08-1143 | Omnilex

V.R. DE ANGELIS M.D., P.C., R.T. DOMINGO M.D., P.C, V.R. DE ANGELIS M.D., P.C.,
TAX MATTERS PARTNER, VINCENT DE ANGELIS, JEANETTE DE ANGELIS,
RODOLFO DOMINGO, BERNADETTE DOMINGO, KEITH DURANTE, KATHLEEN
DURANTE, ANTHONY J. CAPIZZI, MARY ANN CAPIZZI,

Petitioners-Appellants-Cross-Appellees,

-V-
COMMISSIONER OF INTERNAL REVENUE,

Respondent-Appellee-Cross-Appellant.

Before: LEVAL, POOLER, and PARKER, Circuit Judges.

Petitioners, who are doctors and their wives, the doctors' professional corporations, and a
partnership comprised of the professional corporations appeal from orders of the Tax Court
(Laro, J.) finding deficiencies in their payments of income taxes for tax years 1993 and 1994.
Affirmed.

IRA B. STECHEL, Wormser, Kiely, Galef & Jacobs LLP, New York, NY (John T Morin and
Jennifer L. Marlborough, on the brief) for Petitioners-Appellants-Cross-Appellees.

RANDOLPH L. HUTTER, Attorney, for John DiCicco, Acting Assistant Attorney General, Tax
Division, Department of Justice, Washington, DC (Kenneth L. Greene, Attorney, on the brief) for
Respondent-Appellee-Cross-Appellant.

PER CURIAM:

We affirm the orders of the Tax Court for the reasons stated in its decision. See V.R.
DeAngelis M.D.P.C. v. Comm'r of Internal Revenue, 94 T.C.M. (CCH) 526 (2007), a copy of
which is annexed to this opinion as an appendix. We have considered petitioners' arguments for
a contrary result and found them to lack merit.

APPENDIX

T.C. Memo. 2007-360
T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

## United States Tax Court. V.R. DEANGELIS M.D.P.C. & R.T. Domingo M.D.P.C., V.R. Deangelis M.D.P.C., Tax Matters Partner, et al., EN! Petitioners

FN1. Cases of the following petitioners are consolidated herewith: Vincent and Jeanette DeAngelis (collectively,
DeAngelises), docket No. 10635-05;Rodolfo and Bernadette Domingo (collectively, Domingos), docket No.
10636-05;Keith and Kathleen Durante (collectively, Durantes), docket No. 10637-05, and Anthony J. and Mary Ann
Capizzi (collectively, Capizzis), docket No. 10638-05. While the parties sometimes refer to the name "DeAngelis" as "De
Angelis", we consistently refer to that name as "DeAngelis". We also note that the first word in the name of each relevant
professional corporation is a complete word but that the parties sometimes refer to the word by its initial letter. With the
exception of the caption and of the partnership, V.R. DeAngelis M.D.P.C. & R.T. Domingo M.D.P.C., whose name is
actually spelled using only the initial letter of the first word of each professional corporation referenced therein, we refer
to each professional corporation by using its full first word.

V.
COMMISSIONER OF INTERNAL REVENUE, Respondent.
Nos. 10634-05, 10637-05, 10635-05, 10638-05, 10636-06.

Dec. 5, 2007.

John T. Morin and Ira B. Stechel, for petitioners.

Peter James Gavagan, Peggy J. Gartenbaum, and Thomas A. Dombrowski, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

LARO, Judge.

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

*1 These cases are consolidated for purposes of trial, briefing, and opinion. Each couple consists of a medical doctor and his wife,
and each doctor is the sole owner of an S corporation that was a partner in the partnership V.R. DeAngelis M.D.P.C. & R.T.
Domingo M.D.P.C. (VRD/RTD). These cases concern amounts paid in 1993 and 1994 by the S corporations to VRD/RTD and
its ensuing contributions of those amounts to the Severance Trust Executive Program Multiple Employer Supplemental Benefit
Plan and Trust (STEP), a plan that was promoted to wealthy professionals as a welfare benefits fund that was part of a
10-or-more-employer plan described in section 419A(f)(6).IN2 STEP used the contributions to purchase and pay the premiums
on six whole life insurance policies, five of which were each written with respect to one or both spouses of each couple (with the
exception of the Capizzis, who had no policy insuring either of their lives) and were each payable to the beneficiaries of the
insured's choosing in the event of the insured's death. The sixth life insurance policy was written on the life of Kerry Quinn (Ms.
Quinn), an employee of VRD/RTD who was its office manager.

FN2. Unless otherwise indicated, section references are to the applicable versions of the Internal Revenue Code, Rule
references are to the Tax Court Rules of Practice and Procedure, and dollar amounts are rounded to the dollar. We use
the term "plan" for convenience and do not suggest that any part of the STEP plan is a bona fide plan for Federal income
tax purposes.

For each subject year, respondent determined in the notice of final partnership administrative adjustment (FPAA) that VRD/RTD
could not deduct the $585,000 it paid in that year to STEP as contributions to a welfare benefits fund. The FPAA stated in part
that the payments were not ordinary and necessary business expenses under section 162(a).

Respondent determined in the notices of deficiency that the individual petitioners had the following deficiencies in their 1993 and
1994 Federal income taxes:

Individual Petitioners

1993

1994

DeAngelises

$246,768

$208,447

Domingos

185,422

184,932

Durantes

29,174

42,020

Capizzis

1,957

1,546

The deficiencies generally are based on two determinations.
First, respondent determined that the payments that the S
corporations made to VRD/RTD for contribution to the STEP
plan were not deductible by the S corporations because they
were not ordinary and necessary business expenses under
section 162(a). Respondent accordingly increased the net

amount of passthrough income received by each doctor from
his S corporation. Second, respondent determined that each
doctor received income under section 61(a) in the amount of
the life insurance premiums that were paid by his S corporation
on his behalf.

We decide whether the S corporations and VRD/RTD were

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T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
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(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

entitled to deduct the payments related to the STEP plan as
ordinary and necessary business expenses under section 162(a).
We hold they were not to the extent that the payments related
to the life insurance written on a life of someone other than Ms.
Quinn. FN3We also decide whether each doctor realized income
in the amount of the life insurance premiums that were paid by
his S corporation on his behalf. We hold he did not.

FN3. We understand respondent to have conceded
that the payments are deductible to the extent they
relate to the insurance written on the life of Ms.
Quinn.

## FINDINGS OF FACT

### I. Preliminaries

*2 Some facts were stipulated. The stipulated facts and the
exhibits submitted therewith are incorporated herein by this
reference. We find the stipulated facts accordingly. VRD/RTD
had a legal address in the State of New York when its petition
was filed. The individual petitioners resided in the State of
New York when their petitions were filed.

### II. Individual Petitioners

### A. Overview

Petitioner doctors are Vincent DeAngelis (Dr. DeAngelis),
Rodolfo Domingo (Dr. Domingo), Keith Durante (Dr.
Durante), and Anthony J. Capizzi (Dr. Capizzi) (collectively,
doctors). During 1993 and 1994, each doctor wholly owned an
S corporation that employed the doctor to provide his medical

and surgical services for VRD/RTD. Each S corporation was
a professional corporation (PC), the sole employee of which
was its owner. The names of the PCs of Drs. DeAngelis,
Domingo, Durante, and Capizzi were Vincent R. DeAngelis M
.D.P.C., Rodolfo T. Domingo M.D.P.C., Keith Durante
M.D.P.C., and Anthony J. Capizzi M.D.P.C., respectively.

Each doctor and his wife filed a joint Form 1040, U.S.
Individual Income Tax Return, for each of the years 1993 and
1994. Each couple's returns reported compensation received
from the doctor's PC during those years.FN4

FN4. We use the term "compensation" to refer to
wages, salaries, and the like. Unlike petitioners, we
do not consider the term "compensation" to include
the doctors' distributive shares of income from their
PCs. See sec. 61(a)(1), (13) (distinguishing as
separate items of gross income "Compensation for
services, including fees, commissions, fringe benefits,
and similar items" from "Distributive share of
partnership gross income"); cf. Campbell v.
Commissioner, 943 F.2d 815. 822 (8th Cir.1991),
affg. in part and revg. in part on other grounds T.C.
Memo. 1990-162. Nor (as discussed below) does the
STEP plan define the term "compensation" to include
such distributive shares.

### B. Dr. DeAngelis

During 1993, 1994, and 1995, Dr. DeAngelis's PC reportedly
paid Dr. DeAngelis compensation of $928,000, $581,000, and
$60,000, respectively. The DeAngelises' corresponding Federal
income tax returns included those amounts in gross income. Dr.
DeAngelis's PC did not reportedly pay Dr. DeAngelis any
compensation thereafter.

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T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

### C. Dr. Domingo

During 1993, 1994, 1995, and 1996, Dr. Domingo's PC
reportedly paid Dr. Domingo compensation of $753,000,
$452,976, $485,843, and $62,000, respectively. The
Domingos' corresponding Federal income tax returns included
those amounts in gross income. Dr. Domingo's PC did not
reportedly pay Dr. Domingo any compensation thereafter.

### D. Dr. Durante

During 1993, 1994, 1995, and 1996, Dr. Durante's PC
reportedly paid Dr. Durante compensation of $136,000,
$240,000, $283,919, and $208,079, respectively. The
Durantes' corresponding Federal income tax returns included
those amounts in gross income. During 1998 through 2003, Dr.
Durante's PC reportedly paid Dr. Durante compensation of
$289,398, $340,527, $258,393, $250,604, $258,208 and
$240,000, respectively. The Durantes' corresponding Federal
income tax returns included those amounts in gross income.
The record does not allow the Court to find the amount of
compensation (if any) that Dr. Durante's PC reportedly paid
Dr. Durante in 1997.

### E. Dr. Capizzi

During 1993 and 1994, Dr. Capizzi's PC reportedly paid Dr.
Capizzi compensation of $609,000 and $719,001, respectively.
The Capizzis' corresponding Federal income tax returns
included those amounts in gross income. During 1996 through
2003, Dr. Capizzi's PC reportedly paid Dr. Capizzi
compensation of $336,240, $240,070, $272,043, $294,601,
$293,331, $190,271, $194,130 and $148,423, respectively.
The Capizzis' corresponding Federal income tax returns
included those amounts in gross income. The record does not

allow the Court to find the amount of compensation (if any)
that Dr. Capizzi's PC reportedly paid Dr. Capizzi in 1995.

III. VRD/RTD

A. General Information

*3 VRD/RTD was formed as a partnership on July 1, 1982,
under the laws of New York. VRD/RTD provided medical and
surgical services to its patients through the doctors and
operated under the name "South Shore Surgical Specialists".
VRD/RTD reported its income and expenses for Federal
income tax purposes using the cash receipts and disbursements
method. VRD/RTD filed 1993 and 1994 Forms 1065, U.S.
Partnership Return of Income, for its taxable years ended
December 31, 1993 and 1994, respectively.

