Opinion
16685-22
07-17-2024
TIMOTHY LOYAL TINGELSTAD & ANNETTE MARIE TINGELSTAD, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER AND DECISION
Tamara W. Ashford Judge
This matter is before the Court to decide on cross-Motions for Summary Judgment filed by the parties pursuant to Rule 121.
Unless otherwise indicated, Rule references are to the Tax Court Rules of Practice and Procedure, statutory references are to the Internal Revenue Code, Title 26 U.S.C., in effect at all relevant times, and regulation references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times.
On December 26, 2023, petitioners filed a Motion for Summary Judgment. In their motion petitioners contend that no genuine dispute exists as to any material fact and that the Court should find as a matter of law that for the 2019 taxable year they do not owe any additional income tax as a result of Mr. Tingelstad's surrendering a whole life insurance policy with Northwestern Mutual Life Insurance Company (Northwestern Mutual Life).
By Order served on the parties on January 3, 2024, the Court ordered respondent to file a response to petitioners' motion no later than January 23, 2024. On January 22, 2024, respondent filed an Objection to Motion for Summary Judgment, and then the next day he filed a Motion for Summary Judgment, along with a Declaration of Paul A. George in Support of Motion for Summary Judgment.
On January 22, 2024, respondent filed an unopposed Motion for Leave to File Out of Time Motion for Summary Judgment, lodging the summary judgment motion and the declaration; at the time, this case had been calendared for trial at the remote Session of the Court commencing on February 26, 2024, and pursuant to the Court's Standing Pretrial Order for that trial session, summary judgment motions were to be filed by December 28, 2023. On January 23, 2024, the Court granted respondent's motion for leave and his summary judgment motion and declaration were filed as of that date.
In these filings, respondent agrees with petitioners that summary adjudication of this case is appropriate because no material facts are in dispute, but contends that the Court should enter judgment against petitioners.
On February 21, 2024, at the Court's direction, petitioners filed an Objection to Motion for Summary Judgment, reiterating that they are entitled to judgment in their favor as a matter of law.
As explained below, we will grant respondent's motion and deny petitioners' motion.
Background
Petitioners resided in Minnesota when they timely filed their Petition with the Court.
In 2019, Mr. Tingelstad was employed as an attorney; Mrs. Tingelstad was employed as a health coach.
In February 1993, when Mr. Tingelstad was 33 years old, he acquired a $100,000 whole life insurance policy on his life from Northwestern Mutual Life. Mrs. Tingelstad was designated the policy's beneficiary. Under the terms of the policy, Mr. Tingelstad was eligible for dividends, which could be paid to him in cash or used in the following ways: (1) to purchase paid-up additional insurance, (2) to be reinvested in the policy in order to accumulate interest, and (3) to reduce the policy's premiums. Additionally, the policy provided that Mr. Tingelstad could borrow against the policy in an amount not in excess of its cash value. To that end, the policy provided that policy debt consisted of all outstanding loans and accrued interest, and that unpaid interest would be added to loan principal. The policy also provided that Mr. Tingelstad could surrender the policy and receive as a distribution the cash value of the policy less any policy debt.
As reflected on his application for the policy, Mr. Tingelstad selected the policy premium payment option of "Monthly (ISA only)" and thus Northwestern Mutual Life set up an Insurance Service Account (ISA) so that Mr. Tingelstad's premium payments could be made via electronic funds transfers. The ISA history going back to 1999 and up to 2019 for the policy shows that each year the policy dividend either partially or fully paid Mr. Tingelstad's annual premium.
Mr. Tingelstad took out three $10,000 loans against the cash value of the policy. The first loan originated on March 3, 2009; the second loan originated on November 2, 2009; and the third loan originated on September 28, 2010. All loans had an 8% interest rate, which was the rate that Mr. Tingelstad elected as reflected on his application for the policy.
Although the policy stated that a "loan may be obtained on written request," none of Mr. Tingelstad's loan requests were in writing; instead, he made verbal requests. Additionally, although Northwestern Mutual Life did not generate loan documents for each request, petitioners do not dispute that Mr. Tingelstad requested the loans and that he received the loan proceeds.
For at least 2014-18, Northwestern Mutual Life sent Mr. Tingelstad a Life Insurance Annual Policy Statement that showed, inter alia, the total and net death benefit amounts, the total and net cash value amounts, the annual dividend amount and use of the amount, and the total loan balance amount (together with the 8% interest rate).
