                  T.C. Summary Opinion 2005-26



                     UNITED STATES TAX COURT



    JULIE J. REVOLINSKI AND KENNETH T. WHITE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3860-04S.               Filed March 14, 2005.


     Julie J. Revolinski and Kenneth T. White, pro sese.

     Gavin L. Greene, for respondent.



     ARMEN, Special Trial Judge:   This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time that the petition was filed.1   The decision to




     1
        Unless otherwise indicated, all subsequent section
references are to the Internal Revenue Code in effect for 2001,
the taxable year in issue, and all Rule references are to the Tax
Court Rules of Practice and Procedure. All monetary amounts are
rounded to the nearest dollar.
                               - 2 -

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

should not be cited as authority.

     Respondent determined a deficiency in petitioners’ Federal

income tax for the taxable year 2001 of $1,342.

     The issue for decision is whether a distribution of $8,944

resulting from the surrender of a life insurance policy is

includable in petitioners’ gross income.   We hold that it is.

Background

     Some of the facts have been stipulated, and they are so

found.   We incorporate by reference the parties’ stipulation of

facts and accompanying exhibits.

     At the time that the petition was filed, petitioners resided

in Santa Cruz, California.

     On July 17, 1987, Kenneth T. White (petitioner) acquired a

universal life insurance policy (the policy) with Pacific Mutual

Life Insurance Co. (Pacific Life).

     The policy entitled petitioner to withdraw funds against the

policy’s accumulated value.   The policy defined accumulated value

as the net amount of premiums (premiums paid less premium load

charge) plus interest and dividends earned minus deductions

(e.g., withdrawal amounts, mortality charges, administrative

charges, insurance loads, and rider chargers).

     The policy also entitled petitioner to borrow against the

policy as collateral up to the loan value available.   The policy
                                   - 3 -

defined loan value as the cash surrender value less loan interest

and fees associated with the policy.         The policy defined cash

surrender value as the accumulated value less the surrender

charge and any policy loan debt.      The policy required loan

repayment at any time before the lapse of the policy, but loan

interest was payable in advance, with any unpaid interest to be

added to the loan principal.

     Between 1987 and 1992, petitioner paid premiums on the

policy as follows:

                      Year         Amount Paid

                      1987           $6,260
                      1988              780
                      1989              520
                      1990            5,520
                      1991            1,000
                      1992              485
                        Total        14,565

     Between December 1993 and October 1994, petitioner contacted

Pacific Life to request funds from the policy allegedly for a

downpayment on a home.2      Petitioner received the following

distributions:

            Date           Loan            Interest   Payment
          Processed       Amount            Charged   Amount

          12/13/93        $5,159             $159     $5,000
           2/17/94         2,044               44      2,000
           5/17/94         1,513               13      1,500
          10/3/94          7,716              316      7,400
           Total          16,432              532     15,900


     2
        It appears that petitioner made his requests by
telephone.
                               - 4 -

Pacific Life classified these distributions as policy loans.    For

each distribution, Pacific Life issued to petitioner a policy

loan statement indicating the amount of the loan, the interest

charged, and the outstanding loan balance.   Petitioner was not

required to sign any formal loan agreements with respect to these

distributions.   Petitioner never contacted Pacific Life regarding

the classification of these distributions as policy loans.

     Throughout the life of the policy, Pacific Life sent

petitioner an account statement at the end of each policy year

reporting the following: Beginning accumulated value for the

year, premiums paid, premium load charge, cost of insurance

charges (mortality charges, administrative charges, insurance

loads, and rider charges), interest earned, withdrawal amount,

dividends earned, the accumulated value at the end of the year,

current surrender charge, current loan debt (including unpaid

loan interest), and current cash surrender value.   According to

the account statements, the accumulated value of the policy on

July 16, 1988, increased from $5,729 to $23,467 as of July 16,

2001.

     On August 7, 2001, petitioner surrendered the policy.    As of

that date, petitioner’s investment in the policy was $14,565, the

accumulated value was $23,509, the outstanding loans plus accrued

interest payable was $23,125, and the cash surrender value
                              - 5 -

totaled $384 (i.e., $23,509 less $23,125), which petitioner

received in cash.

     For the taxable year 2001, Pacific Life issued a Form 1099-

R, Distributions From Pensions, Annuities, Retirement or Profit-

Sharing Plans, IRAs, Insurance Contracts, etc., reporting a gross

distribution of $23,509 and a taxable distribution of $8,944.

Pacific Life computed the taxable distribution as the accumulated

value of $23,509 less petitioner’s investment in the policy of

$14,565.

     Petitioners did not report the distribution of $8,944 on

their 2001 Federal income tax return.   Respondent determined that

petitioners received gross income of $8,944 from the surrender of

the policy.

     Petitioners timely filed with the Court a petition

challenging respondent’s determination.   Paragraph 4 of the

petition states, in part:

     I took out most of the cash surrender value of this
     policy in 1993-94 totaling $14,400 as down payment on a
     home. I made no payments, nor did I receive any money
     from this account until 2001 when I received $384
     remaining cash value to allow the policy to lapse.
     Total distributions=$14,784. The reported $8,945 was
     kept by Pacific Life in fees and charges and never
     distributed to us. (Note: The insurance load was paid
     by interest earned on my premium; during the 13 years
     the policy was in force it totaled~$3,276. If this
     value is taxable, we would happily pay any tax due on
     it.)
                                - 6 -

Discussion

     Generally, the Commissioner’s determinations are presumed

correct, and the taxpayer bears the burden of proving that those

determinations are erroneous.   Rule 142(a); Welch v. Helvering,

290 U.S. 111, 115 (1933).   The burden of proof may shift to the

Commissioner under section 7491 in certain circumstances.    On the

basis of the record, we hold that section 7491(a) does not

operate to place the burden of proof on respondent; in short,

petitioners did not introduce testimony evidence sufficient to

place in doubt the exactitude of the documentary record.

