FLORENCE Y. BARNES, PETITIONER V. UNITED STATES OF AMERICA No. 86-925 In the Supreme Court of the United States October Term, 1986 On Petition for a Writ of Certiorari to the United States Court of Appeals for the Seventh Circuit Memorandum for the United States in Opposition Petitioner contends that payments she received as survivor benefits from her deceased husband's employer constituted life insurance proceeds, and hence that those payments are excludable from income under Section 101(a)(1) of the Internal Revenue Code. /1/ This contention was correctly rejected by the court of appeals, and there is no basis for review by this Court. 1. a. Petitioner is the widow of an employee of the University of Illinois who died on August 23, 1970. At the time of his death, petitioner's husband was a participant in the Illinois State Universities Retirement System, which provides retirement, disability, and death and survivor benefits to employees and their families. See Ill. Rev. Stat. ch. 108 1/2, art. 15 (1979) (reprinted in part at Pet. App. 29-79). Both the retirement and survivor benefits are financed by a combination of employee and employer contributions. Pet. App. 1-2. The Illinois statute designates certain beneficiaries who are eligible to receive survivor benefits under the plan upon the death of a participating employee (Section 15-143; see Pet. App. 2, 43-47). /2/ If none of those designated beneficiaries is alive on the date of the employee's death, a refund of the employee's contributions plus interest is made to his estate (Sections 15-141, 15-142; see Pet. App. 4, 39-40). The survivor benefits consist of an initial $1,000 lump sum payment upon death, followed by periodic payments based on a percentage of the average of the deceased employee's final five years' salary. The survivor benefits may be reduced if the employee was already receiving a retirement annuity prior to his death (Sections 15-145, 15-146; see Pet. App. 43-47). The survivor benefits may also be reduced or forfeited entirely under certain circumstances, and they may affect the amount of other benefits payable under the plan (Sections 15-145, 15-147; see Pet. App. 4, 43-47). /3/ b. After her husband's death, petitioner began receiving $250 each month in survivor benefits pursuant to the Illinois plan. On her 1978 and 1979 tax returns, petitioner excluded these amounts from her gross income on the theory that they were "life insurance" proceeds excludable under I.R.C. Section 101(a)(1). Upon examination of her returns, the Commissioner determined that these amounts were not paid under a life insurance contract and hence represented taxable income to her. The Commissioner assessed deficiencies against petitioner in the amounts of $716 for 1978 and $743 for 1979. Petitioner paid the deficiencies and filed administrative claims for refund, which were denied. Pet. App. 2. Petitioner then brought this refund suit in the United States District Court for the Central District of Illinois. The district court granted summary judgment for petitioner (Pet. App. 7-18). The court held that the plan pursuant to which the survivor benefits were paid had the requisite elements of "risk shifting and risk distribution" (id. at 13) essential to a life insurance contract. c. The court of appeals unanimously reversed, holding that the survivor benefit plan did not qualify as a life insurance contract for purposes of I.R.C. Section 101(a)(1) (Pet. App. 1-6; 801 F.2d 984). The court began with the well-settled proposition that the "(f)undamental characteristics of life insurance are risk shifting and risk distribution" (Pet. App. 3 (citing cases)). The court then explained that the Illinois survivor benefits plan neither shifted the risk from insured to insurer, nor distributed the risk among the plan's participants, because survivor benefits were not paid in all events upon the insured's death. Rather, in a variety of circumstances, the insured's contributions were simply refunded, leaving the risk of loss (death) with the insured or his estate. By virtue of this refundability feature, the court concluded, the insured's premiums were not "irrevocably committed" to the plan; the risk of loss was not irrevocably shifted to the insurer; and the risk of loss was not distributed among the insureds as a group. Pet. App. 3, 5-6. Pointing to the restrictions placed on the right to receive survivor benefits and the interrelationship between those benefits and the retirement benefits under the plan, the court found that the survivor benefits were simply one element in an integrated pension program (id. at 4). It thus concluded that the benefits were not received "under a life insurance contract" and hence could be not excluded from petitioner's income under Section 101(a)(1). 2. The court of appeals correctly rejected petitioner's contention that her survivor benefits were excludable from gross income. Section 101(a)(1) of the Code states the general rule that "amounts received * * * under a life insurance contract" are excludable from gross income if paid by reason of the insured's death. Hence, petitioner's contention rests on the assertion that the Illinois survivor benefits plan is a "a life insurance contract." 