year (term) life insurance on his or her life.

Premiums on the underlying insurance policies were substantially greater than the cost of term life insurance because they funded both the cost of term life insurance and credits which would be applied to conversion universal life policies of the individual insureds. The credits applied to a conversion policy were “earned” on that policy evenly over 120 months, meaning that policyholders generally could withdraw any earned amount or borrow against it with no out-ofpocket expense. Held : The corporate employer/participants (N and L) may not deduct contributions to their plans in excess of the cost of term life insurance .

Held

, further , L may deduct payments made outside its plan for life insurance on two of its employees to the extent the payments funded term life insurance. Held , further , neither M, a sole proprietorship/participant, nor N may deduct contributions to its plan to purchase life insurance for certain nonemployees.

Held

, further , sec. 264(a)(1), I.R.C., precludes M from deducting contributions to its plan to purchase life insurance for its two employees.

Held

, further , in the case of N and L, the disallowed deductions are constructive dividends to their employee/owners.

Held

, further , Ps are liable for the accuracyrelated penalties for negligence or intentional disregard of rules or regulations determined by R under sec. 6662(a), I.R.C.; L also is liable for the addition to tax for failure to file timely determined by R under sec. 6651(a), I.R.C.

Held

, further , no P is liable for a penalty under sec. 6673(a)(1)(B), I.R.C.

Neil L. Prupis

, Kevin L. Smith , and Theresa Borzelli , for petitioners.

Randall P. Andreozzi

, Peter J. Gavagan , Mark A. Ericson , and Matthew I. Root , for respondent.

The third test case involves an individual working as a sole proprietor and two of his employees. This group is the Wan B. Lo, Ph.D., D.O., d.b.a. Marlton Pain Control and Acupuncture Respondent determined that each petitioner was liable for deficiencies in Federal income tax as a result of the VEBA determinations and that each petitioner was liable for a related accuracy-related penalty under section 6662(a) for negligence or intentional disregard of rules or regulations. In the case of Lakewood, respondent also determined that it was liable for a 15percent addition to tax under section 6651(a) for failure to file timely its 1992 Federal income tax return and a section 6621 increased rate of interest on its 1991 deficiency as to interest accruing after July 20, 1995.

Each petitioner petitioned the Court to redetermine respondent’s determinations. Respondent’s notices of deficiency Akhilesh S. and Dipti A. Desai, docket No. 2981-97 Addition to Tax Accuracy-Related Penalty Year Deficiency Sec. 6651(a)(1)

Sec. 6662(a)

1991 $42,047 — $8,409 1992 15,751 — 3,150 1993 25,016 — 5,003 Kevin T. and Cheryl McManus, docket No. 2985-97 Addition to Tax Accuracy-Related Penalty Year Deficiency Sec. 6651(a)(1)

Sec. 6662(a)

1991 $6,821 — $1,364 1992 6,146 — 1,229 1993 8,214 — 1,643 Arthur and Lois M. Hirshkowitz, docket No. 2994-97 Addition to Tax Accuracy-Related Penalty Year Deficiency Sec. 6651(a)(1)

Sec. 6662(a)

1991 $82,933 — $16,587 1992 45,233 — 9,047 1993 79,853 — 15,971 Marlton Group Wan B. and Cecilia T. Lo, docket No. 4572-97 Addition to Tax Accuracy-Related Penalty Year Deficiency Sec. 6651(a)(1)

Sec. 6662(a)

1993 $41,807 — $8,361 1994 49,970 — 9,994 We decide the following issues:

1. Whether Neonatology and Lakewood may deduct contributions to their respective plans in excess of the amounts needed to purchase current-year (term) life insurance for their covered employees. We hold they may not.

2. Whether Lakewood may deduct payments made outside of its plan to purchase additional life insurance for two of its 8. Whether Lakewood is liable for the addition to tax for failure to file timely determined by respondent under section 6651(a). We hold it is.

9. Whether we should grant respondent’s motion to impose a

$25,000 penalty against each petitioner under section 6673(a)(1)(B). We hold we shall not.

Unless otherwise indicated, section references are to the

Internal Revenue Code applicable to the relevant years, Rule references are to the Tax Court Rules of Practice and Procedure, and dollar amounts are rounded to the dollar.

FINDINGS OF FACT

I. Overview of Petitioners

Neonatology is a professional medical corporation wholly owned by Ophelia J. Mall, M.D. (Dr. Mall). Its principal place of business was in New Jersey when we filed its petition. Dr. Mall and her husband, Mr. Mall (collectively, the Malls), resided in New Jersey when we filed their petition.

Neonatology reports its income and expenses for Federal income tax purposes using the cash receipts and disbursements method and the calendar year. It reported the following relevant amounts on its 1992 and 1993 Federal corporate income tax returns:

1993 10/1991 12/1991 1992 (As amended)

Total income $2,303,425 $403,869 $2,411,265 $2,286,460

Officers’ compensation 987,554 350,000 1,171,931 940,895

Salaries & wages 148,750 29,167 200,565 303,750

Pension, profit-sharing, plans 46,907 25,000 132,428 169,170

Employee benefit programs -0- -0- -0- -0-Other deductions (VEBA contribution) 480,901 -0- 209,869 296,056 Taxable income (loss) 3,664 (103,857) (23,325) (7,796) Income tax 1,246 -0- -0- -0-Alt. minimum tax -0- -0- -0- 20,531 It filed its 1992 Federal corporate income tax return untimely on May 28, 1993.

Marlton is a sole proprietorship owned by Wan B. Lo (Dr. Lo), and he reports Marlton’s income and expenses on his personal Schedule C, Profit or Loss from Sole-Proprietor Business, using the cash receipts and disbursements method and the calendar year. Dr. Lo reported the following amounts for Marlton on Schedules C of his joint 1993 and 1994 Federal individual income tax returns: 1993 1994 Gross income $875,477 $868,275 Wages 130,944 124,939 Pension, profit-sharing, plans 16,920 17,396 Employee benefit programs 100,000 120,000 Net profit 406,863 381,122 Dr. Lo and his wife, Cecilia (Ms. Lo) (collectively, the Los), resided in New Jersey when we filed their petition. II. The Subject VEBA’s Pacific Executive Services (PES) was a California partnership formed by two insurancemen named Stephen R. Ross (Mr.

Medical Profession Association, respectively. PES established, manages, and controls both of these associations, neither of which is a valid or operating professional association. PES established both associations for the sole purpose of forming the subject VEBA’s and of furthering its VEBA scheme by misleading targeted investor/medical professionals into believing that respectable, established medical associations were sponsoring an investment in the VEBA’s. PES named the VEBA’s after the medical profession to attempt further to legitimize its sale of the advertised tax benefits with the targeted investors. PES paid an established medical society, the Medical Society of New Jersey, a voluntary society of physicians and surgeons operating in the State of New Jersey, approximately $25,000 to endorse the SC VEBA as a final attempt to legitimize its scheme. PES represented to the Medical Society of New Jersey that the SC VEBA provided medical professionals with tax-deductible payments for high policy limits of life insurance and the potential to convert some or all of those payments into annuities or cash value life insurance which would allow the policyholders ultimately to withdraw that cash value tax free.

The subject VEBA’s are structured so that each participating employer establishes its own plan thereunder, executes its own plan document, and has a plan name that bears its own name. Each employer, with the aid of an insurance salesman (primarily Mr.

written notice of termination to the trustee. When an employer terminates its plan, assets remaining in that plan are distributed to the employer’s covered employees in proportion to their compensation.

Independent entities serve as trustees of the respective trusts underlying the subject VEBA’s, and each trust’s terms are the same except for the sponsor’s name. Under the trusts’ terms, each participating employer agrees to make the contributions required by the administrator to provide benefits under the plan, and neither the participating employer nor another employer is liable for a participating employer’s contributions. Any benefits payable under one plan are paid solely from that plan’s allocable share of the trust fund, and neither the participating employer, administrator, nor trustee is liable for the inadequacy of funds required to be paid. Each plan and corresponding trust account benefit exclusively the related employer’s covered employees and their beneficiaries, and no part of that trust account may be used for, or diverted to, purposes other than the exclusive benefit of those employees.

III. The Insurance Companies

The Inter-American Insurance Co. of Illinois (InterAmerican) specializes in providing to small, closely held corporations products such as qualified pension and profit sharing plans and group life insurance plans. When Inter-American was formed in the late 1970’s, it was owned indirectly by Beaven/Inter-American Cos., Inc. (Beaven/Inter-American), the wholly owned company of Raymond G. Ankner (Mr. Ankner), who has worked in the insurance industry for more than 30 years. InterAmerican liquidated on December 23, 1991, pursuant to a court order to do so, and Beaven/Inter-American changed its name to Beaven Cos., Inc. Mr. Ankner currently markets the life insurance products described herein through a company of his called CJA & Associates.

Capital Holding Agency Group, Inc. (Capital Holding), underwrites life and health insurance, annuities, and other insurance products offered for sale through certain of its affiliated insurance companies; e.g., Commonwealth Life Insurance Co. (Commonwealth) and Peoples Security Life Insurance Co. (Peoples Security, sometimes referred collectively with Commonwealth as Commonwealth). Capital Holding changed its name to Providian Agency Group, Inc., in 1994, and 3 years later, AEGON NV acquired Providian Agency Group, Inc., Commonwealth, and Peoples Security. Commonwealth and Peoples Security merged with the Monumental Life Insurance Co. in 1998, and all three companies are currently part of the AEGON USA Insurance Group (AEGON USA).

