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T* (PRECEDENTIAL
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T* (
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T* (       obÌåÓýd July 29, 2002
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T* (
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T* (UNITED STATES COURT OF APPEALS
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T* (FOR THE THIRD CIRCUIT
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T* (
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T* (No. 01-2862
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T* (
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T* (NEONATOLOGY ASSOCIATES, P.A.
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T* (\(Tax Court No. 97-1201\)
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T* (\(Tax Court No. 97-1208\)
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T* (ESTATE OF STEVEN SOBO, DECEASED and
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T* (COMMISSIONER OF INTERNAL REVENUE
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T* (KEVIN T. and CHERYL MCMANUS
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T* (\(Tax Court No. 97-2994\)
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T* (
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T* (LAKEWOOD RADIOLOGY, P.A.
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T* (
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T* (v.
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T* (COMMISSIONER OF INTERNAL REVENUE
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T* (
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T* (\(Tax Court No. 97-2995\)
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T* (
) Tj
T* (Neonatology Associates, P.A., John J.
) Tj
T* (and Ophelia Mall, Estate of Steven Sobo,
) Tj
T* (Deceased, and Bonnie Sobo, Executrix,
) Tj
T* (and Bonnie Sobo, Surviving Wife,
) Tj
T* (Akhilshi S. and Dipti A. Desai,
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T* (Kevin T. and Cheryl McManus,
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T* (Arthur and Lois M. Hirshkowitz and
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T* (Lakewood Radiology, P.A.,
) Tj
T* (
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T* (       Appellants
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T* (
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T* (                                2
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T* (
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T* (
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T* (On Appeal from the United States Tax Court
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T* (\(T.C. Nos. 97-1201/1208/2795/2981/2985/2994/2995\)
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T* (Tax Court Judge: Honorable David Laro
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T* (
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T* (Argued: July 11, 2002
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T* (
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T* (BEFORE: SCIRICA and GREENBERG, Circuit Judges ,
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T* (and FULLAM, District Judge*
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T* (
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T* (\(obÌåÓýd: July 29, 2002\)
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T* (
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T* (       Neil L. Prupis
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T* (       Lampf, Lipkind, Prupis,
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T* (        Petigrow & LaBue
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T* (       80 Main Street
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T* (       West Orange, NJ 07052
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T* (
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T* (       Kevin L. Smith \(argued\)
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T* (       Hines Smith
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T* (       3080 Bristol Street, Suite 540
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T* (       Costa Mesa, CA 92626
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T* (
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T* (       David R. Levin
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T* (       Wiley Rein & Fielding
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T* (       1776 K Street, N.W.
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T* (       Washington, D.C. 20006
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T* (
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T* (        Attorneys for Appellants
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T* (
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T* (       Eileen J. O'Connor
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T* (       Assistant Attorney General
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T* (       Kenneth L. Greene
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T* (       Robert W. Metzler \(argued\)
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T* (       Washington, D.C. 20044
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T* (
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T* (        Attorneys for Appellee
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T* (_________________________________________________________________
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T* (
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T* (* Honorable John P. Fullam, Senior Judge of the United States District
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T* (Court for the Eastern District of Pennsylvania, sitting by designation.
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T* (
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T* (                                3
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T* (
) Tj
T* (
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T* (       Steven J. Fram
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T* (       Archer & Greiner
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T* (       One Centennial Square
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T* (       Haddonfield, NJ 08033
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T* (
) Tj
T* (        Attorneys for Amici Curiae Vijay
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T* (       Sankhla, M.D., Yale Shulman,
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T* (       M.D., Boris Pearlman, M.D., Marvin
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T* (       Cetel, M.D. and Barbara Schneider,
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T* (       M.D.
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T* (
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T* (OPINION OF THE COURT
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T* (
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T* (GREENBERG, Circuit Judge.
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T* (
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T* (I. INTRODUCTION
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T* (
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T* (This matter comes on before this court on appeal from
) Tj
T* (decisions of the United States Tax Court entered April 9,
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T* (2001, in accordance with its opinion filed July 31, 2000,
) Tj
T* (upholding the determination of the Commissioner of
) Tj
T* (Internal Revenue that contributions made by appellants,
) Tj
T* (two professional medical corporations, Neonatology
) Tj
T* (Associates, P.A. and Lakewood Radiology, P.A., into
) Tj
T* (Voluntary Employees Beneficiary Program \(VEBA\) plans in
) Tj
T* (excess of the cost of term life insurance were taxable
) Tj
T* (constructive dividends to the physicians owning the
) Tj
T* (corporations and their spouses rather than employer
) Tj
T* (deductible expenses. See Neonatology Assoc., P.A. v.
) Tj
T* (Comm'r, 115 T.C. 43 \(2000\). We refer to the corporations
) Tj
T* (and individuals collectively as "taxpayers." The
) Tj
T* (consequences of the decisions were substantial for the
) Tj
T* (taxpayers inasmuch as the professional medical
) Tj
T* (corporations were denied deductions they had taken for the
) Tj
T* (contributions and the individuals were charged with
) Tj
T* (significant additional taxable dividend income. The court
) Tj
T* (held further that the individual taxpayers were liable for
) Tj
T* (accuracy-related negligence penalties under I.R.C.
) Tj
T* (S 6662\(a\).
) Tj
T* (
) Tj
T* (Our examination of the record convinces us that the
) Tj
T* (contributions at the heart of this dispute were so far in
) Tj
T* (
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T* (                                4
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T* (
) Tj
T* (
) Tj
T* (excess of the cost of annual life insurance protection that
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T* (they could not plausibly qualify as ordinary and necessary
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T* (business expenses in accordance with I.R.C. S 162. In
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T* (essence, the physicians adopted a specially crafted
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T* (framework to circumvent the intent and provisions of the
) Tj
T* (Internal Revenue Code by having their corporations pay
) Tj
T* (inflated life insurance premiums so that the excess
) Tj
T* (contributions would be available for redistribution to the
) Tj
T* (individual shareholders free of income taxes. As correctly
) Tj
T* (recognized by the Tax Court, these contributions were
) Tj
T* (taxable disguised dividends and not deductible expenses.
) Tj
T* (Moreover, as the individual taxpayers could not in good
) Tj
T* (faith avail themselves of the reliance-on-professional
) Tj
T* (defense, the Tax Court duly held them liable for the
) Tj
T* (accuracy-related negligence penalties. Accordingly, for the
) Tj
T* (reasons we elaborate in more detail below, we will affirm
) Tj
T* (the decisions of the Tax Court.
) Tj
T* (
) Tj
T* (II. BACKGROUND
) Tj
T* (
) Tj
T* (The evidence at the trial disclosed the following facts.
) Tj
T* (Neonatology is a New Jersey professional corporation owned
) Tj
T* (by Dr. Ophelia J. Mall. Lakewood is a New Jersey
) Tj
T* (professional corporation owned equally at the times
) Tj
T* (material here by Drs. Arthur Hirshkowitz, Akhilesh Desai,
) Tj
T* (Kevin McManus, and Steven Sobo until his death on
) Tj
T* (September 23, 1993. Subsequently Dr. Vijay Sankhla, who
) Tj
T* (is not a party to this action, purchased Sobo's interest. The
) Tj
T* (spouses of the doctors, John Mall, Lois Hirshkowitz, Dipti
) Tj
T* (Desai, Cheryl MacManus, and Bonnie Sobo, are parties to
) Tj
T* (this action as the doctors and their spouses filed joint
) Tj
T* (income tax returns. In addition, Bonnie Sobo is a party as
) Tj
T* (executrix of her husband's estate.
