John J. Machacek, Jr.; Marianne Machacek, Petitioners-Appellants,
Commissioner of Internal Revenue, Respondent-Appellee.
Argued: December 5, 2017
from the United States Tax Court. No. 12701-11-David Laro,
L. Richshafer, WOOD & LAMPING LLP, Cincinnati, Ohio, for
S. Moriarty, UNITED STATES DEPARTMENT OF JUSTICE, Washington,
D.C., for Appellee.
L. Richshafer, Jeffrey R. Teeters, WOOD & LAMPING LLP,
Cincinnati, Ohio, for Appellants.
S. Moriarty, Michael J. Haungs, UNITED STATES DEPARTMENT OF
JUSTICE, Washington, D.C., for Appellee.
Before: BATCHELDER, GRIFFIN, and WHITE, Circuit Judges.
N. WHITE, CIRCUIT JUDGE.
John J. Machacek, Jr. (John Machacek) and Marianne Machacek
(together, the Machaceks), a married couple, were the sole
shareholders of John J. Machacek, Jr., Inc. (Machacek, Inc.),
a corporation organized under Subchapter S of the Internal
Revenue Code (an S corporation). John Machacek was also an
employee of Machacek, Inc. The Machaceks appeal the Tax
Court's ruling requiring them to treat as income the
economic benefits resulting from Machacek, Inc.'s payment
of a premium on John Machacek's life insurance policy
under a compensatory split-dollar arrangement. Relying on the
compensatory nature of the arrangement, the Tax Court
rejected the Machaceks' argument that the economic
benefits should be treated as a shareholder distribution.
the Tax Court did not consider the impact of a provision of
the tax regulations specifically requiring that such economic
benefits be treated as shareholder distributions, we reverse
the Tax Court's decision and remand for further
proceedings consistent with this opinion.
2002, Machacek, Inc. adopted the Sterling Benefit Plan in
order to provide certain benefits to its employees. Pursuant
to the plan, Machacek, Inc. provided John Machacek with a
life insurance policy and paid the $100, 000 annual premium
in the 2005 tax year; both Machacek, Inc. and the Machaceks
filed timely tax returns for that year. Because Machacek,
Inc. is an S corporation, its income, losses, deductions, and
credits are "passed through" to shareholders for
tax purposes. Machacek Inc. deducted the $100, 000 premium,
and that amount was thus not included in the Machaceks'
individual income. The Machaceks also did not include as
individual income the economic benefits flowing from the
increase in value of the life insurance policy.
Court determined that Machacek, Inc. was not entitled to
deduct the $100, 000 premium payment. Because the $100, 000
premium payment was not deductible, Machacek, Inc.
underreported its income for that year and, due to the
pass-through nature of S corporations, the increased income
was passed through to the Machaceks, who were then required
to pay income tax on that amount. The non-deductibility of
the premium payment is not disputed, and the Machaceks
concede that they must report the amount of the premium
payment as pass-through income.
dispute here concerns the tax treatment of the economic
benefits flowing to John Machacek as a result of Machacek,
Inc.'s payment of the premium. The parties dispute
whether the Machaceks are required to report as taxable
income-in addition to the pass-through amount of the
premium-the economic benefits flowing from the increase in
value of the life insurance policy caused by the payment of
Court ruled against the Machaceks and found that they were
required to account for the economic benefits in their
Machacek, Inc.'s deduction, when disallowed in 2005,
increased the S corporation's gross income, which
additional income was then passed on to petitioners as the
shareholders of Machacek, Inc. However, Mr. Machacek, in
addition to being a shareholder of the corporation, was also
one of its employees. And in 2006, when the previously
unreported and untaxed portion of the accumulation value of
his policy was determined, the value of the $100, 000
contribution by Machacek, Inc., was properly attributed to
Mr. Machacek as an employee of the S corporation and a
non-owner of the life insurance contract. While this result
may seem aberrational in view of the pass-through treatment
generally afforded to S corporations, it is a result mandated
by the split-dollar life insurance regulations . . . . In
instances other than those governed by the split-dollar life
insurance regulations, the general rule of the non-taxability
of previously taxed S corporation income is unperturbed.
(R. 73 at 6.)
dispute turns on the interplay of the split-dollar life
insurance regulations and Subchapter S.