IV. The Life Insurance Products

Inter-American and Commonwealth both issue a virtually identical conventional group term life insurance product known as the millennium group 5 (MG-5) policy. Premiums on an MG-5 policy are generally commensurate with the life insurance risk assumed by the issuing company and do not present policyholders with asset accumulation. The MG-5 policies allow policyholders to convert their policies to 5-year level annual renewable term, universal or whole life products which do not have any accumulated value (or “conversion credits” as that term is described below).

Inter-American and Commonwealth both issue a second virtually identical innovative life insurance product known as the continuous group (C-group) product. The C-group product is a novel product designed by Inter-American (and later adopted by Commonwealth) to masquerade as a policy that provides only term life insurance benefits in order to make the product marketable to targeted investors and to allow Inter-American to make life insurance purchases from it more attractive than purchases from its larger competitors. The C-group product is actually a universal life product consisting of two related policies. The first policy, the accumulation phase of the C-group product, is a group term life insurance policy known as the C-group term policy. The second policy, the payout phase of the C-group product, is an individual universal life insurance policy known as the C-group conversion universalife (UL) policy. The C-group conversion UL policy is referenced in the C-group term contract and the C-group conversion UL contract as a “special conversion policy”.

The C-group term policy provides covered employees with a life insurance (death) benefit while they work and a cash value that they may access by converting the term policy to the C-group conversion UL policy. Commonwealth and Inter-American assumed that 95 percent of the C-group term policyholders would ultimately convert their policies to C-group conversion UL policies, and they priced both policies together as two components of a single policy. Premiums on the C-group term policy are paid annually, and these premiums are approximately four to six times greater than premiums for a conventional life insurance group term policy (e.g., the MG-5 policy); as discussed infra , premiums on the C-group term policy fund both preconversion death benefits and postconversion credits (conversion credits) anticipated to be applied to the C-group conversion UL policy. If a premium is not paid timely on the Cgroup term policy, the policy terminates; i.e., lapses. Upon its lapsing, an individual policyholder has a guaranteed right (i.e., without evidence of insurability) to convert his or her policy to an individual policy; e.g., the C-group conversion UL policy. A developed and used tables to reference the amount of conversion credits which would accumulate under the C-group term policy and be transferred to the C-group conversion UL policy upon conversion, and the table amounts were referenced in marketing materials provided to prospective customers; no C-group term policyholder who converted to a C-group conversion UL policy ever received anything less than the appropriate amount referenced in the tables. Upon conversion, the C-group conversion UL policy is generally fully funded, and C-group conversion UL policyholders need not pay additional premiums on the C-group conversion UL policy. A converting policyholder may, if he or she desires, pay additional premiums on the C-group conversion UL policy. None of the individual petitioners chose to do so.

Mr. Ankner designed the concept of conversion credits to allow the C-group term policy to operate in tandem with the Cgroup conversion UL policy, while preserving the appearance and argument that the two policies were separate and distinct. Conversion credits generally work as follows. With respect to each premium paid on the C-group term policy, the portion that exceeds the applicable mortality charge (cost of insurance) is set aside in a conversion credit account bearing interest at 4.5 percent per annum for transfer to the C-group conversion UL policy upon conversion thereto. Upon conversion, the conversion credits which have accumulated up to that time (conversion credit credited to the conversion credit balance at or about the end of each certificate year, and, to the extent that the interest on the funds reflected in the balance actually exceeds the credited amount, the excess is returned to the policyholder as an experience refund. The experience refund is credited to the policyholder as a reduction of the next premium due on the policy.

V. The Neonatology Plan

Mr. Cohen introduced Dr. Mall to the SC VEBA, and she decided on her own, without seeking the advice of an independent knowledgeable professional, to cause Neonatology to invest therein. Dr. Mall knew that term life insurance was substantially more expensive to buy through the SC VEBA than through other plans offered to her by the American Medical Association and the American Academy of Pediatrics. She believed that the SC VEBA was the best investment for Neonatology because it offered her the proffered tax benefits and accumulated value. Dr. Mall received correspondence on the SC VEBA but generally chose not to read it before investing in the SC VEBA. Neonatology established the Neonatology Plan under the SC VEBA on January 31, 1991, effective January 1, 1991, and the Malls were the only persons covered by that plan during the relevant years. Mr. Mall was not a paid employee of Neonatology, and he was not eligible to join the plan. Dr. Mall and PES, the plan administrator, allowed Mr. Mall to join the plan, and they made him eligible to receive a death benefit in an amount commensurate with the death benefit payable under other life insurance that he had owned outside the plan. Dr. Mall falsified and backdated documents in an attempt to legitimize Mr. Mall’s participation in the Neonatology Plan and to attempt to legitimize the plan with various governmental agencies and regulatory bodies.

The Neonatology Plan’s adoption agreement provides that all employees covered by the plan will receive a death benefit equal to 6.5 times his or her prior-year “compensation” (defined by the plan to exclude nontaxable fringe benefit items). Neonatology paid Dr. Mall compensation of $240,000, $250,000, and $168,000 during 1991, 1992, and 1993, respectively. Neonatology did not pay Mr. Mall any compensation during those years.

Neonatology contributed to the Neonatology Plan during each year from 1991 through 1993 and, for each subject year, claimed a deduction for those contributions and other related amounts. In 1991, Neonatology contributed $10,000 to the plan on behalf of Dr. Mall. It also paid the plan’s trustee and its administrator $1,000 each. In 1992, Neonatology contributed $10,000 to the plan on behalf of Dr. Mall and $10,000 on behalf of Mr. Mall. It deducted the $20,000 on its 1992 Federal corporate income tax return as an employee benefit program expense, and it deducted on transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year. This policy lapsed on March 15, 1992. 2. Dr. Mall’s Commonwealth C-Group Term Policy Effective March 15, 1992, Commonwealth issued a $650,000 Cgroup term policy (certificate No. 6007725) on the life of Dr. Mall, age 46. The first-year premium was $10,653.50, and the cost of insuring Dr. Mall for that year was $1,764.60. The Neonatology Plan paid the first-year premium, and, at the end of that year, the conversion credit balance was $9,288.90 ($10,653.50 - $1,764.60 + $400); the $400 is the interest of 4.5 percent earned on the conversion credit balance (($9,288.90 -$400) x 4.5% = $400)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the Cgroup term policy was in its first year. The second-year premium, before any experience refund, was $10,731.50. The policy was credited with an experience refund of $106.08, and the Neonatology Plan paid the net premium of $10,625.42 ($10,731.50 - $106.08). The cost of insuring Dr. Mall for the second year was $1,814.34, and, at the end of that year, the conversion credit balance was $19,025.33 ($9,288.90 + $10,731.50 - $1,814.34 + $819.27); the $819.27 is the interest of 4.5 percent earned on the conversion credit balance (($19,025.33 - $819.27) x 4.5% = $819.27)). Of the conversion credit balance, $9,037.03 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the Cgroup term policy was in its second year ($19,025.33 x 47.5%). The Neonatology Plan continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective October 15, 1996, Dr. Mall converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $71,102. At the time of conversion, the Cgroup term policy’s conversion credit balance was $46,508.32, and $44,182.90 of that amount ($46,508.32 x 95%) was transferred to the C-group conversion UL policy for potential earning. Dr. Mall will earn these credits in 120 equal monthly installments, beginning October 1996. The conversion credit balance of $46,508.32 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before February 1, 1993, (2) female, (3) issue age 46, (4) duration of 4 years 7 months, and (5) $650,000 death benefit.

3. Mr. Mall’s Commonwealth C-Group Term Policy

Effective March 15, 1992, Commonwealth issued a $500,000 Cgroup term policy (certificate No. 6010423) on the life of Mr. Mall, age 47. The first-year premium was $10,290, and the cost of insuring Mr. Mall was $2,056.78. The Neonatology Plan paid the first-year premium, and, at the end of that year, the conversion credit balance was $8,603.71 ($10,290 - $2,056.78 + $370.49); the $370.49 is the interest of 4.5 percent earned on the conversion credit balance (($8,603.71 - $370.49) x 4.5% = $370.49)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year.

The second-year premium, before any experience refund, was

$10,530. The policy was credited with an experience refund of $98.25, and the Neonatology Plan paid the net premium of $10,431.75 ($10,530 - $98.25). The cost of insuring Mr. Mall for the second year was $2,250.45, and, at the end of that year, the conversion credit balance was $17,643.01 ($8,603.71 + $10,530 -$2,250.45 + $759.75); the $759.75 is the interest of 4.5 percent earned on the conversion credit balance (($17,643.01 - $759.75) x 4.5% = $759.75)). Of the conversion credit balance, $8,380.43 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the Cgroup term policy was in its second year ($17,643.01 x 47.5%). The Neonatology Plan continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective October 15, 1996, Mr. Mall converted this policy to a fully paid, individually owned C-group conversion UL policy in contributions when they were made, because she received in connection with services property not subject to a substantial risk of forfeiture under section 83.

