Medical Corporations Argue Tax Court Erred in Denying Deductions for Excess Contributions to VEBAs

JURISDICTIONAL STATEMENT

STATEMENT OF RELATED CASES

STATEMENT OF ISSUES

STATEMENT OF THE CASE

STATEMENT OF FACTS

SUMMARY OF ARGUMENT

ARGUMENT

ACM Partnership v. C.I.R., 157 F.3d 231 (3d Cir. 1998)

2. Whether the tax court erred by (a) failing to determine whether the program of benefits established by contributing employers and funded through life insurance contracts was an employee benefit plan and (b) failing to apply the specific statutory provisions governing the tax effects of establishing a plan, I.R.C. §§ 419, 419A, 501(c)(9). (App. 6214-6220, 28-32).

3. Whether the tax court erred (a) in relying on marketing materials, rather than the terms of the plan documents and life insurance contracts, to determine what benefits were provided to employees and whether the employer contributions funded those benefits and (b) by ignoring the form of the arrangement even though non-tax, economic benefits were provided by the arrangement. (App. 6206-6209, 6-31).

4. Whether the tax court erred in determining that a portion of the employer contributions constituted a dividend, rather than reasonable compensation for services rendered under I.R.C. § 162(a). (App. 6196-6206, 30-33).

[6] After reviewing the requested documents and information, the IRS issued a determination letter in December 1988. (App. 1409- 1411). The IRS ruled that the California Association was a VEBA providing a plan of benefits under I.R.C. §501(c)(9). (App. 1409-1411).

[7] In May 1991, the New Jersey Voluntary Employee Beneficiary Association ("New Jersey Association") asked the IRS to determine whether it was a VEBA providing a plan of benefits to its members. (App. 6514). Over a number of months, the IRS requested numerous documents and considerable information from the New Jersey Association about the Association itself and about its plan of benefits, much like the review process the IRS had engaged in with respect to the submission by the California Association. The New Jersey Association responded to the satisfaction of the IRS by providing additional documents and information. (App. 6514-6645). In October 1991, the IRS determined that the New Jersey Association was a VEBA providing a plan of benefits under I.R.C. § 501(c)(9). (App. 1618-1620).

[8] In 1994, the IRS conducted an audit of the California Association and its plan of benefits for the 1990 tax year. (App. 1683, 1674-1675, 1676). The IRS audited the form and operation of the Association as a VEBA, and its trust and plan of benefits. (App. 1683, 1674-1675, 1676). The IRS audit covered, among other things, the plan and trust documents; all books and records of receipts, disbursements, assets and liabilities; check registers, canceled checks, and bank statements; actuarial valuations; calculations made to determine the contribution limits under I.R.C. § 419A; detail on benefit expenses; insurance policies; and, a list of all the participating employers and their employees. (App. 1672, 1673, 1674- 1675, 1676). The IRS spent 43 hours auditing the Association and its plan of benefits. (App. 1677-1680, 1681-1682).

[9] The audit was triggered by a claim that the Association's plan might be discriminatory and that plan participants were not being informed of possible tax consequences; the IRS found the claim to be without merit. (App. 1677-1680, Items D-1 a and D-3 through D-6). The IRS also concluded that the Association's benefit plan was a multiple employer plan within the meaning of I.R.C. §419A(f)(6). (App. 1680, Item E-2). After further review (App. 1674-1675), the IRS concluded that the plan and trust contained no unallowable language (App. 1678-1679, Items D-3 and D-5), that the trust was in compliance with applicable sections of the Internal Revenue Code (App. 1680, Item D-6), and that the VEBA plan and trust exhibited no potential for an IRS audit for the following year. (App. 1680, Item F-1).

[10] Upon completion of its audit of the Association and its trust and plan of benefits, the IRS issued a favorable "no change letter." (App. 1683).

[12] The employee benefits provided by each VEBA's plan were provided through a trust established by the VEBA solely to provide benefits to the contributing employers' participants and beneficiaries. (App. 5736, section 3.01). The plan documents prohibit the use of contributions for any purposes other than the exclusive benefit of the participants and beneficiaries. (App. 5736, section 3.03; App. 5739, section 5.04; App. 1698, section 5.04). Plan benefits were funded by the trust's purchase of group term life insurance covering the lives of plan participants; the participants completed applications for coverage under the plan's group term life insurance policies. (App. 1710, 1711, 1712,-1719, 1720, 1721, 1722, 1727-1731, 1732-1736, 1737, 1738, 1739, 1740-1741, 1742, 1743-1746, 1747-1750, 1751-1759, 1760-1762).

[13] The plan's adoption agreement obligated employers to make contributions to the trust sufficient to fund the premium for insurance benefits for their eligible employees. (App. 1689, section 1.01; 555). The amount of the employers' required contributions equaled the sum of: (a) the premium amounts established by the insurance companies to keep the insurance policies in force, and (b) charges for administration and operation of the plan and trust. (App. 1684-1687).

[14] All employer contributions were assets of the plan and trust, not assets of the employers or employees. The plan's independent trustee exclusively held all rights, title and interest in the assets of the trust, without any right of reversion to anyone.⁴ (App. 5734, section 1.02; App. 5735, section 2.01(c); App. 5747, section 9.01). Thus, if the plan is terminated or an employer terminates its participation in the plan, no assets can revert to any employer; rather, the trustee, exercising its powers under the trust document is required to use the plan's assets solely to satisfy obligations of the plan and to provide participants with benefits described in the plan documents or such other use as permitted under federal and state law. (App. 5746, section 8.03).⁵

[15] Benefits were paid by each VEBA plan in accordance with the plan terms. For example, an insurance benefit was paid to the widow of an employee of one of the appellant employers, who died during one of the years at issue in this case (App. 386, 431); the employer, Lakewood Radiology, received no part of the benefit.

[17] For the taxable years ending in 1991, 1992 and 1993, Lakewood Radiology deducted $480,901.00, $209,869.00 and $296,056.00 for contributions to the VEBA benefit plan, as reported on its federal tax returns. (App. 1819, 1829 and 1846). The deductions for 1991 were solely for contributions to the VEBA plan; contributions in 1992 and 1993 included contributions to the VEBA plan and payments to Peoples Life Insurance Company ("Peoples") for premiums for the purchase of Peoples' group term life insurance coverage for Lakewood employees. (App. 391-394 (for 1991), 394-395 (for 1992), and 395-397 (for 1993)).

