U.S. v.
DRESCHER DOCTRINE: The value of the employer-purchased annuities contract is taxable as part of the taxpayer's gross income in the year in which the annuities were purchased. FACTS: Drescher was an employee of Bausch and Lomb Optical Company (B&L) who was given a voluntary retirement before he reached 65, He was given a non-transferrable annuity in 1939 and 1940 that would begin to pay him when he reached 65 in 1958 or his designated beneficiary if he died. Each policy was issued by Connecticut General Life Insurance Company and was delivered to the Optical Company which retained possession of it. B&L will be in possession of the contract until Mr. Drescher reached 65. The premium paid for each policy was $5,000. The amount of such payment was deducted by the Company in its tax return for the year of payment as part of the compensation paid to Mr. Drescher during that year. His salary as an officer was not reduced because of the purchase of the annuity contract. The policy had no cash surrender value. It only guaranteed a future stream of income for Mr. Drescher or his beneficiary. In filing income tax returns Mr. Drescher reported on the cash basis; the B&L on the accrual basis. Here comes the IRS telling Mr. Drescher that the 5k annuity contract should be a part of his income for the year 1939 and 1940. IRS argued that the contracts are taxable to the annuitant (Mr. Drescher) in the year of purchase by the employer because 22(a), 26 U.S.C.A., sweeps into gross income "compensation for personal service, of whatever kind and in whatever form paid, xxx and income derived from any source whatever." On the other hand, Mr. Drescher cited Treasury rulings to the effect that retirement annuity contracts purchased for an employee gave rise to taxable income only as the annuitant received payments under the contract (so meaning Mr. D could only be taxed once he received the payments); and that the entire amount of each annuity payment was includible in gross income for the year of its receipt if he had made no contribution toward the purchase of the annuity, while, if he had made contributions, he was taxable by 3%. Drescher argues that the annuity is worth nothing to him for the years given by the B&L. The IRS argues that it is worth $5,000. ISSUE: What is the includable income value of the annuity in the tax year 1939 and 1940? Is it the price of the premium paid by B&L (5K) or is it zero because the annuity gives the taxpayer no present income? RULING: The govt won. The value of the annuity contract is equal to the cost to the taxpayer of acquiring identical rights. The court reasoned that the value should lie somewhere between the premium price and zero. Even though Mr. Drescher might die before the annuity started paying, he had some present rights to a future income stream w/ he could designate to a beneficiary. Furthermore, Mr. Drescher could realize present cash payment from a 3 rd party who he could designate as a trustee to hold the future payments in trust for him. However, this would probably worth less than the premium paid by the company based on the risk of Mr. Drescher dying before the annuity began paying and thus the payments going to the beneficiary (meaning: B&L retained the annuity and Mr. D would have to go through hoops to get it early (before retirement). This alone makes it worth less to him than what the B&L paid for it.) The burden of proof was on Mr. Drescher to show that the present value was less than 5k. The case was remanded for the determination of tax. Dissent: Dissenters reasoned that the value of tax was the amount paid by B&L because it represented the present value of the future payments, and was it was the consideration for the contract between Mr. D and B&L. The dollar amount of the policy premium represented what
the market expected the present value of the aggregate payments over Mr. Ds life to be, w/c was greater than 5k. Note: Annuities are amounts received (other than amounts paid by reason of the death of the insured and interest payments on such amounts and other than amounts received as annuities) under a life insurance or endowment contract, but if such amounts (when added to amounts received before the taxable year under such contract) exceed the aggregate premiums or consideration paid (whether or not paid during the taxable year) then the excess shall be included in gross income. In a way, Annuity is some sort of a deferred compensation. Mr. D insists that he should only be taxed after he receives the payments? His tax rate may be lower (marginal rate) when he gets to the payment phase (he may have retired) - additionally, the time value of money. As a result of the govt victory, Mr. D would be required to pay taxes currently on the present value of the policy (5k) plus future taxes on any payments greater than 5k if he lived long enough. Mr. D would have gotten the same value in present terms if B&L had given him a cash bonus large enough so that after the payment of taxes, he would be left with still a 5k bonus.
