Wittstadt v. Commissioner

T.C. Memo. 1995-492

UNITED STATES TAX COURT

GLENN L. WITTSTADT, JR. AND LYNNE M. WITTSTADT, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 7123-93. Filed October 11, 1995.

Robert G. Cassilly, for petitioners.

Alan R. Peregoy, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

DAWSON, Judge: This case was assigned to Special Trial

Judge Robert N. Armen, Jr., pursuant to the provisions of section

7443A(b)(4) of the Internal Revenue Code of 1986, as amended, and

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Rules 180, 181, and 183.1 The Court agrees with and adopts the

Opinion of the Special Trial Judge, which is set forth below.

OPINION OF THE SPECIAL TRIAL JUDGE

ARMEN, Special Trial Judge: For the taxable year 1989,

respondent determined a deficiency in petitioners' Federal income

tax, as well as deficiencies in petitioners' Federal excise taxes

under sections 4973 and 4980A,2 in the total amount of

$89,740.84. The deficiency in income tax includes the 10-percent

additional tax imposed by section 72(t) on early distributions

from qualified retirement plans.

The pivotal issue for decision is whether the distribution

received by petitioner Glenn L. Wittstadt in 1989 from the

Maryland State Teachers' Retirement System qualifies for tax-free

rollover treatment under section 402(a)(5). The resolution of

this issue turns on whether the distribution constitutes a

"partial distribution" as defined by section 402(a)(5)(D)(i).

If we conclude that the distribution in question does not

qualify for tax-free rollover treatment, then we must also

1

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the taxable year in

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

2

Sec. 4973 imposes a 6-percent excise tax on excess

contributions to individual retirement accounts. Sec. 4980A

imposes a 15-percent excise tax on excess distributions from

qualified retirement plans. Both of these taxes are included

within ch. 43 of the Internal Revenue Code. They are therefore

subject to the deficiency procedures set forth in subch. B of ch.

63 of the Internal Revenue Code. See sec. 6211(a).

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decide: (1) Whether petitioners are liable for the 10-percent

additional tax under section 72(t), and (2) whether petitioner

Glenn L. Wittstadt is liable for either the 6-percent excise tax

under section 4973 or the 15-percent excise tax under section

4980A.3

FINDINGS OF FACT

Petitioners resided in Edgewood, Maryland, at the time their

petition was filed with the Court.

Petitioner Glenn L. Wittstadt (petitioner) served as a

teacher in the Baltimore County Public Schools for 31 years. For

most of those 31 years, petitioner was a member of the Teachers'

Retirement System of the State of Maryland (the Retirement

System).

On June 6, 1989, petitioner completed and submitted the

forms necessary to: (1) Transfer (the transfer) from the

Retirement System to the Teachers' Pension System of the State of

Maryland (the Pension System),4 and (2) retire from service as a

teacher. The transfer became effective sometime before July 1,

1989. Petitioner's retirement became effective as of July 1,

3

Respondent concedes that petitioner Lynne M. Wittstadt is

not liable for any deficiency in excise tax under either sec.

4973 or 4980A.

4

For a discussion of the Retirement System and the Pension

System, see generally Hylton v. Commissioner, T.C. Memo. 1995-27;

Hoppe v. Commissioner, T.C. Memo. 1994-635; Hamilton v.

Commissioner, T.C. Memo. 1994-633; Maryland State Teachers

Association v. Hughes, 594 F. Supp. 1353, 1357-1358 (D. Md.

1984).

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1989. At the time of his retirement, petitioner was 54 years

old.

The Retirement System is a qualified defined benefit plan

under section 401(a). The Retirement System requires mandatory

nondeductible employee contributions. The Pension System is also

a qualified defined benefit plan under section 401(a) but

generally does not require mandatory nondeductible employee

contributions. The State of Maryland contributes to both the

Retirement System and the Pension System on behalf of the members

of those systems. The trusts maintained as part of the

Retirement System and the Pension System are both exempt from

taxation under section 501(a).

After the transfer, but before petitioner's retirement, the

Retirement System issued a check to petitioner in the amount of

$216,831.98 (the Transfer Refund).5 The Transfer Refund

consisted of $32,043.53 in previously taxed contributions made by

petitioner during his employment tenure as a teacher, $183,205.77

of earnings, and "pick-up contributions" of $1,582.68. See sec.

414(h). The earnings and "pick-up contributions" constitute the

taxable portion of the Transfer Refund.6

5

We view as legally irrelevant the fact that payment was

stopped on the Transfer Refund check because it was never

received, and that a second check for the same amount was issued

in Sept. 1989 after petitioner retired.

6

The sum of the earnings ($183,205.77) and "pick-up

contributions" ($1,582.68) equals $184,788.45. In the notice of

(continued...)