As of February 2016, Mr. Tingelstad had not made any payments toward his outstanding total loan balance. Consequently, around that time, Northwestern Mutual Life sent Mr. Tingelstad a notice advising him that the balance was now 80% or more of the cash value of the policy and that if the balance continued to grow until it exceeded the policy's cash value, it would cause the policy to terminate. The notice also advised Mr. Tingelstad that surrendering the policy or allowing it to terminate would cause taxable, ordinary income to be reported to him and the Internal Revenue Service (IRS).
Starting in May 2016 and ending in December 2018, Mr. Tingelstad made monthly payments of $500 via the ISA. Northwestern Mutual Life applied those payments (totaling $16,000) to Mr. Tingelstad's outstanding total loan balance.However, on January 2, 2019, Mr. Tingelstad surrendered his policy. Upon surrender, the policy's proceeds paid the outstanding total loan balance (of $42,699.81) in full, and Mr. Tingelstad received $20,308.71 via electronic funds transfer into his checking account at First National Bank; the $20,308.71 represented the net proceeds or value of the policy.
Petitioners assert in their summary judgment motion that the payments made toward the outstanding loan balance totaled $15,500. However, the record includes the loan history maintained by Northwestern Mutual Life with respect to Mr. Tingelstad's policy, which reflects 32 $500 payments totaling $16,000.
At the time of surrender, Mr. Tingelstad's investment in the contract was $25,392.46. Northwestern Mutual Life sent the IRS and Mr. Tingelstad a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for 2019, reflecting a gross distribution of $63,008.52 and $37,616.06 as the taxable amount of the distribution. The former amount represented the cash value of the policy. The latter amount represented the difference between the gross distribution or cash value of the policy and Mr. Tingelstad's investment in the contract of $25,392.46.
Petitioners prepared and timely filed their joint federal income tax return for 2019 (2019 return). Although they reported as income Mr. Tingelstad's wages of $126,978 and taxable interest of $180, they did not report as income either the gross or taxable amounts of the distribution reported by Northwestern Mutual Life on the Form 1099-R ($63,008.52 and $37,616.06, respectively). They also claimed itemized deductions totaling $27,204, reported federal income tax withheld of $15,208, and claimed an overpayment of $1,496, which was apparently refunded to them.
During the IRS's examination of the 2019 return, Mr. Tingelstad contacted Northwestern Mutual Life, questioning whether he had taxable gain as a result of surrendering his policy. In response, Northwestern Mutual Life sent him two letters-one dated January 26, 2022, and the other dated February 17, 2022. In the January 26, 2022, letter, Northwestern Mutual Life explained how, in accordance with federal tax law, the reported taxable gain (of $37,616.06) was calculated; first, the policy's cost basis was determined (the difference between total premiums paid ($55,198.30) and total dividends ($29,805.84)) and then a comparison was made between the policy's accumulated cash value ($63,008.52) and the cost basis ($25,392.46). In the February 17, 2022, letter, Northwestern Mutual Life explained the effect of the loans and the payments made toward the loans; to wit, how neither Mr. Tingelstad's outstanding loan balance at the time of surrendering the policy nor any of the loan payments he made affect the policy's cost basis or his taxable gain and thus only premium payments affect the cost basis, which in turn affects the taxable gain. Northwestern Mutual Life also advised that it had reviewed its records again and verified that its calculations with respect to determining the taxable gain were correct.
On May 23, 2022, the IRS sent petitioners a notice of deficiency, determining a deficiency of $8,270 in petitioners' federal income tax based on the Form 1099-R and a substantial understatement of income tax penalty under section 6662(a) of $1,654.
Respondent has now conceded the section 6662(a) penalty.
Discussion
I. Summary Judgment
The purpose of summary judgment is to expedite litigation and avoid unnecessary and expensive trials. FPL Grp., Inc. & Subs. v. Commissioner, 116 T.C. 73, 74 (2001). The Court shall grant summary judgment if the moving party shows that there is no genuine dispute as to any material fact and a decision may be rendered as a matter of law. Rule 121(a)(2); see also Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994). The burden is on the moving party to demonstrate that there is no genuine dispute as to any material fact; consequently, factual inferences will be viewed in a light most favorable to the party opposing summary judgment. Dahlstrom v. Commissioner, 85 T.C. 812, 821 (1985); Jacklin v. Commissioner, 79 T.C. 340, 344 (1982). The nonmoving party may not rest upon the mere allegations or denials of its pleadings, but must set forth specific facts showing that there is a genuine dispute for trial. Rule 121(d); Sundstrand Corp., 98 T.C. at 520. On the basis of the record in this case, we conclude that there is no genuine dispute as to any material fact. Consequently, we may render a decision as a matter of law.
