McGOWEN v. COMMISSIONER OF INTERNAL REVENUE
BILL S. McGOWEN; CAROLYN M. McGOWEN, Petitioners-Appellants,
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
United States Court of Appeals, Tenth Circuit.
September 2, 2011.
Before O'BRIEN, HOLLOWAY, and GORSUCH, Circuit Judges.
TERRENCE L. O'BRIEN, Circuit Judge.
The Commissioner of Internal Revenue assessed an income tax deficiency of $171,631 against Bill and Carolyn McGowen for the 2004 tax year. He determined the taxpayers' joint federal income tax return mischaracterized proceeds from the termination of a life insurance contract as a discharge of a debt and therefore improperly excluded the gain from the taxpayers' income. The United States Tax Court upheld the Commissioner's deficiency determination, concluding the proceeds from the termination of the policy were income from a life insurance contract pursuant to 26 U.S.C. § 72(e) and the McGowens were required to report the gain as income. We affirm.1BACKGROUND On May 30, 1986, Carolyn McGowen purchased a variable life insurance policy on her life for a single premium of $500,000.2 The premium funds were to be invested and the gains added to increase the policy's value over time. The policy allowed her to borrow against its value, using only the policy as security. The insurance company, however, could terminate the policy if the policy debt exceeded its cash value. By February 28, 2004, Carolyn's debt on the policy ($1,064,784.86)3 exceeded its cash surrender value by $2,038.82. Due to the negative balance, the insurance company sent a notice to Carolyn advising the "outstanding debt on [her] variable life insurance ha[d] now exceeded its cash value." (R. Ex. 15-J) The notice gave her until March 30, 2004, to make a minimum loan repayment of $108,313.42 if she wished to keep the policy active. If she did not make a payment, the insurance company would terminate the policy on that date. It also read:
Termination of your policy coverage will result in a taxable event. Any deferred gain in the policy will be reported to you and the [IRS] on a Form 1099-R. As of February 28, 2004, the taxable gain is $562,746.04.