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If petitioner had not transferred to the Pension System but

rather had remained a member of the Retirement System, he would

have been entitled to retire and receive a normal service

retirement benefit, including a regular monthly annuity. He

would not, however, have been entitled to receive a transfer

refund because a transfer refund is only payable to those who

elect to transfer from the Retirement System to the Pension

System.

As a member of the Pension System, petitioner receives a

retirement benefit based upon his salary and his creditable years

of service, specifically including those years of creditable

service recognized under the Retirement System. However, due to

petitioner's receipt of the Transfer Refund, petitioner's monthly

annuity is less than the monthly annuity he would have received

if he had not transferred to the Pension System but had retired

under the Retirement System.

The Transfer Refund was mailed, in the form of a check, to

T. Rowe Price, a mutual fund in Baltimore, Maryland, and

deposited into an IRA account in petitioner's name in accord with

a Limited Power of Attorney for Bank to Accept Deposit of Refund

Check.

On their Federal income tax return for 1989, petitioners did

not report any part of the Transfer Refund as income. In the

6

(...continued)

deficiency, however, this total is shown as $184,787.54.

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notice of deficiency, respondent determined that the Transfer

Refund was not eligible for tax-free rollover treatment under

section 402(a)(5). Therefore, respondent determined that, under

sections 402(a)(1) and 72, the taxable portion of the Transfer

Refund was includable in petitioners' gross income. As

corollaries to this determination, respondent also determined

that petitioners are liable for: (1) The 10-percent additional

tax under section 72(t), (2) the excise tax under section 4973 on

excess contributions to individual retirement accounts, and (3)

the excise tax under section 4980A for excess distributions from

qualified retirement plans.7

OPINIONOPINION

I. Rollover Issue

Petitioners contend that the Transfer Refund received by

petitioner from the Retirement System was paid "on account of

[petitioner's] separation from the service" within the meaning of

section 402(e)(4)(A)(iii). Respondent contends to the contrary.

The parties agree that our resolution of this matter will dictate

whether or not the Transfer Refund qualifies as a partial

distribution eligible for rollover treatment under section

402(a)(5)(D) and consequently whether or not petitioners are

liable for the deficiency that respondent determined.

7

See supra note 3 regarding respondent's concession as to

petitioner Lynne M. Wittstadt.

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A "partial distribution" is defined as "any distribution to

an employee of all or any portion of the balance to the credit of

such employee in a qualified trust; except that such term shall

not include any distribution which is a qualified total

distribution". Sec. 402(a)(5)(E)(v). The parties agree that the

Transfer Refund was not a qualified total distribution.8

In order to be eligible for tax-free rollover treatment, the

"partial distribution" must be "payable as provided in clause

(i), (iii), or (iv) of subsection (e)(4)(A) (without regard to

the second sentence thereof)". Sec. 402(a)(5)(D)(i)(I). As

relevant herein, section 402(e)(4)(A) provides that a

distribution must be made either "(i) on account of the

employee's death", "(iii) on account of the employee's separation

from the service", or "(iv) after the employee has become

disabled". Petitioners do not contend that the Transfer Refund

was received either on account of petitioner's death or after any

disability. Therefore, our analysis is limited to section

402(e)(4)(A)(iii), i.e., the requirement that the distribution be

made "on account of the employee's separation from the service".

8

See Humberson v. Commissioner, T.C. Memo. 1995-470;

Pumphrey v. Commissioner, T.C. Memo. 1995-469; Dorsey v.

Commissioner, T.C. Memo. 1995-97; Brown v. Commissioner, T.C.

Memo. 1995-93; Hoppe v. Commissioner, T.C. Memo. 1994-635;

Hamilton v. Commissioner, T.C. Memo. 1994-633; Sites v. United

States, 75 AFTR 2d 95-2503 at 95-2507, 95-1 USTC par. 88,029 (D.

Md. 1995).

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The phrase "on account of" is not defined in either the

Internal Revenue Code or in the accompanying regulations.9 See

Burton v. Commissioner, 99 T.C. 622, 626 (1992). The burden of

proving that the Transfer Refund was received "on account of"

petitioner's separation from the service is on petitioners. Rule

142(a); Burton v. Commissioner, supra at 632; Sarmir v.

Commissioner, 66 T.C. 82, 88 (1976). This burden is particularly

heavy because we have recently held, in a case involving

virtually identical facts and circumstances, that a taxpayer's

receipt of a distribution from the Retirement System upon

transferring to the Pension System was not received on account of

his retirement but rather on account of the transfer from the

Retirement System to the Pension System. Hylton v. Commissioner,

T.C. Memo. 1995-27; see also Adler v. Commissioner, T.C. Memo.

