US District Judge Donovan Frank of the District Court for the District of Minnesota asserted that the corporation has an insurable interest in the life of those employees and, therefore, can be the named beneficiary on the policies.
According to Frank, the corporation was the named beneficiary on the COLIs that were established to solve funding problems on death benefits the corporation offered to its employees. Frank said the corporation had a reasonable right to expect pecuniary gain from the continuing of the employees’ lives or fear from the loss of their death.
However, Frank said a factual dispute existed as to whether the COLIs had a practical nontax effect to entitle the company to a tax deduction on the loan interest that it received on loans from the COLIs. The court said expert discovery needed to be conducted to determine if the COLIs were shams.
According to the opinion, Xcel Energy Inc.’s predecessor Public Service Co. of Colorado (PSCo) established in the early 1980s a group life insurance program for its employees that allowed a death benefit equal to three times the employee’s salary if the employee died while working for PSCo, and for retired employees a benefit equal to one and one half times the employee’s salary at the time of retirement. PSCo realized that its liability to its employees under these plans was greater than it could pay for and that it had to come up with a different solution to fund the potential benefits, the court said.
PSCo identified the employees that were most likely to receive the benefits and purchased 2,435 COLIs on the employees. PSCo was the named beneficiary on the policies. PSCo informed its employees of the purpose of the plan and the employees agreed to the plan, the court said. PSCo paid premiums to Provident Life and Accident Co. for the policies and then transferred the policies to its subsidiary, PSR Investments Inc. (PSRI).
On its 1993 and 1994 federal income tax returns, PSCo deducted the policy loan interest expense. The Internal Revenue Service (IRS) disallowed the deductions as a sham transaction, the court said. The government argued that Xcel had no insurable interest in the lives of its employees and thus it was not entitled to the tax deduction.
Noting that Colorado law governed the question of whether Xcel had an insurable interest in its employees, the court said the Colorado Court of Appeals defined interest to exist when the personal relations between parties resulted in one party having a reasonable right to expect some pecuniary advantage from the continuance of the other’s life or fear of loss from the other’s death.
The opinion in Xcel Energy Inc. v. U.S., D. Minn., No. 04-1449 (DWF/FLN), 10/12/05 is here .