VI. The Lakewood Plan

Mr. Cohen introduced Drs. Hirshkowitz and Desai to the SC

VEBA in 1990. Drs. Hirshkowitz and Desai both knew that the premiums paid on the C-group product were more expensive than the cost of term life insurance. They caused Lakewood to invest in the SC VEBA anyway because, as they understood it, the SC VEBA ultimately allowed Lakewood’s principals to withdraw the excess premiums from the plan tax free by way of policy loans. All of Lakewood’s principals are physicians, and Dr. Hirshkowitz, on the basis of his conversations with Mr. Cohen, understood that the SC VEBA allowed policyholders to convert their C-group term policies to individual policies which allowed the withdrawal of the cash value at no additional expense. Dr. Desai, on the basis of his conversations with Mr. Cohen, understood that premiums on the Cgroup product covered both term insurance and conversion credits, and, in his capacity as a member of Lakewood’s board of directors, would have spoken against the SC VEBA had the conversion credits not been available. Drs. Hirshkowitz and Desai both relied on the word of Mr. Cohen as to the validity of the SC VEBA, seeking no independent competent professional advice No Lakewood employee covered by the Lakewood Plan, if he or she had died, would ever have received a death benefit equal to 2.5 times or 8.15 times his or her prior-year compensation. Each of Lakewood’s employee/owners decided the amount that Lakewood would contribute to the SC VEBA on his or her behalf, and Lakewood wrote separate checks for each employee/owner’s contribution, noting on the check the name of the person for whom the contribution was made.

On its Federal corporate income tax return for its taxable year ended October 31, 1991, Lakewood claimed a $480,901.49 deduction for VEBA contributions made to the Lakewood Plan for the following persons’ benefits:

Trustee’s fees........ $1,000.00

Dr. Hirshkowitz.......254,051.49

Dr. Desai.............122,750.00

Dr. Sobo.............. 83,100.00

Dr. McManus........... 20,000.00

480,901.49 On its 1992 Federal corporate income tax return, Lakewood claimed a $209,869.03 deduction for VEBA contributions made for the following persons’ benefits:

Dr. Hirshkowitz......$136,678.43

Dr. Desai............ 42,056.44

Dr. Sobo............. 13,213.52

Dr. McManus.......... 17,920.64

209,869.03 This deduction consists of contributions to the Lakewood Plan and $70,000 that Lakewood paid directly to Peoples Security for Cgroup term policies purchased outside of the Lakewood Plan for Drs. Hirshkowitz and Desai. Of the $70,000 paid to Peoples Security, $50,000 was attributable to the coverage of Dr. Hirshkowitz, and $20,000 was attributable to the coverage of Dr. Desai.

On its 1993 Federal corporate income tax return, Lakewood claimed a $296,055.90 deduction for VEBA contributions made for the following persons’ benefits:

Trustee’s fees........ $1,000.00

Dr. Hirshkowitz.......211,119.90

Dr. Desai............. 55,000.00

Dr. Sobo..............¹

5,000.00 Dr. Sankhla........... 5,750.00 Dr. McManus........... 18,186.00 296,055.90¹ The Lakewood Plan returned this $5,000 to Lakewood in October 1993.

This deduction consists of contributions to the Lakewood Plan and $82,926.23 that Lakewood paid directly to Peoples Security for Cgroup term policies purchased outside of the Lakewood Plan for Drs. Hirshkowitz, Sankhla, and Desai. Of the $82,926.23 paid to Peoples Security, $57,168.80 was attributable to the coverage of Dr. Hirshkowitz, $5,750 was attributable to the coverage of Dr. Sankhla, and $20,007.43 was attributable to the coverage of Dr. Desai.

During the relevant years, the Lakewood Plan purchased 12 insurance policies on the lives of Lakewood’s principals. The attributes of these policies are as follows.

1. Dr. Hirshkowitz’ Inter-American C-Group Term Policy

Effective December 31, 1990, Inter-American issued a $1 million C-group term policy (certificate No. 5076058) on the life of Dr. Hirshkowitz, age 57. The first-year premium was $48,680, and the cost of insuring Dr. Hirshkowitz for that year was $9,475.15. The Lakewood Plan paid the first-year premium, and, at the end of that year, the conversion credit balance was $40,969.07 ($48,680 - $9,475.15 + $1,764.22); the $1,764.22 is the interest of 4.5 percent earned on the conversion credit balance (($40,969.07 - $1,764.22) x 4.5% = $1,764.22)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year. This policy lapsed on December 31, 1991.

2. Dr. Desai’s Inter-American C-Group Term Policy

Effective December 31, 1990, Inter-American issued a $1 million C-group term policy (certificate No. 5076059) on the life of Dr. Desai, age 45. The first-year premium was $17,390, and the cost of insuring Dr. Desai for that year was $3,419.48. The Lakewood Plan paid the first-year premium, and, at the end of that year, the conversion credit balance was $14,599.19 ($17,390 - $3,419.48 + $628.67); the $628.67 is the interest of 4.5 percent earned on the conversion credit balance (($14,599.19 -$628.67) x 4.5% = $628.67)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the Cgroup term policy was in its first year. This policy lapsed on December 31, 1991.

3. Dr. Sobo’s Inter-American C-Group Term Policy

Effective December 31, 1990, Inter-American issued a $1 million C-group term policy (certificate No. 5076057) on the life of Dr. Sobo, age 38. The first-year premium was $10,800, and the cost of insuring Dr. Sobo for that year was $2,374.08. The Lakewood Plan paid the first-year premium, and, at the end of that year, the conversion credit balance was $8,805.09 ($10,800 -$2,374.08 + $379.17); the $379.17 is the interest of 4.5 percent earned on the conversion credit balance (($8,805.09 - $379.17) x 4.5% = $379.17)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year. This policy lapsed on December 31, 1991. 4. Dr. Hirshkowitz’ Commonwealth C-Group Term Policy Effective October 31, 1991, Commonwealth issued a $150,000 C-group term policy (certificate No. 6000972) on the life of Dr. Hirshkowitz, age 58. The first-year premium was $7,540.50, and the cost of insuring Dr. Hirshkowitz for that year was $1,572.75. The Lakewood Plan paid the first-year premium, and, at the end of that year, the conversion credit balance was $6,236.30 ($7,540.50 - $1,572.75 + $268.55); the $268.55 is the interest of 4.5 percent earned on the conversion credit balance (($6,236.30 -$268.55) x 4.5% = $268.55)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the Cgroup term policy was in its first year. The second-year premium, before any experience refund, was $7,720. The policy was credited with an experience refund of $115.21, and the Lakewood Plan paid the net premium of $7,604.79 ($7,720 - $115.21). The cost of insuring Dr. Hirshkowitz for the second year was $1,665.17, and, at the end of that year, the conversion credit balance was $12,844.23 ($6,236.30 + $7,720 -$1,665.17 + $553.10); the $553.10 is the interest of 4.5 percent earned on the conversion credit balance (($12,844.23 - $553.10) x 4.5% = $553.10)). Of the conversion credit balance, $6,101.01 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the Cgroup term policy was in its second year ($12,844.23 x 47.5%). The third-year premium, before any experience refund, was $7,972.50. The policy was credited with an experience refund of $176.01, and the Lakewood Plan paid the net premium of $7,796.49 ($7,972.50 - $176.01). The cost of insuring Dr. Hirshkowitz for the third year was $1,798.22, and, at the end of that year, the conversion credit balance was $19,874.34 ($12,844.23 + $7,972.50 - $1,798.22 + $855.83); the $855.86 is the interest of 4.5 percent earned on the conversion credit balance (($19,874.34 -$855.83) x 4.5% = $855.83)). Of the conversion credit balance, $17,935.59 could have been transferred at this time to the Cgroup conversion UL policy, upon conversion thereto, because the C-group term policy was in its third year ($19,874.34 x 90.25%). The Lakewood Plan continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective October 31, 1996, Dr. Hirshkowitz converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $44,653. At the time of conversion, the balance in the C-group term policy’s conversion credit account was $35,400, and $33,630 of that amount ($35,400 x 95%) was transferred to the C-group conversion UL policy for potential earning. Mr. Hirshkowitz will earn these credits in 120 equal monthly installments, beginning October 1996. The conversion credit balance of $33,630 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before February 1, 1993, (2) male, (3) issue age 58, (4) duration of 5 years, and (5) $150,000 death benefit.

5. Dr. Desai’s Commonwealth C-Group Term Policy

Effective October 31, 1991, Commonwealth issued a $150,000

C-group term policy (certificate No. 6000973) on the life of Dr. Desai, age 46. The first-year premium was $2,836.50, and the cost of insuring Dr. Desai for that year was $565.11. The Lakewood Plan paid the first-year premium, and, at the end of that year, the conversion credit balance was $2,373.60 ($2,836.50 - $565.11 + $102.21); the $102.21 is the interest of 4.5 percent earned on the conversion credit balance (($2,373.60 - $102.21) x 4.5% = $102.21)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year.

