Court Opinion

ID: 4584566
Source: CourtListenerOpinion
Date Created: 2020-11-06 22:00:24.339909+00
Date Added: 2024-06-11T13:42:30.881766
License: Public Domain

USCA11 Case: 19-12875    Date Filed: 11/06/2020    Page: 1 of 9

                                                                    [PUBLISH]

            IN THE UNITED STATES COURT OF APPEALS

                    FOR THE ELEVENTH CIRCUIT
                      ________________________

                             No. 19-12875
                       ________________________

                D.C. Docket No. 1:17-cv-00326-ALB-SRW

ALAN C. TURNHAM, M.D., et al.,

                                                          Plaintiffs-Appellants,

                                  versus

COMMISSIONER OF INTERNAL REVENUE,

                                                          Defendant-Appellee.

                       ________________________

              On Appeal from The United States District Court
                   For the Middle District of Alabama

                       ________________________

                           (November 6, 2020)
           USCA11 Case: 19-12875          Date Filed: 11/06/2020      Page: 2 of 9

Before NEWSOM and BRANCH, Circuit Judges, and RAY,* District Judge.

RAY, District Judge:

       While the changeover from winter to spring is marked by warmer days and

the greening of landscape, a less desirable indication of the change of seasons is the

obligation to file one’s annual Federal tax return. This duty, though never pleasant,

is a part of our civic and legal responsibility.

       In a sense, the Federal tax structure is the ultimate honor system, as it “is based

on a system of self-reporting.” United States v. Bisceglia, 420 U.S. 141, 145 (1975).

In other words, although independent information is often forwarded to the

government by third parties, our system depends upon taxpayers fairly and honestly

informing the government as to both their income for the previous year and any

deductions that would reduce the taxable amount. And, sometimes the law imposes

a duty upon the taxpayer to inform the Internal Revenue Service (“IRS”) when the

taxpayer has taken a tax deduction that is questionable. This appeal presents just

such a case.

       The Appellants, a medical doctor and the subchapter S Corporation for which

he works, filed suit against the IRS due to penalties it assessed against them for their

failure to inform the IRS about questionable deductions the Corporation took for

*
The Honorable William M. Ray II, United States District Judge for the Northern District of
Georgia, sitting by designation.

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           USCA11 Case: 19-12875           Date Filed: 11/06/2020       Page: 3 of 9

contributions it made for life insurance benefits. For several years, the Corporation

participated in a multi-employer welfare benefit plan designed to provide pre-

retirement and post-retirement life insurance benefits to covered employees. Multi-

employer plans enable small employers to pool their contributions to purchase

insurance for their employees, often at cheaper rates, and the employers may claim

tax deductions for the contributions if they are otherwise deductible as ordinary and

necessary business expenses under I.R.C. § 162(a). See Curcio v. Commissioner,

T.C. Memo. 2010-115, 2010 WL 2134321, at *13 (2010), aff’d, 689 F.3d 217 (2nd

Cir. 2012). While there generally are limitations on the amount of the deduction

allowed (rules §§ 419 and 419A), those limits do not apply if the plan has 10 or more

participating employers and meets other conditions, such as that the employers

cannot normally “contribute more than 10 percent of the total contributions, and the

plan must not be experience rated with respect to individual employers.” 1 Notice

95-34, 1995-1 C.B. 309, 1995 WL 300780, at *1 (June 5, 1995).

       Because the IRS became aware that some financial companies offered multi-

employer welfare benefits plans that included 10 or more employers, but did not

satisfy the other requirements so as to qualify for the full deduction for the

contributions, the IRS issued Notice 95-34 to warn about the types of plans that were

1
 Experience rating is a measurement that the insurance industry uses to evaluate the insurance
risk of an employer based on their experience.
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           USCA11 Case: 19-12875           Date Filed: 11/06/2020      Page: 4 of 9

not entitled to the § 419A(f)(6) deduction.2 When a welfare plan is equivalent to the

plans listed in the notice, or at least substantially similar thereto, the affected

taxpayers benefiting from the deductions must put the IRS on notice of the

questionable nature of the claim,3 so as to allow the IRS an opportunity to examine

the same, such as through an audit.