1995-148 (involving a transfer from the Maryland State Employees'

Retirement System to the Maryland State Employees' Pension

System), on appeal (4th Cir., June 29, 1995).10

9

The definition provided by the dictionary, "by reason of"

or "because of", is not enlightening in this instance. See

Webster's Third New International Dictionary (1981).

10

The plan provisions of the Maryland State Employees'

Retirement System and the Maryland State Employees' Pension

System are set forth in secs. 1 through 80 and secs. 111 through

129, respectively, of Article 73B of the Annotated Code of

Maryland. The plan provisions of the Maryland State Teachers'

Retirement System and the Maryland State Teachers' Pension System

are set forth in secs. 81 through 104 and secs. 140 through 155,

respectively, of Article 73B of the Annotated Code of Maryland.

The secs. governing the foregoing two Retirement Systems contain

(continued...)

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In 1979, the Maryland State legislature (the legislature)

adopted legislation, effective January 1, 1980, that created the

Pension System and enabled participants in the Retirement System

to voluntarily transfer to the Pension System.11 See Md. Ann.

Code, art. 73B, secs. 83(8), 86B(6), 89(1)(e), 141, 142 (1988).

Petitioners' principal contention is as follows:

Petitioner's election to receive a lump sum

distribution of his employee contribution was an

election made pursuant to the retirement policy legally

established by the Board [of Trustees for the Maryland

State Retirement and Pension Systems] and was not

pursuant to the statutory transfer option in Section

83(8).

According to petitioners' theory, this policy was specifically

designed to encourage retiring members of the Retirement System

to transfer to the Pension System.

Petitioners contend that petitioner did not satisfy the

predicate requirements to transferring from the Retirement System

to the Pension System imposed by Md. Ann. Code, art. 73B, sec.

10

(...continued)

virtually identical provisions authorizing distributions to

employees and teachers who choose to transfer from a retirement

system to a pension system. See Md. Ann. Code, art. 73B, secs.

11B(5), 14(1)(g) (1988), regarding the Maryland State Employees'

Retirement System; Md. Ann. Code, art. 73B, sec. 89(1)(e) (1988),

regarding the Maryland State Teachers' Retirement System.

11

The Pension System and the related transfer option to

that system from the Retirement System were created in part

because of concern about the actuarial integrity of the

Retirement System due in particular to the unlimited post-

retirement cost-of-living adjustments afforded those individuals

retiring under the Retirement System. See Hylton v.

Commissioner, T.C. Memo. 1995-27; Sites v. United States, 75 AFTR

2d 95-2503, 95-1 USTC par. 88,029 (D. Md. 1995).

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83(8) (1988), and therefore could only have transferred under a

policy established in accord with the enabling statute that

created the Board of Trustees for the Maryland State Retirement

and Pension Systems (the Board). Specifically, petitioners argue

that petitioner failed to initiate the transfer by filing the

appropriate election form at least 90 days prior to the date that

the transfer was to become effective, as required by Md. Ann.

Code, art. 73B, sec. 83(8) (1988); therefore, according to this

argument, petitioner was permitted to transfer to the Pension

System, and to receive the Transfer Refund, on account of his

retirement.

Petitioners' argument, while colorable, is not persuasive.

First, petitioner was the only witness at trial. Not only did he

fail to call any representative of the Maryland State Retirement

Agency or any member of the Board, but, more fundamentally, he

failed to persuade us of the existence of a policy in Maryland

whereby individuals could elect to transfer from the Retirement

System to the Pension System without satisfying the requirements

of Md. Ann. Code, art. 73B, sec. 83(8) (1988). Rule 142(a);

Burton v. Commissioner, supra at 632; Sarmir v. Commissioner,

supra at 88.

Moreover, petitioner testified that he was aware: (1) He

could have transferred from the Retirement System to the Pension

System at any time after 1979 and received a transfer refund; (2)

an election to transfer (and thereby receive a transfer refund)

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had to be made before retirement; and (3) he could have retired

without electing to transfer from the Retirement System to the

Pension System, under which circumstance he would not have

received a transfer refund. Therefore, even if such a policy did

exist, petitioner acknowledges that only an election to transfer

from the Retirement System to the Pension System was necessary in

order to receive a transfer refund. In other words, he need not

have retired. Accordingly, even under the policy that petitioner

argues existed, petitioner's Transfer Refund would have been

received on account of the election to transfer from the

Retirement System to the Pension System. This is consistent with

Md. Ann. Code, art. 73B, sec. 83(8) (1988), under which we find

petitioner transferred from the Retirement System to the Pension

System.

As we discussed in Hylton v. Commissioner, supra, and Adler

v. Commissioner, supra, there is no causal link under Maryland

law between a taxpayer's election to transfer from the Retirement

System to the Pension System and a taxpayer's election to retire.

