Opinion ID: 4320610
Heading Depth: 3
Heading Rank: 4

Heading: The Commissioner’s Argument

Text: The Tax Court concluded, and the Commissioner now argues, that the economic benefits should be treated as individual income—rather than as a shareholder distribution—because John Machacek received life insurance as part of a compensatory split-dollar arrangement. The Commissioner correctly notes that such treatment would be uncontroversial if the recipient of the economic benefits were an ordinary employee, rather than an S corporation’s shareholderemployee. The distinction between John Machacek’s different roles—employee and shareholder—is therefore key to the Commissioner’s position. In response to the Machaceks’ reliance on § 1.301-1(q)(1)(i), the Commissioner points only to the distinction between compensatory and shareholder arrangements. The Commissioner recognizes that § 1.301-1(q)(1)(i) applies to both compensatory and shareholder arrangements but concludes that it “does not mean that in any situation where a compensatory arrangement covers a shareholder, the taxpayer’s status as a shareholder trumps his status as an employee, causing the economic benefit to be treated as a distribution to a shareholder,” because “[s]uch an interpretation of the regulation would make no sense, as it would defeat the reason for distinguishing between a compensatory arrangement and a shareholder arrangement.” (Appellee’s Br. at 37.) The Commissioner does not set out what it sees to be “the reason for distinguishing between a compensatory arrangement and a shareholder arrangement,” and it is not clear that treating all economic benefits to shareholders as distributions would undermine the purpose of the regulations. The structure of the split-dollar regulations implies that the No. 17-1131 Machacek, et al. v. Commissioner Page 9 regulations were intended to broaden the scope of the term. Indeed, commentators at the time the regulations were passed recognized that split-dollar arrangements were defined “so broad[ly] that arrangements not previously considered split-dollar may well be swept within its scope.” Margaret Gallagher Thompson, The Final Split-Dollar Regulations: The IRS Offers Up a Complex Array of Rules, Journal of Accountancy (Feb. 1, 2004), https://www.journalofaccountacy.com/issues/2004/feb/thefinalsplitdollarregulations.html. Further, the split-dollar regulations apply to all situations, not just situations where the nonowner of the policy is a shareholder, and thus there are obvious reasons for distinguishing between shareholder and compensatory arrangements. Finally, the Commissioner notes that “Machacek, Inc. will be entitled to a deduction in a future tax year,” pursuant to 26 C.F.R. § 1.83-6(a)(5), “when it actually transfers ownership of the policy to John Machacek.” (Appellee’s Br. at 41; see also id. at 26.) The Commissioner appears to rely on a possible future deduction as a way to counter the Tax Court’s acknowledgement that the result below “may seem aberrational.” The Commissioner argues that “it is [the Machaceks], not the Commissioner, who are arguing for an inequitable result under which they would escape taxation on the accumulation value of the policy, and realize an additional tax advantage when their corporation deducts the cost of the policy in the future.” (Appellee’s Br. at 41.) However, the Machaceks will also have personal tax consequences when the policy is transferred.