The second-year premium, before any experience refund, was

$2,890.50. The policy was credited with an experience refund of $44.06, and the Lakewood Plan paid the net premium of $2,846.44 ($2,890.50 - $44.06). The cost of insuring Dr. Desai for the second year was $607.89, and, at the end of that year, the conversion credit balance was $4,865.74 ($2,373.60 + $2,890.50 -$607.89 + $209.53); the $209.53 is the interest of 4.5 percent earned on the conversion credit balance (($4,865.74 - $209.53) x 4.5% = $209.53)). Of the conversion credit balance, $2,311.23 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the Cgroup term policy was in its second year ($4,865.74 x 47.5%). The third-year premium, before any experience refund, was $2,962.50. The policy was credited with an experience refund of $66.69, and the Lakewood Plan paid the net premium of $2,895.81 ($2,962.50 - $66.69). The cost of insuring Dr. Desai for the third year was $665.36, and, at the end of that year, the conversion credit balance was $7,485.21 ($4,865.74 + $2,962.50 -$665.36 + $322.33); the $322.33 is the interest of 4.5 percent earned on the conversion credit balance (($7,485.21 - $322.33) x 4.5% = $322.33)). Of the conversion credit balance, $6,755.40 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the Cgroup term policy was in its third year ($7,485.21 x 90.25%). The Lakewood Plan continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective October 31, 1996, Dr. Desai converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $22,916. At the time of conversion, the Cgroup term policy’s conversion credit balance was $13,143.16, and $12,486 of that amount ($13,143.16 x 95%) was transferred to the C-group conversion UL policy for potential earning. Dr. Desai will earn this amount in 120 equal monthly installments, beginning October 1996. The conversion credit balance of $12,486 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before February 1, 1993, (2) male, (3) issue age 46, (4) duration of 5 years, and (5) $150,000 death benefit. 6. Dr. Sobo’s $150,000 Commonwealth C-Group Term Policy Effective October 31, 1991, Commonwealth issued a $150,000 C-group term policy (certificate No. 6000971) on the life of Dr. Sobo, age 38. The first-year premium was $1,620, and the cost of insuring Dr. Sobo for that year was $356.11. The Lakewood Plan paid the first-year premium, and, at the end of that year, the conversion credit balance was $1,320.76 ($1,620 - $356.11 + $56.87); the $56.87 is the interest of 4.5 percent earned on the conversion credit balance (($1,320.76 - $56.87) x 4.5% = $56.87)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year.

The second-year premium, before any experience refund, was

$1,638. The policy was credited with an experience refund of $24.48, and the Lakewood Plan paid the net premium of $1,613.52 ($1,638 - $24.48). The cost of insuring Dr. Sobo for the second year was $370.54.

Dr. Sobo died on September 23, 1993. On December 14, 1993, the Lakewood Plan paid $150,000 to Bonnie W. Sobo (Ms. Sobo) as the beneficiary of this policy.

7. Dr. McManus’ Commonwealth C-Group Term Policy

Effective October 31, 1991, Commonwealth issued a $2.1 million C-group term policy (certificate No. 6001004) on the life of Dr. McManus, age 34. The first-year premium was $18,186, and the cost of insuring Dr. McManus for that year was $4,496.72. The Lakewood Plan paid the first-year premium, and, at the end of that year, the conversion credit balance was $14,305.30 ($18,186 - $4,496.72 + $616.02); the $616.02 is the interest of 4.5 percent earned on the conversion credit balance (($14,305.30 -$616.02) x 4.5% = $616.02)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the Cgroup term policy was in its first year. The second-year premium, before any experience refund, was $18,186. The policy was credited with an experience refund of $265.36, and the Lakewood Plan paid the net premium of $17,920.64 ($18,186 - $265.36). The cost of insuring Dr. McManus for the second year was $4,465.82, and, at the end of that year, the conversion credit balance was $29,286.63 ($14,305.30 + $18,186 -$4,465.82 + $1,261.15); the $1,261.15 is the interest of 4.5 percent earned on the conversion credit balance (($29,286.63 -$1,261.15) x 4.5% = $1,261.15)). Of the conversion credit balance, $13,911.15 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its second year ($29,286.63 x 47.5%).

The third-year premium, before any experience refund, was

$18,186. The policy was credited with an experience refund of $401.32, and the Lakewood Plan paid the net premium of $17,784.68 ($18,186 - $401.32). The cost of insuring Dr. McManus for the third year was $4,433.46, and, at the end of that year, the conversion credit balance was $44,975.93 ($29,286.63 + $18,186 -$4,433.46 + $1,936.76); the $1,936.76 is the interest of 4.5 percent earned on the conversion credit balance (($44,975.93 -$1,936.76) x 4.5% = $1,936.76)). Of the conversion credit balance, $40,590.78 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its third year ($44,975.93 x 90.25%).

The Lakewood Plan continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective October 1, 1996, Dr. McManus converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $187,827. At the time of conversion, the Cgroup term policy’s conversion credit balance was $78,672.63, and $74,739 of that amount ($78,672.63 x 95%) was transferred to the C-group conversion UL policy for potential earning. Dr. McManus will earn these credits in 120 equal monthly installments, beginning October 1996. The conversion credit balance of $74,739 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before February 1, 1993, (2) male, (3) issue age 34, (4) duration of 5 years, and (5) $2.1 million death benefit. 8. Dr. Hirshkowitz’ Commonwealth C-Group Term Policy Effective December 31, 1991, Commonwealth issued a $1 million C-group term policy (certificate No. 6004482) on the life of Dr. Hirshkowitz, age 58. The premium for the 10-month period from December 31, 1991, through October 30, 1992, was $41,891.67, and the cost of insuring Dr. Hirshkowitz for the 10-month period was $8,814.60. The Lakewood Plan paid the 10-month premium, and, at the end of that 10-month period, the conversion credit balance was $34,317.46 ($41,891.67 - $8,814.60 + $1,240.39); the $1,240.39 is the interest of 4.5 percent earned on the conversion credit balance (($34,317.46 - $1,240.39) x 4.5% x 10/12 = $1,240.39)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year.

The premium for the next 12-month period, before any experience refund, was $51,470. The policy was credited with an experience refund of $200, and the Lakewood Plan paid the net premium of $51,270 ($51,470 - $200). The cost of insuring Dr. Hirshkowitz for the second year was $11,189.96, and, at the end of that year, the conversion credit balance was $77,954.39 ($34,317.46 + $51,470 - $11,189.96 + $3,356.89); the $3,356.89 is the interest of 4.5 percent earned on the conversion credit balance (($77,954.39 - $3,356.89) x 4.5% = $3,356.89)). Of the conversion credit balance, $37,028.34 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its second year ($77,954.39 x 47.5%).

The third-year premium for the next 12-month period, before any experience refund, was $53,150. The policy was credited with an experience refund of $1,321.18, and the Lakewood Plan paid the net premium of $51,828.82 ($53,150 - $1,321.18). The cost of insuring Dr. Hirshkowitz for the third year was $12,095.03, and, at the end of that year, the conversion credit balance was $124,364.78 ($77,954.39 + $53,150 - $12,095.03 + $5,355.42); the $5,355.42 is the interest of 4.5 percent earned on the conversion credit balance (($124,364.78 - $5,355.42) x 4.5% = $5,355.42)). Of the conversion credit balance, $112,239.22 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its third year ($124,364.78 x 90.25%).

The Lakewood Plan continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective October 31, 1996, Dr. Hirshkowitz converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $296,937. At the time of conversion, the C-group term policy’s conversion credit balance was $227,084.21, and $215,730 of that amount ($227,084.21 x 95%) was transferred to the C-group conversion UL policy for potential earning. Dr. Hirshkowitz will earn these credits in 120 equal monthly installments, beginning October 1996. The conversion credit balance of $215,730 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before February 1, 1993, (2) male, (3) issue age 58, (4) duration of 4 years 10 months, and (5) $1 million death benefit.

9. Dr. Desai’s Commonwealth C-Group Term Policy

Effective December 31, 1991, Commonwealth issued a $1 million C-group term policy (certificate No. 6004483) on the life of Dr. Desai, age 46. The premium for the 10-month period from December 31, 1991, through October 30, 1992, was $15,758.33, and the cost of insuring Dr. Desai for this 10-month period was $3,149.57. The Lakewood Plan paid the 10-month premium, and, at the end of that 10-month period, the conversion credit balance was $13,081.59 ($15,758.33 - $3,149.57 + $472.83); the $472.83 is the interest of 4.5 percent earned on the conversion credit balance (($13,081.59 - $472.83) x 4.5% x 10/12 = $472.83)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year. The premium for the next 12-month period, before any experience refund, was $19,270. The policy was credited with an experience refund of $60, and the Lakewood Plan paid the net premium of $19,210 ($19,270 - $60). The cost of insuring Dr. Desai for the second year was $4,064.12, and, at the end of that year, the conversion credit balance was $29,560.40 ($13,081.59 + $19,270 - $4,064.12 + $1,272.93); the $1,272.93 is the interest of 4.5 percent earned on the conversion credit balance (($29,560.40 - $1,272.93) x 4.5% = $1,272.93)). Of the conversion credit balance, $14,041.19 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its second year ($29,560.40 x 47.5%).