#### B. Partners and Employees

During 1993 and 1994, the five partners of VRD/RTD were the
four PCs of the doctors and a fifth PC owned by another
doctor, Edgar Borrero (Dr. Borrero). The senior partner of
VRD/RTD was Vincent R. DeAngelis M.D.P.C. The partners'
percentages of profits, losses, and ownership of capital for
1993 were as follows:

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T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

Partner

Beginning of Year

End of Year

Vincent R. De Angelis M.D.P.C.

35.09%

25%

Rodolfo T. Domingo M.D.P.C

25.81

Anthony J. Capizzi M.D.P.C.

20.58

Edgar Borrero M.D.P.C.

18.52

Keith Durante M.D.P.C.1

FN1. Keith Durante M. D. P.C. became a partner of VRD/RTD on or about July 1,
1993.

The partners' percentages of profits, losses, and ownership of
capital for 1994 were as follows:

Partner

Beginning of Year

End of Year

Vincent R. De Angelis M.D.P.C

25%

34%

Rodolfo T. Domingo M.D.P.C.

Anthony J. Capizzi M.D.P.C.

Edgar Borrero M.D.P.C.

Keith Durante M.D.P.C.

During 1993 and 1994, VRD/RTD employed nurses, office
staff, and an office manager (i.e., Ms. Quinn). VRD/RTD had
at least 29 employees during 1993 and at least 34 employees
during 1994. VRD/RTD did not directly pay the doctors any
compensation during either subject year.

### C. Arrangements With PCs

VRD/RTD entered into arrangements with the PCs for the
provision of the doctors' medical services. The doctors
performed their services for the patients of VRD/RTD, and

VRD/RTD billed the patients for the fees due on these
services. VRD/RTD received payment of the fees, deposited
the payments into its bank account, and reported the payments
as income on its Forms 1065. Dr. Domingo performed services
for VRD/RTD through the end of 1999; afterwards, through
2003, Dr. Domingo continued to work for his PC performing
services for other than VRD/RTD. Dr. DeAngelis terminated
his services with VRD/RTD on or about December 31, 2003.

### D. Partnership Agreement

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T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

The VRD/RTD partnership agreement in effect for the subject
years (partnership agreement) was executed on June 19, 1990.
The partnership agreement stated that Drs. DeAngelis and
Domingo were employed by their PCs and that any future
doctor who wished his PC to become a partner of VRD/RTD
had to be employed by his PC. The partnership agreement
stated that it was anticipated that Dr. DeAngelis would fully
retire from VRD/RTD on July 1, 1994, and that Dr. Domingo
would not retire until 1 year after Dr. DeAngelis retired. If Dr.
DeAngelis continued working for VRD/RTD until at least July
1, 1995, the partnership agreement allowed Dr. Domingo to
retire at the same time as Dr. DeAngelis or at any time after
July 1, 1996. The partnership agreement provided for payments
to be made to a doctor's PC in case the doctor became disabled.

IV. STEP

A. Overview

*4 STEP purports to provide eligible employees with
severance benefits, funded entirely by their participating
employer through the purchase of whole life insurance policies,
and, if elected, an employer-provided optional life insurance
benefit payable upon the death of a covered employee or an
alternate insured. ENSSTEP invested the contributions made to
the STEP plan in whole life insurance policies issued by eight
insurance companies; namely, Metropolitan Life Insurance Co.
(MetLife), Allmerica Financial Life Insurance and Annuity
Co., National Life Insurance Co. of Vermont, Prudential Life
Insurance Co. of America, Equitable Life Assurance Society of
the United States, ITT Hartford Life Insurance Co., New York
Life Insurance and Annuity Corp., and Massachusetts Mutual
Life Insurance Co. The life insurance policies insured the
individuals covered by the STEP plan, and the STEP plan
assets, as reported, consisted largely of the cash values of those
policies. Insurance agents earned substantial commissions on
the sales of the life insurance policies; e.g., $605,053 in 1994.

FN5. An employee's severance benefits were paid
from the cash value of his or her whole life insurance
policy.

Drs. DeAngelis, Domingo, and Durante (collectively,
participating doctors) participated in the STEP plan through
their PCs and VRD/RTD. Alvin Rapp (Mr. Rapp) was an
authorized insurance agent of MetLife, and he recommended
that all contributions to the STEP plan made on behalf of the
participating doctors be invested in whole life insurance
policies issued by MetLife. That recommendation was
followed. Each whole life insurance policy related to a
participating doctor required that a payment be made annually
on December 28 for the policy year beginning on that date.

### B. Formation of the STEP Plan

The originator of the STEP concept was Kenneth L. Katz (Mr.
Katz), an insurance agent credentialed as a chartered life
underwriter and a chartered financial consultant. In 1988, Mr.
Katz asked his friend, Jeffrey Mamorsky (Mr. Mamorsky), to
draft a plan that could be marketed as a tax-beneficial welfare
benefits fund that complied with section 419A(f)(6). Mr.
Mamorsky was an attorney practicing primarily in the area of
employee benefits and compensation. Mr. Mamorsky later also
served as counsel to the STEP plan; in that capacity, Mr.
Mamorsky was available and willing to discuss with covered
employees (at the expense of the STEP plan) the manner in
which they should prepare their applications for benefits from
the plan. The intent of the STEP plan was to create an
incentive to buy, and thus to generate the sale of, whole life
insurance policies through a claim of permissible tax avoidance
and the ability to pay and deduct premiums on the purchased
policies which would eventually be transferred to and owned
by the insureds. Many participants in the STEP plan believed

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T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

that the plan was one of deferred compensation.

Mr. Mamorsky prepared an initial version of the STEP plan on
or about December 15, 1989, and Mr. Katz began operating the
STEP plan at that time. Mr. Mamorsky prepared a second
version of the STEP plan in 1990. Mr. Mamorsky wrote other
and all versions of the STEP plan through June 2001, with an
understanding that the deductibility of contributions was
critical both to the marketability of the STEP plan and to the
operation and existence of STEP. The various versions of the
STEP plan through June 2001 included the following:

Version 1:

Executed on December 15, 1989

Version 2:

Version 1 Amended and Restated on July 26, 1990

Version 3:

Executed on January 30, 1992

Version 4:

Executed on December 29, 1993

Version 5:

Executed as of November 1, 1994

Version 6:

Executed as of February 14, 1997

Version 7:

Executed as of June 11, 2001

*5 The four versions executed in or after 1993 were stated as
effective as of January 1, 1993.5V6

FN6. There is also a 1992 version of the STEP plan
for MetLife and, beginning in February 1997,
separate plans and trusts for the eight insurance
companies whose policies were sold through STEP.
According to petitioners, the participating doctors
were covered by version 3 when VRD/RTD adopted
the STEP plan on or about Dec. 20, 1993, and were
covered by version 4 as of Dec. 29, 1993.

### C. Trustees, Administrators, and Sponsors

Connecticut National Bank was the STEP plan trustee from the
plan's inception through April 1, 1992. The successor trustees
were United States Trust Co. of New York (U.S.Trust), Mellon
Trust of New York (Mellon Trust), and STEP Plan Services,
Inc. (SPSI). U.S. Trust served as trustee from April 1, 1992,
through February 14, 1997; Mellon Trust served as trustee
from February 14, 1997, through February 2002; and SPSI
served as trustee from February 2002 to date.

STEP, Inc., served as the STEP plan administrator from the
plan's inception through July 26, 1990. Teplitzky & Co., L.L.C.
(Teplitzky & Co.), acting primarily through its principal Jeffrey

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(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

Teplitzky (Mr. Teplitzky), was the successor plan administrator
from July 26, 1990, through February 7, 2002. The current
plan administrator is SPSI. During the relevant time, Daniel E.
Carpenter (Mr. Carpenter) had sole signatory authority on
behalf of SPSI and served as its chairman.

STEP, Inc., also served as the STEP plan sponsor from the
plan's inception until April 1, 1992. U.S. Trust served as the
successor plan sponsor from April 1, 1992, until February 14,
1997, when first STEP, Inc., and subsequently Teplitzky & Co.
took over as successor plan sponsor. On February 7, 2002,
Teplitzky & Co. resigned as plan sponsor and appointed SPSI
as the successor plan sponsor.

During the subject years, Teplitzky & Co., acting as the STEP
plan administrator, ran the daily operation of the STEP plan.
U.S. Trust, as plan sponsor, interacted with the insurance
companies whose policies were owned by the STEP plan and
conducted the plan's marketing activities.

### D. Marketing Documents

The STEP plan marketing documents set forth detailed
examples of when severance benefits would and would not be
paid under the plan.INZThese examples allowed individuals
covered by the plan to time their departures from their
businesses and to phrase their requests for severance benefits
so that benefits would be paid to them under the STEP plan as
they anticipated. The STEP plan marketing documents warned
participants that "Benefits accrued for an employee are
forfeited if the employee does not qualify for benefits under a
bona fide severance as determined by STEP's Independent
Fiduciary".FN8 The STEP plan marketing documents advised
participating employers that deductions for contributions to the
STEP plan could be ultimately disallowed but that only taxes
and interest, and no additional amounts such as penalties,

would then be due because STEP had received an "opinion
letter" from Mr. Mamorsky stating that it was "more likely than
not" that the deductions would be allowed.

FN7. Upon adopting the plan, each participating
employer also was provided examples of qualifying
severance events.

FN8. In operation, however, forfeitures could occur
only when projected plan assets equaled or exceeded
projected plan liabilities on an employer by employer
basis.

#### E. Independent Fiduciary

The STEP plan administrator had the sole authority to make
determinations relating to "dismissal", "Total Disability", or
"death", conditions that were prerequisites to the receipt of
benefits from the STEP plan as written. In making those
determinations, the plan administrator was required to rely on
rules and regulations established by the STEP plan
"Independent Fiduciary". Jules Pagano (Mr. Pagano) was the
independent fiduciary of the STEP plan from its inception
through February 2002; the STEP plan did not have any
independent fiduciary thereafter. While serving as independent
fiduciary, Mr. Pagano was authorized to and routinely did
provide individuals seeking to obtain benefits under the plan
with personal guidance on how to frame their requests so that
they would receive their anticipated benefits under the plan as
written. Upon receiving an actual claim for benefits, Mr.
Pagano and the STEP plan administrator relied upon the
documents submitted to them by the claimant and did not
perform an independent investigation or verification of the
claim. If a participant's claim for benefits as submitted did not
qualify for benefits under the STEP plan, the STEP plan
allowed the participant to reform his or her claim in order to

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T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
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(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

receive his or her anticipated benefits.

##### F. Version 4 of the STEP PlanIN2

FN9. In our findings of fact set forth under this
subheading, section references are to version 4 of the
STEP plan.