II. Taxation of Distributions from Life Insurance Contracts
Gross income includes all income from whatever source derived including, but not limited to, life insurance contracts. § 61(a)(9). As relevant to this case, any amount that is received under a life insurance contract on its complete surrender, and which is not received as an annuity, is generally included in gross income to the extent it exceeds the investment in the contract. § 72(e)(1)(A), (5)(A), (C). The "investment in the contract" is defined under the Internal Revenue Code (Code) as the aggregate amount of premiums or other consideration paid for the contract, minus the aggregate amount previously received under the contract, to the extent such amount was excludable from gross income. § 72(e)(6); Treas. Reg. § 1.72-6(a).
When Mr. Tingelstad surrendered his Northwestern Mutual Life policy, Northwestern Mutual Life correctly applied the policy's cash value to the outstanding balance on his policy debt, thereby extinguishing that debt. That action was the economic equivalent of Northwestern Mutual Life's paying Mr. Tingelstad the proceeds and his using those proceeds to pay off his policy debt. See Black v. Commissioner, T.C. Memo. 2014-27; Sanders v. Commissioner, T.C. Memo. 2010-279; McGowen v. Commissioner, T.C. Memo. 2009-285, aff'd, 438 Fed.Appx. 686 (10th Cir. 2011); Atwood v. Commissioner, T.C. Memo. 1999-61; see also Brown v. Commissioner, T.C. Memo. 2011-83, aff'd, 693 F.3d 765 (7th Cir. 2012); Barr v. Commissioner, T.C. Memo. 2009-250. Or put another way, the extinguishment of Mr. Tingelstad's policy debt had the effect of a constructive distribution of the cash value in the policy to him, id., and that constructive distribution is the $63,008.52 gross distribution that Northwestern Mutual Life reported on the Form 1099-R it sent to the IRS and Mr. Tingelstad.
Turning to the tax treatment of the $63,008.52 distribution, as indicated above, that amount is gross income to Mr. Tingelstad insofar as it exceeds his investment in the contract. The record establishes that Mr. Tingelstad's investment in his life insurance contract with Northwestern Mutual Life was $25,392.46. Consequently, $37,616.06 is gross income to Mr. Tingelstad, i.e., the taxable amount of the distribution.
III. Petitioners' Contentions
Petitioners contend that Northwestern Mutual Life incorrectly computed the amounts reported on the Form 1099-R. More specifically, they contend that the methods used by Northwestern Mutual Life to compute those amounts were flawed in two ways: (1) Northwestern Mutual Life understated the cost basis or investment in the contract and (2) Northwestern Mutual Life overstated the cash surrender value of the policy. According to petitioners, any tax liability as a result of surrendering the policy "must be based upon [their] cash accounting method," not upon Northwestern Mutual Life's "self-serving accounting practices."
Based upon their method, petitioners assert on page 6 of their summary judgment motion that they incurred a taxable gain of $7,810, but on other pages of their motion (see pp. 1-2, 5, and 7 of their motion) they assert that they incurred a loss of either $4,890, $7,690, or $20,390.
Petitioners' contentions lack merit. As an initial matter, petitioners' notion that they have "the right to choose their own acceptable accounting method upon which their tax liability is determined" is itself a "self-serving" notion and one that is concocted out of whole cloth; it is well-settled that the Code, and more specifically section 72(e), governs and provides clear direction on how to calculate gain upon the surrender of a life insurance policy. Treas. Reg. § 1.72-1(a); see also Brown, T.C. Memo. 2011-83, slip op. at 10-18.
In a case such as this and as indicated above, when a life insurance policy is surrendered, non-death, non-annuity amounts received are included in gross income to the extent they exceed the investment in the contract. § 72(e)(5)(A). Section 72(e)(6) defines "investment in the contract" as the aggregate amount of premiums or other consideration paid for the contract, minus the aggregate amount previously received under the contract, to the extent such amount was excludable from gross income. See also Treas. Reg. § 1.72-6(a). Accordingly, "investment in the contract is (i) the total premiums or other consideration paid minus (ii) the total amount (a) received under the contract and (b) excludable from gross income." Brown, T.C. Memo. 2011-83, slip op. at 15. Dividends with respect to a life insurance policy that are paid but "retained by the insurer as a premium or other consideration paid for the contract" reduce aggregate premiums paid because those amounts were previously received and excludable from gross income. § 72(e)(4)(B), (6)(B); see also Massachusetts Mut. Life Ins. Co., v. United States, 103 Fed.Cl. 111, 164 (2012), aff'd, 782 F.3d 1354 (Fed. Cir. 2015) ("A dividend . . . would, therefore, 'represent a reduction or return of premiums.'" (quoting Treas. Reg. § 1.72-1(a)); Moseley v. Commissioner, 72 T.C. 183, 186-88 n.4 (1979) ("[S]ec. 72 . . . treats dividends paid before maturity or surrender of a policy as a reduction in premium cost.").