The third-year premium for the next 12-month period, before any experience refund, was $19,750. The policy was credited with an experience refund of $474.65, and the Lakewood Plan paid the net premium of $19,275.35 ($19,750 - $474.65). The cost of insuring Dr. Desai for the third year was $4,449.23, and, at the end of that year, the conversion credit balance was $46,879.92 ($29,560.40 + $19,750 - $4,449.23 + $2,018.75); the $2,018.75 is the interest of 4.5 percent earned on the conversion credit balance (($46,879.92 - $2,018.75) x 4.5% = $2,018.75)). Of the conversion credit balance, $42,309.13 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its third year ($46,879.92 x 90.25%).

The Lakewood Plan continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective October 1, 1996, Dr. Desai converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $151,656. At the time of conversion, the Cgroup term policy’s conversion credit balance was $84,397.58, and $80,177.70 of that amount ($84,397.58 x 95%) was transferred to the C-group conversion UL policy for potential earning. Dr. Desai will earn these credits in 120 equal monthly installments, beginning October 1996. The conversion credit balance of $80,177.70 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before February 1, 1993, (2) male, (3) issue age 46, (4) duration of 4 years 10 months, and (5) $1 million death benefit.

10. Dr. Sobo’s Commonwealth C-Group Term Policy

Effective December 31, 1991, Commonwealth issued a $1 million C-group term policy (certificate No. 6004474) on the life of Dr. Sobo, age 39. The premium for the 10-month period from December 31, 1991, through October 30, 1992, was $9,583.33, and the cost of insuring Dr. Sobo for this 10-month period was $2,079.88. The Lakewood Plan paid the 10-month premium, and, at the end of that 10-month period, the conversion credit balance was $7,784.83 ($9,583.33 - $2,079.88 + $281.38); the $281.38 is the interest of 4.5 percent earned on the conversion credit balance (($9,583.33 - $281.38) x 4.5% x 10/12 = $281.38)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year. The premium for the next 12-month period, before any experience refund, was $11,620. The policy was credited with an experience refund of $20, and the Lakewood Plan paid the net premium of $11,600 ($11,620 - $20). The cost of insuring Dr. Sobo for the second year was $2,588.77.

On February 3, 1994, the Lakewood Plan paid Ms. Sobo $1 million as the beneficiary of this policy. Pursuant to the plan, Dr. Sobo’s death benefit should have been $2,682,858 (prior-year compensation of $329,185 multiplied by 8.15). The Lakewood Plan had assets from which it could have paid Ms. Sobo more than the $1,150,000 that it did (the $1 million on this policy and the $150,000 on certificate No. 6000971). The Lakewood Plan retained those assets for the remaining covered employees.

11. Dr. Sankhla’s Commonwealth MG-5 Policy

Effective December 31, 1991, Commonwealth issued a $150,000

MG-5 policy on the life of Dr. Sankhla, age 38, for a 1-year premium of $397.50. The policy was renewed for a second year at a premium of $397.50, and for a third year at a premium of $397.50. The Lakewood Plan paid all three of these premiums. 12. Dr. Hirshkowitz’ Commonwealth C-Group Term Policy Effective December 31, 1993, Commonwealth issued a $100,000 C-group term policy (certificate No. 6022354) on the life of Dr. Hirshkowitz, age 60. The premium for the 10-month period from December 31, 1993, through October 30, 1994, was $4,496.67, and the cost of insuring Dr. Hirshkowitz for that 10-month period was $1,107.84. The Lakewood Plan paid the 10-month premium, and, at the end thereof, the conversion credit balance was $3,515.91 ($4,496.67 - $1,107.84 + $127.08); the $127.08 is the interest of 4.5 percent earned on the conversion credit balance (($3,515.91 -$127.08) x 4.5% x 10/12 = $127.08)). None of the conversion credit balance could have been transferred at this time to the Cgroup conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year.

In addition to its purchase of these 12 life insurance policies, the Lakewood Plan, during the subject years, purchased three group annuities designated for certain Lakewood employees. None of these annuities funded the life insurance provided under the plan. The Lakewood Plan generally purchased these annuities to accumulate wealth to pay future premiums on the C-group term policies. The attributes of these annuities are as follows. 1. Plus II Group Annuity Effective December 31, 1990, Inter-American issued to the Lakewood Plan a Plus II group annuity (#C15518/C91063). The Lakewood Plan deposited $78,240 into the annuity on the day it was effective and $92,700 in 1991. The Lakewood Plan closed the annuity in April 1997, withdrawing $230,169.02 . The $59,229.02 difference between the total deposits ($170,940) and the amount withdrawn ($230,169.02) represents interest.

2. Commonwealth Sygnet 24 Group Annuity Effective in 1991

Effective October 31, 1991, Commonwealth issued to the

Lakewood Plan a Sygnet 24 group annuity (#D10120/D90039). This annuity is designed for asset accumulation over a long period of time and has surrender charges that grade off over 6 years. The Lakewood Plan deposited $242 into the annuity on the day it was effective, $143,344.17 in 1992, and $33,664.37 in 1993. The Lakewood Plan withdrew $76,442.08 from the annuity on November 4, 1994, and $93,301.59 on December 12, 1995, in closing it. The Lakewood Plan used both withdrawals to pay C-group term policy premiums for Drs. Hirshkowitz and Desai. The Lakewood Plan paid $30,153.10 of charges on its deposits and $4,138.44 of surrender charges on its withdrawals. The $26,784.67 difference between the (1) total deposits into the account ($177,250.54) and (2) sum of the charges ($34,291.54) plus total withdrawals ($169,743.67), represents interest.

3. Commonwealth Sygnet 24 Group Annuity Effective in 1993

Effective December 30, 1993, Commonwealth issued to the

Lakewood Plan a second Sygnet 24 group annuity (#D11794/D90214). The Lakewood Plan deposited $75,551.50 into the annuity on the day it was effective and closed the annuity on November 25, 1996, withdrawing $65,078.20. The Lakewood Plan paid a $15,865.68 charge on its deposit and a $3,436.85 surrender charge on its withdrawal. The $7,042.45 difference between the (1) deposit ($75,551.50) and (2) sum of the charge ($3,436.85) plus withdrawal ($65,078.20) represents interest.

Beginning in 1992, Lakewood purchased outside of the SC VEBA three Peoples Security C-group term policies. Lakewood owned these policies and deducted the underlying premiums as VEBA contributions. The attributes of these policies are as follows. 1. Dr. Desai’s Peoples Security C-Group Term Policy Effective August 15, 1992, Peoples Security issued a $1,005,000 C-group term policy (certificate No. 7003612) on the life of Dr. Desai, age 46. The first-year premium was $19,004.55, and the cost of insuring Dr. Desai for that year was $3,786.22. Lakewood paid this premium, and, at the end of that year, the conversion credit balance was $15,903.15 ($19,004.55 -$3,786.22 + $684.82); the $684.82 is the interest of 4.5 percent earned on the conversion credit balance (($15,903.15 - $684.82) x 4.5% = $684.82)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year.

The second-year premium, before any experience refund, was

$19,366.35. The policy was credited with an experience refund of $145.33, and Lakewood paid the net premium of $19,221.02 ($19,366.35 - $145.33). The cost of insuring Dr. Desai for the second year was $4,072.87, and, at the end of that year, the conversion credit balance was $32,600.48 ($15,903.15 + $19,366.35 - $4,072.87 + $1,403.85); the $1,403.85 is the interest of 4.5 percent earned on the conversion credit balance (($32,600.48 -$1,403.85) x 4.5% = $1,403.85)). Of the conversion credit balance, $15,485.23 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its second year ($32,600.48 x 47.5%).

Lakewood continued to pay the premiums on this policy, net of the applicable experience refund, through 1996. Effective February 15, 1996, Dr. Desai converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $106,353. At the time of conversion, the C-group term policy’s conversion credit balance was $58,141.90, and $55,234.80 of that amount ($58,141.90 x 95%) was transferred to the C-group conversion UL policy for potential earning. Dr. Desai will earn these credits in 120 equal monthly installments, beginning February 1996. The conversion credit balance of $55,234.80 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before February 1, 1993, (2) male, (3) issue age 46, (4) duration of 3 years 6 months, and (5) $1,005,000 death benefit.

2. Dr. Hirshkowitz’ Peoples Security C-Group Term Policy

Effective August 15, 1992, Peoples Security issued a

$940,000 C-group term policy (certificate No. 7002550) on the life of Dr. Hirshkowitz, age 59. The first-year premium was $48,861.20, and the cost of insuring Dr. Hirshkowitz for that year was $10,907.54. Lakewood paid this premium, and, at the end of that year, the conversion credit balance was $39,661.57 ($48,861.20 - $10,907.54 + $1,707.91); the $1,707.91 is the interest of 4.5 percent earned on the conversion credit balance (($39,661.57 - $1,707.91) x 4.5% = $1,707.91)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year. The second-year premium, before any experience refund, was $50,440.40. The policy was credited with an experience refund of $362.35, and Lakewood paid the net premium of $50,078.05 ($50,440.40 - $362.35). The cost of insuring Dr. Hirshkowitz for the second year was $11,830.58, and, at the end of that year, the conversion credit balance was $81,793.61 ($39,661.58 + $50,440.40 - $11,830.58 + $3,522.21); the $3,522.21 is the interest of 4.5 percent earned on the conversion credit balance (($81,793.61 -$3,522.21) x 4.5% = $3,522.21)). Of the conversion credit balance, $38,851.96 could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its second year ($81,793.61 x 47.5%).