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 return for the payment of premiums. See Central Bank v. Hume, 128 U.S. 195, 205 (1888). It is generally recognized that the identifying characteristics of a life insurance contract include (1) shifting the risk of economic loss caused by the premature death of the insured from his beneficiaries to the insurance program and (2) distributing that risk of economic loss among the program's participants. See Helvering v. Le Gierse, 312 U.S. 531, 539 (1941). As the court of appeals held, the feature of the Illinois survivor benefits plan that provides for refunding of contributions is inconsistent with the risk-shifting requirement of a true life insurance contract. In a genuine life insurance arrangement, the insured parts with a specified sum of money (typically, periodic premiums) in exchange for the insurer's agreement to pay a specified sum of money in the event of his death. In this way, the risk of loss (death) is, economically speaking, shifted to the insurer from the insured. Because the insured commits his premium payments to the insurance plan, "the insured and insurer are each betting on the (former's) longevity" (Pet. App. 3). If the insured has a long life, his estate may well end up with less money by way of insurance proceeds than the insured paid by way of premiums during his lifetime. Under the Illinois plan, by contrast, the participant does not commit his contributions to the program. Even if he or his survivors fail to qualify for benefits, he or his beneficiaries are assured of a refund of the amount he has paid into the fund, together with interest. Accordingly, the employee has not placed a "bet" on his longevity, since he realizes no adverse economic consequences in the event that he has a long life. See Edgar v. Commissioner, 39 T.C.M. (CCH) 816, 822 (1979). Moreover, the employee continues to bear the risk of loss from his death in those situations where there are no statutorily-designated beneficiaries at the time of his death, so that his contributions are refunded. In those circumstances, the risk of death is not shifted to the insurer, but rather rests where it started -- with the insured and his estate. /4/ The plan at issue here also differs from the prototype life insurance contract because the survivor benefits are not fixed sums payable at all events. Rather, the survivor benefits are payable only to a restricted class of beneficiaries: dependent spouses, dependent minor children or dependent parents. And even if qualified beneficiaries exist when the employee dies, the survivor benefits may cease if the circumstances of the beneficiaries change to eliminate their dependency. Unlike typical life insurance payments, the level of survivor payments is not fixed; it is based among other things on a percentage of the deceased employee's final five years' salary. The amount of the benefit payment can also vary depending on whether the employee was receiving a retirement annuity when he died and on whether the designated beneficiaries are already receiving survivor benefits due to the death of another employee covered by this plan. In short, the plan is not a life insurance plan. Rather, in keying the survivor benefits to the employee's salary and the beneficiaries' need, the plan is much more akin to an integrated pension plan composed of interrelated retirement, death and survivor benefits. See Lilly v. Commissioner, 45 T.C. 168, 173 (1965). /5/ 3. Petitioner's contention (Pet. 26-29) that the decision below conflicts with Ross v. Odom, 401 F.2d 464 (5th Cir. 1968), is without merit. Ross involved death benefits received under a plan set up to benefit Georgia state employees, but the provisions of that plan were considerably different from those of the Illinois plan at issue here. Notably, the Georgia plan, like a typical life insurance policy, guaranteed immediate payment of a particular sum either to the estate or to designated beneficiaries upon the death of the employee. And the death benefit plan for Georgia employees was independent of the state's parallel retirement program. Under the Illinois plan, by contrast, the death benefit is not fixed and is not paid at all events. If there are no surviving statutorily-designated beneficiaries, the survivor benefits are not paid and instead the employee's contributions are refunded to his estate. The benefits are reduced if the employee was receiving a retirement annuity at the time of his death, and the benefits terminate altogether if the beneficiary loses dependency status or becomes eligible for another larger survivor benefit. Finally, benefits under the Illinois plan may not commence immediately -- for example, if a widow has not reached age 55 and has no dependent children. There are thus several characteristics of the instant survivor benefit plan