Appeal from the United States District Court for the Central District of Illinois, Danville Division. No. 84 C 2060- Harold A. Banker, Chief Judge.
Before CUMMINGS, Chief Judge, BAUER and CUDAHY, Circuit Judges.
This issue in this case is whether certain benefits received by the plaintiff were paid pursuant to a life insurance contract and are thus excluded from income under 26 U.S.C. § 101(a)(1). Because we determine that there was no life insurance contract, we reverse the district court's judgment for plaintiff.
Plaintiff, Florence Barnes, is the widow of an employee of the University of Illinois Urbana-Champaign campus) who died on August 23, 1970. At the date of his death, plaintiff's husband was subject to the provisions of the State Universities Retirement System, set forth in Ill. Rev. Stat. ch. 108 1/2, art. 15 (1979). The Retirement System provides both retirement and disability benefits to employees and their families. The Survivors Insurance Benefit was added to the Retirement System in 1959. 1959 Ill. Laws 1009 (codified at Ill. Rev. Stat. ch. 108 1/2, § 15-145 to 148). Both the retirement and insurance plans are financed by a combination of employee and employer contributions.
After her husband, died, plaintiff began receiving $3,000 per year (in month installments of $250) in survivors insurance benefits. Plaintiff excluded this amount from her taxable income pursuant to 26 U.S.C. § 101(a)(1) and (d). Upon audit the Internal Revenue Service (IRS) assessed deficiencies for the years 1978 and 1979, asserting that the payments constituted a "pension/annuity" taxable under 26 U.S.C. § 61. The plaintiff was assessed for tax deficiencies in those years for $716 and $743, respectively. She paid the deficiencies, filed claims for refund, and upon disallowance of her claims brought this suit for refund.
The district court granted Barnes' motion for summary judgment. Defendant appeals. We must decide whether the plaintiff's insurance program constitutes a life insurance contract for purposes of 26 U.S.C. § 101(a)(1), which allows an unlimited exemption from gross income for life insurance proceeds, if paid by reason of the insured's death.*fn1
Except as otherwise provided . . . gross income does not include amounts received (whether in single sum or otherwise) under a life insurance contract, if such amounts are paid by reason of the death of the insured.
The traditional definition of a life insurance contract is an agreement to pay a certain sum of money upon the death of the insured in consideration of the payment of premiums. Central Bank of Washington v. Hume, 128 U.S. 195, 205, 32 L. Ed. 370, 9 S. Ct. 41. Fundamental characteristics of life insurance are risk shifting and risk distribution. Helvering v. Le Gierse, 312 U.S. 531, 539, 85 L. Ed. 996, 61 S. Ct. 646 ; Ross v. Odom, 401 F.2d 464, (5th Cir. 1968). Risk shifting is transferring the risk of loss caused by premature death from the insured and his or her beneficiaries to the insurer. Risk distribution is spreading the risk of this economic loss among the participants in the insurance program. Thus a life insurance contract pays out of a common fund upon an individual's death regardless of whether the amount is more or less than the decedent paid into the fund. Ross v. Odom, 401 F.2d 464, 467 (5th Cir. 1968). Although there are variations on this theme, the common life insurance contract pays the insured's estate or beneficiaries a definite sum of money upon the death of the insured from a particular peril or from any peril. See Couch on Insurance § 1.73 (Rev. 2d ed.)
Simply put, the insured and insurer are each betting on the longevity of the insured. The risk to the insurer is that death will come before the value of premiums paid exceeds the death benefit. The insured risks that the value of his or her payments will surpass the promised payment before death. If the contract operates to insure a risk-free system for either party, it is not a life insurance contract. Helvering v. Le Gierse, 312 U.S. 531, 85 L. Ed. 996, 61 S. Ct. 646 ; Edgar v. Commissioner, 1979 T.C. Memo 524, 39 T.C.M. (CCH) 816, 822 (1979).
Our analysis of the survivors insurance benefits program provided by the state discloses three important factors. The first critical factor is the refundability of contributions. According to the survivors insurance plan, contributions made by the insured will never be forfeited. If the employee is terminated or retires, his or her contributions are refundable. The same is true if the employee dies leaving no statutorily qualified beneficiaries. Similarly, in some circumstances under the retirement and death benefit programs contributions are returned to the insured or beneficiary. For the employee-insured the premium payments into the fund are not irrevocably committed. Under this arrangement, the insured takes no risk of death since the insured is entitled to the return of at least the amount of contributions (plus interest) in any event. See Edgar v. Commissioner, T.C. Memo 1979-524, 39 T.C.M. (CCH) 816, 822 (1979).
The second factor is the interrelationship between the retirement, disability, death benefit, and the survivors insurance programs. The amount of the benefits under both the retirement plan and the death benefit programs depend in part on whether survivors insurance benefits are also payable. See, e.g., §§ 15-141, 15-142. Additionally, although payments are made separately, contributions to the programs are pooled for investment purposes. This interdependence among the types of programs supports the notion that it is in reality one integrated program of which the survivors insurance benefits provides a survivorship element for the retirement program. See Lilly v. Commissioner, 45 T.C. 168, 173 (1965).
The third factor to be considered is the number and type of restrictions placed on the right to receive benefits under the survivors insurance program. Benefits are payable only to a restricted class of beneficiaries: a dependent spouse, dependent children, or dependent parents. For example, a surviving spouse must be either over 55 or still caring for dependent children. Benefit payments their stop if the surviving spouse remarries if the children lose their dependency status, and may also stop if any of them dies. Furthermore, if the beneficiary is already receiving survivors insurance benefits when a second covered employee dies, he or she is entitled only to the larger of the two benefits. And, as noted earlier, if the employee dies leaving no qualified beneficiaries, his or her estate received only the amount of past contributions and no death benefits. Whatever the characterization of this plan, it does not provides for benefit payments immediately upon the death of the insured. Cf. Ross v. Odom, 401 F.2d 464 (5th Cir. 1968). Rather, it is obviously designed to assist certain surviving dependents only while they ...