[18] As with all contributing employers, in return for Lakewood's contributions to the VEBA plan, certificates of coverage under the plan's group term life insurance policies, were issued to its employees. The certificates were for two types of group term life insurance policies: Continuous Group Term ("C Group Term") and Millennium Group 5 ("MG 5").⁶

[19] One of the Peoples Security C Group Term certificates, purchased with Lakewood Radiology contributions, was issued to Dr. Sankhla who was not then an owner of Lakewood Radiology.⁷ (App. Op. 5) The court below denied Lakewood's deductions for a portion of the contributions to purchase C Group coverage for its employees, including contributions for Dr. Sankhla's coverage. The tax court held that all disallowed contributions were disguised dividends paid to the insureds, even though Dr. Sankhla was not an owner legally capable of receiving a dividend. (App. 23-24).

[21] In return for Neonatology's contributions to the VEBA plan, certificates of coverage under the plan's group term life insurance policies were issued. Neonatology's contributions to the plan were used to purchase coverage only under the plan's C Group Term life insurance policy.⁹

[23] Both the C Group Term and the MG 5 Term policies were group term life insurance policies. (App. 1833-1842, 1843-1854, 2984- 2992, 1814-1832, 6311, 6346-6347). They were priced differently but in accordance with insurance industry practices, and both policies had all the customary features and characteristics of group term insurance. (App. 1833-1842, 1843-1854).

[24] The C Group Term and MG 5 Term policies were designed for small employer groups, to be used in combination for long and short term employees. (App. 460-469). The C Group Term policy was designed for longer-term employees, including but not limited to owner employees. (App. 458). For example, Dr. Sankhla of Lakewood Radiology was covered under C Group Term long before becoming an owner employee (App. 5, 23). The MG 5 Term policy was designed for shorter term, transitional employees. (App. 460-469).

[25] In part because the MG 5 Term policy was designed to cover shorter term employees, it was priced like many common forms of term insurance; its premium rates increase dramatically over time. (App. 458-460; App. 1814-1832). On the other hand, because the C Group Term policy was designed for longer-term employee participation, it was priced in part to levelize the premiums over the longer term. (App. 460-469, 1814-1832)¹¹. Due to this levelizing factor, the C Group Term policy premiums are higher in the early years of coverage but lower in the later years, when compared to premiums for policies like the MG-5.¹² (App, 460-469). The comparison chart of the pricing of these two different types of term policies, prepared by petitioners' expert witness, demonstrates that, over the expected working life of a participant, the sum of the premiums under either policy (C Group or MG 5) was approximately the same. (App. 1814- 1832).

[26] The tax court and the IRS permitted the deductions for contributions to purchase insurance benefits under the MG 5 policies.¹³ The tax court disallowed a significant portion of the contributions to the plan for coverage under the C Group Term policies, even though over the expected working life of a participant, the sum of the premiums under either policy (C Group or MG 5) was approximately the same. (App. 1814-1832).

[27] The pricing of term policies to levelize premiums, with the possibility of non-guaranteed conversion credits in a conversion policy, is a common insurance practice. (App. 1814-1832, 457). In addition to this levelizing factor, the insurers had other actuarially-based, underwriting considerations for pricing the C Group Term policy, which were not present with MG 5. In general, when insuring small employer groups, there is a substantial risk of "adverse selection" that affects pricing assumptions. (App. 460-469) Adverse selection is the choice by someone who is not healthy (1) to seek insurance coverage, where he/she believes the illness will not be detected during the underwriting process and, more importantly, (2) to continue to keep that coverage in force (App. 460-469). The C Group and MG 5 policies were issued with simplified underwriting in which only a few health-related questions were asked. (App. 4852- 4853).

[28] The C Group Term was intended for small employer groups, so the risk of adverse selection was a significant factor in its pricing. Certainly, in the small employer market, there is a greater likelihood that a single key employee or a small number of highly compensated employees, who have either short or long-term health issues, will insist that their employer seek and maintain coverage. (App. 460-469). Because the C Group policy was designed for this niche market, there was a greater expectation of adverse selection by more highly paid employees (with commensurately higher benefits as a multiple of compensation) than for the MG 5 product. (App. 460-469).

[29] The C Group Term and the MG 5 Term policies were filed with and approved by various state departments of insurance as group term life insurance policies. (App. 5889 and 5890, 6647). The C Group Term policy requires that the entire amount of the premium must be paid in order to keep coverage in force. (App. 1838, section 16, and 1848, section 16). Like the MG 5, the C Group Term policy does not have cash or surrender values payable to the employee or anyone else, upon lapse or termination of coverage. (App. 1833-1842, 1843-1854, 6311-6313, 6648, 453-454). Because there are no cash or surrender values, neither policy can be used as collateral to obtain a loan. (App. 1833-1842, 1843-1854, 453-454, 6311-6313, 6648).

[30] Even the conversion feature of the C Group Term policy is consistent with the conclusion that it is only term insurance. All group term life insurance policies are required to offer to insureds the benefit of the right to convert from the group policy to an individual insurance policy that will have cash value. (App. 456; see also, e.g., N.J. Stat. Ann. § 1713:27-19 and 20 (1971). Under the plan's C Group Term policy, any participant who ceases to be an employee of a contributing employer may convert to one of several types of individual policies,¹⁴ including a special conversion policy.¹⁵ (App. 1833-1842, 1843-1854).

[31] Under the special conversion policy, if the experience of the insurer under the C Group policy warranted, the insurer could (in its sole discretion) use the positive experience from the C Group policy to credit premiums under the conversion policy; these "conversion credits" were an option, not an obligation, of the insurer in the event of positive experience under the group policy. (App. 460-469, 530-531).

[32] The premiums paid to the insurance company for C Group Term coverage are assets of the insurance company at risk to pay all insurance claims.¹⁶ Whether or not there may be any conversion credits to be applied by the insurance company depends on a quarterly, actuarial review of the experience of the entire C Group block of policies, not just a particular plan participant's experience. In other words, there is no guaranteed conversion amount credited to or payable from any "conversion credit accumulation account" in the name of, or identified with, a particular certificate holder.¹⁷The determination of whether and to what extent conversion credits may be available depends upon insurance company assumptions of expected future experience, lapse rates, mortality rates, conversion rates, investment rates, expense levels and other experience factors of the insurer. (App. 460-469, 531, 1855-1863). Because future experience is unknown, the amount of any conversion credits potentially available is subject to change and is not guaranteed. (App. 6342, 6358, 456-457, 530-531, 543, 542, 544).

[33] There is no guarantee by the insurance company, the plan, or anyone else that a participant whose plan coverage is provided under the C Group Term policy will receive, upon conversion, an individual policy to which any (let alone a particular, guaranteed amount of) conversion credits might be applied. (App. 1833-1842, 1861, 6342, 6358, 6228, 986[,] 534, 457). Not surprisingly, the mere possibility that a participant may someday convert to a universal life policy, to which conversion credits might be applied, has no value that can be transferred or assigned. (App. 1833-1842 and 1843- 1854, 6313). Consequently, there is no dollar for dollar match between the contributions paid by contributing employers and any conversion credits or any cash value under the special conversion policy.