Lakewood continued to pay the premiums on this policy, net of the applicable experience refund, through 1995. Effective October 15, 1995, Dr. Hirshkowitz converted this policy to a fully paid, individually owned C-group conversion UL policy in the face amount of $164,406. At the time of conversion, the Cgroup term policy’s conversion credit balance was $129,411.70, and $122,941.12 of that amount ($129,411.70 x 95%) was transferred to the C-group conversion UL policy for potential earning. Dr. Hirshkowitz will earn these credits in 120 equal monthly installments, beginning October 1995. The conversion credit balance of $122,941.12 equaled the amount referenced in Commonwealth’s table of conversion credit values for the following variables: (1) Business issued before February 1, 1993, (2) male, (3) issue age 59, (4) duration of 3 years 2 months, and (5) $940,000 death benefit.

3. Dr. Sankhla’s Peoples Security C-Group Term Policy

Effective January 31, 1993, Peoples Security issued a

$500,000 C-group term policy (certificate No. 7003453) on the life of Dr. Sankhla, age 39. The first-year premium was $5,750, and the cost of insuring Dr. Sankhla for that year was $1,245.51. Lakewood paid this premium, and, at the end of that year, the conversion credit balance was $4,707.19 ($5,750 - $1,245.51 + $202.70); the $202.70 is the interest of 4.5 percent earned on the conversion credit balance (($4,707.19 - $202.70) x 4.5% = $202.70)). None of the conversion credit balance could have been transferred at this time to the C-group conversion UL policy, upon conversion thereto, because the C-group term policy was in its first year.

During the relevant years, Commonwealth, Inter-American, and

Peoples Security paid Kirwan, Mr. Murphy, and Mr. Ankner (either indirectly through one of his companies or directly) commissions of $90,503.82, $6,681.23, and $20,960, respectively, on the Cgroup products and Sygnet group annuities sold to the Lakewood Plan. Kirwan also received, in or about 1996, commissions equal to 5 percent of the conversion credits, both earned and unearned, which were applied to the C-group conversion UL policies of Drs. Hirshkowitz, Desai, and McManus. These commissions totaled $29,746.93 (($33,630 x 5%) + ($12,486 x 5%) + ($74,739 x 5%) + ($215,730 x 5%) + ($80,177.70) + ($55,234.80) + ($122,941.12 x 5%).

The 1991, 1992, and 1993 Forms W-2 issued by Lakewood to

Drs. Hirshkowitz, Desai, Sobo, McManus, and Sankhla did not report any taxable life insurance benefits provided to them under the Lakewood Plan. Dr. Hirshkowitz reported $4,590, $4,590, and $13,338 as P.S. 58 income on his joint 1991, 1992, and 1993 Federal individual income tax returns, respectively. Drs. Desai, Sobo, McManus, and Sankhla did not report on their 1991, 1992, or 1993 Federal individual income tax returns any income from the life insurance benefits provided to them by Lakewood. Respondent determined that Lakewood could not deduct the amounts claimed as contributions to the Lakewood Plan in its October 31, 1991, and its 1992 and 1993 taxable years and disallowed the related claimed deductions of $480,901, $209,869, and $296,056, respectively. In contrast with the Neonatology adjustments, respondent’s Lakewood adjustments do not reflect the fact that an employee/owner (Dr. Hirshkowitz) reported P.S. 58 income as to the benefits that he received from the Lakewood Plan. Consistent with the Neonatology determination, respondent determined primarily that Lakewood’s contributions to its plan were not deductible under section 162(a) to the extent they did not provide current-year life insurance protection. Respondent determined alternatively that the contributions were not deductible under section 404(a)(5); respondent determined that the Lakewood Plan was not a “welfare benefit fund” under section 419(e) but a nonqualified plan of deferred compensation subject to the rules of section 404. Respondent determined as a second alternative that, assuming that the Lakewood Plan is a “welfare benefit fund”, any deduction of the contributions was precluded by section 419; for this purpose, respondent determined that the SC VEBA was not a “10-or-more employer plan” under section 419A(f)(6) as asserted by petitioners.

As to the petitioning individuals of the Lakewood group, respondent determined that each group of petitioning individuals had “additional income” in the following amounts for the respective years from 1991 through 1993: Dr. and Ms. Hirshkowitz-–$254,051, $136,678, and $211,120; Dr. and Ms. Desai-–$122,750, $42,056, and $55,000; Dr. and Ms. McManus-–$20,000, $17,921, and $18,186; and the Estate of Steven Sobo, Deceased, Also during 1994, the Marlton Plan purchased from the First Colony Life Insurance Co. (First Colony) a $412,800 graded premium policy on the life of Ms. Lo, age 44, and a $264,008 graded premium policy on the life of Edward Lo, age 45. The Marlton Plan paid First Colony a $584.26 annual premium on Ms. Lo’s policy and a $556.34 annual premium on Edward Lo’s policy. The beneficiary of both policies was the Marlton plan trustee. The annual premium on these two policies remained constant for the first 10 years and then increased substantially unless the policyholder provided evidence of insurability to begin another 10-year period of reduced, level premiums.

The Marlton Plan paid no benefits during the subject years. On their joint 1993 Federal individual income tax return, the Los reported no P.S. 58 income. They reported P.S. 58 income of $4,288 on their joint 1994 Federal individual income tax return. Respondent determined that Marlton could not deduct its contributions to the Marlton Plan and increased the Los’ income by $102,500 in 1993 and $116,212 in 1994 to reflect the following adjustments:

1993 1994 Contributions to the Marlton Plan $100,000 $120,000 Administrator’s fees 2,500⁵⁰⁰ Subtotal 102,500 120,500 Less: P.S. 58 costs included in income -0-4,288 Adjustment 102,500 116,212 Respondent determined primarily that the contributions were not deductible under section 162(a). Respondent determined alternatively that the contributions were not deductible under section 404(a)(5); respondent determined that the Marlton Plan was not a “welfare benefit fund” under section 419(e) but a nonqualified plan of deferred compensation subject to the rules of section 404. Respondent determined as a second alternative that, assuming that the Marlton Plan is a “welfare benefit fund”, any deduction of the contributions was precluded by section 419; for this purpose, respondent determined that the NJ VEBA was not a “10-or-more employer plan” under section 419A(f)(6) as asserted by petitioners. Respondent determined as a third alternative that any deduction of the contributions was precluded by section 264(a); for this purpose, respondent determined that each life insurance policy issued under the Marlton Plan covered the life of a person financially interested in Dr. Lo’s trade or business and that Dr. Lo was directly or indirectly a beneficiary under the policy.

OPINION

We must determine the tax consequences flowing from the subject VEBA’s, which, petitioners claim, are “10-or-more employer plans” entitled to the favorable tax treatment set forth tax-free asset accumulation. The subject VEBA’s were not designed, marketed, purchased, or sold as a means for an employer to provide welfare benefits to its employees. Cf. Booth v. Commissioner , 108 T.C. 524, 561-563 (1997) (designers of welfare benefit funds intended to provide employees with real welfare benefits that would not be subject to abuse). The small business owners at bar (namely, the petitioning physicians) invested in the VEBA’s through their businesses and caused their businesses to purchase the C-group product from the insurance salesmen. The insurance salesmen, guided by the designer of the C-group product, represented to the physicians that favorable tax consequences would flow from an investment in the VEBA’s and the purchase of the C-group product.

Before turning to the issues at hand, we pause to pass on our perception of the trial witnesses. We observe the candor, sincerity, and demeanor of each witness in order to evaluate his or her testimony and assign it weight for the primary purpose of finding disputed facts. We determine the credibility of each witness, weigh each piece of evidence, draw appropriate inferences, and choose between conflicting inferences in finding the facts of a case. The mere fact that one party presents unopposed testimony on his or her behalf does not necessarily mean that the elicited testimony will result in a finding of fact in that party’s favor. We will not accept the testimony of witnesses at face value if we find that the outward appearance of the facts in their totality conveys an impression contrary to the spoken word. See Boehm v. Commissioner , 326 U.S. 287, 293 (1945); Wilmington Trust Co. v. Helvering , 316 U.S. 164, 167-168 (1942); see also Gallick v. Baltimore & O. R. Co.

, 372 U.S. 108, 114-115 (1963); Diamond Bros. Co. v. Commissioner , 322 F.2d 725, 730-731 (3d Cir. 1963), affg. T.C. Memo. 1962-132.

Petitioners called eight fact witnesses and one expert witness. Petitioners’ fact witnesses were Drs. Desai, Hirshkowitz, and Mall, Messrs. Ankner, Mall, and Ross, and AEGON USA employees Paula Jackson and Timothy Vance. Petitioners’ expert witness was Jay M. Jaffe, F.S.A., M.A.A.A. (Mr. Jaffe). Mr. Jaffe is the president and sole consultant of Actuarial Enterprises, Ltd., and we generally recognized him as an expert on the characterization of an insurance policy as term insurance. We recognized him as such but expressed concern as to whether he was actually an unbiased expert who could help us. Mr. Jaffe generally testified that the C-group term policy and the C-group conversion UL policy were separate insurance products with no interrelationship.

