McGOWEN v. COMMISSIONER OF INTERNAL REVENUE
BILL S. McGOWEN; CAROLYN M. McGOWEN, Petitioners-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
No. 10-9000.
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.1 BACKGROUNDOn 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.
* This order and judgment is an unpublished decision, not binding precedent. 10th Cir. R. 32.1(A). Citation to unpublished decisions is not prohibited. Fed. R. App. 32.1. It is appropriate as it relates to law of the case, issue preclusion and claim preclusion. Unpublished decisions may also be cited for their persuasive value. 10th Cir. R. 32.1(A). Citation to an order and judgment must be accompanied by an appropriate parenthetical notation — (unpublished). Id.
1. Our jurisdiction derives from 26 U.S.C. § 7482(a)(1).
2. The parties submitted the case to the tax court on a fully stipulated set of facts, with attached joint exhibits.
3. According to the policy, debt is the sum of all outstanding loans plus accrued interest.
4. Because the tax court rejected the McGowens' argument that the event was a discharge of debt, it did not reach the McGowens' claim they were insolvent under 26 U.S.C. § 108.
5. Section 72(e)(1) requires taxpayers to include in their gross income any amount received under a "life insurance contract" that "is not received as an annuity." 26 U.S.C. § 72(e)(1)(A)(i),(ii).
6. At oral argument, counsel for the McGowens stated the record clearly established Carolyn McGowen "was insolvent" even excluding the million plus dollars of the policy liability. (Oral Argument, March 9, 2011.)
7. The parties also stipulated there was "no material change in [the McGowens'] assets and liabilities from March 30, 2004 until May 1, 2004, except for the termination of the life insurance policy. . . ." (R. Doc. 10 at 4.)
8. The McGowens concede the loans taken out against Carolyn's life insurance contract were "nonrecourse" policy loans. (Opening Br. at 2, 6, 11-15.) If the policy loans are "nonrecourse," the cash surrender value equals satisfaction of the debt, regardless of whether the policy debt actually exceeded the cash value. Even if we were to consider the amount borrowed in excess of the policy's cash value, the McGowens would still be solvent by approximately $1,662.38 (assets of $3,701.20 minus remaining policy debt after the cash surrender value was applied, $2,038.82). (See R. Exs. 12-J at 52, 18-J.)