[34] If a participant dies while covered under the C Group policy, then a death benefit is paid -- nothing more or less, even if the insurer's experience under the C Group policy has been positive. (App. 1920-1929 and 1930-1978, 6358, 532). Similarly, if the participant ceases employment, converts to the special conversion policy, and dies, then only the death benefit is paid (App. 1920-1929 and 1930-1978, 6358, 531-532, 477), and there are no conversion credits or cash value. (App. 1920-1929 and 1930-1978, 6358, 531, 532, 477).

[35] If an employee does not apply for a special conversion policy or if an employee is not eligible for such a policy, there is not even a possibility of conversion credits.¹⁸ In fact, coverage lapsed in many instances, including coverage for employees of Neonatology and Lakewood Radiology, and no conversion policy was applied for or issued. (App. 1864, 525). When coverage lapsed, the insurer paid no benefits.

[36] Even if conversion credits are made available by the insurance company in the conversion policy, the conversion policy is only a universal life insurance policy (App. 476, 445-447), filed with and approved as such by state insurance commissioners (App. 516- 517, 488-489, 488-489[sic]). As a standard universal life insurance policy, the special conversion policy's accumulation of cash value is affected by mortality charges, administrative charges, expense levels and interest rates, and is subject to risks and uncertainties like any other universal life insurance policy -- including whether the policy is kept in force. (App. 1920-1929 and 1930-1978, 1979-1993, App. 477). Again, there is no dollar for dollar match between the employers' contributions and any cash value in a conversion policy.

[38] The only marketing materials authorized by the insurance companies to explain the insurance policies were illustrations derived from a software program at CJA's offices. (App. 513-514, 550). CJA's agents may have prepared marketing materials, but they were not given to the appellant employers or plan participants either at or before the employer's adoption of the plan (App. 6655, 6656, 6657, 6658, 6659), and they were not seen by the insurance companies.¹⁹

[40] The designers of the VEBA and the program of benefits obtained two legal opinions and a CPA's review. (App. 5751-5765, 5766-5793, 5794). The IRS reviewed the program and issued a determination of tax exemption under I.R.C. § 501(c)(9). (App. 1409-1411, 1618-1620). The IRS also audited the virtually identical program of benefits of the California Association, and the IRS required no changes. (App. 1683).

[41] Subsequently, the IRS audited Lakewood Radiology and Neonatology Associates and their owner-employees who were plan participants. The IRS disallowed the employers' contributions to the plan for C Group coverage for their employees, and ruled that each employee had income in the amount of disallowed contributions. The IRS also assessed accuracy related penalties. No formal guidance with respect to "10-or-more employer plans" like the VEBA plans, see footnote 5 supra, was issued by the IRS until 1995 when it issued Notice 95-34, and the first case interpreting the application of Notice 95-34 was Booth v. C.I.R., 108 T.C. 524 (1997). The employers and employee owners petitioned the tax court, challenging the IRS determinations.

[45] The tax court declined to determine whether the employer contributions were being made to an employee benefit plan. However, this Court has consistently required a determination of whether an employee benefit plan has been established, before determining the implications of the arrangement, regardless of the context. E.g., Gruber v. Hubbard Bert Karle Weber, Inc., 159 F.3d 780, 786 (3d Cir. 1998).

[46] Specific Internal Revenue Code provisions determine the deductibility of contributions to employee benefit plans and the taxation of plan benefits, e.g., I.R.C. §§ 404, 419; the tax court erred by failing to apply these specific provisions to the arrangement the employers had established to provide insurance benefits to their employees.

[47] Having ignored the compensatory intent evidenced by the employers' arrangement to provide employee benefits, the court subjugated the terms of the plan documents and insurance contracts in favor of promises in marketing materials, contrary to the rulings of this Court. Haberern v. Kaupp Vascular Surgeons Ltd. Defined Benefit Pension Plan, 24 F.3d 1491 (3d Cir. 1994). Moreover, the tax court (1) ignored the well-settled law of this Circuit that state insurance law determines the rights of parties to insurance contracts and (2) ignored the insurance policy provisions, relying instead on unauthorized marketing materials. Estate of Connelly v. United States, 551 F.2d 545 (3d Cir. 1977); N.J. Stat. Ann. § 17B:25-5 (policy "shall constitute the entire contract"); Vantage Development Corp., Inc. v. American Environment Technologies Corp., 598 A.2d 948, 951, 251 N.J. Super. 516, 522 (1991) (court cannot ignore terms of the policy).

[48] The tax court did not rule that the arrangement was a sham, and the court failed to consider the significant non-tax economic effects of the arrangement. Contrary to the rulings of this Court, the tax court erred by disregarding the form of the arrangement -- that is, the rights and obligations of the employers, employees, and insurers under the plan and the policies. ACM Partnership v. C.I.R., 157 F.3d 231 (3d Cir. 1998).

[49] Erring in its failure to respect the form of the arrangement, United Parcel Service v. C.I.R., 254 F.3d 1014 (11th Cir. 2001), Evans v. Dudley, 295 F.2d 713 (3d Cir. 1961), the tax court compounded its error by recharacterizing the disallowed, employer contributions as disguised dividends to be taxed as income. The tax court's recharacterization flowed from its error in misapplying the test under Treas. Reg. § 1.162-7(b)(1) for determining whether employer contributions are compensation or dividends. The test is whether the employer payments are reasonable and are actually payments for services. B.B. Rider Corp. v. U.S., 725 F.2d 945, 84-1 USTC p. 9171 (3d Cir. 1984); Pediatric Surgical Associates v. C.I.R., T.C. Memo. 2001-81, T.C.M. (RIA) 2001-081 (2001). The court's errors led it to ignore the corporate form -- deeming disallowed contributions to be dividends, even though contributions were made on behalf of a nonowner employee, who as a matter of law cannot be paid a dividend, but can be paid compensation.

[50] The tax court repeatedly erred by failing to analyze legal issues consistent with the rulings of this Court, ignoring the terms of the plan and insurance policies, and substituting its own pricing for the premium established by the insurers. The court chose to set a price for the cost of term insurance and to declare that any amount in excess of the court's price must be deemed a dividend. Quarrelling with the size of the deductions, the tax court "legislated" new rules about funding insurance benefits for employees.

[51] If the tax court's substantive analysis is upheld, the establishment and maintenance of employee benefit plans in this Circuit and nationwide will be jeopardized. The ruling below should be reversed.

