which he has a future right if such portion “is inaccessible to the owner” of the

policy (i.e., the employer) or is “inaccessible to the owner’s general creditors.” Id.

subdiv. (ii)(B).

      Petitioners had a “future right” to the Policy cash value because they had the

exclusive right to designate who would receive death benefits under the Policy.

See Our Country Home Enters., Inc., 145 T.C. at 45-46, 53-54. Moreover, once a

participating employer had made contributions to the Legacy/Flex Trust, those

contributions were irrevocable and were inaccessible to the employer and its credi-

tors. Employers and their creditors likewise had no access to the income or assets

(including insurance contracts) held by the Legacy/Flex Trust. Thus, although

petitioners during 2011-2012 could not withdraw funds from the Policy or the
                                        - 22 -

[*22] Legacy/Flex Plan, the Policy cash value, in its entirety, was “inaccessible to

the owner” (i.e., the S Corp.) and was “inaccessible to the owner’s general credit-

ors.” See sec. 1.61-22(d)(4)(ii)(B), Income Tax Regs.4

      Although the Legacy/Flex Plan documents make clear that the Policy cash

value was not subject to the claims of any participating employer or its creditors,

petitioners assert that a clawback provision in the bankruptcy code could lead to a

different outcome. Under 11 U.S.C. sec. 548(e)(1) (2012), a bankruptcy trustee

may claw back any transfers made by a debtor within 10 years of the petition date

if the transfer (among other things) was made to a self-settled trust or to a similar

device whose beneficiary was the debtor. This provision is irrelevant here. The

Legacy and Flex Trusts were not self-settled trusts. And the S Corp., the debtor in

the scenario petitioners imagine, was not a beneficiary of the Legacy or Flex Trust.




      4
        Petitioners insist that they enjoyed no economic benefit beyond the cost of
current insurance protection--i.e., $178 for 2011 and $213 for 2012--because they
could not withdraw cash from the Policy or from the Legacy/Flex Plan currently.
This argument ignores the governing regulation, which explicitly states that a non-
owner possessing future rights “has current access to that portion of the policy
cash value” that is “inaccessible to the owner” or “inaccessible to the owner’s gen-
eral creditors.” Sec. 1.61-22(d)(4)(ii)(B), Income Tax Regs.
                                        - 23 -

[*23] We accordingly hold that petitioners had “current access” to the entire cash

value of the Policy during 2011 and 2012. The economic benefit provided to them

during those years was not limited to the cost of current life insurance protection,

but also included the amount of policy cash value to which they had current ac-

cess, “to the extent that such amount was not actually taken into account for a

prior taxable year.” Sec. 1.61-22(d)(2)(ii), Income Tax Regs. We leave to further

proceedings the computation of the exact amounts to be included in petitioners’

gross income for each year, as well as a determination as to whether they are liable

for accuracy-related penalties under section 6662A or 6662(a).

      To reflect the foregoing,


                                                 An appropriate order will be issued.