) Tj
T* (
) Tj
T* (Following the enactment of the Tax Reform Act of 1986
) Tj
T* (\(TRA\), Pub.L. 99-514, 100 Stat. 2085, insurance salesmen
) Tj
T* (Stephen Ross and Donald Murphy formed Pacific Executive
) Tj
T* (Services \(PES\), a California partnership designed to
) Tj
T* (provides services to retirement plan administrators and
) Tj
T* (employee benefit advisors unfamiliar with the impact of the
) Tj
T* (TRA. See App. at 377. Specifically, Ross and Murphy
) Tj
T* (devised a program to allow closely held corporations to
) Tj
T* ("create a tax deduction for [ ] contributions to [an] employee
) Tj
T* (
) Tj
T* (                                5
) Tj
T* (
) Tj
T* (
) Tj
T* (welfare benefit plan going in and a permanent tax deferral
) Tj
T* (coming out." App. at 2672.
) Tj
T* (
) Tj
T* (To achieve this end, PES created two voluntary
) Tj
T* (employees' beneficiary associations, the Southern California
) Tj
T* (Medical Profession Association VEBA \(SC VEBA\) and the
) Tj
T* (New Jersey Medical Profession Association VEBA \(NJ VEBA\).1
) Tj
T* (A VEBA, as defined in I.R.C. S 501\(c\)\(9\), is a tax-exempt
) Tj
T* (program providing members, their dependents, or
) Tj
T* (designated beneficiaries with life, sick, accident, or other
) Tj
T* (benefits "if no part of the net earnings of such association
) Tj
T* (inures \(other than through such payments\) to the benefit of
) Tj
T* (any private shareholder or individual."
) Tj
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) Tj
T* (Under the PES VEBA programs, each participating
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T* (and designating a trust administrator with exclusive control
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T* (over all assets. The plan adoption agreement obligates
) Tj
T* (employers to make, whether in the form of group insurance
) Tj
T* (policies or group annuities, contributions towards the life
) Tj
T* (insurance benefits of employees and their beneficiaries,
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) Tj
T* (compensation. Benefits payable under any plan are paid
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T* (solely from that plan's allocable share of the trust fund,
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T* (and the participating employer, administrator, and trustee
) Tj
T* (are not liable for any shortfall in the funds required to be
) Tj
T* (paid. Upon termination of a plan, all its remaining assets
) Tj
T* (are distributed to the employer's covered employees in
) Tj
T* (proportion to their compensation. PES enlisted the services
) Tj
T* (of Barry Cohen, a longtime insurance salesman with the
) Tj
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) Tj
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) Tj
T* (
) Tj
T* (The SC VEBA plans at issue in this case, the Neonatology
) Tj
T* (Employee Welfare Plan and the Lakewood Employee Welfare
) Tj
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) Tj
T* (continuous group \(C-group\) term policy certificates from the
) Tj
T* (Inter-American Insurance Co. of Illinois, Commonwealth
) Tj
T* (_________________________________________________________________
) Tj
T* (
) Tj
T* (1. Notwithstanding what might be regarded as a geographical anamoly,
) Tj
T* (only the SC VEBA is involved here. There was, however, an additional
) Tj
T* (petitioner in the Tax Court, not a party on this appeal, Wan B. Lo, d/b/a
) Tj
T* (Marlton Pain Control and Acupuncture Center, who established a plan
) Tj
T* (under the NJ VEBA.
) Tj
T* (
) Tj
T* (                                6
) Tj
T* (
) Tj
T* (
) Tj
T* (Life Insurance Co., and Peoples Security Life Insurance Co.
) Tj
T* (The C-group product provided routine group term life
) Tj
T* (insurance with an added component, a "special" conversion
) Tj
T* (policy through which a covered employee, under certain
) Tj
T* (circumstances,2 could opt to convert his or her policy to an
) Tj
T* (individual policy, the C-group conversion universalife \(UL\)
) Tj
T* (policy. By converting from a C-group to an individual UL
) Tj
T* (policy, the employee could access funds paid by the
) Tj
T* (employer to the group policy that exceeded the applicable
) Tj
T* (mortality charge, i.e. the cost of insurance. The excess
) Tj
T* (funds, depending on the year in which the conversion takes
) Tj
T* (place,3 are paid out with interest as so-called "conversion
) Tj
T* (credits."
) Tj
T* (
) Tj
T* (In addition to being able to access surplus amounts, a
) Tj
T* (policyholder upon conversion to the UL policy may borrow
) Tj
T* (any amounts against his or her policies not required to
) Tj
T* (keep the policies in force.4 When the policyholder dies, the
) Tj
T* (loans are to be repaid from the policy death benefits, which
) Tj
T* (ordinarily are not subject to income tax. See  I.R.C. S 101.
) Tj
T* (Of course, by borrowing the money the taxpayer effectively
) Tj
T* (would be withdrawing money the medical corporations paid
) Tj
T* (for the conversion privilege on a tax free basis. Thus, as if
) Tj
T* (_________________________________________________________________
) Tj
T* (
) Tj
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) Tj
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T* (left the class eligible for coverage, \(3\) the underlying contract terminated,
) Tj
T* (\(4\) the underlying contract was amended to terminate or reduce the
) Tj
T* (insurance of a class of insured employees, or \(5\) the underlying contract
) Tj
T* (terminated as to an individual employer or plan. See App. at 1836, 1846.
) Tj
T* (
) Tj
T* (3. Under the applicable schedule, none of the conversion credit balance
) Tj
T* (is transferred to the C-group conversion UL policy if conversion occurs
) Tj
T* (in the C-group term policy's first year. However, if conversion takes place
) Tj
T* (in the C-group term policy's fourth year or beyond, 95% of the
) Tj
T* (conversion credit balance is transferred to the C-group conversion UL
) Tj
T* (policy. Policyholders could not receive more than 95% of their conversion
) Tj
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) Tj
T* (to the insurance agent upon conversion. See App. at 2161-62, 4710,
) Tj
T* (4713.
) Tj
T* (
) Tj
T* (4. Notably, the interest due on any loan policy was equal to the interest
) Tj
T* (credited on the asset accumulation. In other words, there were no out-
) Tj
T* (of-pocket costs to the debtor-policyholder. See  App. at 2164. To hedge
) Tj
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) Tj
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) Tj
T* (
) Tj
T* (                                7
) Tj
T* (
) Tj
T* (
) Tj
T* (by magic, cash derived from the corporations would be
) Tj
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) Tj
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) Tj
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) Tj
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) Tj
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) Tj
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) Tj
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) Tj
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) Tj
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) Tj
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) Tj
T* (employee's compensation of the prior year. See  App. at 434,
) Tj
T* (1807. John Mall, Dr. Mall's husband, was not a paid
) Tj
T* (employee of Neonatology and thus was not eligible to join
) Tj
T* (the plan. Nevertheless, Dr. Mall and PES, the plan
) Tj
T* (administrator, allowed Mr. Mall to join the plan, making
) Tj
T* (him eligible to receive a death amount commensurate to
) Tj
T* (that payable under life insurance that he had owned
) Tj
T* (outside the plan \($500,000\). See Supp. App. at 108-09. The
) Tj
T* (Neonatology Plan purchased three C-group life insurance
) Tj
T* (policies, two on Dr. Mall's life and one on Mr. Mall's life.
) Tj
T* (See App. at 434-39. Neonatology contributed to the
) Tj
T* (Neonatology Plan during each year from 1991 through 1993
) Tj
T* (and, for each subject year, claimed a tax deduction for
) Tj
T* (those contributions and other related amounts.
) Tj
T* (
) Tj
T* (Lakewood, on the basis of conversations between its
) Tj
T* (principals and Cohen, established the Lakewood Plan under
) Tj
T* (the SC VEBA on December 28, 1990, effective January 1,
) Tj
T* (1990. Under the plan, each covered employee was to
) Tj
T* (receive a life insurance benefit equal to 2.5 times his or her
) Tj
T* (prior-year compensation. See App. at 387. Lakewood
) Tj
T* (amended its plan as of January 1, 1993, to increase the
) Tj
T* (compensation multiple to 8.15. The Lakewood Plan
) Tj
T* (purchased 12 C-group life insurance policies on the lives of
) Tj
T* (Drs. Hirshkowitz, Desai, Sobo, McManus, and Sankhla and
) Tj
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T* (three group annuities toward future premiums on the
) Tj
T* (policies. See App. at 400-26. Lakewood also purchased
) Tj
T* (three C-group policies outside of the Lakewood Plan. The
) Tj
T* (individual owners on their own behalf determined the
) Tj
T* (amounts contributed by Lakewood to the SC VEBA. See
) Tj
T* (App. at 1015-16, 3674-87. For each subject year, Lakewood
) Tj
T* (claimed a tax deduction for those contributions and other
) Tj
T* (related amounts.