The record reflects (and indeed petitioners acknowledge throughout their summary judgment motion (see pp. 1-2 and 5-6 of their motion)) that Mr. Tingelstad paid aggregate premiums totaling $55,198.30 for his Northwestern Mutual Life policy. The record also reflects that Mr. Tingelstad received $29,805.84 in dividends that were excludable from gross income because they were paid and retained by Northwestern Mutual Life to reduce or eliminate the policy's premiums. In accordance with section 72(e), that dividend amount gets subtracted from the aggregate premiums amount, resulting in an investment in the contract of $25,392.46.
We do note that in other parts of their summary judgment motion (see pp. 2-4, 9, and 12 of that motion), petitioners reference or rely on an amount for aggregate premiums of $54,199 or $54,900.
Petitioners contend that the investment in the contract was at least $70,400- the aggregate premiums plus the $500 monthly payments Mr. Tingelstad made. This is erroneous; the $500 monthly payments were not investments, i.e., "premiums or other consideration paid for the contract" (and thus should not be part of the calculation for Mr. Tingelstad's investment in the contract). The record unmistakably shows that these payments were applied to reduce Mr. Tingelstad's outstanding total balance for the loans he took out against the policy. Petitioners cannot turn a blind eye to that fact, particularly given that the annual statements Northwestern Mutual Life sent to Mr. Tingelstad for at least 2014-18, taken together, show that these payments were being applied to reduce his outstanding total loan balance.
Assuming arguendo that these payments had not been applied to reduce Mr. Tingelstad's outstanding total loan balance, if anything they would have been considered payments to purchase paid-up additional insurance which, under the terms of the policy, increase the policy's cash value.
Regarding the cash surrender value of Mr. Tingelstad's policy, petitioners contend that the "true" cash surrender value was not $63,008.52, but rather $20,308.71-"the value of the cash" Mr. Tingelstad received when he surrendered the policy, i.e., the net proceeds Northwestern Mutual Life paid to him after Northwestern Mutual Life "withheld" $42,699.81 (representing the outstanding amount of Mr. Tingelstad's policy debt) from the value of the policy. Petitioners' contention predominantly hinges on their belief that the policy debt was not "legal and enforceable." Their contention is misplaced.
For federal income tax purposes, Mr. Tingelstad's policy loans were true loans. See McGowen, T.C. Memo. 2009-285; see also Atwood, T.C. Memo. 1999-61. The record unmistakably shows that pursuant to the policy's terms, Mr. Tingelstad elected an 8% interest rate on amounts borrowed against the policy; this is indicative of bona fide debt. See McGowen, T.C. Memo. 2009-285, slip op. at 8 (first citing Salley v. Commissioner, 55 T.C. 896, 903 (1971), aff'd, 464 F.2d 479 (5th Cir. 1972); then citing Kay v. Commissioner, 44 T.C. 660, 670-72 (1965), and then citing Dean v. Commissioner, 35 T.C. 1083, 1085 (1961)). Consequently, petitioners would not have had to (and they did not) recognize these loan proceeds as taxable income upon Mr. Tingelstad's receipt, id. (first citing Commissioner v. Indianapolis Power & Light Co., 493 U.S. 203, 207-08 (1990); and then citing Commissioner v. Tufts, 461 U.S. 300, 307 (1983)), because Mr. Tingelstad was obliged to repay the loans to Northwestern Mutual Life, see Tufts, 461 U.S. at 307.
In sum, there were no flaws in the methods used by Northwestern Mutual Life to calculate Mr. Tingelstad's taxable gain resulting from him surrendering his policy.Accordingly, respondent having shown that there is no genuine dispute of material fact and that he is entitled to judgment as a matter of law, it is hereby
In so holding, we have considered all of the arguments made by the parties and, to the extent they are not addressed herein, we find them to be moot, irrelevant, or without merit.
ORDERED that petitioners' Motion for Summary Judgment, filed December 26, 2023, is denied. It is further
ORDERED that respondent's Motion for Summary Judgment, filed January 23, 2024, is granted. It is further
ORDERED AND DECIDED that there is a deficiency in income tax due from petitioners for the 2019 taxable year in the amount of $8,270.00. It is further
ORDERED AND DECIDED that there is no penalty due from petitioners under I.R.C. § 6662(a) for the 2019 taxable year; respondent now concedes that petitioners are liable for this penalty.