Respondent called two fact witnesses and one expert witness. Respondent’s fact witnesses were Mr. Cohen and Vincent Maressa, the latter of whom is the executive director and general counsel of the Medical Society of New Jersey. Respondent’s expert witness was Charles DeWeese, F.S.A., M.A.A.A. (Mr. DeWeese). Mr. DeWeese is an independent consulting actuary, and we recognized him as an expert on, among other things, the difference between group term insurance and universal life insurance. Mr. DeWeese generally testified that the C-group term policy and the C-group conversion UL policy were one insurance product; i.e., both policies were parts of a single life insurance product. We have broad discretion to evaluate the cogency of an expert’s analysis. Sometimes, an expert will help us decide a case. See, e.g., Booth v. Commissioner , supra at 573; Trans City Life Ins. Co. v. Commissioner , 106 T.C. 274, 302 (1996); see also M.I.C. Ltd. v. Commissioner , T.C. Memo. 1997-96; Proios v.

Commissioner

, T.C. Memo. 1994-442. Other times, he or she will not. See, e.g., Estate of Scanlan v. Commissioner , T.C. Memo.

1996-331, affd. without published opinion 116 F.3d 1476 (5th Cir. 1997); Mandelbaum v. Commissioner , T.C. Memo. 1995-255, affd.

without published opinion 91 F.3d 124 (3d Cir. 1996). We weigh an expert’s testimony in light of his or her qualifications and with due regard to all other credible evidence in the record. See Estate of Kaufman v. Commissioner , T.C. Memo. 1999-119. We may embrace or reject an expert’s opinion in toto, or we may pick and choose the portions of the opinion we choose to adopt. See Helvering v. National Grocery Co.

, 304 U.S. 282, 294-295 (1938);

Silverman v. Commissioner

, 538 F.2d 927, 933 (2d Cir. 1976), affg. T.C. Memo. 1974-285; IT&S of Iowa, Inc. v. Commissioner , 97 T.C. 496, 508 (1991); Parker v. Commissioner , 86 T.C. 547, 562 (1986); see also Pabst Brewing Co. v. Commissioner , T.C. Memo.

1996-506. We are not bound by an expert’s opinion and will reject an expert’s opinion to the extent that it is contrary to the judgment we form on the basis of our understanding of the record as a whole. See Orth v. Commissioner , 813 F.2d 837, 842 (7th Cir. 1987), affg. Lio v. Commissioner , 85 T.C. 56 (1985);

Silverman v. Commissioner

, supra at 933; Estate of Kreis v.

Commissioner

, 227 F.2d 753, 755 (6th Cir. 1955), affg. T.C. Memo. 1954-139; IT&S of Iowa, Inc. v. Commissioner , supra at 508; Chiu v. Commissioner , 84 T.C. 722, 734 (1985); see also Gallick v.

Baltimore & O. R. Co.

, supra at 115; In re TMI Litig.

, 193 F.3d 613, 665-666 (3d Cir. 1999).

Mr. DeWeese is no stranger to this Court. He testified in

Booth v. Commissioner

, 108 T.C. 524 (1997), as an expert on multiple employer plans. We find him to be reliable, relevant, and helpful. We credit his opinion as set forth in his report and as clarified at trial. We rely on his opinion in making our findings of fact and reaching the conclusions we draw therefrom.

We turn to the nine issues for decision and address each of these issues seriatim.

1. Contributions to the Neonatology and Lakewood Plans

We decide first the question of whether section 162(a) allows Neonatology and Lakewood to deduct their contributions to their plans. Section 162(a) generally provides a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. A taxpayer must meet five requirements in order to deduct an item under this section. The taxpayer must prove that the item claimed as a deductible business expense: (1) Was paid or incurred during the taxable year; (2) was for carrying on his, her, or its trade or business; (3) was an expense; (4) was a necessary expense; and (5) was an ordinary expense. See Commissioner v. Lincoln Savs. & Loan Association , 403 U.S. 345, 352 (1971); Welch v. Helvering , 290 U.S. 111, 115 (1933). A determination of whether an expenditure satisfies each of these requirements is a question of fact. See Commissioner v. Heininger , 320 U.S. 467, 475 (1943).

Petitioners argue that Neonatology and Lakewood meet all five requirements with respect to their contributions to their plans, and, hence, petitioners assert, those contributions are fully deductible under section 162(a). Petitioners contend that the contributions were paid as compensation because, they assert, the contributions funded a fringe benefit in the form of term with commercial interest does not recharacterize the deposited funds as the cost of term insurance simply because Neonatology ultimately decided to abandon the funds. Although it is true that Neonatology and the insurancemen represented in form that Neonatology paid the entire $9,906 to Inter-American as a premium on term life insurance, the fact of the matter is that neither Neonatology nor Inter-American actually considered the excess premium to fund the cost of term life insurance. The substance of the purported premium payment outweighs its form, and, after closely scrutinizing the facts and circumstances of this case, including especially the interrelationship between the two policies underlying the C-group product and the expectations and understandings of the parties to the contracts underlying that product, we are left without any doubt that the amount credited to the conversion account balance was neither charged nor paid as the cost of current life insurance protection. The parties to those contracts have always expected and understood that the conversion credit balance would be returned to the insured in the future by way of no-cost policy loans.

We also recognize that the conversion credit balance would not be paid in addition to the underlying policy’s face value when the insured died, and, if the insured had borrowed from the balance, that the death benefit would be reduced by the amount of any outstanding loan. In the case of Dr. Sobo, for example, his to characterize the excess contributions as compensation does not necessarily mean that the payments were compensation in fact. The facts of this case do not support petitioners’ assertion that Neonatology and Lakewood had the requisite compensatory intent when they made the contributions to their plans. We find nothing in the record, except for petitioners’ assertions on brief, that would support such a finding. See Rule 143(b) (statements on brief are not evidence). Indeed, all reliable evidence points to the contrary conclusion that we reach as to this issue. On the basis of our review of the record, we are convinced that the purpose and operation of the Neonatology Plan and the Lakewood Plan was to serve as a tax-free savings device for the owner/employees and not, as asserted by petitioners, to provide solely term life insurance to the covered employees. To be sure, some of the plans even went so far as to purchase annuities for designated employee/owners.

2. Lakewood’s Payments Made Outside of Its Plan

Lakewood made payments outside of the Lakewood Plan for additional life insurance for two of its employees. Lakewood argues that these payments are deductible in full under section 162(a) as ordinary and necessary business expenses. We disagree. For the reasons stated above, we hold that these payments are nondeductible constructive distributions to the extent they did not fund term life insurance. The payments are deductible to the In the event of Ms. Lo’s death, the face value of her life insurance policy would be paid to the Marlton Plan, for which Dr. Lo and Edward Lo would be the remaining beneficiaries. Although Dr. Lo would not be the sole beneficiary of those death benefits, section 264(a)(1) requires only that he be a beneficiary in order to render the premiums nondeductible. See Keefe v. Commissioner , 15 T.C. 947, 952-953 (1950). Nor does it matter for purposes of section 264(a)(1) that he was not expressly listed on Ms. Lo’s policy as the beneficiary thereof. See Rieck v. Heiner , 25 F.2d 453 (3d Cir. 1928).

Dr. Lo, as opposed to Edward Lo, also stood to gain the most from the plan assets, were Ms. Lo to have died. Whereas Edward Lo had a fairly inexpensive term life insurance policy, Dr. Lo had a fairly expensive universal life policy. Ms. Lo’s life insurance proceeds also could be used to pay the premiums on the policies, thus satisfying the obligation of Marlton to do so. See Rodney v. Commissioner , 53 T.C. 287, 318-319 (1969) (benefit requirement of section 264(a)(1) is satisfied where the insurance would ultimately satisfy an obligation of the taxpayer); Glassner v. Commissioner , supra (same).

6. Disallowed Payments

A corporate distribution is taxed as a dividend to the recipient shareholder to the extent of the corporation’s earnings and profits. The portion of the distribution that is not a dividend is a nontaxable return of capital to the extent of the shareholder’s stock basis. The remainder of the distribution is taxed to the shareholder as gain from the sale or exchange of property. See sec. 301(c); Enoch v. Commissioner , 57 T.C. 781, 793 (1972); see also Commissioner v. Makransky , 321 F.2d at 601.

Petitioners do not challenge respondent’s determination that

Lakewood and Neonatology had sufficient earnings and profits to characterize the subject distributions as dividends. We sustain respondent’s determination that all the distributions are taxable dividends to the recipient employee/owners. See Rule 142(a); Welch v. Helvering , 290 U.S. at 115.

