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Termination of Nonexempt Welfare Benefit Plan Results in Taxable Distributions.
(Parker Tax Publishing December 09, 2013)

Because the underlying policies of a terminated welfare benefit plan owned by the taxpayers were substantially certain to be distributed to them or placed within their control, the value of the policies were includible in the taxpayers' income. Gluckman v. Comm'r, 2013 PTC 371 (2d Cir. 11/22/13).

Thomas Gluckman and his wife, Roby, were employees and majority shareholders of Fownes Brothers & Co., Inc. a clothing accessories manufacturer. Thomas was president and director of Fownes. In December 1999, Fownes, at the direction of the Gluckmans, adopted the Advantage Death Benefit Plan and Trust (i.e., the Advantage Plan), a 10-or-more-employer welfare benefit plan under Code Sec. 419A(f)(6), which offered preretirement life insurance to employees on a tax deductible basis. The plan was not a tax-exempt trust. As of 2000, the Gluckmans were both covered employees. The Advantage Plan was terminated by the plan administrator, BISYS Insurance Services, Inc., effective December 31, 2003. Before that time, Fownes submitted on October 24, 2003, corporate resolutions authorizing a complete distribution of the policies to take effect on November 28, 2003. The resolution was signed by affected participants, including the Gluckmans, each of whom waived the right to purchase the underlying policies.

On December 17, 2003, Thomas signed an agreement providing that Fownes would participate in the Millennium Multiple Employer Welfare Benefit Plan, another 10-or-more-employer welfare benefit plan. The change-of-ownership forms listed the Millennium Plan as the new owner of the insurance policies, as of January 22, 2004. On February 9, 2004, the issuing insurance company acknowledged the change of ownership, and BISYS notified taxpayers that they would be receiving information about their tax obligations in connection with the termination from the Advantage Plan. The Gluckmans did not include as income in 2003 the value of the underlying life insurance policies. The IRS determined that the Gluckmans' interest in the policies was substantially vested and, under Code Sec. 402(b)(1), was required to be included in income. The IRS also assessed and accuracy-related penalty under Code Sec. 6662.

The Tax Court agreed with the IRS and held that once Fownes authorized withdrawal from the Advantage Plan, the underlying policies were substantially certain to be distributed to the Gluckmans or placed within their control, and, more importantly, were placed within the Gluckmans' control no later than early November 2003. The Tax Court rejected the Gluckmans' argument that the policies were at all times owned by a welfare benefit plan and subject to a substantial risk of forfeiture, as well as the argument that the Fownes board of directors, not the Gluckmans, had control over the disposition of the policies. The Gluckmans appealed.

The Second Circuit affirmed the Tax Court's decision. The court noted that, after Fownes withdrew from the Advantage Plan, BISYS provided Fownes, which was controlled by the Gluckmans, with the change-of-ownership and change--f beneficiary forms, giving the Gluckmans the ability to name themselves or another welfare benefit plan as the owner and beneficiary of the underlying policies. According to the court, the fact that the Gluckmans chose to name a different welfare benefit plan as the new owner of the policies did not negate the fact that the Gluckmans had the ability to name themselves or anyone else as owners. The Gluckmans did not establish that anyone else exercised or could have exercised authority over the use or distribution of the policies following the formal termination from the Advantage Plan. The court agreed with the Tax Court that, in October of 2003, the policies were not subject to a substantial risk of forfeiture.

Finally, the Second Circuit observed that, although the Gluckmans could have rebutted the assessment of the penalty by providing evidence that the underpayment was made in good faith and with reasonable cause, they produced no such evidence. As a result, the court also upheld the penalty assessment.

For a discussion of the taxation of distributions from non-exempt employee trusts, see Parker Tax ¶135,505.(Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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