) Tj
T* (
) Tj
T* (                                8
) Tj
T* (
) Tj
T* (
) Tj
T* (The IRS audited Neonatology's tax returns for calendar
) Tj
T* (years 1992 and 1993 and Lakewood's tax returns for fiscal
) Tj
T* (year 1991 \(ending October 31, 1991\) and calendar years
) Tj
T* (1992 and 1993. As a consequence of the audits, the
) Tj
T* (Commissioner made the following determinations. First,
) Tj
T* (with respect to the deductions claimed by Neonatology for
) Tj
T* (amounts paid to the SC VEBA and by Lakewood for
) Tj
T* (amounts paid to the SC VEBA and to the three non-plan C-
) Tj
T* (group policies, he allowed only the cost of annual term life
) Tj
T* (insurance protection and disallowed the excess amounts of
) Tj
T* ($43,615 and $986,826 for Neonatology and Lakewood
) Tj
T* (respectively. See App. at 2265-66, 2283-85. The
) Tj
T* (Commissioner based his disallowance on alternative bases:
) Tj
T* (\(1\) the excess contributions were not ordinary and
) Tj
T* (necessary business expenses under I.R.C. S 162\(a\); \(2\) even
) Tj
T* (if the amounts constituted ordinary and necessary business
) Tj
T* (expenses, they nevertheless were not deductible under
) Tj
T* (I.R.C. SS 404\(a\) and 419\(a\), which limit the deductibility of
) Tj
T* (contributions paid to deferred compensation plans and
) Tj
T* (welfare benefit plans. See App. at 2266, 2285.5
) Tj
T* (
) Tj
T* (Second, the Commissioner determined with respect to the
) Tj
T* (individual owners that amounts paid to the SC VEBA
) Tj
T* (program increased personal incomes by $39,343 for Dr.
) Tj
T* (Mall and her husband, $219,806 for Dr. Desai, $56,107 for
) Tj
T* (Dr. McManus, $601,849 for Dr. Hirshkowitz, and $101,314
) Tj
T* (for Dr. Sobo \(his estate\). See App. at 2271, 2311, 2297,
) Tj
T* (2320. The Commissioner included the excess contributions
) Tj
T* (as income to the individual taxpayers on alternative bases:
) Tj
T* (\(1\) the amounts were deposited in the plans for the
) Tj
T* (economic benefit of the individual taxpayers and as such
) Tj
T* (constituted constructive dividends under I.R.C.SS 61\(a\)\(7\)
) Tj
T* (and 301; \(2\) assuming that the Neonatology and Lakewood
) Tj
T* (Plans constituted deferred compensation plans, the excess
) Tj
T* (contributions were includible under section 402\(b\). See
) Tj
T* (_________________________________________________________________
) Tj
T* (
) Tj
T* (5. Specifically, the Commissioner ruled that as deferred compensation
) Tj
T* (plans, the Neonatology and Lakewood Plans did not satisfy the I.R.C.
) Tj
T* (S 404\(a\)\(5\) "separate account" requirement for the contributions to be
) Tj
T* (deductible. If the plans were characterized as welfare benefit funds,
) Tj
T* (I.R.C. S 419\(b\) limited the deductions as the plans could not qualify for
) Tj
T* (the "10-or-more-employer plans" exception to section 419\(b\) in I.R.C.
) Tj
T* (S 419A\(f\)\(6\).
) Tj
T* (
) Tj
T* (                                9
) Tj
T* (
) Tj
T* (
) Tj
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T* (App. at 2271, 2297, 2311, 2320. Lastly, the Commissioner
) Tj
T* (determined that by reason of the underpayment of taxes
) Tj
T* (the individual taxpayers were subject to penalties under
) Tj
T* (I.R.C. S 6662\(a\).
) Tj
T* (
) Tj
T* (Neonatology, Lakewood, and the individual owners
) Tj
T* (petitioned the Tax Court challenging the IRS's
) Tj
T* (determinations. After a bench trial, the court sustained the
) Tj
T* (Commissioner on the ground that:
) Tj
T* (
) Tj
T* (       The Neonatology Plan and the Lakewood Plan are
) Tj
T* (       primarily vehicles which were designed and serve in
) Tj
T* (       operation to distribute surplus cash surreptitiously \(in
) Tj
T* (       the form of excess contributions\) from the corporations
) Tj
T* (       for the employee/owners' ultimate use and benefit . . . .
) Tj
T* (       The premiums paid for the C-group term policy
) Tj
T* (       exceeded by a wide margin the cost of term life
) Tj
T* (       insurance . . . . What is critical to our conclusion is
) Tj
T* (       that the excess contributions made by Neonatology and
) Tj
T* (       Lakewood conferred an economic benefit on their
) Tj
T* (       employee/owners for the primary \(if not sole\) benefit of
) Tj
T* (       those employee/owners, that the excess contributions
) Tj
T* (       constituted a distribution of cash rather than a
) Tj
T* (       payment of an ordinary and necessary business
) Tj
T* (       expense, and that neither Neonatology nor Lakewood
) Tj
T* (       expected any repayment of the cash underlying the
) Tj
T* (       conferred benefit.
) Tj
T* (
) Tj
T* (Neonatology, 115 T.C. at 89-91.
) Tj
T* (
) Tj
T* (Without addressing the alternative grounds for the
) Tj
T* (Commissioner's conclusions, the court rejected taxpayers'
) Tj
T* (arguments that the possibility of forfeiture in certain
) Tj
T* (situations like policy lapse or death rendered all excess
) Tj
T* (payments into de facto contributions to life insurance
) Tj
T* (protection. Id. at 89-90 \("The mere fact that a C-group term
) Tj
T* (policyholder may forfeit the conversion credit balance does
) Tj
T* (not mean, as petitioners would have it, that the balance
) Tj
T* (was charged or paid as the cost of term life insurance."\).
) Tj
T* (The court also rejected the idea that contributions which in
) Tj
T* (fact did not fund term life insurance were paid as
) Tj
T* (compensation for services, rather than dividends, because
) Tj
T* (as a factual matter neither Neonatology nor Lakewood had
) Tj
T* (the requisite compensatory intent when the contributions
) Tj
T* (
) Tj
T* (                                10
) Tj
T* (
) Tj
T* (
) Tj
T* (were made. Id. at 93. Lastly, the court agreed with the
) Tj
T* (Commissioner that the individual taxpayers were in fact
) Tj
T* (negligent and could not circumvent the accuracy-related
) Tj
T* (penalties by asserting a good faith, reliance-on-professional
) Tj
T* (defense nor could they do so by claiming that the case
) Tj
T* (involved tax matters of first impression.
) Tj
T* (
) Tj
T* (The Tax Court entered its decisions on April 9, 2001.
) Tj
T* (Taxpayers timely appealed on July 6, 2001. We have
) Tj
T* (jurisdiction over this appeal pursuant to I.R.C.S 7482, and
) Tj
T* (the Tax Court had jurisdiction over the petitions pursuant
) Tj
T* (to I.R.C. SS 6213\(a\) and 7442.