       The Appellants, however, gave no such notice to the IRS regarding the

deductions they were claiming for the nearly $837,000 in contributions the

Corporation made to its multi-employer benefit plan for 2009-2011. When it found

out nonetheless, the IRS issued the tax penalties pursuant to statute for Appellants’

failure to file the required notices. 4 The Appellants sued to overturn those penalties,

and the district court granted summary judgment to the IRS. Upon review of the

record that is before us on this appeal, and with the benefit of oral argument, we have

no difficulty in determining that the district court correctly granted summary

judgment to the IRS. The subject plan is at least substantially similar to the type of

2
 Tax Problems Raised by Certain Tr. Arrangement Seeking to Qualify for Exemption from Section
419, 1995-1 C.B. 309 (1995) (“Guidance is provided to taxpayers concerning the significant tax
problems raised by certain trust arrangements being promoted as multiple employer welfare
benefit funds exempt from the limits of sections 419 and 419A of the Code. In general, these
arrangements do not satisfy the requirements for exemption under section 419A(f)(6).”).
3
 The required disclosure of participation in these transactions must be made on an annual Form
8886 (Reportable Transaction Disclosure Statement). 26 C.F.R. § 1.6011-4(d).
4
  See Turnham v. United States, 383 F. Supp. 3d 1288, 1289 (M.D. Ala. 2019) (noting “[t]hat
statute [26 U.S.C. § 6707A] imposes penalties on persons who fail to include information on their
returns ‘with respect to a reportable transaction’”).

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          USCA11 Case: 19-12875      Date Filed: 11/06/2020   Page: 5 of 9

plans that the IRS has indicated do not qualify for the exemption and the

corresponding full deduction. Accordingly, we affirm the district court’s decision

that the IRS was correct to issue the penalties on the ground that the Appellants did

not file the required notice.

      The subject employee welfare plan was marketed as the PREPare Plan (the

“Plan”). Participating employers contribute funds to the Affiliated Employers

Health & Welfare Trust (the “Trust”), which then uses these contributions to

purchase and maintain group term life insurance policies and annuity products that

fund the benefits. A participating employer’s contributions to the Trust are divided

into two parts. One portion of the contributions is forwarded by the Trust to the

insurance company, which uses them to pay the premiums required to maintain the

group term life insurance that funds the covered employees’ pre-retirement death

benefits. The second, and indeed the overwhelmingly larger, portion of the

contribution is invested into an annuity contract with the insurance company. Thus,

the Plan provides term life insurance coverage for participating employees until they

retire, and after retirement, the Plan provides them with a certificate of insurance

that is “fully paid-up” (meaning that no further premiums would be owed, ever).

      A most interesting aspect of these transactions is that the promoters of the

Plan advised that, with fully paid up certificates of insurance, “a participant could

make an irrevocable assignment of the beneficiary and, by doing so, move the

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          USCA11 Case: 19-12875        Date Filed: 11/06/2020    Page: 6 of 9

insurance out of his estate; alternatively, he could sell the death benefit to a willing

beneficiary or convert the certificate in whole or in part to a health reimbursement

benefit.” Vee’s Marketing, Inc. v. United States, No. 13-CV-481-BBC, 2015 WL

2450497, at *2 (W.D. Wis. May 21, 2015), aff’d, 816 F.3d 499 (7th Cir. 2016). In

other words, potential participants were told that they “would be the beneficial

owner[s] of the paid-up contract and could add it to [their] estate planning trusts, sell

the contract for cash or trade it for medical benefits.” Id. (covered employees

“[could] sell a portion or all of [their] post-retirement coverage to an independent

settlement company in exchange for a lump-sum or stream of income payment.”).