*6 Section 1.11, 1.13, and 1.14 of the STEP plan defines the
terms "Covered Employee", "Eligible Employee", and
"Employee". Section 2.1(c) states that "The Employer shall
transmit to the Plan Administrator written notice of any
substantial or unusual change in a Covered Employee's
Compensation or status (e.g., from fulltime to parttime) as it
occurs, but in any event no later than 30 days after the change
occurs". Section 3.1 states that "A Covered Employee's
Severance Benefit shall be determined in accordance with the
Severance Benefit formula elected in the Adoption Agreement.
In no event, however, may a Covered Employee's Severance
Benefit exceed two times his Compensation paid during the
twelve full-month period immediately preceding his
Termination of Employment".

Section 3.3 states that an employer shall elect in the adoption
agreement either a "fixed benefit" or a "flexible benefit". As to
a fixed benefit, section 3.3 states that the benefit payable to a
covered employee shall equal the sum of the future service
component for each year of participation plus the past service
component. The future service component equals for each year
of participation the amount of that year's "Compensation
[defined as the "amount specified by the Employer in the
Adoption Agreement"] multiplied by the Severance Benefit
percentage elected by the Employer in the Adoption
Agreement". The past service component equals the product of
(1) the benefit percentage elected by the employer in the
adoption agreement, (2) a fraction not to exceed 1, the

numerator of which is the covered employee's past service and
the denominator of which is 10, and (3) the covered employee's
total compensation for the 10 years preceding the year of
termination of employment.

As to a flexible benefit, section 3.3 allows a different percent
of compensation to be elected for each year of service and
states that the formula for computing a severance benefit is
made applicable to the employer's contribution each year. In
addition, there is a provision for adjustments each year based
on benefits provided to other employees, forfeitures,
investment earnings, and cost of insurance for the covered
employee.

Section 4.1 states that the employer must annually contribute
to the STEP plan such amounts as are calculated by the plan
actuary to provide for severance benefits of its covered
employees. The total amount to be contributed by all
employers is "based upon reasonable actuarial assumptions and
methods taking into account the experience of the Plan, as an
undivided and unweighted pool with no differentiation as to
Covered Employees (other than those differentiations
described below) or Participating Employers". The amount to
be contributed by each employer is to be its allocable portion
of the total for all employers."\1ºSection 4.I also states that the
employer must contribute the cost of 1-year term life insurance
for any life insurance benefit elected in the adoption
agreement.

FN10. In operation, the STEP plan neither employed
a plan actuary nor determined amounts to be
contributed by the employers.

*7 Section 5.2(a) states that a participating employer must pay
the STEP plan the annual cost of equivalent 1-year term
insurance if the employer elects a life insurance benefit for its

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(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

employees. Section 5.2(b) states that an employee may elect
additional life insurance beyond the amount elected by the
employer and that the employer must pay the STEP plan the
annual cost of the equivalent 1-year term insurance and the
employee must reimburse the employer for the additional cost.
Section 5.2(c) states that the insurance benefit payable to the
beneficiary of a covered employee is equal to the amount
elected by the employer plus the amount elected by the
employee. Section 5.2(f) states that the STEP plan may name
the beneficiary, or the insured may name a beneficiary as long
as the employer reimburses the STEP plan. Section 5.2(g)
states that if the employer does not pay amounts due on the
policy for the death benefit, STEP may declare the policy
lapsed or surrender the policy, or the beneficiary will be
changed to STEP. Section 5.2(h) states that if the employer
fails to make required payments, the insured may buy the
policy from STEP for the policy value.

Section 10.4(a) states that an employer can withdraw from the
STEP plan at any time and that the employees will have frozen
benefits equal to the amounts they would have been eligible for
on the dates of withdrawal. Section 10.5 states that if an
employer fails to make a required contribution, it will be
treated as if it withdrew on that date, and it will be treated the
same as in the case of a withdrawal under section 10.4.

Section 11.1 and 11.3 allows the plan sponsor to "amend,
modify or delete, in whole or in part, any provision of the Plan,
provided the duties and responsibilities of the Trustee shall not
be altered without its written consent" and states that "no
amendment or reorganization may be made to this Plan which
shall change or alter the fundamental purpose of the Plan
expressed in the preface hereto". Section 11.2 allows the plan
sponsor to reorganize the participating employers into other or
separate plans.

#### V. VRD/RTD's Introduction to the STEP Plan

A. Introduction to the Plan

In late 1993, Drs. DeAngelis and Domingo were engaged in
estate planning with their accountant, Richard Freeman (Mr.
Freeman), and an estate planning attorney, Victor Finmann
(Mr. Finmann). Mr. Freeman advised Dr. DeAngelis to acquire
additional life insurance coverage and suggested that he
consider a severance pay plan for VRD/RTD. Mr. Freeman
introduced Dr. DeAngelis to Mr. Rapp. Mr. Rapp discussed the
STEP plan with Dr. DeAngelis and Mr. Freeman,
characterizing the plan as a way to receive additional insurance
coverage and to provide severance benefits, both with pretax
dollars. Mr. Rapp recommended to Dr. DeAngelis that
VRD/RTD form a section 419 welfare benefit trust because, he
stated, it would secure immediate Federal income tax
deductions, allow the owner-employees to accumulate
significant wealth on a tax-deferred basis, secure assets with
insurance company guaranties, and protect assets from
creditors. Dr. DeAngelis discussed the STEP plan with the
other doctors, their wives, Mr. Finmann, and others. Mr.
Finmann advised Dr. DeAngelis that he was skeptical as to the
validity of the STEP plan, as promoted.

### B. Decision to Join Plan

*8 On December 20, 1993, Dr. DeAngelis decided on behalf
of VRD/RTD to join the STEP plan and to provide coverage
thereunder for the participating doctors and for Ms. Quinn. Dr.
Borrero declined to participate in the STEP plan after hearing
the presentation of the representatives of STEP. Dr. Capizzi
initially expressed an intent to participate in the STEP plan but
subsequently decided not to participate in the plan.

C. Illustrations

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

In or about late 1993, Mr. Rapp provided Drs. DeAngelis and
Domingo with life insurance policy illustrations reflecting
varying amounts of life insurance benefits and premium costs.
Mr. Rapp informed Dr. Domingo that his projected severance
benefit after 5 years would be $253,000 if he made two annual
contributions of $225,000 and that the projected benefit would
increase annually by approximately $238,000 for each
additional $225,000 contribution that he made annually
beginning in year 3. Mr. Rapp informed Dr. DeAngelis that his
projected severance benefit after 3 years would be $312,000 if
he made two annual contributions of $300,000 and that the
projected benefit would increase by approximately $320,000
for each additional $300,000 contribution that he made
annually beginning in year 3.

### VI. VRD/RTD's Adoption of the STEP Plan

#### A. Execution of Adoption Agreement

On or about December 20, 1993, Dr. DeAngelis executed an
adoption agreement for the STEP plan on behalf of VRD/RTD,
making VRD/RTD a participating employer in the STEP plan
effective as of January 1, 1993. VRD/RTD consented in the
agreement to any future amendment of the STEP plan.

VRD/RTD elected in the adoption agreement to provide
severance benefits to its eligible employees in the amount of 10
percent of an employee's compensation for each year of
participation, with no credit for past service. VRD/RTD also
elected not to provide the optional life insurance benefit. Drs.
DeAngelis and Domingo understood that in order for
VRD/RTD to claim deductions for its contributions to STEP
they had to couch any subsequent application for benefits in
terms that appeared to make the severance event nonvolitional.

#### B. Relevant Provisions in the Adoption Agreement

Eligible employees were defined in the adoption agreement as
all full-time employees, other than controlling owners, who
were 21 and had completed 1 year of service and whose job
title was "doctor" or "office administrator/business mgr". A
"controlling owner" was defined in the adoption agreement as
a person who owned more than a 25-percent voting interest in
the participating employer, unless four or fewer other persons
owned in the aggregate a greater voting interest than the
person. The adoption agreement stated that the eligible
employees were Drs. DeAngelis, Domingo, Durante, and
Capizzi, and Ms. Quinn, and that Dr. Borrero was an employee
who was excluded. EN !! The adoption agreement defined the
term "compensation" as "Total Compensation paid during the
applicable period, including wages, bonuses and over time
[sic], etc., but not including deferred compensation other than
compensation deferred pursuant to Code Section 401(k).
Compensation shall also include salary reduction contributions
excludable from gross income pursuant to Code Section 125."

FNII. As noted above, Dr. Capizzi subsequently
decided not to participate in the STEP plan. Ms.
Quinn was the only employee of VRD/RTD who was
covered by the STEP plan.

#### C. Other Relevant Provisions

*9 According to the STEP plan, a covered employee was
purportedly eligible to receive a severance benefit from the
plan upon termination of employment (except for termination
for cause) under the following circumstances: "dismissal; any
termination of employment unless such termination constitutes
a 'voluntary separation without good cause' within the meaning

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

of New York State Unemployment Insurance Law; total
disability; or death.INI2The STEP plan stated that benefits
would normally start on the first day of the second month after
approval of the claim for benefits, that the usual form of
payment would be in equal monthly installments over 24
months from the date of the employee's termination, that the
first installment would include any payments delayed because
of processing, and that severance benefits could not exceed two
times the employee's last 12 months of compensation before
termination of employment. The STEP plan did not limit the
amount of life insurance benefits that could be received by a
covered employee and stated that the optional life insurance
benefit (if elected) would be received in addition to the
severance benefit if the covered employee died while employed
by the participating employer. The STEP plan stated that a
participating employer could choose to withdraw from the
plan, that a participating employer could constructively
withdraw from the plan by failing to make an annual
contribution or by violating a plan provision, and that upon
withdrawal, any optional life insurance benefit could be
discontinued or purchased from the plan by the employee or
alternate insured at a cost equal to the policy's value (defined
as the amount that would be paid upon surrender of the
coverage determined before the application of surrender
charges). The STEP plan stated that the optional life insurance
benefit also could be discontinued if the covered employee
terminated service with the employer, the employer failed to
make a contribution with respect to the coverage, or the
covered employee ceased to be a covered employee. According
to the STEP plan, any life insurance that was not purchased
could be surrendered by the trustee or continued with the plan
as beneficiary.

A. Forwarding Fees

The PCs of the participating doctors forwarded to VRD/RTD
amounts required by STEP to pay the premiums due on the
whole life insurance policies written on the lives of the
participating doctors. The PCs and VRD/RTD referred to these
transactions as "forwarding fees". During the subject years,
VRD/RTD received the following amounts of forwarding fees
from the PCs:

FN12. In operation, the STEP plan paid benefits to
participants even though the covered employee did
not fall within one of these circumstances.