) Tj
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T* (
) Tj
T* (III. DISCUSSION
) Tj
T* (
) Tj
T* (There are three principal issues before us on appeal: \(1\)
) Tj
T* (whether the Tax Court correctly determined that the
) Tj
T* (amounts contributed in excess of the cost of per annum
) Tj
T* (term life insurance were not ordinary and necessary
) Tj
T* (business expenses and therefore not deductible; if yes, \(2\)
) Tj
T* (whether those amounts constituted dividends, includible as
) Tj
T* (taxable individual income, or compensation to the
) Tj
T* (individual taxpayers; and, \(3\) whether the individual
) Tj
T* (taxpayers were negligent. Our review of the Tax Court's
) Tj
T* (legal conclusions is plenary and is based on the"clearly
) Tj
T* (erroneous" standard for its findings of fact. See ACM P'ship
) Tj
T* (v. Comm'r, 157 F.3d 231, 245 \(3d Cir. 1998\); Pleasant
) Tj
T* (Summit Land Corp. v. Comm'r, 863 F.2d 263, 268 \(3d Cir.
) Tj
T* (1988\). Moreover, taxpayers bear the burden of refuting the
) Tj
T* (IRS's determinations. See Welch v. Helvering,  290 U.S. 111,
) Tj
T* (115, 54 S.Ct. 8, 9 \(1933\).6
) Tj
T* (
) Tj
T* (A. The Deficiencies
) Tj
T* (
) Tj
T* (Section 162\(a\) of the Internal Revenue Code7 allows for
) Tj
T* (_________________________________________________________________
) Tj
T* (
) Tj
T* (6. The burden of proof may be shifted to the Commissioner in certain
) Tj
T* (circumstances for audits conducted after July 22, 1998. See I.R.C.
) Tj
T* (S 7491. These modifications to the Internal Revenue Code have no
) Tj
T* (bearing on this case.
) Tj
T* (
) Tj
T* (7. The Internal Revenue Code, I.R.C. S 162\(a\), provides that "[t]here shall
) Tj
T* (be allowed as a deduction all the ordinary and necessary expenses paid
) Tj
T* (or incurred during the taxable year in carrying on any trade or
) Tj
T* (business."
) Tj
T* (
) Tj
T* (                                11
) Tj
T* (
) Tj
T* (
) Tj
T* (the deduction of all ordinary and necessary expenses
) Tj
T* (incurred in carrying on a trade or business providing five
) Tj
T* (requirements are met: the item claimed as deductible \(1\)
) Tj
T* (was paid or incurred during the taxable year; \(2\) was for
) Tj
T* (carrying on a trade or business; \(3\) was an expense; \(4\) was
) Tj
T* (a necessary expense; and \(5\) was an ordinary expense. See
) Tj
T* (Comm'r v. Lincoln Sav. & Loan Ass'n, 403 U.S. 345, 352, 91
) Tj
T* (S.Ct. 1893, 1898 \(1971\). Beyond peradventure, employee
) Tj
T* (benefits like life insurance are a form of compensation
) Tj
T* (deductible by the employer.8 See Treas. Reg. S 1.162-10\(a\);
) Tj
T* (see also Joel A. Schneider, M.D., S.C. v. Comm'r, 1992 T.C.
) Tj
T* (Memo. 992-24, 63 T.C.M. \(C.C.H.\) 1787. To the extent,
) Tj
T* (however, that Neonatology's and Lakewood's expenditures
) Tj
T* (did not fund term life insurance, the Tax Court found that
) Tj
T* (they did not meet the five requirements delineated above
) Tj
T* (and therefore were not deductible. This factual finding was
) Tj
T* (not clearly erroneous. See Comm'r v. Heininger , 320 U.S.
) Tj
T* (467, 475, 64 S.Ct. 249, 254 \(1943\).
) Tj
T* (
) Tj
T* (The record amply supports the conclusion that taxpayers
) Tj
T* (paid artificially inflated premiums in a creative bookkeeping
) Tj
T* (ploy conceived by their insurance specialists to exploit what
) Tj
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T* (they thought were loopholes in the tax laws. Indeed, we do
) Tj
T* (not see how a court examining this case could conclude
) Tj
T* (otherwise. Charles DeWeese, the Commissioner's expert,
) Tj
T* (testified that amounts paid into the C-group policies
) Tj
T* (exceeded conventional life insurance premiums by nearly
) Tj
T* (500%. See App. at 804-08, 2156.9  Evidence at trial
) Tj
T* (_________________________________________________________________
) Tj
T* (
) Tj
T* (8. Of course, the mere fact that the benefit is a form of deductible
) Tj
T* (compensation does not necessarily mean that it is taxable to the
) Tj
T* (employee. See I.R.C. S 79. We note that the parties do not treat section
) Tj
T* (79 as significant here.
) Tj
T* (
) Tj
T* (9. It should be noted that the Tax Court made certain credibility
) Tj
T* (determinations, finding DeWeese, an independent consulting actuary, to
) Tj
T* (be a "reliable, relevant, and helpful" witness whose testimony was
) Tj
T* (bolstered by a voluminous record with stipulations to more than 2,000
) Tj
T* (facts and with more than 1,500 exhibits. See Neonatology, 115 T.C. at
) Tj
T* (86-87. By the same token, the court found that the opinions expressed
) Tj
T* (by taxpayers' sole expert, Jay Jaffe, were of minimal help, considering
) Tj
T* (his close relationship to one of the insurance companies that provided
) Tj
T* (the C-group product at issue in the case. See id. \(experts who act as
) Tj
T* (advocates, "can be viewed only as hired guns of the side that retained
) Tj
T* (
) Tj
T* (                                12
) Tj
T* (
) Tj
T* (
) Tj
T* (demonstrated that Dr. Mall knew that term life insurance
) Tj
T* (was substantially more expensive to buy through the SC
) Tj
T* (VEBA than through other plans offered to her under the
) Tj
T* (auspices of the American Medical Association and the
) Tj
T* (American Academy of Pediatrics. She nevertheless opted to
) Tj
T* (form the Neonatology Plan because she believed that it
) Tj
T* (offered her the best tax benefits. See App. at 1025. Dr.
) Tj
T* (Hirshkowitz testified that Lakewood intentionally paid more
) Tj
T* (expensive premiums on the C-group policies than it would
) Tj
T* (have for conventional life insurance protection. See App. at
) Tj
T* (998. Dr. Desai, another Lakewood owner, testified that his
) Tj
T* (independent personal life insurance cost him substantially
) Tj
T* (less than the policies issued pursuant to the SC VEBA. See
) Tj
T* (App. at 1047. Like Dr. Mall, the Lakewood owners
) Tj
T* (nevertheless invested in the SC VEBA program because of
) Tj
T* (Cohen's representation of tax benefits and cash returns
) Tj
T* (that they could anticipate receiving. See App. at 1014-15.
) Tj
T* (
) Tj
T* (The record also reveals that excess premium amounts did
) Tj
T* (not pay for actual current year life insurance protection but
) Tj
T* (rather paid for conversion credits. The compliance manager
) Tj
T* (of the Providian Corporation, the parent of the
) Tj
T* (Commonwealth Life Insurance Company which issued
) Tj
T* (policies involved here, stated in a letter to the IRS that the
) Tj
T* ("premiums paid for the term policy are higher than the
) Tj
T* (traditional term policy because of the conversion privilege
) Tj
T* (and the costs of conversion credits." App. at 3690.
) Tj
T* (DeWeese, belying taxpayers' claim that C-group premiums
) Tj
T* (were higher than those under ordinary term life policies
) Tj
T* (because they were calibrated to the higher risks of longer
) Tj
T* (_________________________________________________________________
) Tj
T* (
) Tj
T* (them, and this not only disparages their professional status but
) Tj
ET
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T* (precludes their assistance to the court in reaching a proper and
) Tj
T* (reasonably accurate conclusion"\) \(quoting Jacobson v. Comm'r, T.C.
) Tj
T* (Memo. 1989-606, 58 T.C.M. \(C.C.H.\) 645\)\). The court also found that
) Tj
T* (some of taxpayers' fact witnesses "testified incredibly with regard to
) Tj
T* (material aspects of this case" and that their testimony, for the most part,
) Tj
T* (was "self-serving, vague, elusive, uncorroborated, and/or inconsistent
) Tj
T* (with documentary or other reliable evidence." Id. These types of
) Tj
T* (credibility determinations are ensconced firmly within the province of a
) Tj
T* (trial court, afforded broad deference on appeal. See Dardovitch v.
