Gerlie v. Richard, et ux. v. Commissioner, TC Memo 2010-159 (7/22/10)

Facts: In late 2001, a husband and wife (taxpayers) purchased three life insurance policies from the same broker. In each instance, the broker, through his corporation, issued a check to the taxpayers to cover the cost of the initial premium on the policies, which the taxpayers deposited. Shortly thereafter, the taxpayers wrote their own check to the insurance companies to pay the premiums on the associated policies.

In return for the premium payments provided by the broker, the taxpayers executed a recourse promissory note in favor of the broker in an amount approximating the total amount of premiums provided to the taxpayers. The note was payable one year from the date of its execution and provided that interest would be paid at a rate of 3% per annum.

On their 2001 federal income tax return, the taxpayers did not report as income any portion of the amounts received from the broker in 2001. The IRS issued a timely notice of deficiency for 2001, requiring the taxpayers to include in income the full amount they received from the rebate—an amount totaling $233,327. Taxpayers appealed the deficiency determination, arguing that the amount they received was in the form of a loan, not a rebate.

Ruling: Relying on previous decisions made in the context of non-recourse notes, the Tax Court held that the recourse nature of the note extended by the taxpayer was immaterial where there was no evidence that the taxpayer intended to repay the notes and thus no genuine indebtedness created by the notes. The Tax Court noted that when a taxpayer purchases insurance coverage but receives a reimbursement of the premium payment from an insurance broker, pursuant to a rebating scheme, the taxpayer has received income within the meaning of IRC Section 61.

Several factors examined by the Court rebutted the notion that the taxpayers intended in good faith to repay the note. Such factors included the fact that (1) there was no evidence of a demand for repayment or any other action by either the taxpayer or broker occasioned by the failure to make the payment when it was due, (2) the taxpayers at the time of trial had not made any payment of principal or interest on the note— some 5½ years after the note was due and (3) there was no evidence that any collateral was provided.

Finding that there was never any genuine indebtedness offsetting the taxpayers’ receipt of $233,327 in premium rebates, the Court confirmed that the taxpayers had taxable income in this amount for 2001.

This article is an excerpt from the August 2010 Central Intelligence – click here for the full edition.