VII. VRD/RTD's Contributions to STEP

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

1993

1994

Vincent R. DeAngelis M.D.P.C.

$300,000

Rodolfo T. Domingo M.D.P.C.

225,000

Keith Durante M.D.P.C.

50,000

Total

575,000

The PCs deducted these forwarding fees as expenses in the
year of payment.

*10 VRD/RTD recorded its receipt of the forwarding fees from
the PCs as "Fee Income-DeAngelis PC", "Fee
Income-Domingo PC", and "Fee Income-Durante PC",
respectively. VRD/RTD recorded that these amounts were
received from the PCs as pension contributions with respect to
the participating doctors. VRD/RTD also received a total of
$10,000 in each of the years 1993 and 1994, from the five PCs
that were partners in VRD/RTD. The $10,000 was forwarded
in each year to the STEP plan to pay the premium due on the
policy insuring the life of Ms. Quinn. Of the $10,000, Dr.
Capizzi's PC paid $2,400 in 1993 and $2,000 in 1994. The
record does not allow the Court to find the portion of the
$10,000 in either year that was paid by any of the other PC
partners.

During each of 1993 and 1994, VRD/RTD contributed
$585,000 to the STEP plan and recorded each of these
contributions as a "Pension Contribution". VRD/RTD's
partnership return reported the forwarding fees received from
the P.Cs as income and claimed a corresponding deduction for
"Retirement plans, etc." VRD/RTD did not make any further
contribution to STEP, and neither STEP nor any petitioner
directly paid any further premium on the subject life insurance
policies after the premiums were paid on December 28, 1994,
for the policy year beginning on that date.

B. Issuance of Policies

When VRD/RTD adopted the STEP plan, all of VRD/RTD's
contribution to the plan was invested in whole life insurance
policies issued by MetLife and sold by Mr. Rapp. The
particular policies were selected by the participating doctors in
consultation with Mr. Rapp. All of the policies were
participating whole life insurance polices, with the additional
feature that extra premiums could be paid to purchase paid-up
additions rider insurance (PUAR). A PUAR feature, when
elected, essentially prefunds the annual premiums for a policy
and accumulates any extra proceeds in the policy until needed
to pay premiums in a later year.

As of December 28, 1993, MetLife issued the following six life
insurance policies with respect to VRD/RTD's initial
contribution to the STEP plan:

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

Insured

Policy #

Type of Policy

Face Value

Dr. DeAngelis

931250799PR

Whole life

$2,156,442

Both DeAngelises

931250800A

Survivor whole life

4,818,200

Dr. Domingo

931250797PR

Whole life

1,327,656

Both Domingos

931250798A

Survivor whole life

3,500,000

Dr. Durante

931250795PR

Whole life

1,804,135

Ms. Quinn

931250796PR

Whole life & 409,184

Four of these policies were individual whole life insurance
policies separately insuring the lives of Ms. Quinn and each of
the participating doctors. The other two policies were joint and
survivor whole life insurance policies (survivor whole life
policies) or, in other words, life insurance that was not payable
to the beneficiary until the deaths of both insureds. One
survivor whole life policy insured both DeAngelises
(DeAngelises survivor whole life policy), and the other
survivor whole life policy insured both Domingos (Domingos
survivor whole life policy). Neither Jeanette DeAngelis nor
Bernadette Domingo was an employee of VRD/RTD, and the
survivor whole life insurance policies were purchased by Drs.
DeAngelis and Domingo as part of their Federal estate tax
plans. On December 28, 1993, Dr. DeAngelis was 60 years
old, Jeanette DeAngelis was 61 years old, and each of the
Domingos was 61 years old. Also on that date, Dr. Durante was
37 years old, and Ms. Quinn was 38 years old. Dr. DeAngelis
canceled other life insurance that he personally owned so that
insurance on the lives of him and his wife could be purchased
through the STEP plan with pretax dollars.

*11 The initial owner of each of the six policies was U.S.
Trust, as trustee of the STEP plan. When U.S. Trust was
replaced as trustee, the successor trustee was listed as owner.
As further discussed below, in 2001 STEP transferred to the
Domingos ownership of the two policies written on the lives of
one or both of them; in 2002, STEP transferred to Dr.
DeAngelis ownership of the policy written on his life; and in

2003, STEP transferred ownership of each of the remaining
policies to the insured or insureds named on the policy.

The insured doctors designated the beneficiaries for their
policies, and Ms. Quinn designated the beneficiaries for her
policy; the STEP plan trustee was never listed as a beneficiary
of any of the policies. The beneficiaries of the subject policies
were:

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

Insured

Beneficiary

Dr. DeAngelis Both DeAngelises Dr. Domingo Both Domingos Dr. Durante

DeAngelis Family Limited Partnership DeAngelis Family Irrevocable Life Insurance Trust Domingo Family Irrevocable Life Insurance Trust Domingo Family Irrevocable Life Insurance Trust Kathleen Durante

Ms. Quinn

Mother, 2 sisters, and 3 brothers

FN1. The original beneficiary was Dr. DeAngelis's wife. On or about Sept. 6,
2002, MetLife changed the beneficiary to the DeAngelis Family Limited
Partnership pursuant to the request of Dr. DeAngelis.

Mr. Rapp recommended that the beneficiary of each of the
survivor whole life policies be listed as an insurance trust in
order to minimize the Federal estate tax consequences to the
family of the insured, and Drs. DeAngelis and Domingo
followed that recommendation. STEP wanted any life
insurance benefit to be paid directly to the personal beneficiary
of the insured, rather than to or through the STEP plan,
because STEP did not want the STEP plan to be overfunded if
and when it were to receive that benefit.

Two annual premiums were paid on each of the six policies,
one for the policy year beginning December 28, 1993, and the
other for the policy year beginning December 28, 1994. As to
each policy, those premiums included the base premiums
necessary to fund the whole life insurance component of the
policy and premiums for PUAR. These payments were
consistent with illustrated payments contained in
correspondence from Mr. Rapp. The base premiums and
PUAR premiums on the policies were as follows:

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

Insured

Policy #

Base Premium

PUAR

Total

Dr. DeAngelis

931250799PR

$81,596.64

$98,403.36

$180,000

Both DeAngelises

931250800A

103,762.66

16,237.34

120,000

Dr. Domingo

931250797PR

53,093.13

52,656.87

105,750

Both Domingos

931250798A

77,845.00

42,155.00

120,000

Dr. Durante

931250795PR

21,996.32

28,003.68

50,000

Ms. Quinn

931250796PR

6,173.67

5,826.33

12,000

Total

587,750

Premiums were paid in the 2 years as follows:

Insured

Policy #

1993

1994

Dr. DeAngelis

931250799PR

$180,000

$178,625

Both DeAngelises

931250800A

120,000

Dr. Domingo

931250797PR

105,750

104,375

Both Domingos

931250798A

120,000

Dr. Durante

931250795PR

50,000

Ms. Quinn

931250796PR

12,000

Total 1

587,750

585,000

FN1. We recognize that VRD/RTD deducted for 1993 contributions totaling
$585, 000. In that the premiums paid in 1993 totaled $587, 750, we are unable to
find in the record an explanation as to who paid the extra $2, 750.

*12 The funds used to pay the premiums attributable to the two
policies written on the lives of one or both of the DeAngelises
came from Dr. DeAngelis's PC, the funds used to pay the
premiums attributable to the two policies written on the lives
of one or both of the Domingos came from Dr. Domingo's PC,
and the funds used to pay the premiums for the policy written
on the life of Dr. Durante (Dr. Durante policy) came from his
PC. The funds used to pay the premiums attributable to the
policy written on the life of Ms. Quinn (Ms. Quinn policy)
were taken on some apportioned basis from all five PCs that
were partners in VRD/RTD.INI2In each of those cases, the

funds used to pay the premiums went from each PC to
VRD/RTD, from VRD/RTD to the STEP plan, and from the
STEP plan to MetLife.

FN13. As discussed above, the record does not allow
the Court to find the specifics of that apportionment
other than as to Dr. Capizzi's PC.

C. Additional Correspondence

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

On September 19, 1995, Mr. Katz provided Mr. Freeman with
revised illustrations for the life insurance policies written with
respect to Drs. DeAngelis and Domingo. Those illustrations
had been requested by Drs. DeAngelis and Domingo to help
them determine whether they wanted to make any additional
contributions on their policies. The illustrations assumed that
premiums were paid for only 3 years, 4 years, or 5 years. Mr.
Katz informed Mr. Freeman that the projected severance
benefits for Drs. DeAngelis and Domingo were approximately
the cash values in their policies. Mr. Katz informed Mr.
Freeman that he was formulating illustrations for the policies
that would show a cash withdrawal of severance benefits and
the premium required to continue the policies thereafter. On
September 20, 1995, Mr. Rapp provided Drs. DeAngelis and
Domingo with answers from MetLife and STEP to questions
asked by those doctors.

On or about October 30, 1995, Mr. Katz provided Dr.
DeAngelis with revised illustrations for his insurance policies
showing only 2 years of out-of-pocket premium payments. Mr.
Katz also provided Mr. Freeman with various other
illustrations for the insurance policies written on the lives of
Drs. DeAngelis and Domingo.

### VIII. Payments of Premiums

#### A. Dr. DeAngelis Policy

The December 28, 1993 and 1994, premiums of $81,596.64 on
the policy written on the single life of Dr. DeAngelis (Dr.
DeAngelis policy) were paid timely, EN14 and PUAR was
purchased with additional premiums of $98,403.36 in 1993 and
$97,028.36 in 1994. In 1996, the premium due on this policy
as of December 28, 1995, was paid timely with a dividend

withdrawal of $16,658.17 and a portion of a withdrawal of
$123,004.98 from the PUAR. FNIS As to the withdrawal from the
PUAR, $64,938.47 was used to pay the December 28, 1995,
premium on this policy, and $58,066.51 was used to pay the
December 28, 1995, premium on the DeAngelises survivor
whole life policy. In 1997, the premium due on December 28,
1996, on the Dr. DeAngelis policy was paid timely with a
dividend withdrawal of $15,247.77 and a withdrawal of
$66,348.87 from the PUAR. The premium due on December
28, 1997, was not paid timely, and the policy lapsed for
nonpayment of premiums. MetLife converted the policy to
nonforfeiture extended term insurance with a face value of
$2,192,891 through August 21, 2000, at which time it was set
to be depleted of its cash value and thus to terminate without
value.FNI6

FN14. Although the premiums were not actually paid
until after the due dates, we consider them to have
been paid "timely". To this end, we understand each
of the subject insurance policies to have allowed a
grace period after the due date so that a premium paid
during that period would be timely in the sense that
the policy would not lapse.

FN15. A dividend withdrawal relates to a dividend
payable on a policy.