[52] A deductible, ordinary and necessary business expense includes "a reasonable allowance for salaries or other compensation for personal services actually rendered." I.R.C. § 162(a)(1). Employee benefits, such as life insurance, have long been held to be a form of deductible compensation. Greensboro Pathology Associates, P.A. v. United States, 698 F.2d 1196 (Fed. Cir. 1982); Schneider, M.D., S.C v. C.I.R., T.C. Memo. 1992-24, 63 T.C.M. (CCH) 1787 (1992). As recently explained in Pediatric Surgical Associates v. C.I.R., T.C. Memo. 2001-81, T.C.M. (RIA) 2001-081 (2001), I.R.C. § 162(a)(1) establishes a two-pronged test for determining whether payments are compensation for services. To be deductible, the payments must be (1) reasonable and (2) actually in return for services. See Treas. Reg. § 1.162-7(a). This Court has long applied this test. B.B. Rider Corp. v. United States, 725 F.2d 945 (3d Cir. 1984).

[54] In Schneider, MD., S.C. v. C.I.R., T.C. Memo. 1992- 24 63 T.C.M. (CCH) 1787, 1791 (1992), neither the court nor the IRS questioned the reasonableness of a death benefit in the amount of 14 times compensation, a far greater multiple of compensation than in the instant case. In the instant case, neither the IRS nor the court ever questioned the reasonableness of the amounts of the death benefits funded by employer contributions. Thus, the only issue under Code § 162 to be resolved is whether the employer contributions were actually paid for services rendered.

[56] The tax court recently confirmed that anything paid to or on behalf of the only employee in a corporation providing personal services is presumptively compensation. Pediatric Surgical Associates v. C.I.R., T.C. Memo. 2001-81, T.C.M.(RIA)2001- 081(2001). Dr. Mall was the only employee of Neonatology Associates, so the presumption is that payments made on her behalf by her personal services business were compensation. The tax court in the instant case disregarded this presumption.

[57] For Neonatology and Lakewood, whether compensatory intent has been demonstrated is a factual question. Pediatric Surgical Associates v. C.I.R., T.C. Memo. 2001-81, T.C.M. (RIA) 2001-081 (2001)". [sic] Having ignored the presumption for Neonatology, the court's factual analysis of compensatory intent for both employers consisted of its bald statement that it found "nothing in the record [to support a finding of compensatory intent,] other than Petitioners' assertions on brief". (App. 31). Yet, even a cursory review of the record reveals that the employers' contributions were paid to an employee benefit plan, thus demonstrating the requisite compensatory intent.²⁰See, e.g., 29 U.S.C. § 1001; I.R.C. § 419; Treas. Reg. § 1.501(c)(9)-3. However, the tax court refused to consider the compensatory nature of the benefit arrangement, by expressly declining to decide whether the arrangement was an employee benefit plan (App. fns 2, 3, 4, and 31), thereby rejecting the rulings of this Court. Gruber v. Hubbard Bert Karle Weber, Inc., 159 F.3d 780, 786 (3d Cir. 1998).

[59] This Court consistently holds that a plan to provide employee benefits is established if from the surrounding circumstances a reasonable person can ascertain the intended benefits, a class of beneficiaries, the source of financing, and procedures for receiving benefits. See, e.g., Henglein v. Informal Plan For Plant Shutdown Benefits, 974 F.2d 391, 399 (3d Cir. 1992); Diebler v. United Food and Commercial Workers' Local Union 23, 973 F.2d 206 (3d Cir. 1992). The requirement that there exist an identifiable class of beneficiaries is satisfied even if the benefit in question is conferred on only a single person. See Williams v. Wright, 927 F.2d 1540, 1545 (11th Cir. 1991).

[60] In order to be considered a plan established or. maintained by an employer, as opposed to a program under which insurance entrepreneurs market and sell a product, two criteria must be met: (1) the contributing employers must exercise some control over the benefit program, directly or indirectly and (2) the contributing employers must have a common economic or representation interest, unrelated to the provision of benefits. Hubbard Bert Karle Weber, Inc., 159 F.3d 780, 787 (3d Cir. 1998). Both criteria are met here: (1) no one disputes the contributing employers exercised some control over the benefit program and (2) the employers and their employees were physician service providers, having common interests. Thus, under the law of this Circuit, the facts here demonstrate compensatory intent, because the employers established an employee benefit plan -- whether a multiple employer plan or a collection of individual plans for each contributing employer. See Gruber, 159 F.3d at 786.²¹

[62] When an employer makes a contribution on behalf of an employee to an employee benefit plan, the tax implications for the employer and the employee depend upon the type of benefit being provided. If the benefits are provided through life insurance contracts, then specific provisions of the Code determine the deductibility of contributions and the taxation of benefits. See, e.g., I.R.C. §§ 79, 419, 419A, 501(c)(9).

[63] Employee benefits provided under an insurance contract include not only death benefits, but also the benefit of the right to convert. See Treas. Reg.§ 1.501(c)(9)-3(b) (defining "Life Benefits" to mean a benefit, which "may be provided directly or through insurance" and "also may include a right to convert to individual coverage"; Treas. Reg. § 1.79.0 (acknowledging a "right to convert (or continue) life insurance after group life insurance coverage terminates").

[64] The tax court's analytical failure to apply applicable Code provisions was recently addressed in United Parcel Service v. C.I.R., 254 F.3d 1014 (11th Cir. 2001). The United Parcel Service decision demonstrates that the characterization of a transaction for tax purposes requires an analysis founded on the Internal Revenue Code provisions specifically directed to the kind of transaction at issue. Id. at 1018.

[65] Had the tax court in the instant case followed Third Circuit precedent and determined whether the employers were contributing to an employee benefit plan, the court could not have ignored -- as it did -- the Code's specific rules for benefit plans, e.g., I.R.C. §§ 79, 419, 419A, 501(c)(9). Application of those rules demonstrates that the issue is not whether a deduction to the plan is allowable, but rather the timing of the deduction.

[66] Employer contributions that are not deductible in the year made are carried over and treated as contributed in the next year, or in other subsequent years for deduction purposes. See, e.g., I.R.C. § 419(d). Application of the correct Code provisions simply does not convert a contribution to an employee benefit plan into a deemed dividend. The court erred by not applying the Code's benefit plan rules to the benefit plan at issue.