) Tj
T* (Haltzman, 190 F.3d 125, 140 \(3d Cir. 1999\).
) Tj
T* (
) Tj
T* (                                13
) Tj
T* (
) Tj
T* (
) Tj
T* (term employees in small markets,10 testified that the bulk of
) Tj
T* (the gross premiums went to accumulate assets for
) Tj
T* (distribution to the individual participants upon conversion.
) Tj
T* (See App. at 2173. In addition, the record supports the
) Tj
T* (conclusion that payments made to the Lakewood Plan for
) Tj
T* (annuities were made not to fund current life insurance
) Tj
T* (protection for employees but rather were made as an
) Tj
T* (investment for the trustee to pay premiums on future C-
) Tj
T* (group premiums. See App. at 976, 993-94, 1041-42.
) Tj
T* (
) Tj
T* (In sum, the evidence fully supports, indeed compels, the
) Tj
T* (finding that the contributions in excess of the amounts
) Tj
T* (necessary to pay for annual term life insurance protection
) Tj
T* (were distributions of surplus cash and not ordinary and
) Tj
T* (necessary business expenses. Considering the sound
) Tj
T* (reasoning of the Tax Court and our own intensive review of
) Tj
T* (the facts here, we conclude that it is implausible that the
) Tj
T* (owners of Neonatology and Lakewood, educated and highly
) Tj
T* (trained medical professionals, knowingly would have
) Tj
T* (overpaid substantially for term life insurance unless they
) Tj
T* (contemplated receiving an added boon such as a tax-free
) Tj
T* (return of the excess contributions.
) Tj
T* (
) Tj
T* (Taxpayers advance two arguments to the effect that the
) Tj
T* (court erred by not limiting its consideration to the written
) Tj
T* (plan documents and life insurance contracts rather than
) Tj
T* (relying on extraneous evidence like the plan marketing
) Tj
T* (materials which discuss the availability of conversion
) Tj
T* (credits. First, they maintain that the Neonatology and
) Tj
T* (Lakewood SC VEBA programs were employee benefit plans
) Tj
T* (under the Employee Retirement Income Security Act, 29
) Tj
T* (U.S.C. S 1001 et seq., \(ERISA\). Thus, they contend that
) Tj
T* (representations made outside of the plan documents
) Tj
T* (cannot be used to consider rights and obligations arising
) Tj
T* (out of the plans. See Br. of Appellants at 35. Second, they
) Tj
T* (argue that under governing state insurance law, the tax
) Tj
T* (implications of a group term life insurance policy are
) Tj
T* (determined only on the basis of the policy language itself.
) Tj
T* (As the literal provisions of the plans discuss only insurance
) Tj
T* (benefits -- that is, a death benefit and an option to convert
) Tj
T* (to an individual policy upon termination of employment --
) Tj
T* (_________________________________________________________________
) Tj
T* (
) Tj
T* (10. See Br. of Appellants at 44 and n.30.
) Tj
T* (
) Tj
T* (                                14
) Tj
ET
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T* (
) Tj
T* (
) Tj
T* (but say nothing about excess contributions returning as
) Tj
T* (conversion credits, taxpayers claim that the Tax Court was
) Tj
T* (compelled to conclude from the strict form of their plans
) Tj
T* (that all contributions in fact went to providing insurance
) Tj
T* (benefits.
) Tj
T* (
) Tj
T* (Inasmuch as taxpayers did not raise the ERISA issue
) Tj
T* (before the Tax Court, we need not consider it on this
) Tj
T* (appeal. See Visco v. Comm'r, 281 F.3d 101, 104 \(3d Cir.
) Tj
T* (2001\). While we recognize that in some exceptional
) Tj
T* (circumstances an appellate court may review a defaulted
) Tj
T* (argument, in this case there are compelling reasons
) Tj
T* (militating against our overlooking procedural norms to
) Tj
T* (consider whether ERISA governed the SC VEBA programs
) Tj
T* (as our determination may prejudice persons not parties to
) Tj
T* (this case.11
) Tj
T* (
) Tj
T* (In any event, even assuming for purposes of argument
) Tj
T* (that the plans were employee benefit plans under ERISA,
) Tj
T* (the fact remains that under well-established tax  principles
) Tj
T* (a court is not limited to plan documents in determining the
) Tj
T* (tax consequences of a transaction. See, e.g., Comm'r v.
) Tj
T* (Court Holding Co., 324 U.S. 331, 334, 65 S.Ct. 707, 708
) Tj
T* (\(1945\) \("The incidence of taxation depends upon the
) Tj
T* (substance of a transaction."\); ACM P'ship, 157 F.3d at 247
) Tj
T* (\("we must look beyond the form of the transaction to
) Tj
T* (determine whether it has the economic substance that its
) Tj
T* (form represents"\) \(citations omitted\); Lerman v. Comm'r,
) Tj
T* (939 F.2d 44, 54 \(3d Cir. 1991\) \(Commissioner and courts
) Tj
T* (have "the power and duty . . . to look beyond the mere
) Tj
T* (forms of transactions to their economic substance and to
) Tj
T* (_________________________________________________________________
) Tj
T* (
) Tj
T* (11. An amicus brief has been filed in this case on behalf of five
) Tj
T* (physician-participants in the VEBA program who have filed a civil
) Tj
T* (complaint against the insurance companies that wrote the C-group
) Tj
T* (policies, Sankhla v. Commonwealth Life Ins. Co. et al., No. 01-CV-4761
) Tj
T* (\(U.S.D.C. N.J.\). Amici have an interest in the outcome of this case
) Tj
T* (because the extent to which we address whether the plans are governed
) Tj
T* (by ERISA could affect resolution of the issue of whether their state law
) Tj
T* (claims against the insurance companies are preempted. See Amicus Br.
) Tj
T* (at 1-2. Rather than needlessly prejudice the rights of litigants in
) Tj
T* (separate proceedings, we do not discuss the applicability of ERISA to the
) Tj
T* (VEBA plans.
) Tj
T* (
) Tj
T* (                                15
) Tj
T* (
) Tj
T* (
) Tj
T* (apply the tax laws accordingly."\).12  The cases cited by
) Tj
T* (taxpayers,13 on the other hand, involve only disputes over
) Tj
T* (_________________________________________________________________
) Tj
T* (
) Tj
T* (12. Taxpayers, conflating the so-called "substance-over-form" doctrine
) Tj
T* (with the "economic substance" or "sham transaction" doctrine,
) Tj
T* (mistakenly argue as well that a court may not disregard the form of an
) Tj
T* (arrangement until it determines that the arrangement lacks any
) Tj
T* (economic substance other than obtaining tax deductions. See Br. of
) Tj
T* (Appellants at 41 \("If . . . there is any economic substance to the
) Tj
ET
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T* (arrangement apart from the alteration of tax liabilities, then the form of
) Tj
T* (the arrangement must be respected, even if the arrangement was
) Tj
T* (motivated by tax avoidance or minimization."\). In actuality, the two
) Tj
T* (doctrines are distinct. The substance-over-form doctrine is applicable to
) Tj
T* (instances where the "substance" of a particular transaction produces tax
) Tj
T* (results inconsistent with the "form" embodied in the underlying
) Tj
T* (documentation, permitting a court to recharacterize the transaction in
) Tj
T* (accordance with its substance. The economic substance doctrine, in
) Tj
T* (contrast, applies where the economic or business purpose of a
) Tj
T* (transaction is relatively insignificant in relation to the comparatively
) Tj
T* (large tax benefits that accrue \(that is, a transaction "which actually
) Tj
T* (occurred but which exploit[s] a feature of the tax code without any
) Tj
T* (attendant economic risk," Horn v. Comm'r, 968 F.2d 1229, 1236 n.8
) Tj
T* (\(D.C.Cir. 1992\)\); in that situation, where the transaction was an
) Tj
T* (attempted tax shelter devoid of legitimate economic substance, the
) Tj
T* (doctrine governs to deny those benefits. See generally Rogers v. United
) Tj
T* (States, 281 F.3d 1108, 1113-18 \(10th Cir. 2002\). The Tax Court in this
) Tj
T* (case, however, based its decision solely on the substance-over-form
) Tj
T* (doctrine, finding that the form of the VEBA was not reflective of its
) Tj
T* (genuine substance. In addition to the evidence we have set forth, the Tax
) Tj
T* (Court's determination further is reinforced, inter alia, by the fact that
) Tj
T* (taxpayers were allowed to convert the C-group term policies to individual
) Tj
T* (C-group conversion UL policies even though none of the five required
) Tj
T* (conditions for conversion were present, see Supp. App. at 106, 111-12,
) Tj
T* (and by the fact that the amount of life insurance taken on the Lakewood
) Tj
T* (principals did not correspond to the amount of benefits for which they
) Tj
T* (were eligible under the plan documents. See, e.g., App. at 389, 400-03
) Tj
T* (\(Dr. Hirshkowitz had C-group certificates on his life for over a million
) Tj
T* (dollars even though he was eligible for life benefits of less than $500,000
) Tj
T* (-- 2.5 times his 1991 compensation of $181,199.09\). Moreover, even
) Tj
T* (under the economic substance doctrine taxpayers would be hard-pressed
) Tj
T* (to argue that the transactions involving the excess term life insurance
) Tj
T* (payments had sufficient economic substance to be respected for tax
) Tj
T* (purposes.