FN16. Extended term insurance is a life insurance
policy nonforfeiture option that may be exercised
when the policy lapses because of a failure to pay a
premium owed on the policy. Under this option, the
cash value of a lapsed policy is used to maintain the
full original death benefit until the cash value is
depleted.

### B. DeAngelises Survivor Whole Life Policy

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

*13 The December 28, 1993 and 1994, premiums of
$103,762.66 on the DeAngelises survivor whole life policy
were paid timely, and PUAR was purchased in each year with
additional premiums of $16,237.34. In 1996, the premium due
on December 28, 1995, was paid timely with a dividend
withdrawal of $11,563.68, a withdrawal of $34,133.47 from
the PUAR, and the above-referenced $58,066.51 withdrawal
from the Dr. DeAngelis policy. In 1997, the premium due on
December 28, 1996, was paid with a dividend withdrawal of
$12,363 and a policy loan of $91,399.66. The premium due on
December 28, 1997, was not paid timely, and the policy lapsed
for nonpayment of the premium. MetLife converted the policy
to participating reduced paid-up insurance with a face value of
$588,731.5N17

FN17. A reduced paid-up feature is another life
insurance policy nonforfeiture option that may be
exercised when the policy lapses because of a failure
to pay a premium owed on the policy. If such a
feature is exercised, the remaining cash value of the
policy is used to purchase a single premium life
insurance policy with a lower death benefit. While the
death benefit is reduced, the cash value in the policy
is used up more slowly than under other nonforfeiture
options.

On or about August 23, 1999, upon the request of Dr.
DeAngelis (and in connection with a similar request of Dr.
Domingo with respect to the Domingos survivor whole life
policy), the DeAngelises survivor whole life policy was
reinstated by MetLife to the full face value and converted
retroactively to a policy with an automatic premium loan
(APL) provision.INI8That feature was then applied to pay the
premiums of $103,762.66 due on December 28, 1997 and
1998, through an APL of $207,525.32. MetLife's stated reason
for reinstating the DeAngelises survivor whole life policy was

that the policy had lapsed because of "company error";
specifically, MetLife stated, Dr. DeAngelis wanted loans to be
made automatically from the policy to pay the premiums and
was not advised by the broker that the policy was set up with
a nonforfeiture option of reduced paid-up insurance. The
DeAngelises survivor whole life policy lapsed again after the
nonpayment of the premium due on December 28, 1999 (the
cash value in the policy was insufficient to support an APL),
and in October 2000 was converted to participating reduced
paid-up insurance with a face value of $669,547.

FN18. APL provisions allow an insurance company
to pay a premium due on a policy by way of a loan
taken out against the cash value of the policy. The
loan is subject to interest charges and affects the
policy's cash value only as a potential reduction of
that value. The total amount of outstanding loans on
the policy is usually less than the policy's cash value
because the policy will generally lapse when the total
amount of the loans exceeds that cash value.

#### C. Dr. Domingo Policy

The December 28, 1993 and 1994, premiums of $53,093.13 on
the policy written on the single life of Dr. Domingo (Dr.
Domingo policy) were paid timely, and PUAR was purchased
with additional premiums of $52,656.87 in 1993 and
$51,281.87 in 1994. In 1996, the premium due on December
28, 1995, was paid timely with a dividend withdrawal of
$10,358.01 and a withdrawal of $42,735.12 from the PUAR.
In 1997, the premium due on December 28, 1996, was paid
timely with a dividend withdrawal of $10,416.38 and a
withdrawal of $42,676 .75 from the PUAR. The premium due
on December 28, 1997, was not paid timely, and the policy
lapsed for nonpayment of the premium. MetLife continued the
policy as nonparticipating paid-up term insurance with a face
value of $1,377,206 through December 1, 2000, at which time
it was set to be depleted of its cash value and thus to terminate

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

without value.

D. Domingos Survivor Whole Life Policy

The December 28, 1993 and 1994, premiums of $77,845 on
the Domingos survivor whole life policy were paid timely, and
PUAR was purchased in each year with additional premiums
of $42,155. In 1996, the premium due on December 28, 1995,
was paid timely with a dividend withdrawal of $8,960 and a
withdrawal of $68,885 from the PUAR. In 1997, the premium
due on December 28, 1996, was paid timely with a dividend
withdrawal of $9,616, a withdrawal of $21,407 from the
PUAR, and a policy loan of $46,820. The premium due on
December 28, 1997, was not paid timely, and the policy lapsed
for nonpayment of the premium. MetLife converted the policy
to reduced paid-up insurance with a face value of $511,542.

*14 On or about October 19, 1999, upon the request of Dr.
Domingo (and in connection with the above-referenced similar
request of Dr. DeAngelis), the Domingos survivor whole life
policy was reinstated by MetLife to the full face value and
converted retroactively to a policy with an APL provision. That
feature was then applied to pay the premiums of $77,845 due
on December 28, 1997 and 1998, through an APL of $155,690.
MetLife's stated reason for reinstating the Domingos survivor
whole life policy in 1999 was that the policy had lapsed
because of "company error"; specifically, MetLife stated, Dr.
Domingo wanted loans to be made automatically from the
policy to pay premiums and was not advised by the broker that
the policy was set up with a nonforfeiture option of reduced
paid-up insurance. The Domingos survivor whole life policy
lapsed again after the nonpayment of the premium due on
December 28, 1999 (the cash value in the policy was
insufficient to support an APL), and in 2000 was converted to
participating reduced paid-up insurance with a face value of
$579,263.

E. Dr. Durante Policy

The December 28, 1993 and 1994, premiums of $21,996.32 on
the Dr. Durante policy were paid timely, and PUAR was
purchased in each year with additional premiums of
$28,003.68. In 1996, the premium due on December 28, 1995,
was paid timely with a dividend withdrawal of $1,881.58 and
a withdrawal of $20,114.74 from the PUAR. In 1997, the
premium due on December 28, 1996, was paid timely with a
dividend withdrawal of $1,618.17 and a withdrawal of
$20,378.15 from the PUAR. The premium due on December
28, 1997, was not paid timely, and the policy lapsed for
nonpayment of the premium. MetLife continued the policy as
nonparticipating paid-up term insurance with a face value of
$1,864,269 through February 1, 2005, at which time it was set
to be depleted of its cash value and thus to terminate without
value.

#### F. Ms. Quinn Policy

The December 28, 1993 and 1994, premiums of $6, 173.67 on
the Ms. Quinn policy were paid timely, and PUAR was
purchased in each year with additional premiums of $5,826.33.
In 1996, the premium due on December 28, 1995, was paid
timely with a dividend withdrawal of $422.06 and a withdrawal
of $5,751.61 from the PUAR. In 1997, the premium due on
December 28, 1996, was paid timely with a dividend
withdrawal of $337.18 and a withdrawal of $5,836.49 from the
PUAR. The premium due on December 28, 1997, was not paid
timely, and the policy lapsed for nonpayment of the premium.
MetLife continued the policy as nonparticipating paid-up term
insurance with a face value of $410,881 through May 7, 2003,
at which time it was set to be depleted of its cash value and
thus to terminate without value.

#### IX. Dispute of Drs. DeAngelis and Domingo

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

In 1999, Dr. DeAngelis received a statement from STEP
showing that the death benefit for the DeAngelises survivor
whole life policy had decreased by approximately $3.5 million.
The statement caused Dr. DeAngelis to write letters to STEP,
Teplitzky & Co., and Mr. Rapp, requesting an explanation for
the decrease in value. Dr. DeAngelis (and ultimately Dr.
Domingo) also retained an attorney as to this matter.

*15 On investigation, Dr. DeAngelis concluded that the
policies had lapsed for nonpayment of premiums, contrary to
the advice that he had received at the inception of his
participation in STEP that the policies would be self-sustaining
after the making of the first two contributions. Because the
option on each policy to pay the annual premiums through an
APL had not been elected on the insurance application form,
each of the six subject policies lapsed as of the end of 1997.

The failure to make the APL election on the insurance
application forms was partially that of Mr. Rapp, who
misunderstood the expressed intent of Drs. DeAngelis and
Domingo that the APL election be made on their policies. After
the lapse of the policies, much correspondence on the subject
ensued between Drs. DeAngelis and Domingo and their lawyer,
on the one hand, and MetLife, Mr. Rapp, and/or Teplitzky &
Co., among others, on the other hand, and Drs. DeAngelis and
Domingo threatened to file a lawsuit as to the matter. Drs.
DeAngelis and Domingo sought from MetLife the
reinstatement of their and Ms. Quinn's single individual
policies as reduced paid-up insurance retroactively to the
original lapse date.

X. Reinstatement of Policies

##### A. Overview

On January 24, 2002, Marcia McDermott (Ms. McDermott), an
internal consultant for MetLife, asked MetLife to reinstate the
lapsed policies of Dr. DeAngelis and Ms. Quinn as paid-up
insurance retroactively to the original lapse date, as if the
policies had never lapsed. Previously, Ms. McDermott had
made a similar request as to the Dr. Domingo policy. Because
Dr. Durante did not ask Ms. McDermott to seek a similar
reinstatement of the Dr. Durante policy, Ms. McDermott did
not ask MetLife to reinstate the Dr. Durante policy.

#### B. Dr. Domingo Policy

STEP transferred ownership of the Dr. Domingo policy to Dr.
Domingo in or about November 2001. Although the policy
technically had no value, Dr. Domingo wanted the policy
because Ms. McDermott had agreed to reinstate the policy as
a reduced paid-up policy retroactive to December 28, 1997.
Subsequently, pursuant to the request of Dr. Domingo, MetLife
changed the Dr. Domingo policy to reduced paid-up insurance
retroactively effective to December 28, 1997, with a face value
of $195,924. MetLife stated in part that it was making this
change because neither Dr. Domingo nor the STEP plan trustee
had received timely notice of either the lapse of the policy or
multidistrict litigation involving MetLife's marketing practices;
the trustee had directed MetLife to send all mail to the trustee
in care of the STEP plan administrator. Following this change,
the Dr. Domingo policy has continued as participating reduced
paid-up insurance.

From December 28, 1993, through the present, Dr. Domingo
received life insurance coverage of $195,924 to $1,377,206
through the Dr. Domingo policy. As of December 28, 2005, the
policy's death benefit and net cash surrender value were
$267,034.57 and $185,025.58, respectively.

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

#### C. Dr. DeAngelis Policy

*16 On or about January 24, 2002, the ownership of the Dr.
DeAngelis policy was changed to his name. Shortly thereafter,
the Dr. DeAngelis policy was changed from nonforfeiture
extended term insurance to participating reduced paid-up
insurance retroactively effective to December 28, 1997, with
a face value of $264,809. MetLife stated in part that it was
making this change because neither Dr. DeAngelis nor the
STEP plan trustee had received timely notice of either the lapse
of the policy or multidistrict litigation involving MetLife's
marketing practices; the trustee had directed MetLife to send
all mail to the trustee in care of the STEP plan administrator.
Before the formal change of ownership, Dr. DeAngelis
understood that the policy technically had no value but that
MetLife was going to change the policy to reduced paid-up
status retroactively to 1997. As of December 28, 2004 and
2005, respectively, the Dr. DeAngelis policy had a death
benefit of $349,286 and $360,559.21 and a net cash surrender
value of $232,215.81 and $244,798.07.