[68] Contrary to the tax court's conclusion, an employer's motivation to obtain a tax deduction does not prevent the establishment of an employee benefit plan. "Over and over again courts have said that there is nothing sinister in so arranging one's affairs as to keep taxes as low as possible . . . [N]obody owes any public duty to pay more than the law demands. . ." C.I.R v. Newman, 159 F.2d 848, 850-851 (2d Cir. 1947) (Hand, J. dissenting), rev'g., 5 T.C. 603 (1945); see also Frank Lyon Co. v. United States, 435 U.S. 561, 580 (1978) ("tax laws affect the shape of nearly every business transaction."); Ed Miniat, Inc. v. Globe Life Insurance Group Inc., 805 F.2d 732 (7th Cir. 1986) (owner employees established employee benefit plan to provide insurance benefits, even though motivated by tax reasons).

[69] There is no provision of the Internal Revenue Code stating either (a) that employer intent to obtain a tax deduction or (b) marketing efforts aimed at promoting employee benefit plans for tax reasons are determinative of the terms of a plan, the entitlement of the participants, or the legitimacy of the deductions taken for the contributions to fund the benefits. See Northern Indiana Public Service Co. v. C.I.R., 115 F.3d 506 (7th Cir. 1997) ("tax- avoidance motive is not inherently fatal to a transaction . . . taxpayer has a legal right to conduct his business so as to decrease (or altogether avoid) the amount of what otherwise would be his taxes.").

[70] Contrary to the conclusion of the tax court, whether a plan of benefits is established to take advantage of favorable tax treatment does not render it something other than a plan of employee benefits described in the plan's governing documents. This Court holds that "an employer is free to develop an employee benefit plan as it wishes, because when it does so it makes a corporate management decision. . ." Haberern v. Kaupp Vascular Surgeons Ltd. Defined Benefit Pension Plan 24 F.3d 1491 (3d Cir. 1994). Despite the real world employee benefits under the plan (e.g., the million dollar-plus death benefit to the widow of Dr. Sobo), the tax court deemed the benefit arrangement to be "speciously designed," because the court questioned the employers' motives, and ignored the form of the arrangement, that is, the express provisions of the plan and insurance policies.

[71] Contrary to the rulings of this Court, the tax court subjugated the plans' governing documents in favor of marketing materials that were not binding on and had not been approved by the insurance companies that issued the policies to the plans (Jackson Tr. 443-444, 509) or seen by the plans' participants (App. 6655, 6656, 6657, 6659). This Court has consistently ruled that "unless and until the written plan is altered in a manner, and by a person or persons authorized in the plan, neither the plan administrator nor a court is free to deviate from the terms of the original plan." Schoonejongen v. Curtiss-Wright Corp., 18 F.3d 1034 (3rd Cir. 1994).²²

[72] Contrary to the conclusions of the tax court, this Court holds that representations outside of the plan document (like the marketing materials in the instant case) cannot determine the rights and obligations under a plan. See Deibler, 973 F.2d at 209; Henglein v. Informal Plan For Plant Shutdown Benefits, 974 F.2d 391, 399-400 (3d Cir. 1992). In Haberern v. Kaupp Vascular Surgeons Ltd. Defined Benefit Pension Plan 24 F.3d 1491 (3d Cir. 1994), this Court refused to allow parole evidence to contradict plan terms, because to rule otherwise "will create a precedent for any beneficiary to make claims for benefits beyond those provided in a plan. It would be difficult to reconcile that result with our cases holding that oral or informal amendments to ERISA benefit plans are precluded." Id. at 150. See Henglein v. Colt Industries Operating Corporation, 260 F.3d 201 (3d Cir. 2001).²³

[73] In direct conflict with the rulings of this Court, the tax court ignored the provisions of the plan (which provide only insurance benefits -- a death benefit and the option of converting to an individual policy upon termination of employment), in favor of promotions in marketing materials about the conversion option that did not reflect the terms of the plan.

[75] In Estate of Connelly v. United States, 551 F.2d 545, 551 n. 15 (3d Cir. 1977), this Court concluded that the tax implications of a group term life insurance policy require an examination of the rights under the policy as determined under state law. Cf. Morgan v. C.I.R., 309 U.S. 78, 80 (1940); Burnet v. Harmel, 287 U.S. 103, 110 (1932);²⁴see also H.R. Conf. Rep. No. 861, 98th Cong., 2d Sess. 1075 (1984), 1984-3 (Vol. 2) C.B. 329 ("[a] life insurance contract is defined as any contract, which is a life insurance contract under the applicable State or foreign law. . . ."); 15 U.S.C. § 1012(a) ("business of insurance . . . shall be subject to the laws of the several States . . .")

[76] Without any analysis of the insurance policies' terms or applicable state law, the tax court focused on unauthorized marketing materials to form its view of the rights and duties under the policies. The court concluded that the amount of the employer contribution, which it believed to exceed the cost of insurance (the so called "excess contribution"), must constitute a taxable dividend, and not a deductible insurance premium. Critical to this erroneous conclusion was the court's determination -- without any analysis of applicable state law or the terms of the policies -- that the "excess contributions . . . conferred an economic benefit on [the] employee/owners . . ." (App. 30) Yet, the only economic benefit (other than insurance benefits) was the hope or expectation of nonguaranteed "conversion credits" at some unknown date in the future. Even the IRS's expert witness agreed, after careful review of the policies, that conversion credits are not guaranteed. (App. 6342, 6358; see also App. 1833-1842, 1843-1854, 1814-1832, 6649, 530-531, 534, 543, 542, 544, 456-457). Like all insurance policies, the C Group Term coverage of plan participants was governed by the C Group Term policy language.²⁵

[77] Contrary to the court's view, the entire amount of the premium for C Group Term coverage billed to the trust by the insurers (and in turn billed by the trust to the employers) had to be paid to provide plan benefits; the premium was not divided into component parts. (App. 1838, section 16, and 1848, Bates # 010009, section 16). If an employer failed to pay the full amount of the billed premium, C Group coverage for all employees lapsed; there was no resulting payment of cash to the employer or its employees, because the C Group Term policy had no cash value. (App. 1833-1842, 1843-'854, 6311-6313, 6648, 453-454). Similarly, the C Group Term policy cannot be borrowed against or used for collateral, because the policy has no cash value. (App. 6311-6313, 6648, 453-454).

[78] The express provisions of the C Group Term policy bear the unmistakable marks of group term life insurance. No marketing materials -- especially those that were neither authorized by the insurance company nor seen by the employers or their employees-can alter the rights and duties under the policy and change a group term life insurance policy into something else. E.g., Estate of Connelly v. United States, 551 F.2d 545 (3d Cir. 1977). Moreover, the insurance policy, as well as the agents' agreements with the insurance company, state that no agent is authorized to alter or amend the insurance contract, to waive any conditions or restrictions contained therein, to extend the time for paying premiums, or to bind the insurance company by making any promise or representation. (App. 1839, section 21; App. 1849, section 21; App. 2472 section 3.2; App. 1486 section 3.2). The tax court erred by subjugating the terms of the insurance policies to the marketing materials, contrary to applicable law.