) Tj
T* (13. See Br. of Appellants at 29-36 \(citing Gruber v. Hubbard Bert Karle
) Tj
T* (Weber, Inc., 159 F.3d 780 \(3d Cir. 1998\); Haberern v. Kaupp Vascular
) Tj
T* (Surgeons Ltd. Defined Benefit Pension Plan, 24 F.3d 1491 \(3d Cir. 1994\);
) Tj
T* (Schoonejongen v. Curtiss-Wright Corp., 18 F.3d 1034 \(3d Cir. 1994\);
) Tj
T* (Henglein v. Informal Plan for Plant Shutdown Benefits, 974 F.2d 391 \(3d
) Tj
T* (Cir. 1992\)\).
) Tj
T* (
) Tj
T* (                                16
) Tj
T* (
) Tj
T* (
) Tj
T* (ERISA benefits between private parties, not disputes over
) Tj
T* (tax liabilities between private parties and the
) Tj
T* (Commissioner. While the cases lay out certain principles for
) Tj
T* (determining rights and obligations under an ERISA plan,
) Tj
T* (including the standard contract theory that the literal
) Tj
T* (terms of a plan document must guide all analysis, the
) Tj
T* (cases say nothing about the proper evidentiary protocol for
) Tj
T* (evaluating the tax ramifications of an employer benefit
) Tj
T* (plan. In sum, we have no intention of importing ERISA
) Tj
T* (principles into this tax dispute.
) Tj
T* (
) Tj
T* (Moreover, we reject taxpayers' contention that the Tax
) Tj
T* (Court erred by not limiting its evaluation to the plan
) Tj
T* (documents in light of state insurance law. The court did
) Tj
T* (not construe or interpret the terms of the individual
) Tj
T* (taxpayers' life insurance policies, but rather characterized
) Tj
ET
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T* (the contributions made towards those policies for purposes
) Tj
T* (of determining tax liabilities. While the former endeavor
) Tj
T* (indeed would implicate state law,14 the latter is singularly a
) Tj
T* (question of federal law. See, e.g., Thomas Flexible Coupling
) Tj
T* (Co. v. Comm'r, 158 F.3d 828, 830 \(3d Cir. 1946\).
) Tj
T* (
) Tj
T* (In view of our conclusion that the contributions in
) Tj
T* (dispute were not ordinary and necessary business expenses
) Tj
T* (under I.R.C. S 162\(a\), we next consider whether the district
) Tj
T* (court erred in determining that the contributions
) Tj
T* (constituted dividends rather than compensation to the
) Tj
T* (individual taxpayers and thus deductible to the
) Tj
T* (corporations on that basis.15 Under I.R.C. S 316\(a\), a
) Tj
T* (dividend is a distribution of property made by a corporation
) Tj
T* (to its shareholders out of its earnings and profits. See
) Tj
T* (Comm'r v. Makransky, 321 F.2d 598, 601-03 \(3d Cir. 1963\).
) Tj
T* (_________________________________________________________________
) Tj
T* (
) Tj
T* (14. Curiously, taxpayers fail to specify which state's insurance law
) Tj
T* (applies: New Jersey, where all of the physicians reside, or Pennsylvania,
) Tj
T* (where the insurance agents who promoted the VEBA were located.
) Tj
T* (
) Tj
T* (15. In their brief, taxpayers indicate that the Tax Court erred in
) Tj
T* (characterizing the "disallowed contributions as constructive dividends
) Tj
T* (rather than deductible compensation." Br. at 46 \(emphasis added\). See
) Tj
T* (King's Ct. Mobile Home Park, Inc. v. Comm'r, 98 T.C. 511, 512 \(1992\)
) Tj
T* (\("The first question is whether the diversion of $58,365 of petitioner's
) Tj
T* (income by its controlling shareholder for personal use constitutes the
) Tj
T* (payment of deductible wages or the distribution of a dividend."\) \(footnote
) Tj
T* (omitted\).
) Tj
T* (
) Tj
T* (                                17
) Tj
T* (
) Tj
T* (
) Tj
T* (Dividends are taxed as a component of gross income. See
) Tj
T* (I.R.C. S 61\(a\)\(7\). A shareholder, even if the corporation has
) Tj
T* (dispensed with the formalities of declaration, may be
) Tj
T* (charged with a disguised or constructive dividend if the
) Tj
T* (corporation confers a direct benefit on him from available
) Tj
T* (earnings and profits without expectation of repayment. See,
) Tj
T* (e.g., Crosby v. United States, 496 F.2d 1388-89 \(5th Cir.
) Tj
T* (1974\); Noble v. Comm'r, 368 F.2d 439, 443 \(9th Cir. 1966\);
) Tj
T* (see also Magnon v. Comm'r, 73 T.C. 980, 993-94 \(1980\)
) Tj
T* (\("Where a corporation confers an economic benefit on a
) Tj
T* (shareholder without the expectation of repayment, that
) Tj
T* (benefit becomes a constructive dividend, taxable to the
) Tj
T* (shareholder, even though neither the corporation nor the
) Tj
T* (shareholder intended a dividend."\).
) Tj
T* (
) Tj
T* (In this case, the record fully supports the conclusion of
) Tj
T* (the Tax Court that the individual taxpayers were chargeable
) Tj
T* (with constructive dividends. Indeed, Neonatology and
) Tj
T* (Lakewood, by design surrendering any expectation of
) Tj
T* (remuneration, purchased products that generated a
) Tj
T* (considerable economic bounty for their shareholders in the
) Tj
T* (form of conversion credits. Furthermore, nothing in the
) Tj
T* (record illustrates that taxpayers diverted these corporate
) Tj
T* (assets with the requisite "compensatory intent." See King's
) Tj
T* (Ct. Mobile Home Park, Inc. v. Comm'r, 98 T.C. 511, 514-15
) Tj
T* (\(1992\) \(business expense may be deducted as
) Tj
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T* (compensation only if the payor intends at the time that the
) Tj
T* (payment is made to compensate the recipient for services
) Tj
T* (performed\).16 Moreover, support for a conclusion, though
) Tj
T* (certainly not dispositive, that the excess contributions were
) Tj
T* (not paid as compensation for services rendered is supplied
) Tj
T* (by the fact that the Neonatology and Lakewood plans were
) Tj
T* (made available only to those individuals who owned the
) Tj
T* (corporations and not to their non-equity employees.