Similarly, under Maryland law, there is no causal link between

the receipt of the Transfer Refund and a taxpayer's retirement.

No such causal link exists because a taxpayer is not obliged,

under Maryland law, to transfer from the Retirement System to the

Pension System either in order to continue working or in order to

retire. Similarly, under Maryland law, a taxpayer is not obliged

to retire upon electing to transfer from the Retirement System to

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the Pension System. In other words, petitioner could have

transferred from the Retirement System to the Pension System and

received the Transfer Refund at any time after 1979 during his

employment tenure with the State; he was under no obligation

whatsoever to retire solely by virtue of having transferred from

the Retirement System to the Pension System. E.g., Hamilton v.

Commissioner, T.C. Memo. 1994-633 (Baltimore County teacher who

elected to transfer from Retirement System to Pension System and

receive transfer refund in 1989 remained so employed at least

through date of trial in 1994); see Hoppe v. Commissioner, T.C.

Memo. 1994-635 (Maryland State employee who elected to transfer

from Employees' Retirement System Employees to Employees' Pension

System and receive transfer refund in 1989 remained so employed

at least through date of trial in 1994).

Upon electing to transfer from the Retirement System to the

Pension System and receiving the Transfer Refund, petitioner was

at liberty to dispose of the Transfer Refund as he saw fit. In

other words, Maryland law did not prescribe or otherwise limit

the options available to petitioner in disposing of the Transfer

Refund. Hylton v. Commissioner, supra.

Having considered all of petitioners' arguments and finding

them unpersuasive, we hold that petitioner did not receive the

Transfer Refund "on account of [petitioner's] separation from the

service". Rather, we hold that petitioner received the Transfer

Refund on account of his election to transfer from the Retirement

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System to the Pension System, an election that was unrelated to

petitioner's separation from the service.12

Having concluded that the Transfer Refund was not eligible

for tax-free rollover treatment under section 402(a)(5) as a

"partial distribution", we sustain respondent's income tax

determination for the taxable year in issue.

II. Section 72(t) Additional Tax Issue

We turn next to respondent's determination that petitioners

are liable for the 10-percent additional tax imposed by section

72(t).

Section 72(t) provides for a 10-percent additional tax on

early distributions from qualified retirement plans. Paragraph

(1), which imposes the tax, provides in relevant part as follows:

(1) Imposition of Additional Tax.--If any taxpayer

receives any amount from a qualified retirement plan

* * * , the taxpayer's tax under this chapter for the

taxable year in which such amount is received shall be

increased by an amount equal to 10 percent of the

portion of such amount which is includible in gross

income.

We have already sustained respondent's determination that

the taxable portion of the Transfer Refund is includable in

petitioners' gross income in the year of receipt. Because none

of the exceptions of section 72(t)(2)(A) apply to relieve

12

We acknowledge that petitioner elected to retire on the

same day that he elected to transfer from the Retirement System

to the Pension System. The temporal proximity of these

independent elections is not, however, relevant to our conclusion

of law. Adler v. Commissioner, supra; Hylton v. Commissioner,

supra.

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petitioners of this additional tax, we also sustain respondent's

determination that petitioners are liable for the 10-percent

additional tax imposed by section 72(t). See O'Connor v.

Commissioner, T.C. Memo. 1994-170; Wheeler v. Commissioner, T.C.

Memo. 1993-561; cf. Dorsey v. Commissioner, T.C. Memo. 1995-97;

Brown v. Commissioner, T.C. Memo. 1995-93.

III. Excise Tax Issues

Finally, we turn to respondent's excise tax determinations.

Section 4973(a) imposes a 6-percent excise tax on excess

contributions to an IRA. As relevant herein, an "excess

contribution" is the amount contributed in excess of the amount

allowable as a deduction under section 219, exclusive of amounts

properly rolled over tax free. Sec. 4973(b). As discussed

above, because petitioner's Transfer Refund was not eligible for

tax-free rollover treatment, so much of petitioner's IRA

contribution in 1989 as exceeds $2,000 is subject to the excise

tax under section 4973(a).

Section 4980A(a) imposes a 15-percent excise tax on excess

distributions from qualified retirement plans. As relevant

herein, an "excess distribution" is defined as the aggregate

amount of the retirement distributions with respect to any

individual during any calendar year to the extent that such

amount exceeds $150,000. Sec. 4980A(c)(1). Because petitioner's

Transfer Refund exceeded $150,000, petitioner is also subject to

this tax; however, petitioner is entitled to an offset for the

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amount of tax imposed by section 72(t) to the extent attributable

to the excess distribution. Sec. 4980A(b).

IV. Conclusion

In order to give effect to our disposition of the disputed

issues,

Decision will be entered

under Rule 155.