[80] However, under controlling law, in order to disregard the form of the arrangement, a court (after first determining the rights of the parties to the insurance contracts under state law) must determine that the arrangement (including the rights and obligations under those contracts) has no economic substance other than obtaining tax deductions; the tax court made no such determination here. See Frank Lyon Co. v. United States, 435 U.S. 561, 583-84 (1978); C.I.R. v. Court Holding Co. 324, U.S. 331 (1945). There are hundreds of cases that apply this rule, ignored by the tax court. E.g., Gregory v. Helvering, 293 U.S. 465 (1935); ACM Partnership v. C.I.R., 157 F.3d 231 (3d Cir. 1998); United Parcel Service v. C.I.R., 254 F.3d 1014 (11th Cir. 2001); Northern Indiana Public Service Co. v. C.I.R., 115 F.3d 506 (7th Cir. 1997).

[81] The C Group Term policy is a real-life group term insurance contract and the premium, whether high or low, was the premium established by the insurer to keep the policy in force. The tax court objected to the size of the premiums, but there was "no need to crack walnuts with a sledge hammer."²⁷Foglesong v. C.I.R., 621 F.2d 865 (7th Cir. 1980).

[82] If, as in the instant case, there is any economic substance to the arrangement apart from the alteration of tax liabilities, then the form of the arrangement must be respected, even if the arrangement was motivated by tax avoidance or minimization. See Frank Lyon Co. v. United States, 435 U.S. 561 (1978); United Parcel Service v. C.I.R., 254 F.3d at 1018; Shirar v. C.I.R., 916 F.2d 1414, 1418 (9th Cir. 1990). In Gregory v. Helvering, 293 U.S. 465 (1935), the United States Supreme Court stressed that the taxpayer's intent to avoid taxes was irrelevant; to disregard the form, it is the absence of non-tax, economic effects -- not the presence of a motive to avoid taxes -- that is controlling.²⁸ Contrary to this weight of authority, the tax court erroneously disregarded the form of the arrangement.

[83] In United Parcel-Service v. C.I.R., 254 F.3d 1014 (11th Cir. 2001), the taxpayer purchased an insurance policy to cover risks of damage or loss that the taxpayer had previously self- insured. The court, despite what appeared to be a transparent attempt to shift revenues off-shore, respected the form of the arrangement.

[84] Without a determination that the arrangement lacked any economic substance, the tax court (a) erred by disregarding the form of the arrangement; (b) erred by not addressing whether there is some non-tax economic impact from the arrangement of benefits; and, (c) erred by only focusing on the intent of the taxpayers. Evans v. Dudley, 295 F.2d 713 (3d Cir. 1961); ACM Partnership v. C.I.R., 157 F.3d 231, 248, 251, 253-54, 262 (3d Cir. 1998).

[85] In the instant case, the tax court ignored the non-tax, economic effects on the employers, employees, and insurer, as well as the economic substance and business purpose that supported the pricing of the C Group Term policy. The employees received insurance benefits; the entire premium became an asset of the insurance company. The employers provided compensation to their employees in the form of insurance benefits in return for the amounts they contributed to the plan. And, the insurers issuing the C Group Term policy accepted genuine insurance obligations, agreeing to pay a death benefit in return for the policy premium.

[86] As to the size of the premium, which so offended the tax court and led to its result-oriented conclusion, the record is replete with actuarial considerations supporting the pricing of the C Group coverage -- considerations that fit hand-in-glove with the employer's, non-tax economic purpose for the arrangement -- namely, compensating employees for their services. There was unrebutted testimony from the designer or [sic] the C Group policy that the premium was based on the policy's design for longer term employees, who were expected to stay with their employer over their entire working life. (App. 458, 460-469). The C Group policy was priced to somewhat levelize the premiums over the expected working life of such employees. (App. 1814-1832, 457).³⁰ The uncontroverted evidence demonstrates that, on a cumulative basis, the cost of C Group Term coverage is about the same as MG 5 coverage over time. (App. 460, 462, 1814-1832).³¹ Substituting its own judgment for that of the insurer, the tax court ignored the evidence and engaged in pricing insurance.

[87] Finally, the conversion feature of the C Group Term policy is consistent, in substance, with the conclusion that it is simply group term insurance. The existence [sic] conversion privilege cannot be subterfuge; all group term life insurance policies are required to offer to insureds the benefit of the right to convert from the group policy to an individual insurance policy that will have cash value. (App. 456, App. 9; see also, e.g. N.J. Stat. Ann. § 17B:27-19 and 20 (1971)). Moreover, there was a business purpose and economic substance to the determination of whether and to what extent conversion credits may be applied to a conversion policy, inconsistent with the tax court's view that the application of conversion credits was merely a tax planning device.

[88] Unrebutted testimony established that the insurance company conducted a quarterly, actuarial review of the experience of the entire C Group Term block of policies to determine whether it could use positive experience from the C Group policy to apply conversion credits to the conversion policy; this was an option, not an obligation, of the insurer. (App. 460-469, 530-531). The premiums paid to the insurance company for C Group Term coverage are assets of the insurance company at risk to pay all insurance claims; whether or not conversion credits may be applied to the conversion policy depends on insurance company assumptions of expected future experience, lapse rates, mortality rates, conversion rates, investment rates, expense levels and other experience factors of the insurer. (App. 460-469, 530-531, 1855-183).³²

[89] Ignoring the rulings of this Court and the non-tax economic benefits to contributing employers and employees, as well as the business purposes associated with the arrangement of benefits, the tax court erroneously [ ] by disregarding the form of the arrangement to provide insurance benefits.

[91] In addition, it is instructive to consider the ownership interests of Lakewood Radiology (an appellant employer). Lakewood was equally owned by four employees. (App. 5) Their compensation was not based on their ownership percentage; their plan benefits were based on their compensation, not on their ownership percentage. No plan benefit was related to or a multiple of an employee's ownership interest, and no evidence to the contrary was presented at trial. Moreover, Lakewood contributions to the plan were not made in equal amounts for each of the employee-owners even though they each owned 25%. Unlike dividends, but just like compensation, the disallowed contributions were related to the employees' salaries, not their ownership interests.

[92] In addition, one of the employees of Lakewood Radiology, Dr. Sankhla, was a non-owner employee. The disallowed contribution his C Group Term was paid by Lakewood Radiology in May, 1993 (App 395).³³

[93] The court disallowed the majority of the contributions made on behalf of Dr. Sankhla, ruling that all disallowed contributions were deemed dividends (App. 33), even those made on behalf of Dr. Sankhla. Appellants have been unable to find any case supporting the tax court's ruling, in disregard of the corporate form, that a non-owner employee can be paid a dividend.