Petitioners challenge the timing of that income, however, arguing that it is not taxable to the employee/owners in the year determined by respondent; i.e., the year in which Neonatology and Lakewood contributed the excess amounts to their plans or, in the three instances where the insurance was purchased directly from Peoples Security, in the year that Lakewood paid Peoples Security for that insurance. Petitioners assert that the income is not taxable to the employee/owners until after the subject years because the conversion credit balance would be forfeited if the underlying policy lapsed or if the insured died. Petitioners observe that the employee/owners’ ability to withdraw the conversion credit balance was limited to the percentage of that balance that was transferred to the C-group conversion UL policy. Petitioners observe that the transferred credits could be reached by an insured only if a C-group term policy was converted to a Cgroup conversion UL policy, and then only in equal increments over 120 months. Petitioners observe that an insured would forfeit the transferred credits in the event of his or her death. Petitioners rely primarily on section 83(a).

Respondent argues that the income is taxable currently. Respondent asserts that the excess contributions purchased insurance contracts and annuities for the benefit of the employee/owners. Respondent asserts that the employee/owners had the unfettered ability to withdraw the conversion credit balances at their whim.

We agree with respondent that the dividends are taxable in the years that he determined. As mentioned supra , we view Neonatology and Lakewood’s excess contributions to their plans as We disagree with all of petitioners’ assertions as to the accuracy-related penalties determined by respondent under section 6662(a) and (b)(1). Section 6662(a) and (b)(1) imposes a 20percent accuracy-related penalty on the portion of an underpayment that is due to negligence or intentional disregard of rules or regulations. Negligence includes a failure to attempt reasonably to comply with the Code. See sec. 6662(c). Disregard includes a careless, reckless, or intentional disregard. See id.

An underpayment is not attributable to negligence or disregard to the extent that the taxpayer shows that the underpayment is due to the taxpayer’s reasonable cause and good faith. See secs. 1.6662-3(a), 1.6664-4(a), Income Tax Regs.

Reasonable cause requires that the taxpayer have exercised ordinary business care and prudence as to the disputed item. See United States v. Boyle , 469 U.S. 241 (1985); see also Hatfried, Inc. v. Commissioner , 162 F.2d 628, 635 (3d Cir. 1947); Girard Inv. Co. v. Commissioner , 122 F.2d 843, 848 (3d Cir. 1941);

Estate of Young v. Commissioner

, 110 T.C. 297, 317 (1998). The good faith reliance on the advice of an independent, competent professional as to the tax treatment of an item may meet this requirement. See United States v. Boyle , supra ; sec. 1.66644(b), Income Tax Regs.; see also Hatfried, Inc. v. Commissioner , supra at 635; Girard Inv. Co. v. Commissioner , supra at 848;

Ewing v. Commissioner

, 91 T.C. 396, 423 (1988), affd. without published opinion 940 F.2d 1534 (9th Cir. 1991). Whether a taxpayer relies on advice and whether such reliance is reasonable hinge on the facts and circumstances of the case and the law that applies to those facts and circumstances. See sec. 1.66644(c)(i), Income Tax Regs. A professional may render advice that may be relied upon reasonably when he or she arrives at that advice independently, taking into account, among other things, the taxpayer’s purposes for entering into the underlying transaction. See sec. 1.6664-4(c)(i), Income Tax Regs.; see also Leonhart v. Commissioner , 414 F.2d 749 (4th Cir. 1969), affg.

T.C. Memo. 1968-98. Reliance may be unreasonable when it is placed upon insiders, promoters, or their offering materials, or when the person relied upon has an inherent conflict of interest that the taxpayer knew or should have known about. See Goldman v. Commissioner , 39 F.3d 402 (2d Cir. 1994), affg. T.C. Memo.

1993-480; LaVerne v. Commissioner , 94 T.C. 637, 652-653 (1990), affd. without published opinion 956 F.2d 274 (9th Cir. 1992), affd. in part without published opinion sub nom. Cowles v. Commissioner , 949 F.2d 401 (10th Cir. 1991); Marine v.

Commissioner

, 92 T.C. 958, 992-93 (1989), affd. without published opinion 921 F.2d 280 (9th Cir. 1991). Reliance also is unreasonable when the taxpayer knew, or should have known, that the adviser lacked the requisite expertise to opine on the tax The “professional” to whom petitioners refer is their insurance agent, Mr. Cohen. Mr. Cohen is not a tax professional, nor do we find that he ever represented himself as such. Petitioners’ mere reliance on Mr. Cohen was unreasonable, given the primary fact that he was known by most of them to be involved intimately with and to stand to gain financially from the sale of both the subject VEBA’s and the C-group product. Given the magnitude of petitioners’ dollar investment in the C-group product and the favorable consequences which Mr. Cohen represented flowed therefrom, any prudent taxpayer, especially one who is as educated as the physicians at bar, would have asked a tax professional to opine on the tax consequences of the C-group product. The represented tax benefits of the C-group product were simply too good to be true. Such is especially so when we consider the fact that the physicians who testified admitted that they knew that term insurance was significantly less expensive than the premiums purportedly paid under the C-group product solely for term insurance.

Petitioners assert on brief that they also relied on tax opinion letters written by tax attorneys and accountants. We do not find that such was the case. The record contains neither a credible statement by one or more of the individual petitioners to the effect that he or she saw and relied on a tax opinion letter, nor a tax opinion letter written by a competent, independent tax professional. In fact, petitioners have not even proposed a finding of fact that would support a finding that such a tax opinion letter exists, let alone that any of them ever read be “major” from the point of view of accepting Mr. Cohen’s representations of the tax consequences which flowed from the SC VEBA.

We also are not persuaded by petitioners’ assertion that the accuracy-related penalties are inapplicable because, they claim, the issues at bar are matters of first impression. It is not new in the arena of tax law that individual shareholders have tried surreptitiously to withdraw money from their closely held corporations to avoid paying taxes on those withdrawals. The fact that the physicians at bar have attempted to do so in the setting of a speciously designed life insurance product does not negate the fact that the underlying tax principles involved in this case are well settled. Nor does the application of the negligence accuracy-related penalty turn on the fact that this case is a “test case” as to the tax consequences flowing from a taxpayer’s participation in the subject VEBA’s. When the requirements for the negligence accuracy-related penalty are met, a taxpayer in a test case is just as negligent as the taxpayers who have agreed to be bound by the resolution of the test case. We conclude that each of petitioners is liable for the accuracy-related penalties determined by respondent. 8. Addition to Tax for Failure To File Timely Lakewood filed its 1992 tax return with the Commissioner on May 28, 1993. The unextended due date of the return was March 15, 1993, and Lakewood neither requested nor received an extension from that date. Respondent determined that Lakewood’s untimely filing made it liable for an addition to tax under section 6651(a) equal to 15 percent of the underpayment, and Lakewood has not shown reasonable cause for its untimely filing. We sustain respondent’s determination and hold that Lakewood is liable under section 6651(a) for an addition to tax of 5 percent for each month during which its failure continued, or, in other words, a 15-percent addition to tax as determined by respondent. See sec. 6651(a)(1); see also Rule 142(a).

9. Penalties Under Section 6673(a)(1)(B)

Respondent moves the Court under section 6673(a)(1)(B) to impose a $25,000 penalty against each petitioner, asserting that petitioners’ positions in this proceeding are frivolous and groundless. Respondent asserts that the C-group product is a “deceptive subterfuge” that was “designed to deceive on its face”. Respondent asserts that petitioners have not proven the critical allegations set forth in their petitions as to the operation of the C-group product and that, at trial, petitioners, through their counsel, Mr. Prupis and Kevin Smith (Mr. Smith), contested unreasonably the admissibility of documents that respondent obtained from third parties as to the workings of the C-group product. Respondent asserts that petitioners, through Messrs. Prupis and Smith, failed to comply fully with discovery to established law and unsupported by a reasoned, colorable argument for change in the law, see Coleman v. Commissioner , 791 F.2d 68, 71 (7th Cir. 1986). Section 6673(a)(2)(B) provides this Court with the discretion to sanction respondent’s counsel if he or she “unreasonably and vexatiously” multiples any proceedings before us.

The mere fact that petitioners are defending the position that was advertised to them in connection with their investment in the subject VEBA’s is insufficient grounds to penalize each petitioner under the facts herein. Petitioners are not directly responsible for most of the actions listed by respondent in support of his motion to impose penalties. Those actions are best traced to petitioners’ counsel, and, given the facts of this case, we decline to impute the actions of petitioners’ counsel to petitioners themselves for the purposes of imposing a penalty under section 6673(a)(1)(B). Petitioners have reasonably relied on the advice of their trial counsel that their litigating positions had merit. See Murphy v. Commissioner , T.C. Memo.

1995-76 (section 6673 penalty against taxpayer was inappropriate where serious failure to present credible evidence at trial was attributable to her counsel).

We conclude our report directing the parties to prepare computations under Rule 155 in all but one of the docketed cases, taking into account the cost of term life insurance for those employees who were eligible to receive that protection. In reaching our holdings we have considered all of petitioners’ arguments for contrary holdings; those arguments not discussed herein are irrelevant or without merit. We also have considered respondent’s arguments as to his determinations to the extent necessary to reject or sustain each determination . We also have considered all of respondent’s arguments as to his motion to impose a penalty against each petitioner.

As mentioned supra

, Decision will be entered for respondent in docket No. 4572-97, decisions will be entered under Rule 155 in all other dockets, and an appropriate order will be issued denying respondent’s motion to impose penalties under section 6673(a)(1)(B)

.