#### D. Ms. Quinn Policy

On January 3, 2003, Dr. DeAngelis formally terminated
VRD/RTD's participation in STEP. At that time, Dr.
DeAngelis offered on behalf of VRD/RTD to purchase from
the STEP plan the DeAngelises survivor whole life policy, the
Dr. Durante policy, and the Ms. Quinn policy. Dr. DeAngelis
offered to purchase these policies at a cost of 10 percent of
each policy's cash value, payable as a withdrawal from the
policy's cash value.

On July 28, 2003, STEP assigned the ownership of the Ms.
Quinn policy to Ms. Quinn. No severance event had occurred
under the STEP plan to permit this assignment. In connection
with the assignment, Ms. Quinn executed a claim settlement

and release form, backdated to January 3, 2003, the day of
VRD/RTD's formal termination of its participation in the STEP
plan.

On August 7, 2003, STEP informed Ms. Quinn that it had
asked MetLife to change the ownership of the Ms. Quinn
policy from the STEP trustee to Ms. Quinn and that any action
to reinstate the policy had to be made by Ms. Quinn. One day
later, MetLife informed SPSI that it had received STEP's
request to change the ownership of the Ms. Quinn policy but
MetLife's records indicated that the policy had expired and was
no longer in force. At the request of Dr. DeAngelis, the Ms.
Quinn policy was changed by MetLife later in 2003 to reduced
paid-up insurance retroactively effective to December 28,
1997, with a face value of $34,135. On September 30, 2003,
MetLife confirmed to Ms. Quinn that she was the owner of the
Ms. Quinn policy and that the policy was being continued as
reduced paid-up insurance in the amount of $34,135, which
would increase as dividends were credited to the policy.

On or after January 16, 2004, Ms. Quinn surrendered the Ms.
Quinn policy to MetLife and received a check from MetLife in
the amount of $15,573.69. MetLife processed the check on
January 27, 2004. From December 28, 1993, through January
16, 2005, Ms. Quinn received life insurance coverage of
$34,135 to $410,881 through the Ms. Quinn policy.

XI. Survivor Whole Life Policies

A. Domingos Survivor Whole Life Policy

*17 On December 10, 2001, STEP assigned the ownership of
the Domingos survivor whole life policy to Dr. Domingo. As
of December 28, 2001, the Domingos survivor whole life
policy had a total death benefit of $596,009.81, less an

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

outstanding policy loan of $220,206.85, for a net death benefit
of $375,802.96. As of the same date, the Domingos survivor
whole life policy had a cash surrender value of $224,475.17,
less the outstanding policy loan of $220,206.85, for a net cash
surrender value of $4,268.32. As of November 2006, the
Domingos survivor whole life policy had a cash value base of
$277,316.37, a cash value of additional insurance of
$21,380.58, an existing loan of $279,056.26, and loan interest
due of $13,793.75, for a net cash surrender value of $5,846.94.
From December 28, 1993, through the present, the Domingos
received life insurance coverage of between $511,542 and
$3,500,000 through the Domingos survivor whole life policy.

#### B. DeAngelises Survivor Whole Life Policy

On July 28, 2003, STEP assigned the ownership of the
DeAngelises survivor whole life policy to the DeAngelises. No
severance event had occurred under the STEP plan to permit
this assignment. In connection with the assignment, Dr.
DeAngelis also executed a claim settlement and release form
backdated to January 3, 2003.

As of various times, the policy's death benefit and net cash
surrender value were as follows:

As of

Death Benefit

Net Cash Surrender Value

3/1/1999

$595,195.38

$186,974.68

12/28/1999

4,663,784.34

220,495.10

12/28/2000

678,528.13

236,229.57

12/28/2001

688,464.08

253,038.08

2/5/2003

699,316.63

272,153.06

3/31/2003

669,547.00

274,537.72

12/28/2004

713,391.54

305,930.83

@ 2009 Thomson Reuters/West. No Claim to Orig. US Gov. Works.

12/28/2005

XII. Dr. Durante Policy

As of March I, 1999, the cash surrender value of the Dr.
Durante policy was $52,982.52. As of December 31, 2001, the
cash surrender value of the policy was $23,508.43. As of
February 25, 2003, the cash surrender value of the Dr. Durante
policy was $21,811.95. As of each of these dates, the death
benefit payable under the policy was $1,864,269.

On July 28, 2003, STEP assigned the ownership of the Dr.
Durante policy to Dr. Durante. No severance event had
occurred under the STEP plan to permit this assignment. In
connection with the assignment, Dr. Durante also executed a
claim settlement and release form backdated to January 3,
2003.

On August 4, 2003, the cash surrender value of the Dr. Durante
policy was $17,635.98, and the death benefit was $1,864,269.
The Dr. Durante policy had no value once it expired on
February 1, 2005. From December 28, 1993, through February
1, 2005, Dr. Durante received life insurance coverage of
$1,804,135 to $1,864,269 through the Dr. Durante policy.

##### XIII. Acquisition of STEP

STEP was acquired from Teplitzky & Co. in February 2002 by
STEP Acquisition Group, Inc. Afterwards, SPSI offered
participants three options. Option A was "To continue
participation in the STEP Plan & Trust as the Plan is now and
as it is amended from time to time."Option B was "To
terminate our participation in the STEP Plan & Trust and to
have 80% of the potential severance benefit paid out to each of

719,830.71
324,053.39

our employees over a 24 month period."Option C was "To
terminate our participation in the STEP Plan and rollover 90%
of the potential severance benefit to purchase new insurance
policies to provide death benefit protection in the BENISTAR
419 Plan and Trust."The STEP plan does not provide for any
of these options. On June 28, 2002, Dr. DeAngelis signed a
STEP "Option Selection Form" stating that VRD/RTD had
decided "To continue participation in the STEP Plan & Trust
as the Plan is now and as it is amended from time to time."

#### XIV. Recordkeeping for the STEP Plan

*18 STEP maintained its records of employer contributions;
insurance policy premiums; potential severance benefits; policy
values; termination, surrender, or withdrawal dates; forfeitures;
severance payments; "frozen" potential severance benefits; and
surrenders and withdrawals on an employee-by-employee basis
within each employer group, further segregated by each of the
eight insurance companies participating in the STEP plan.
STEP maintained its books and records first by insurance
company, second by employer group, and finally by each
individual employee. Forms 5500-C/R, Return/Report of
Employee Benefit Plan, filed by the STEP plan were generally
broken down by insurance company, employer group, and
employee. Forms W-2, Wage and Tax Statement, were issued
to participants with separate employer identification numbers
for each life insurance company.

Each insurance policy was essentially a separate account for
the covered employee on whose life the policy was written.
The account included all of the employer's contributions for
that employee, was increased by all of the income earned as a
result of those contributions, was reduced by all insurance
company charges to provide the life insurance benefits for only

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

that employee, and was used as the base from which to
calculate the purported severance benefits of that employee. A
severance benefit that was paid out to an employee was
typically not equal to what had been paid in by way of
employer contributions. The employer contribution was
invested by STEP, and the assets grew.

VRD/RTD's contributions were invested in the individual
insurance policies of the participating doctors and Ms. Quinn.
The contributions for each policy were accounted for
separately. Dividends were credited to the policy, and
insurance charges were taken out of each of the policies to pay
for the cost of providing the covered employee with life
insurance coverage. STEP applied a factor to the cash value of
the life insurance policy on the covered employee's life in order
to compute the benefit payable to the employee. The insurance
policies (or the cash derived therefrom) were distributed to
VRD/RTD's participating employees without regard to STEP's
purported computation of the allowable amounts of severance
benefits.

#### XV. Dr. Domingo's Receipt of Plan Benefits

On April 3, 1997, Dr. Domingo wrote to Mr. Katz requesting
a "legal opinionated [sic] letter" regarding his "intent to retire
within the time period of 3 years" for "business reasons and for
continuity of our surgical group."Dr. Domingo requested that
any response be sent to him "Personal and Confidential." Mr.
Katz relayed Dr. Domingo's letter to Mr. Pagano. On May 1,
1997, Mr. Pagano advised Dr. Domingo that he would receive
full benefits under the STEP criteria of "good cause" and
"genuine business purpose" if he resigned after being asked to
retire. Mr. Pagano advised Dr. Domingo that he would not
qualify for benefits if he agreed to work for VRD/RTD in a
different capacity.

*19 On March 21, 2001, Dr. Domingo informed Teplitzky &
Co. that on January 1, 1999, he "retired completely from my
surgical practice" and wanted to know about the severance
monetary benefits available to him. On March 28, 2001,
Teplitzky & Co. informed Dr. Domingo that he needed to
establish a severance event in order to qualify for benefits
under the plan and had to establish to the satisfaction of the
plan's independent fiduciary that the termination was for good
cause within the meaning of New York State Unemployment
Insurance Law. Teplitzky & Co. enclosed examples of “good
cause" under New York law and advised Dr. Domingo to call
Mr. Mamorsky if he had any questions.

On June 17, 2001, Dr. Domingo relayed to the STEP plan
administrator his revised request for severance benefits,
including a formal "Request for Benefit Payments" and an
attached "Reason for Termination of Service". The revised
claim removed all reference to his prior statement that he had
"completely retired" from his surgical practice. The revised
claim stated that on October 5, 1998, VRD/RTD asked him to
terminate his association with the group effective January 1,
1999, because his financial contribution to the group was not
satisfactory. Dr. Domingo claimed that his compensation for
the last 12-month period before his termination of service was
$323,334.

On July 16, 2001, VRD/RTD mailed to Teplitzky & Co. an
"Employer Request for Payment of Benefits" for Dr. Domingo
listing the date of severance as January 1, 1999, and stating that
the compensation paid to Dr. Domingo for the last 12-month
period before termination of employment was $323,334.
Attached to the request was the same "Reason for Termination
of Service" that Dr. Domingo had attached to his benefit
request. Both forms were signed by Dr. DeAngelis on June 30,
2001. Before that request, neither VRD/RTD nor Dr. Domingo
notified STEP that Dr. Domingo had stopped providing
services to VRD/RTD on January 1, 1999.

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360

(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

On August 10, 2001, Teplitzky & Co. forwarded Dr.
Domingo's claim for severance benefits to Mr. Pagano, asking
Mr. Pagano if he agreed or disagreed with the claim. On
September 4, 2001, Mr. Pagano informed Teplitzky & Co. that
he had reviewed Dr. Domingo's claim for severance benefits
and that he confirmed that it was an "induced termination due
to non renewal of contract" which would be a qualifying event
for severance benefits under the STEP plan.