[95] A finding of negligence necessarily includes a finding that the appellants failed to make any reasonable attempt to comply with the provisions of the Internal Revenue Code; a finding of disregard must be based on carelessness, recklessness, or intent. However, the facts do not support such findings.

[96] The appellants were initially approached by experienced professionals with whom they had an existing professional relationship. (App. 6, 10, 6660, 6661, 6662). The program of life insurance benefits was endorsed by their own professional organization, the New Jersey Medical Society. (App. 7, 6663, 6664, 6665).

[97] The court disregarded appellants' reliance on the advice of professionals, such as their own accountants who reviewed the benefit program and prepared their tax returns. (App. 6666, 6667, 35). The court ignored reality -- people generally turn to those they already know and trust, especially for financial advice. The court rejected the reliance on the legal opinions obtained by the benefit program's designers, because there was no evidence that the employees had read them. (App. 34-35). However, the engagement agreement between the VEBA administrator and the employers included a statement that the trust would be submitted to the IRS for approval. (App. 3670-3671, 3672-3673).

[98] Finally, the tax court refused to acknowledge that it was resolving issues of first impression. However, the government presented this case to the tax court as a "test case." (App. 2). Indeed the IRS issued no guidance with respect to this type of benefit program until 1995 in Notice 95-34. And, the first case, to consider issues described in Notice 95-34 was Booth v. C.I.R., 108 T.C. 524 (1997). The Booth case was decided in 1997, years after the employers made their contributions to the plan and took the related tax deductions.

[99] Under the circumstances of this case, accuracy related penalties are unwarranted. Simple fairness should preclude the assessment of penalties where there is no clear authority in this Circuit to support the rulings of the tax court.

[101] The employers entered into legally binding arrangements to provide benefits to their employees, and benefits were in fact provided. In disregard of controlling law, the tax court concluded that the deductibility of the contributions to fund the plan of benefits depends upon the motives behind the establishment of the plan. Contrary to the rulings of this Court, the tax court concluded that marketing materials written to promote an arrangement to provide employee benefits take precedence over the actual terms of the plan's governing documents, and that the marketing materials control the benefit entitlement of the participants and the legitimacy of the deductions taken for the contributions to fund the employee benefits. Ignoring the settled law in this jurisdiction, the tax court ruled that employer contributions to an employee benefit plan are not compensation for services rendered, but instead are deemed dividends.

[102] Upon the foregoing, it is respectfully submitted that the judgment of the court below is erroneous as a matter of law and should, therefore, be reversed.

Dated: January 2, 2002

Dated: January 3, 2002

²Because the amount of the insurance benefit is a multiple of annual compensation, employer contributions were also related to compensation generally along the same ratios. (Schedules A and B, discussed below, identify the amount of the contributions made by Lakewood Radiology and Neonatology Associates). However, if upon enrolling as a participant, an employee were found to be unhealthy and rated a substandard risk, his or her life insurance benefit was reduced to the amount that could be purchased with the same premium that would be paid if the employee were a standard underwriting risk. (App. 1688-1709).

³The four owner-employees each owned a 25% share of the corporation but received disparate compensation in each of the years in question ; they were not compensated on the basis of their ownership, but rather on their services for the corporation. It was this compensation on which the amount of life insurance was based. Dr. Mall was the sole owner of Neonatology, the other contributing employer appellant (App. 4); Dr. Mall's benefit was based on a multiple of her compensation, not her ownership percentage.

⁴At all times the trustees of the trust for both the California and New Jersey VEBAs have been entities separate and independent from the insurance companies and employers participating in the plan and trust or the New Jersey VEBA trust, App. 5731-5750, 5711-5730), for the California VEBA Trust, (App. 1542, 379).

⁵The benefit plans were intended to be ten-or-more employer plans under I.R.C. §419A(f)(6), as acknowledged in the "no change" letter issued on September 30, 1994. (App. 1683, generally 1677-1680, 1681-1682, 1674-1675, 1676). The trustee held all the assets of the VEBA trust as one fund (App. 5734, section 1.02, App. 1548, section 2.01 (c)), and reported its valuation of the trust as a whole on one annual IRS Form 990, App. 1621-1645); the VEBA benefit plan had one hundred or more contributing employers each year (App. 2040-2080, 2081-2118); even the IRS conceded that the VEBA did not maintain experience rating arrangements with respect to individual employer groups. (App. 2168, p. 28, para. 2; 641-6412). The court below expressly declined to rule on the I.R.C. § 419 issues. (App. 37 at footnotes 3 and 4).

⁶Attached as Schedule A is a table of certificates issued to Lakewood Radiology employees for the years at issue, the amount of premium paid for each year, and the death benefit. In addition, Lakewood Radiology also paid premiums directly to Peoples Security Life Insurance Company for life insurance benefits for its employees under additional C Group and MG 5 policies; these are also identified in Schedule A.

⁷The tax court acknowledged that Dr. Sankhla became an owner after Dr. Sobo's death in late September, 1993. (App. 5). In fact, he became an owner in July, 1994. (App. 1911). The court further acknowledged that his C Group Term policy, for which the company contributed $5,750, was issued effective January 31 1993. (App. 23). The premium was actually submitted by Lakewood in May, 1993. (App. 395).

⁸The contributions made by Neonatology Associates for C Group Term coverage on the life of Dr. Mall's husband were taken as deductions on Neonatology Associates' federal tax returns. The petitioners conceded that the husband was not an eligible plan participant and that the deductions should be disallowed.

⁹Attached as Schedule B is a table of the Neonatology employee certificates issued for the years at issue, the amount of premium paid for each year, and the death benefit amount.

¹⁰The tax court erroneously concluded that the C Group Term policy was an "asset accumulation" phase of a universal life policy. Yet, when Inter-American filed for liquidation and Commonwealth issues replacement C Group Term coverage to former Inter-American insureds, the Commonwealth coverage was issued at new issue ages. (App. 535-536); no assets were transferred to anyone by Inter-American, when Commonwealth provided replacement coverage for plan participants.

¹¹C Group premiums were not perfectly level; there was some modest increase over-time. (App. 1814-1832).

¹²In the later years, the price of a typical yearly renewable term policy, including the MG 5 Term policy, skyrockets, making the cost to the insured of such a term policy in these later years often prohibitive. (App. 1814-1832, 1828-1832).

