Before KALODNER, STALEY and HASTIE, Circuit Judges.
Were payments made to taxpayer by his employer, pursuant to the express provisions of his employment contract, "because of permanent ailment", tax exempt amounts "received through * * health insurance * * *" under Section 22(b)(5) of the Internal Revenue Code of 1939?*fn1
That is the question presented by this appeal from the judgment of the District Court*fn2 which answered it negatively, thereby making the payments received taxable as ordinary income rather than compensation for illness exempt from taxation.
The facts as stipulated, supplemented by the oral testimony of two physicians, may be summarized as follows:
Otto E. Kuhn ("taxpayer")*fn3 entered into a contract with his employer, Botany Mills, Inc. ("Botany"), on May 31, 1951. He was then sixty-six years old and two years earlier had suffered a cardiac ailment. The contract recited that taxpayer had been employed by Botany or its predecessors for more than twenty-seven years and was at the time a vice-president; that Botany was desirous of having taxpayer continue in an active management capacity through December 31, 1951, and thereafter, in a consulting capacity during his lifetime, and that taxpayer was willing to be so employed provided he received reasonable compensation. It expressly provided that taxpayer was to be paid through 1951 at an annual salary of $35,000, plus certain contingent incentive compensation, and thereafter, for life, at an annual rate of $25,000 provided he made himself available for consulting purposes "at all reasonable and proper times" not to exceed 100 days a year. In the event of permanent disability taxpayer was to be paid $15,000 a year. The critical clause making the latter provision reads as follows:
"* * * provided, however, that such payments shall nevertheless be continued during the lifetime of Kuhn but at the reduced rate of $15,000 per annum, if Kuhn is unable to perform the services set forth in (a) above because of permanent ailment and incapacity if such condition is attested by competent medical certificate submitted to the corporation."
Taxpayer was paid at the rate of $25,000 a year during his employment in 1952. On or about December 15, 1952, he received a letter from his physician recommending that "you will see your way clear to decide on a permanent retirement." The letter was submitted to Botany and accepted by it as competent medical evidence of taxpayer's permanent incapacity. During 1953 taxpayer received $15,000 from Botany which charged it to operating expenses and not to any reserve for disability. Botany did not deduct any withholding on the $15,000 but reported it on form 1099 of its tax return as "salaries, commissions, or other compensation." Botany has never been licensed as an insurer and no premiums were paid or money set apart to cover taxpayer's disability payments.
In dispute here is the characterization for tax purposes of the 1953 payment. Taxpayer paid income tax on it and filed claim for refund which was disallowed resulting in the instant suit.
The District Court premised its determination that the payments did not constitute health insurance within the meaning of Section 22(b)(5) on these findings: (1) the contract was not part of a previously established plan by Botany for its employees generally; (2) it was not entered into at the inception of the employer-employee relationship between Botany and taxpayer; (3) there was no oral testimony or resolution of Botany's directors from which the intention of the contracting parties could be ascertained; (4) the payments were not to be drawn from a special or otherwise segregated fund; (5) there was no evidence that Botany was authorized to make insurance contracts; and (6) no consideration in the form of premium payment, salary deduction or prospective services was paid by taxpayer for the so-called insurance. It concluded that the payments made upon a showing of permanent disability were still salary payments but at a reduced rate. In doing so it stressed the fact that the agreement provided that "such payments", referring to the $25,000 annual salary for consulting services, "shall nevertheless be continued during the lifetime of Kuhn but at the reduced rate of $15,000 per annum", if he became unable to perform the consulting services by reason of permanent ailment or incapacity.
The Government contends that the contract under consideration is "more akin to an ordinary retirement plan than to compensation for disability." This, it is said, follows from the provisions for partial retirement as a consultant effective January 1, 1952, at the reduced salary of $25,000 per year and the continuation of these payments at a still lower rate in the event such service could not be performed by reason of permanent disability. The Government stresses the fact that the contract was not executed until taxpayer was sixty-six years old, and two years after the diagnosis of his cardiac ailment had been made. It also points to frequent elements of health insurance plans not found in the contract in question - requirement that the insured undergo approved treatment, periodic medical examinations by the insurer, and a termination or other adjustment of the obligation of the insurer in the event the permanent disability does not continue.
Taxpayer relies on the interpretation of Section 22(b)(5) of the 1939 Code by the Supreme Court in Haynes v. United States, 1957, 353 U.S. 81, 77 S. Ct. 649, 1 L. Ed. 2d 671, the earlier case of Epmeier v. United States, 7 Cir., 1952, 199 F.2d 508 and several subsequent decisions.
In Haynes the Supreme Court said (353 U.S. at page 83, 77 S. Ct. at page 650):
"Broadly speaking, health insurance is an undertaking by one person for reasons satisfactory to him to indemnify ...