On September 20, 2001, Teplitzky & Co. notified Dr.
Domingo that his severance benefit had been approved in the
estimated amount of $233,661 and offered Dr. Domingo the
opportunity to "purchase" the Domingos survivor whole life
policy, coverage of which was $587,232, for $5,496. On
September 25, 2001, Dr. Domingo wrote to Teplitzky & Co.
asking for answers to certain questions he had about his
benefits and his life insurance policies, including a question as
to why he had to pay so much to purchase the Domingos
survivor whole life policy. On September 28, 2001, Teplitzky
& Co. responded to Dr. Domingo's questions, indicating,
among other things, that the purchase price for his policy was
determined by subtracting from the $217,305 cash surrender
value of the policy the maximum loan that could be taken of
$211,809, leaving a balance in the policy of $5,496. On
October 9, 2001, Ms. McDermott confirmed in writing to Dr.
Domingo that MetLife would be willing to change the policy
on his life to reduced paid-up status retroactively effective to
the date when a request to make such a change could have been
timely made. Ms. McDermott also informed Dr. Domingo that
the policy was still "technically an asset of the severance plan"
so it would be a "good idea" to get the policy from the plan
before the change was made. Ms. McDermott attached a letter
showing that the policy is presently of "no value to the plan" to
assist Dr. Domingo in getting the policy.

*20 On October 14, 2001, Dr. Domingo advised Teplitzky &
Co. that he wished to purchase the Domingos survivor whole
life policy. One day later, Dr. Domingo sent to Mellon Trust a

$2,000 check from Rodolfo T. Domingo M.D.P.C. and a
$3,496 check from the Domingo Family Limited Partnership
as requested by the STEP plan administrator to purchase the
Domingos survivor whole life policy. On October 24, 2001,
Teplitzky & Co. applied for a policy loan on and requested a
change in ownership of the Domingos survivor whole life
policy. The policy loan was used to pay to Dr. Domingo his
requested severance benefits totaling approximately $220,000.

#### XVI. Dr. DeAngelis's Receipt of Plan Benefits

Dr. DeAngelis filed a claim for severance benefits with STEP
in November 2002. In connection therewith, Dr. DeAngelis on
November 19, 2002, signed a "Request for Payment of
Benefits" stating that he was terminating his services because
of "prostate cancer, with symptoms which interfere with
employee's ability to perform surgery" and that his
compensation for the 12-month period before his termination
of service was approximately $350,000. Dr. DeAngelis
underwent radiation and incurred radiation colitis to try to treat
his prostate cancer and continued to work until December 31,
2003.

Wayne Bursey (Mr. Bursey), the president of SPSI, approved
the claim. Mr. Bursey was concerned about the possibility of
future litigation between Dr. DeAngelis and STEP, insofar as
Drs. DeAngelis and Domingo had threatened suit against the
prior plan administrator but had never instituted any such
litigation.

## OPINION

### 1. Overview

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

We are faced once again with an issue arising from a plan
designed aggressively to bolster the sale of insurance products
through a claim of permissible tax savings. Cf. Neonatology
Associates, P.A. v. Commissioner, 115 T.C. 43, 99 (2000),
affd. 299 F.3d 221 (3d Cir.2002). Respondent determined that
neither the PCs' payments to VRD/RTD related to the STEP
plan nor VRD/RTD's ensuing contributions to the STEP plan
were deductible under section 162(a) as ordinary and necessary
business expenses and that the amounts of the payments were
includable in the doctors' gross income under section 61(a).
Respondent argues that the payments were made for the
doctors' personal benefit. Petitioners argue that the payments
and contributions are deductible under section 1.162-10(a).
Income Tax Regs., as "Amounts paid or accrued within the
taxable year for dismissal wages" and, thus, that the payments
are not includable in the doctors' gross income. We agree with
respondent's determination on the disallowed deductions but
disagree with respondent's determination on the inclusion in
income. We set forth our analysis below primarily in two
sections. The first section sets forth our opinion of the
credibility of the witnesses. The second section sets forth our
opinion on the substantive issues at hand.

### II. Credibility of the Witnesses

#### A. Expert Witnesses

*21 At trial, each party called an expert witness in support of
their and his respective positions. Petitioners called Michael L.
Frank (Mr. Frank), and the Court recognized him as an expert
on experience rating and risk sharing. Mr. Frank is an actuary
who graduated from the University of Michigan in 1987 and
has worked in the insurance industry ever since. He currently
works for his own company in part (1) advising employers on
the purchase of insurance, (2) consulting on employee benefits
and the plans related thereto, (3) brokering and underwriting
insurance, and (4) helping insurance and other companies

underwrite insurance. His credentials include that he is licensed
to sell life and other forms of insurance in 18 States, that he is
an associate of the Society of Actuaries, that he is a member of
the American Academy of Actuaries, and that he is a fellow of
the Conference of Consulting Actuaries. Petitioners retained
him less than 3 months before trial to testify as an expert in this
proceeding. Mr. Carpenter, with whom Mr. Frank has had a
longstanding working and personal relationship, recommended
him.

Respondent called Charles C. De Weese (Mr. De Weese) at trial
to testify as an expert, and the Court recognized Mr. De Weese
as an expert on multiple-employer benefit plans, insurance
experience rating, and individual life insurance policies. Mr.
De Weese is an independent consulting actuary who graduated
from Yale University in 1968 and has worked in the insurance
industry ever since. His credentials include that he has been a
fellow of the Society of Actuaries since 1972, a member of the
American Academy of Actuaries since 1974, and a fellow of
the Conference of Consulting Actuaries since 1987. Various
courts, including this one, have previously recognized Mr.
De Weese as an expert on subjects similar to those relevant
herein, and he has repeatedly testified as an expert on those
subjects, including twice in this Court. See Neonatology
Associates, P.A. v. Commissioner, supra at 85-86; Booth v.
Commissioner, 108 T.C. 524, 573 (1997).

The Court has broad discretion to evaluate the cogency of an
expert's analysis. See Neonatology Associates, P.A. v.
Commissioner, supra at 85.Sometimes, an expert will help us
decide a case. See, e.g., id .; Booth v. Commissioner, supra at
573; Trans City Life Ins. Co. v. Commissioner, 106 T.C. 274.
302 (1996). Other times, he or she will not. See, e. g., Estate of
Scanlan v. Commissioner, T.C. Memo. 1996-331, affd. without
published opinion 116 F.3d 1476 (5th Cir. 1997); Mandelbaum
v. Commissioner. T.C. Memo.1995-255, affd. without
published opinion 91 F.3d 124 (3d Cir. 1996). Aided by our
common sense and our perception of the expert during his or

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

her testimony, we weigh the helpfulness and persuasiveness of
an expert's testimony in the light of his or her qualifications and
with due regard to all other credible evidence in the record. See
Neonatology Associates, P.A. v. Commissioner, supra at
84-85. We may embrace or reject an expert's opinion in toto, or
we may pick and choose the portions of the opinion to adopt.
See Helvering v. Natl. Grocery Co., 304 U .S. 282, 294-295
(1938); IT & S of Iowa, Inc. v. Commissioner. 97 T.C. 496,
508 (1991). We are not bound by an expert's opinion and will
reject an expert's opinion to the extent that it is contrary to the
judgment we form on the basis of our understanding of the
record as a whole. See IT & S of Iowa, Inc. v. Commissioner,
supra at 508.

*22 In making our findings of fact and reaching our decisions
herein, we have given little weight to the testimony of Mr.
Frank. Although the Court recognized Mr. Frank as an expert
on the stated subjects, we were and remain troubled that Mr.
Frank has a longstanding and continuing working and personal
relationship with Mr. Carpenter and other entities and persons
with financial and/or other direct interests in the resolution of
these cases. See Neonatology Associates. P.A. v.
Commissioner, 115 T.C. at 86 (stating that "An expert witness
loses his or her impartiality when he or she is too closely
connected with one of the parties" and holding that such an
expert is of limited value to the Court). In fact, during trial, we
were forced to admonish Mr. Frank that he should not be
improperly communicating with one or more of the
just-referenced persons and petitioners' counsel. In addition to
that stated relationship, we also on the basis of our observation
of Mr. Frank's candor, sincerity, and demeanor perceived him
to be of little help to the Court in deciding these cases. As to
Mr. De Weese, we have respected his testimony and given that
testimony appropriate weight. When Mr. De Weese previously
testified before this Court, the Court on each occasion found
him to be reliable, relevant, and helpful on the areas that were
the subject of his expertise. See id. at 85-86;Booth v.
Commissioner, supra at 573.We find him likewise helpful in
these cases.

#### B. Fact Witnesses

At trial, petitioners called five witnesses to testify as to the
facts of these cases; respondent called three such witnesses.
Petitioners' fact witnesses were Drs. DeAngelis and Domingo
and Messrs. Mamorsky, Bursey, and Teplitzky. Respondent's
fact witnesses were Dr. Borrero, Mr. Mamorsky, and Ms.
McDermott.FN19On the basis of our perception of the witnesses
and our review of the record as a whole, we do not find much
of the testimony of the fact witnesses to be helpful as to the
critical facts underlying the issues at hand. See generally
Neonatology Associates, P.A. v. Commissioner, supra at 84
(discussing the standards that the Court applies to evaluate the
testimony of trial witnesses). We rely mainly on the testimony
of Mr. De Weese and the voluminous record built by the parties
through their comprehensive stipulation of facts and exhibits.

FN19. For completeness, we note that respondent also
called Mr. Carpenter to testify at an evidentiary
hearing held immediately before trial. Petitioners had
moved the Court approximately I month before trial
to issue an order generally disqualifying Mr.
De Weese from testifying as an expert witness in this
proceeding and had attached to their motion an
affidavit of Mr. Carpenter setting forth serious
allegations questioning the objectivity of Mr.
De Weese. In respondent's response to that motion (as
supplemented by petitioners to address in part a
question by the Court as to why petitioners had not
filed their motion earlier), respondent raised serious
issues of truthfulness on the part of Mr. Carpenter and
requested in part that the Court hold an evidentiary
hearing so that respondent could question Mr.
Carpenter as to his actions connected with this
proceeding and the subject matter thereof. The Court
granted respondent's request. The Court ultimately

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

denied petitioners' motion as supplemented.