¹³While the deductions for contributions to the plan used to purchase the MG 5 policies were allowed, the tax court further noted: "Premiums on an MG 5 policy are generally commensurate with the life insurance risk assumed by the insurance company and do not present policyholders with asset accumulation." (App. 8).

¹⁴Certain employees, of Lakewood Radiology were covered by a Peoples Security Life Insurance company master C Group Term policy, funded by their employer's contributions paid directly to Peoples. Their coverage under the Peoples policy could also be converted, if the employees left the employ of Lakewood. For ease of reference, in the discussion that follows regarding the conversion privilege, no distinction is made between the different C Group Term policies; the policies are functionally the same.

¹⁵As with other group term policies issued by Commonwealth, an employee could convert to a number of universal life polices other than the special conversion policy. (App. 2183-2260, 515).

¹⁶No portion of the contributions -- once paid to the insurance company by the plan for C Group Term coverage for plan participants -- constitutes assets of the VEBA plan or trust, of any contributing employer, or any plan participant. (App. 1833-1842, 1843-1854, 5130-5134, 2017-2039). The plan's assets are the insurance contracts, not the premiums paid to the insurers. (App. 1833-1842, 1843-1854).

¹⁷The tax court refers frequently to a "conversion credit accumulation account," despite the complete absence of any evidence indicating that any such account exists. The insurers' representatives testified that there were no such accounts, and that the conversion account formula in the product specifications was an actuarial formula to calculate conversion credits, if the insurance company were to make them available. (App. 6250).

¹⁸In order to be eligible for conversion credits, C Group Term coverage had to be in place for a specific number of years. (App. 6649-6654).

¹⁹The tax court relied upon certain marketing materials allegedly prepared by agents of CJA that focused on the possibility of a certificate-holder receiving conversion credits in a conversion policy that would accumulate cash value that could be accessed, post- conversion, tax free. (App. 6; see generally, 2687-2690, 7074- 6161). Despite the requirement that any marketing materials be approved in writing by the insurance company before their use or distribution (App. 2409, section 3.2; 2787, section 3.2), these materials were not approved by the insurance company as descriptive of the insurance product (App. 550), and were not even seen by the petitioners (App. 6655, 6656, 6657, 6658, 6659. The agents had authority to alter the terms of the policy. App. 1839, section 21; App. 1849, section 21; App. 2473, section 3.2; App. 2486, section 3.2).

²⁰Evidence that the benefits and contributions were a multiple of compensation is described in the Statement of Facts.

²¹At a minimum, the arrangements at issue in this case are plans under I.R.C. § 4975(e)(1) based on the IRS's rulings that the Associations are VEBAs providing a plan of benefits under I.R.C. § 501(c)(9), (App. 1409-1411, 1618-1620). A similar conclusion must be drawn from the fact of the IRS audit of the California VEBA and its plan, and the IRS's issuance of a "no change" letter. (App. 1683).

²²The failure to follow a plan's governing documents is a violation of law, subjecting the violator to civil liability. Reich v. Compton, 57 F. 3d 270 (3d Cir. 1995) (finding a violation of 29 U.S.C. § 1104(a)(1)(D), where a fiduciary does not act "in accordance with the documents. . . governing the plan").

²³Henglein reversed the district court's award of benefits as "inconsistent with the provisions of the plan documents when read as a whole." See also Confer v. Custom Engineering Co., 952 F.2d 41, 43 (3d Cir. 1991).

²⁴In Rev. Rul. 81-128, 198-1 C.B. 469, the IRS announced that, it would follow Estate of Connelly in the Third Circuit, but nowhere else.

²⁵This is also true of the C Group Term coverage issued by Peoples directly to certain of the Lakewood Radiology employees.

²⁶The phrase "cost of insurance" is a concept associated with whole life or universal life insurance policies. In such policies, an amount representing the "cost of insurance" must be paid to keep the policy from lapsing; the cost of insurance can be less than the scheduled premium, because such policies accumulate cash value that can be used to pay premiums. Albert E. Easton Timothy F. Harris, Actuarial Aspects of Individual Life Insurance and Annuity Contracts, pp. 65-66 (ACTEX Publications, 1999). However, in a term policy, such as the C Group Term, as a matter of contract the entire amount of the premium charged must be paid to keep the policy in force.

²⁷The tax court's Draconian ruling was an overreaction to the size of the premiums. One benefit of a group term insurance plan is the state mandated right to convert without evidence of insurability to a contract that must have cash value. This is a benefit of every group term policy and plan. See Treas. Reg. §1.501(c)(9)-3(b)-3(b).

²⁸See Cottage Sav. Ass'n v. C.I.R., 499 U.S. 554 (1991), in which the Supreme Court rejected the IRS claim that an exchange of participating interests in two groups of mortgages was a sham, because the transaction was motivated by the desires of the taxpayer bank to rid itself of bad loans without having to report them on its financial statements and to take a deduction for losses on the exchange. The Court rejected the IRS argument, because there was a non-tax effect on the taxpayer's economic position. Id. at 558.

²⁹The tax court did not use the word "sham" in its opinion; it did conclude, contrary to the express terms of the policies, that "[t]he C Group product is a novel product designed by Inter-American (and later adopted by Commonwealth) to masquerade as a policy that provides only term life insurance benefits in order to make the product marketable to targeted investors and to make life insurance purchases from it more attractive than purchases from its larger competitors." (App. 8). There has never been a suggestion by an state department of insurance, or any court, that designing a term policy with levelized premiums is a "subterfuge" or anything other than a commercially reasonable and accepted insurance industry practice.

³⁰In addition to evidence of the economic impact of the levelization of premiums, there was considerable testimony about other actuarial considerations -- in particular, the small employer market -- that supported the pricing of the C Group Term policy. (App. 460-46-9). The unique nature of this risk is not reflected in normal mortality tables. (App. 463-469). Hence, some portion of the levelizing of premiums also was intended to buffer against the uncertainties posed by this risk. (App. 463-469). The tax court commented that it believed Mr. Ankner "testified incredibly with regard to material aspects of this case," (App. 28), but the court did not identify any specific testimony it found to be incredible. Nothing in the opinion suggests that the court considered, and found incredible, Mr. Ankner's critical testimony regarding the pricing of the C Group Term product, which he designed.

³¹In his report Mr. Jaffe compared the rates for similar classes of insureds for the MG 5 and the C Group Term, and concluded that over time the total cost was about the same. The tables in the appendix to his Report illustrate this point.

³²Both Mr. Ankner and Ms. Jackson gave critical testimony on this issue. It should not be lost on this Court that the tax court commented that Ms. Jackson (on the record at trial) that she was one of the most credible witnesses the court had ever seen.

³³Dr. Sankhla did become an owner-employee, but not until July 1994. (App. 1911).