) Tj
T* (Furthermore, Dr. Mall directed Neonatology to purchase the
) Tj
T* (C-group product on her husband, a non-employee third-
) Tj
T* (party who did not perform any services for the corporation.17
) Tj
T* (_________________________________________________________________
) Tj
T* (
) Tj
T* (16. To qualify as deductible compensation, a payment also need be
) Tj
T* (reasonable. See Treas. Reg. S 1.162-7\(a\). We do not need to address this
) Tj
T* (point, as the Tax Court correctly determined as a matter of fact that
) Tj
T* (taxpayers did not demonstrate compensatory intent.
) Tj
T* (
) Tj
T* (17. We are satisfied that the mere fact that Dr. Mall partially diverted the
) Tj
T* (benefits to her husband should not change our result.
) Tj
T* (
) Tj
T* (                                18
) Tj
T* (
) Tj
T* (
) Tj
T* (In the circumstances, it is therefore not surprising that Dr.
) Tj
T* (Desai at trial made the matter-of-fact statement that the
) Tj
T* (money contributed by Lakewood to fund insurance
) Tj
T* (premiums and conversion credits is "our money. It's not
) Tj
T* (Lakewood[`s]." App. at 1055.
) Tj
T* (
) Tj
T* (Taxpayers again rely on non-tax ERISA jurisprudence for
) Tj
T* (the exaggerated proposition that payments made pursuant
) Tj
T* (to an employee benefit plan are necessarily compensatory.18
) Tj
T* (However, the plain language of I.R.C. S 419\(a\)\(2\) explicitly
) Tj
T* (contemplates situations where contributions paid or
) Tj
T* (accrued by an employer to a welfare benefit fund are not
) Tj
T* (deductible \(deductions allowed only if "they would
) Tj
T* (otherwise be deductible"\); see also Treas. Reg. S 1.162-10\(a\)
) Tj
T* (\(contributions to employee benefit plans deductible only if
) Tj
T* ("they are ordinary and necessary business expenses."\). To
) Tj
T* (read otherwise inexplicably creates a shelter loophole by
) Tj
T* (allowing taxpayers to transform disbursements into
) Tj
T* (deductible business expenses merely by funneling them
) Tj
T* (through an ERISA plan.
) Tj
T* (
) Tj
T* (We recognize that it is axiomatic that taxpayers lawfully
) Tj
T* (may arrange their affairs to keep taxes as low as possible.19
) Tj
T* (Nevertheless, at the same time the law imposes certain
) Tj
T* (threshold duties which a taxpayer may not shirk simply by
) Tj
T* (manipulating figures or maneuvering assets to conceal their
) Tj
T* (real character. See Court Holding Co., 324 U.S. at 334, 65
) Tj
T* (S.Ct. at 708 \("[t]o permit the true nature of a transaction to
) Tj
T* (be disguised by mere formalisms . . . would seriously
) Tj
T* (impair the effective administration of the tax policies of
) Tj
T* (Congress."\); see also Saviano v. Comm'r, 765 F.2d 643, 654
) Tj
T* (\(7th Cir. 1985\) \("The freedom to arrange one's affairs to
) Tj
T* (minimize taxes does not include the right to engage in
) Tj
T* (_________________________________________________________________
) Tj
T* (
) Tj
T* (18. Taxpayers misread Pediatric Surgical Assoc., P.C. v. Comm'r, 81
) Tj
ET
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T* (T.C.M. \(CCH\) 1474, 1479 \(2001\), for the proposition that anything paid
) Tj
T* (by a corporation for an employee's benefit is presumed legally to be
) Tj
T* (compensation. Rather, Pediatric Surgical clearly iterates that intent to
) Tj
T* (pay compensation "is a factual question to be decided on the basis of the
) Tj
T* (particular facts and circumstances of the case." Id. at 1480.
) Tj
T* (
) Tj
T* (19. See Gregory v. Helvering, 293 U.S. 465, 469, 55 S.Ct. 266, 267
) Tj
T* (\(1935\) \("The legal right of a taxpayer to decrease the amount of what
) Tj
T* (otherwise would be his taxes, or altogether avoid them, by means which
) Tj
T* (the law permits, cannot be doubted."\).
) Tj
T* (
) Tj
T* (                                19
) Tj
T* (
) Tj
T* (
) Tj
T* (financial fantasies with the expectation that the Internal
) Tj
T* (Revenue Service will play along."\). Thus, we conclude that
) Tj
T* (the Tax Court correctly held that the inflated premiums
) Tj
T* (were not allowable corporate business expenses but rather
) Tj
T* (allocations in the nature of dividends and thusly taxable.
) Tj
T* (
) Tj
T* (B. The Penalties
) Tj
T* (
) Tj
T* (Finally, we must consider the aptness of the penalties
) Tj
T* (assessed by the Commissioner and upheld by the Tax
) Tj
T* (Court. The Internal Revenue Code imposes a 20% tax on
) Tj
T* (the portion of an underpayment attributable, among other
) Tj
T* (things, to negligence or the disregard of rules and
) Tj
T* (regulations. I.R.C. SS 6662\(a\) and \(b\)\(1\)."Negligence" can
) Tj
T* (include any failure to make a reasonable attempt to comply
) Tj
T* (with the provisions of the Code, to exercise ordinary and
) Tj
T* (reasonable care in the preparation of a tax return, to keep
) Tj
T* (adequate books and records, or to substantiate items
) Tj
T* (properly. I.R.C. S 6662\(c\); Treas. Reg. S 1.6662-3\(b\)\(1\).
) Tj
T* (Generally speaking, the negligence standard as in the tort
) Tj
T* (context is objective, requiring a finding of a lack of due care
) Tj
T* (or a failure to do what a reasonable and prudent person
) Tj
T* (would do under analogous circumstances. See, e.g., Schrum
) Tj
T* (v. Comm'r, 33 F.3d 426, 437 \(4th Cir. 1994\).
) Tj
T* (
) Tj
T* (On the basis of the record, the Tax Court was justified in
) Tj
T* (concluding as a matter of fact that the individual taxpayers
) Tj
T* (were liable for the section 6662 accuracy-related penalties
) Tj
T* (because they did not meet their burden of proving due care.
) Tj
T* (See Hayden v. Comm'r, 204 F.3d 772, 775 \(7th Cir. 2000\)
) Tj
T* (\(the Commissioner's determination of negligence is
) Tj
T* (presumed to be correct, and the taxpayer has the burden of
) Tj
T* (proving that the penalties are erroneous\); accord Pahl v.
) Tj
T* (Comm'r, 150 F.3d 1124, 1131 \(9th Cir. 1998\) \(burden of
) Tj
T* (disproving negligence on taxpayer\); Goldman v. Comm'r, 39
) Tj
T* (F.3d 402, 407 \(2d Cir. 1994\) \(once the Commissioner
) Tj
T* (determines that a negligence penalty is appropriate, the
) Tj
T* (taxpayer bears the burden of establishing the absence of
) Tj
T* (negligence\). The physician-owners caused their
) Tj
T* (corporations to overpay considerably for term life insurance
) Tj
T* (knowing that the money could be rerouted circuitously to
) Tj
T* (their personal coffers with a net tax savings. Yet,
) Tj
T* (notwithstanding the extraordinary financial implications of
) Tj
T* (the SC VEBA arrangement, the individual taxpayers did not
) Tj
T* (
) Tj
T* (                                20
) Tj
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T* (
) Tj
T* (
) Tj
T* (make a proper investigation or exercise due diligence to
) Tj
T* (verify the program's tax legitimacy. See David v. Comm'r, 43
) Tj
T* (F.3d 788, 789-90 \(2d Cir. 1995\); see also Pasternak v.
) Tj
T* (Comm'r, 990 F.2d 893, 903 \(6th Cir. 1993\) \(holding that a
) Tj
T* (reasonably prudent person should investigate claims when
) Tj
T* (they are likely "too good to be true"\) \(quoting McCrary v.
) Tj
T* (Comm'r, 92 T.C. 827, 850 \(1989\)\).