that distinguish it from Ross and demonstrate that the Illinois plan is not "life insurance." The lower courts have recognized that the decision in Ross turned on the particular provisions at issue there and have not hesitated to distinguish that case when considering other death benefit cases. See Davis v. United States, 323 F. Supp. 858, 862 (S.D. W.Va. 1971) ("Absent a definite benefit payable in any event upon the death of the employee, there is no shifting of risks, and, therefore, no insurance."); Edgar v. Commissioner, 39 T.C.M. (CCH) at 822. Hence, there is no conflict between Ross and the decision below that requires resolution by this Court. /6/ 4. Finally, the issue presented here does not appear to have much importance at this time. The Internal Revenue Service informs us that all cases currently pending on this issue, either in the courts or administratively, involve taxpayers receiving benefits under the same Illinois plan involved in this case. Presumably, these cases will be governed by the Seventh Circuit's decision in this case, and there is no need for review by this Court. In addition, Section 7702 of the Code, added in 1984 (Deficit Reduction Act of 1984, Pub. L. No. 98-369, Section 221, 98 Stat. 767), contains a detailed definition of "life insurance contract," which clearly excludes the survivor benefit plan at issue here. Thus, the question presented in this case has been resolved by Congress prospectively, for contracts issued after December 31, 1984. It is therefore respectfully submitted that the petition for a writ of certiorari should be denied. CHARLES FRIED Solicitor General MARCH 1987 /1/ Unless otherwise noted, all statutory references are to the Internal Revenue Code (26 U.S.C.), as amended (the Code or I.R.C.). /2/ Those beneficiaries include the employee's dependent unmarried children under age 18, the employee's dependent parents, and the employee's widow or dependent widower when he or she either attains age 55 or is charged with the care of the deceased employee's dependent unmarried children. See Pet. App. 4, 43-47. /3/ The survivor benefits received by a surviving spouse may be forfeited entirely upon his or her remarriage, or upon the death of the dependent children. Benefits received by dependent parents or children terminate if they cease to be "dependent." And if a beneficiary is receiving other survivor benefits on behalf of another deceased participant of the plan, the beneficiary must forfeit the smaller benefit. /4/ Petitioner's assertion (Pet. 35-36) that the risk-shifting requirement is satisfied because the employer's contributions are not refundable is quite flawed. As the court of appeals explained (Pet. App. 5), the employer is required to fund the plan for all of its employees. If an employee's participation in the plan ends for some reason, the funds contributed by the employer on the employee's behalf are not lost, but are simply "redirected" to fund the benefits of other employees (ibid.). /5/ Petitioner's reliance (Pet. 42-43) on Estate of Connelly v. United States, 551 F.2d 545 (3d Cir. 1977), a case involving the exclusion from the gross estate of certain life insurance proceeds pursuant to I.R.C. Section 2042(2), is misplaced. As the court of appeals explained below (Pet. App. 5 n.2) the plan at issue in Connelly was a group term life insurance policy whose benefits were payable only to specified beneficiaries, and the court held that those payments could be excluded from the gross estate. That holding has no bearing on this case, for this case is distinguishable from Connelly on several grounds. The payments in Connelly were fixed sums determined by the life insurance plan, and the premiums were forfeited if no benefits were paid. Here, the benefits are keyed to the employee's salary and other need factors, the employee contributions are refundable, and the benefits cease if the beneficiary's dependency status changes. Indeed, it does not even appear to have been disputed in Connelly that the proceeds were from a "life insurance contract"; rather, the dispute there centered on whether the decedent had "incident(s) of ownership" in the life insurance policy within the meaning of Section 2042(2). See 551 F.2d at 548. /6/ Petitioner errs (Pet. 41-42) in citing Commissioner v. Estate of Noel, 380 U.S. 678 (1965), to support the proposition that benefits need not be payable in all events. That case involved a flight insurance policy, which basically represented term life insurance with the "term" being confined to the duration of the plane flight. The risk being insured against was loss of life during the plane flight. For a small, nonrefundable premium, the insured received a guarantee that, upon his death in an airplane crash, his beneficiaries or estate would receive a fixed sum considerably larger than the premium. That is a classic life insurance contract and far different from the situation presented here, where the participant's loss of life is not guaranteed to trigger payment of the survivor benefit.