     Gross income includes income from whatever source derived

including, but not limited to, life insurance contracts.3    Sec.

61(a)(10).   As relevant to this case, any amount which is

received under a life insurance contract on its complete

surrender, and which is not received as an annuity, shall be

included in gross income to the extent it exceeds the investment

in the contract.   Sec. 72(e)(1)(A), (5)(A), (C), (E)(ii).   The

investment in the contract is defined generally as the aggregate

amount of premiums or other consideration paid for the contract

less amounts previously received under the contract, to the

extent such latter amounts were excludable from gross income.

Sec. 72(e)(6).



     3
        The parties do not dispute that the policy is a life
insurance contract. See sec. 7702(a).
                                - 7 -

     Petitioners contend that Pacific Life incorrectly computed

the amounts on Form 1099-R using the policy’s accumulated value

rather than the cash value.   Petitioners argue that the

distributions were withdrawals of petitioner’s investment and

that Pacific Life classified the distributions as loans solely

for internal bookkeeping purposes.      Petitioners allege that

petitioner withdrew his investment of $14,565 as well as

accumulated interest of $932 by October 1994 and that petitioner

received the cash surrender value of $384 in August 2001.      Under

their theory, petitioners compute that they received a gross

distribution of $15,881 ($14,565 + $932 + $384) and that only the

accumulated interest of $1,316 that they actually received is

taxable.   Petitioners’ contention is misplaced.

     Petitioners now challenge for the first time Pacific Life’s

classification of the distributions as true loans.      With respect

to each distribution, however, petitioner received a policy loan

statement clearly identifying each distribution as a policy loan.

In addition, petitioner received annual statements indicating the

outstanding loan balance including interest payable and the

effect of the loan balance to the cash surrender value of the

policy.    We find it remarkable that petitioners contend that the

distributions were not loans when, throughout the life of the

policy, petitioner never contacted Pacific Life to dispute

Pacific Life’s classification of the distributions as loans.
                               - 8 -

Based on the entirety of the record, there is no evidence, other

than petitioner’s self-serving testimony, that the distributions

were anything other than loans under the terms of the policy.

For Federal income tax purposes, petitioner’s policy loans

constituted bona fide indebtedness rather than a withdrawal of

his investment.   See Atwood v. Commissioner, T.C. Memo. 1999-61.

      Next, petitioners argue that Pacific Life’s internal loan

classification created a “fictitious tax liability”.     Under

petitioners’ reasoning, petitioner withdrew the corpus of his

investment, which should have reduced the accumulated value, but

because Pacific Life classified the distributions as loans for

internal bookkeeping purposes, the accumulated value was

artificially inflated and subsequent interest earned was computed

on the basis of the inflated accumulated value.   With respect to

the interest accruing on the inflated accumulated value,

petitioner argues that the interest of $8,944 credited to his

account is not taxable to him because he did not actually receive

it.   Petitioner claims that he received only $15,881 in actual

cash payments and that Pacific Life kept the $8,944 to pay fees

and charges associated with the policy.   We disagree.

      There is no evidence in the record that Pacific Life

classified the distributions as loans solely for internal

accounting purposes.   As stated earlier, the distributions at

issue were policy loans.   Petitioner did not assume any personal
                                 - 9 -

liability for repayment of the loans, and when he surrendered the

policy, the outstanding loan debt (including interest) was

charged against the available proceeds in the policy’s

accumulated value.   This satisfaction of the policy loans was in

effect a pro tanto payment of the policy proceeds to petitioners

and constituted income to them.    See Minnis v. Commissioner, 71

T.C. 1049, 1056 (1979).

     In the alternative, petitioners argue that taxable gain is

calculated using the cash value rather than the accumulated

value.   In support of this contention, petitioners rely on the

use of the term “cash value” in section 72(e)(3)(A) regarding the

allocation of amounts to income and investment.    Section

72(e)(3)(A) provides, in part:

          (3) Allocation of amounts to income and
     investment.--For purposes of paragraph (2)(B)--

                (A) Allocation to income.--Any amount to
           which this subsection applies shall be
           treated as allocable to income on the
           contract to the extent that such amount does
           not exceed the excess (if any) of--

                     (i) the cash value of the
                contract (determined without regard
                to any surrender charge)
                immediately before the amount is
                received, over

                     (ii) the investment in the
                contract at such time. [Emphasis
                added.]

Petitioners’ reliance is misplaced.
                               - 10 -

     The distribution at issue resulted from petitioner’s

surrender of the policy.   As stated earlier, section 72(e)(5)

applies to the surrender of a life insurance contract.    See sec.

72(e)(5)(E).   In contrast, section 72(e)(3) applies only to the

computation of annuities under section 72(e)(2)(B).    In fact,

section 72(e)(5)(A) specifically provides that section

72(e)(2)(B) shall not apply.   Consequently, the computation under

section 72(e)(3)(A) is not applicable.

     For the reasons stated herein, we hold that petitioners

received a taxable distribution of $8,944 resulting from

petitioner’s surrender of the policy.    Accordingly, we sustain

respondent’s determination.

Conclusion

     We have considered all of the other arguments made by

petitioners, and, to the extent that we have not specifically

addressed them, we conclude they are without merit.

     Reviewed and adopted as the report of the Small Tax Case

Division.

     To reflect the foregoing,



                                          Decision will be

                                    entered for respondent.