      Also important is that the Plan, through the investment company, kept track

of the contributions on an employer-by-employer basis, despite that it purported to

aggregate employer contributions to provide group-based benefits.             See Vee’s

Marketing, 2015 WL 2450497, at *2 (noting that the Plan promoter “maintained

records of the contributions by each employer to the Trust, . . . and handled each

participant’s payments separately from those of any other participant”). The Plan

Administrator forwarded employer contributions to the insurance companies with

instructions to apply the premiums to the accounts of specific individually covered

employees; the Trust maintained separate records for each employer, and the insurer

kept detailed accounts of the amounts attributed to each covered employee. The

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          USCA11 Case: 19-12875        Date Filed: 11/06/2020   Page: 7 of 9

insurers also allocated each contribution, per the Plan Administrator, to each

individual employee’s group insurance premium and group annuity account.

      Now, it is true that the Plan documents prohibited participants from accessing

funds contributed to the Trust. Yet, it is also undisputed that the Plan Administrator

withdrew funds attributed to a participating employer’s covered employees from a

group annuity contract and then used those funds to pay group term life insurance

for the same employees. This allowed the Plan Administrator to pay an employer’s

current expenses from amounts that the employer had already contributed but had

been invested in an annuity. The point here is that this set up is less like an

independent (and acceptable) multi-employer benefit plan and more like the listed

“reportable transactions” for which the IRS had indicated would not qualify for an

exemption from the deduction limits.

      These listed transactions “typically are invested in variable life or universal

life insurance on the lives of the covered employees.” 1995-1 C.B. 309. A universal

life insurance policy is a quasi-insurance product in which the premiums partly fund

death benefits and partly accumulate and earn interest to fund future benefits for the

covered person. See Anderson v. Wilco Life Ins. Co., 943 F.3d 917, 920–21 (11th

Cir. 2019). While the investment scheme here did not use universal life insurance

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           USCA11 Case: 19-12875          Date Filed: 11/06/2020      Page: 8 of 9

products in the literal sense, there really isn’t any difference in practical effect. 5 The

combination of a term life policy with a separate (and much larger) annuity product

provided the same generous excess of funds that a universal life policy would itself

provide. And, there is no dispute that a welfare plan using a universal life policy

would likely not be exempt and the contributions thereto would likely not be fully

deductible.

       Another red flag in the subject Plan was the large size of the contributions and

how they were allocated. As to the Appellants, for the three tax years at issue (2009-

2011), only a tiny fraction (roughly 3%) of the nearly $837,000 in contributions was

used to pay the premiums on the group life insurance policy for the Corporation’s

employees. The rest was directed into the group annuity account; yet, the Appellants

claimed a deduction for the entire amount. The result was a significant reduction or

elimination of business income and taxes that would have been due.

       In granting summary judgment to the government, the district court properly

recognized the similarities between the facts of this case and those in Vee’s

Marketing, Inc. decided by the Seventh Circuit. That case involved the same Plan at

issue here and for which the Seventh Circuit found that the IRS correctly assessed

penalties for that taxpayer’s failure to give the same type of notice at issue in this

5
 See Turnham, 383 F. Supp. 3d at 1292 (“That is how the plan was marketed, and that is how it
appeared to operate in practice”).

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          USCA11 Case: 19-12875       Date Filed: 11/06/2020    Page: 9 of 9

case. See Vee's Mktg., Inc. v. United States, 816 F.3d 499, 501 (7th Cir. 2016). In

both cases, the employer contributions were large compared to the cost of the term

insurance, the Plan invested in the products which amounted to the equivalent of

universal life insurance, the trusts owned the insurance contracts, the trust

administrator advised that employees could get benefits by selling their share of the

annuity cash value, and the Plan maintained a separate accounting of the assets per

employer and reflected that separate accounting in reports. We find the holding in

Vee’s Marketing persuasive in the matter before us.

      Having discussed what this case is about, it is important to note that this case

will not decide the ultimate issue as to whether the Appellants were entitled to claim

the questioned deductions; that is the subject of other litigation between the

Appellants and the IRS which is pending in the Tax Court. We do not prejudge who

will prevail in that companion litigation. We find here, however, that as a matter of

law the subject Plan is at a minimum “substantially similar” to the listed transaction

in the IRS Notice, such that the Appellants were required to disclose their

participation in it, as IRS regulations dictated. Because they failed to do so, the IRS

properly issued the penalties against them. Thus, the district court correctly decided

to grant summary judgment to the IRS.

       AFFIRMED.

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