### 111. Substantive Issues at Hand

#### A. Disallowance of Deductions

Section 162(a) generally provides that "There shall be allowed
as a deduction all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or
business". A taxpayer such as VRD/RTD or one of the PCs
must meet five requirements in order to deduct an item under
this section. The taxpayer must prove that the item claimed as
a deductible business expense: (1) Was paid or incurred during
the taxable year; (2) was for carrying on its trade or business;
(3) was an expense; (4) was a necessary expense; and (5) was
an ordinary expense. FN20See Commissioner v. Lincoln Sav. &
Loan Association, 403 U.S. 345. 352 (1971); Welch v.
Helvering, 290 U.S. 111, 115 (1933); see also Rule 142(a)(1).
A determination of whether an expenditure satisfies each of
these requirements is a question of fact. See Commissioner v.
Heininger, 320 U.S. 467, 475 (1943).

FN20. While sec. 7491(a) places the burden of proof
upon the Commissioner in certain cases, the Court has
decided in an unpublished order that sec. 7491(a) has
no applicability to these cases.

*23 Petitioners argue that section 162(a) allowed VRD/RTD
and the PCs to deduct the amounts related to the STEP plan
because those amounts represented "dismissal wages" paid to
a "welfare or similar benefit plan" within the scope of section
1.162-10(a), Income Tax Regs. We disagree. While the STEP
plan may have been cleverly designed to appear to be a welfare
benefits fund and marketed as such, the facts of these cases
establish that the plan was nothing more than a subterfuge

through which the participating doctors, through VRD/RTD,
used surplus cash of the PCs to purchase cash-laden whole life
insurance policies primarily for the benefit of the participating
doctors personally. While employers are not generally
prohibited from funding term life insurance for their employees
and deducting the premiums on that insurance as a business
expense under section 162(a), employees are not allowed to
disguise their investments in life insurance as deductible
benefit-plan expenses when those investments accumulate cash
value for the employees personally. See Neonatology
Associates, P.A. v. Commissioner, supra at 88-89.

The insurance premiums at hand pertained to the participating
doctors' personal investments in whole life insurance policies
that primarily accumulated cash value for those doctors
personally. VRD/RTD's contributions to the STEP plan were
used to pay the initial year's cost of providing life insurance for
each participating doctor and to create an investment fund for
the insured within his whole life insurance policy (or policies
in the cases of Drs. DeAngelis and Domingo). That fund, when
enhanced with expected future dividends, was calculated to be
sufficient to pay for the future years' costs of life insurance
protection and to provide for cash values sufficient to allow for
a distribution of cash to the insured doctor whenever he opted
to claim that he was involuntarily terminated from his business.
As to each investment fund (and as to each insurance policy in
general), the insured doctor regarded that fund (and policy) as
his own, as did the STEP plan trustee, the STEP plan
administrator, and MetLife. Very little (if any) value in one
participating doctor's fund was available to pay to another
insured, and any distribution of cash from the STEP plan to a
participating doctor was directly related to the cash value of his
policy. In many instances, a participating doctor dealt with his
own insurance agent in selecting and purchasing the policy on
his life, received illustrations on an assortment of life insurance
investments that could be made through the STEP plan,
determined the amount of his investment in his life insurance
policy, selected the form of the insurance policy to be issued
for him (e.g., single whole life versus survivor whole life), and

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

selected his policy's face amount. In the latter regard, we note
our finding on the basis of the credible evidence in the record
that Drs. DeAngelis and Domingo, when dealing with Mr.
Rapp, MetLife, and the insurance policies in general, were not
acting as agents of VRD/RTD but were acting in their
individual capacities. We also note our finding that Dr.
Durante was not acting as an agent of VRD/RTD with respect
to his policy.

*24 The use of whole life insurance policies and the direct
interactions between the participating doctors and the STEP
plan representatives support our finding that the participating
doctors in their individual capacities fully expected to get their
promised benefits and that any receipt of those benefits was not
considered by anyone connected with the life insurance
transaction to rest on any unexpected or contingent event. Each
whole life insurance policy upon its issuance was in and of
itself a separate account of the insured doctor, and the insured
(rather than the STEP plan) dictated and directed the funding
and management of the account and bore most risks incidental
to the account's performance. The STEP plan in essence and in
operation was simply an aggregation of separate plans for the
participating doctors and not, as petitioners claim, one single
plan in which various employers participated. The cash value
in a participating doctor's policy was both intended to be and
actually returned to the insured doctor, net of reductions for the
cost of current insurance coverage and other de minimis
amounts that were payable for charges related to the policies or
otherwise incidental to the participation in the STEP plan. In
fact, upon learning that their policies had lost the value that
they expected to receive, Drs. DeAngelis and Domingo
pursued recovery of those losses both directly and aggressively
with their insurance agent and with the STEP plan
representatives and caused the policies written on their lives to
be transferred to them (and the Ms. Quinn policy to be
transferred to her) as they had expected from the start of their
investment in the STEP plan. As to the DeAngelises survivor
whole life policy and the Domingos survivor whole life policy,
the retroactive reinstatement and conversion of those policies

to APL also rebuts petitioners' claim that each insurance policy
was truly an asset of the STEP plan which the plan had the
unfettered right to benefit from, to liquidate, or to dispose of;
to the contrary, the cash value theoretically belonging to the
STEP plan was converted into death benefits for Drs.
DeAngelis and Domingo even though VRD/RTD had stopped
making contributions years before the conversion.

We also note the events leading up to the initial purchase of the
whole life insurance policies. Through the partnership
agreement executed on June 19, 1990, Drs. DeAngelis and
Domingo had expressed their intent to retire in the near future.
Yet, in connection with the planning of their personal estates
and their consideration of ways to reduce the application to
their estates of the Federal estate tax, Dr. DeAngelis caused
VRD/RTD to join the STEP plan on December 30, 1993. Drs.
DeAngelis and Domingo were told that their 1993 and 1994
payments to the STEP plan would suffice to fund the future
costs of providing life insurance benefits for the remainder of
their lives and to provide future distributions of cash to them at
the time of their choosing. From the beginning of their decision
to participate in the STEP plan, the participating doctors were
most concerned about the amounts of, and their ability to
receive, their expected benefits from STEP. In fact, Drs.
DeAngelis and Domingo requested calculations and
illustrations showing how much they would receive depending
upon the number of years that contributions were made to the
STEP plan. Drs. DeAngelis and Domingo also wrote to Mr.
Katz for assurance that they would receive their benefits and
requested a written opinion from the plan sponsor about how
to characterize their planned departures from their practices so
as to meet the terms of the STEP plan as written. STEP advised
the participating doctors on what to say in order to get their
promised benefits, and STEP assured the doctors that a
protocol was in place to ensure that they would get their money
as intended. Because each of the participating doctors' PCs
funded its own employee's benefits under the STEP plan, STEP
was at no significant loss in allowing each PC to remove from
the plan the money it invested therein. FN21

T.C. Memo. 2007-360

FN21. We also are mindful that the provisions in the
STEP plan were routinely not followed; e.g., Dr.
Domingo received a "severance" benefit even though
he informed the STEP plan administrator that he had
"completely retired", a situation that even the author
of the STEP plan admitted was not an eligible event
under the STEP plan as written.

*25 Petitioners rely erroneously on Booth v. Commissioner,
108 T.C. 524 (1997), in arguing that these cases turn primarily
not on the application of section 162(a) but on the question of
whether the STEP plan meets the requirements of section
419A(f)(6). As discussed herein, our decisions in these cases
turn on our factual evaluation of the relationship between the
participating doctors and their whole life insurance policies
without any regard to the STEP plan's qualification under
section 419A(f)(6), and we decide on the basis of the credible
evidence in the record before us that those doctors upon
investing in the STEP plan had the primary right to receive the
value reflected in the insurance policies written on their lives.
We note in this regard that the Court in Booth v.
Commissioner, supra, did not decide the issue under section
162(a) that we decide today.

In sum, we find that the PCs' payments to VRD/RTD were
distributions to the doctors personally and that neither those
payments nor VRD/RTD's ensuing contributions to STEP were
ordinary and necessary business expenses under section 162(a)
(except to the extent they relate to payments of premiums on
the Ms. Quinn policy as discussed supra note 3). Accord
Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43
(2000). Consequently, we hold that those amounts are not
deductible under section 162(a) by either the PCs or
VRD/RTD. FN22

FN22. Although the PCs may arguably be entitled to
deduct the costs of the current life insurance
protection purchased through the STEP plan, see
Neonatology Associates, P.A. v. Commissioner. 115
T.C. 43 (2000), petitioners have not requested any
such deductions, and the record does not allow the
Court to find the amounts of any such deductions.

### B. Inclusion in Income

Respondent determined that the amounts of the life insurance
premiums that were paid by each doctor's PC on his behalf are
includable in the doctor's gross income under section 61(a) as
"accessions to wealth, clearly realized, and over which the
taxpayers have complete dominion."See Commissioner v.
Glenshaw Glass Co., 348 U.S. 426, 431 (1955). We disagree
that those amounts are includable in the doctors' gross income.
While the payments of the premiums were indeed accessions
to the doctors' wealth, our decision on this issue does not rest
simply on that finding. Instead, our decision turns on our
finding that the doctors' PCs were S corporations and that the
payment of the premiums by the PCs was essentially a
distribution to the doctors of corporate profits rather than a
payment that the PCs made to the doctors with a compensatory
intent. See Neonatology Associates, P .A. v. Commissioner,
supra at 91-92, 95-96; see also Neonatology Associates, P.A.
v. Commissioner, 299 F.3d at 231-232.In accordance with the
Federal income tax law applicable to S corporations, most
particularly sections 1367 and 1368, our disallowance of the
deductions claimed by the PCs has the effect of increasing pro
tanto the net income of those PCs, with corresponding
increases to the doctors' distributive shares of that income. That
being so, the payments of the premiums are not taxed a second
time to the doctors.FN23Cf. Neonatology Associates, P.A. v.
Commissioner, 115 T.C. at 95-96 (tax at the shareholder-level
was appropriate where the employer was a C corporation).

T.C. Memo. 2007-360

T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94 T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007
RIA TC Memo 2007-360
(Cite as: T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.))

FN23. In other words, we regard each distribution as
a tax-free recovery of adjusted basis, taking into
account the increase in basis resulting from the
disallowance of deductions claimed by the PC.

*26 We have considered each argument made by petitioners
for holdings contrary to those expressed herein and have
rejected all arguments not discussed herein as irrelevant or
without merit. We also have considered each argument made
by respondent for a holding contrary to that expressed herein
as to the inclusion in income and have rejected all arguments
not discussed herein as irrelevant or without merit.
Accordingly,

Decisions will be entered under Rule 155.

U.S.Tax Ct.,2007.
V.R. Deangelis M.D.P.C. v. C.I.R.
T.C. Memo. 2007-360, 2007 WL 4257483 (U.S.Tax Ct.), 94
T.C.M. (CCH) 526, T.C.M. (RIA) 2007-360, 2007 RIA TC
Memo 2007-360

END OF DOCUMENT

08-1143-ag(L)

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