) Tj
T* (
) Tj
T* (Taxpayers argue that their negligence should have been
) Tj
T* (excused because they relied on the advice of professionals.
) Tj
T* (While it is true that actual reliance on the tax advice of an
) Tj
T* (independent, competent professional may negate a finding
) Tj
T* (of negligence, see, e.g., United States v. Boyle, 469 U.S.
) Tj
T* (241, 250, 105 S.Ct. 687, 692 \(1985\), the reliance itself
) Tj
T* (must be objectively reasonable in the sense that the
) Tj
T* (taxpayer supplied the professional with all the necessary
) Tj
T* (information to assess the tax matter and that the
) Tj
T* (professional himself does not suffer from a conflict of
) Tj
T* (interest or lack of expertise that the taxpayer knew of or
) Tj
T* (should have known about. See Treas. Reg.S 1.6664-4\(c\);
) Tj
T* (Ellwest Stereo Theatres, Inc. v. Comm'r, T.C. Memo. 1995-
) Tj
T* (610, 70 T.C.M. \(C.C.H.\) 1655; see also Zfass v. Comm'r,
) Tj
T* (118 F.3d 184, 189 \(4th Cir. 1997\).
) Tj
T* (
) Tj
T* (The Tax Court concluded that taxpayers could not prevail
) Tj
T* (on a reliance-on-professional defense because they received
) Tj
T* (advice only from Cohen, an insurance agent who stood to
) Tj
T* (profit considerably from the participation of Neonatology
) Tj
T* (and Lakewood in the VEBA program, rather than from a
) Tj
T* (competent, independent tax professional with sufficient
) Tj
T* (expertise to warrant reliance. The circumstances here,
) Tj
T* (including the facts that certified public accountants
) Tj
T* (prepared taxpayers' returns, the New Jersey Medical
) Tj
T* (Society -- a group with dubious tax code proficiency which
) Tj
T* (in fact received royalties to endorse the SC VEBA 20 --
) Tj
T* (purportedly endorsed the program, and the engagement
) Tj
T* (agreement between PES and the employers stated that PES
) Tj
T* (would submit the trust to the IRS for qualification, 21 do not
) Tj
T* (_________________________________________________________________
) Tj
T* (
) Tj
T* (20. See App. at 570-71.
) Tj
T* (
) Tj
T* (21. Notably, the agreement does not say that the IRS did qualify the
) Tj
T* (plan. In fact, as the government points out, the IRS expressly disavowed
) Tj
T* (any opinion as to whether contributions to the plan were deductible. See
) Tj
T* (App. at 1410.
) Tj
T* (
) Tj
T* (                                21
) Tj
T* (
) Tj
T* (
) Tj
T* (suffice for us to disturb the Tax Court's negligence finding
) Tj
T* (on a clear error basis. See Merino v. Comm'r, 196 F.3d 147,
) Tj
T* (154 \(3d Cir. 1999\).
) Tj
T* (
) Tj
T* (In reaching our result, we acknowledge that Dr.
) Tj
T* (Hirshkowitz deviated from the thoroughly head-in-the-sand
) Tj
T* (posture of his fellow taxpayers by soliciting his
) Tj
T* (accountant's opinion of the SC VEBA. See App. at 6666-67.
) Tj
ET
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T* (Nevertheless, the record supports the court's finding with
) Tj
T* (respect to Dr. Hirshkowitz, considering that he did not
) Tj
T* (introduce into evidence precisely what information he
) Tj
T* (showed to his accountant, precisely what advice his
) Tj
T* (accountant gave him, and, more generally, the
) Tj
T* (qualifications of his accountant.
) Tj
T* (
) Tj
T* (We also add the following. When, as here, a taxpayer is
) Tj
T* (presented with what would appear to be a fabulous
) Tj
T* (opportunity to avoid tax obligations, he should recognize
) Tj
T* (that he proceeds at his own peril. In this case, PES devised
) Tj
T* (a program which it marketed as "creat[ing] a tax deduction
) Tj
T* (for the contributions to the employee welfare benefit plan
) Tj
T* (going in and a permanent tax deferral coming out." As
) Tj
T* (highly educated professionals, the individual taxpayers
) Tj
T* (should have recognized that it was not likely that by
) Tj
T* (complex manipulation they could obtain large deductions
) Tj
T* (for their corporations and tax free income for themselves.22
) Tj
T* (
) Tj
T* (In a final attempt to skirt the additional penalties,
) Tj
T* (taxpayers argue that a finding of negligence could not in
) Tj
T* (fairness arise out of a case resolving tax issues of first
) Tj
T* (impression. In this regard, we point out that the parties
) Tj
T* (have indicated that this case is indeed without direct
) Tj
T* (precedent and that other cases are awaiting our disposition.23
) Tj
T* (_________________________________________________________________
) Tj
T* (
) Tj
T* (22. It well may be that reliance on the advice of a professional should
) Tj
T* (only be a defense when the professional's fees are not dependent on his
) Tj
T* (opinion. For example, it is not immediately evident why a taxpayer
) Tj
T* (should be able to take comfort in the advice of a professional promoting
) Tj
T* (a tax shelter for a fee. After all, that professional would have an interest
) Tj
T* (in his opinion. Consideration of this point, however, will have to wait for
) Tj
T* (another day.
) Tj
T* (
) Tj
T* (23. The Tax Court observed that this case is a test case with the result
) Tj
T* (resolving other cases involving SC VEBA and NJ VEBA plans and that
) Tj
T* (the parties in 19 other cases pending before the Tax Court have agreed
) Tj
T* (to be bound by the decision here. See Neonatology, 115 T.C. at 44.
) Tj
T* (
) Tj
T* (                                22
) Tj
T* (
) Tj
T* (
) Tj
T* (This argument, however, does not sway us for this case
) Tj
T* (does not involve novel questions of law but rather is
) Tj
T* (concerned with the application of well-settled principles of
) Tj
T* (taxation to determine whether certain expenditures made
) Tj
T* (by close corporations are deductible as ordinary and
) Tj
T* (necessary business expenses or taxable as constructive
) Tj
T* (dividends. While the setting in which these principles have
) Tj
T* (come to bear is no doubt unusual with its VEBAs, C-group
) Tj
T* (policies, and conversion credits, the law was nevertheless
) Tj
T* (pellucid that taxpayers should have endeavored to verify
) Tj
T* (the validity of their deductions before claiming them.24
) Tj
T* (Moreover, they should have been apprehensive when they
) Tj
T* (examined the scheme, for experience shows that when
) Tj
T* (something seems too good to be true that probably is the
) Tj
T* (case. Overall, we are satisfied that taxpayers now must
) Tj
T* (abide the consequences of the Commissioner's audit as
) Tj
T* (sustained by the Tax Court, including the finding of liability
) Tj
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T* (for accuracy-related penalties under section 6662.
) Tj
T* (
) Tj
T* (IV. CONCLUSION
) Tj
T* (
) Tj
T* (For the foregoing reasons, we will affirm the decisions of
) Tj
T* (the Tax Court.
) Tj
T* (
) Tj
T* (A True Copy:
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T* (Teste:
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T* (_________________________________________________________________
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T* (
) Tj
T* (24. We recognize that courts have overlooked negligence penalties in
) Tj
T* (cases of first impression that involve unclear statutory language. See,
) Tj
T* (e.g., Mitchell v. Comm'r, T.C. Memo. 2000-145, 79 T.C.M. \(C.C.H.\) 1954
) Tj
T* (\(recognizing exception in a case of first impression involving the unclear
) Tj
T* (application of an amendment to the Internal Revenue Code\); Hitchins v.
) Tj
T* (Comm'r, 103 T.C. 711, 720 \(1994\) \(first impression exception applies to
) Tj
T* (issue not previously considered by the court where the statutory
) Tj
T* (language is not entirely clear\). But nothing in this case hinges on the
) Tj
T* (interpretation of vague statutory text.
) Tj
T* (
) Tj
T* (                                23) Tj
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