The opinion
T.C. Memo. 1999-161
UNITED STATES TAX COURT
ROBLENE, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 21576-95R. Filed May 13, 1999.
Paul M. Thielking, for petitioner.
Lawrence H. Ackerman, Judith M. Picken, and Gregory J.
Stull, for respondent.
MEMORANDUM OPINION
HAMBLEN, Judge: This is an action for a declaratory
judgment regarding the qualification of petitioner's employee
stock ownership plan and trust. On August 7, 1995, respondent
issued a final revocation letter to petitioner stating that the
Roblene, Inc. Employee Stock Ownership Plan (the ESOP) failed to
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meet the requirements of section 401(a)1 for the plan years
beginning after July 31, 1986, and that its related trust (the
trust) was not tax exempt under section 501(a) for trust years
ending with or within the affected plan years. Respondent also
revoked the prior determination letter to petitioner dated August
20, 1990.
The issue for decision is whether the ESOP violated the
qualification requirements of section 401(a)(16) in operation,
preventing its related trust from being exempt from income tax
under section 501(a), because amounts contributed to the trust
and allocated to the accounts of the ESOP's participants exceeded
the section 415 limitations for the limitation years that ended
July 31, 1987, through July 31, 1990.2
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code as in effect for the years in issue,
and all Rule references are to the Tax Court Rules of Practice
and Procedure.
2
We note that petitioner alleged, in its second amended
petition, that respondent issued the final revocation letter
after the expiration of the applicable statute of limitations.
We further note that petitioner abandoned this claim as
petitioner does not address this issue in its brief or in its
reply brief.
Moreover, the present action now before this Court is a
declaratory judgment action concerning the qualification of
petitioner's ESOP. This action does not involve the imposition
or collection of tax. There is no applicable statute of
limitations with regard to the issuance of revocation of
qualification letters, as they do not involve the imposition of
tax. Sec. 6501(a) provides:
(continued...)
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We hold that the commissions paid to Robert and Charlene
Peers as independent contractors are not includable in
"participant's compensation" for purposes of the section 415
limitations. Furthermore, we hold that the elective salary
deferrals are employer contributions and as such are not included
in "participant's compensation" for section 415 limitation
purposes. Consequently, we hold that the ESOP failed to meet the
requirements of section 401(a) for the plan years beginning after
July 31, 1986, and that the related trust is not a qualified
trust under section 401(a) for the plan years beginning after
July 31, 1986.
Background
Petitioner is an Iowa corporation with its principal place
of business located in Des Moines, Iowa, at the time of the
filing of the petition in this case. It filed its Federal tax
returns for the years in issue with the Internal Revenue Service
Center in Kansas City, Missouri. Petitioner maintains its tax
records on the accrual method of accounting with a fiscal year
ending July 31 as its taxable year.
2
(...continued)
(a) General Rule.--except as otherwise provided in this
section, the amount of any tax imposed by this title shall
be assessed within 3 years after the return was
filed * * * and no proceeding in court without
assessment for the collection of such tax shall be begun
after the expiration of such period.
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Petitioner was incorporated on August 9, 1985, and its
principal business activity is real estate sales. It is the
employer and plan administrator with respect to the ESOP, a
defined contribution plan. Petitioner established the ESOP and
the trust as of August 12, 1985, effective for plan years
beginning on and after August 12, 1985. The plan years and
limitation years of the ESOP and the trust are the fiscal years
ending July 31. Petitioner amended and restated the plan
document on November 7, 1989, effective August 1, 1989. On
August 20, 1990, respondent issued a favorable determination
letter to petitioner stating that the ESOP, as amended and
restated, was in form qualified under section 401(a) and
consequently the trust was entitled to tax exempt status under
section 501(a). This determination letter applied to plan
year(s) beginning after July 31, 1989.
The ESOP contains a salary reduction cash or deferred
arrangement feature, under which an ESOP participant is permitted
to reduce his cash compensation or to forgo an increase in cash
compensation conditioned upon the employer's making a pretax
contribution in the same amount to the ESOP to the participant's
account.
Apart from the 10 shares of petitioner's stock issued to
Robert and Charlene Peers on August 9, 1985, the ESOP's trust is
and has been the sole shareholder of petitioner since its
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incorporation on August 9, 1985. Petitioner issued shares of its
stock to the trust in payment of the contributions to the trust.
Robert and Charlene Peers were, during the taxable years
that ended July 31, 1987, through 1990, and are the founders and
sole officers of petitioner. Robert Peers was and is its
president, and Charlene Peers was and is the trustee of the
ESOP's trust. Robert and Charlene Peers also have been the only
participants in the ESOP.
Petitioner reported the following deductions on its U.S.
Corporation Income Tax Returns, Forms 1120:
Pension
Compensation Salaries Profit-sharing,
of Officers and Wages etc., plans
Year (Line 12) (Line 13) (Line 24)
1987 $0 $801.01 $45,000
1988 0 0 17,000
1989 0 0 10,050
1990 0 0 9,870
The deductions for "Pension, Profit-sharing, etc., plans" were
reflected as contributions to the trust in the trust's Forms
5500-C, Return/Report of Employee Benefit Plan, for each of such
years.
In addition, petitioner included the following commissions,
paid to nonemployees who were treated by petitioner as
independent contractors, on line 26, "Other deductions":
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Year Commissions
1987 $45,000
1988 68,000
1989 67,000
1990 65,800
Robert and Charlene Peers filed joint U.S. Individual Income
Tax Returns. Their returns reflect the following:
Wages, Salaries, Business Principal
Year tips, etc. Income Business
(Form 1040-Line 7) (Schedule C) (Schedule C)
1987 $0 $32,922 --
1988 0 53,718 Real Estate Sales
1989 31,426.65 57,271.12 Real Estate Sales
1990 40,040 60,543 Realtor
For 1989, we note that no W-2 is included in the record to
determine the source of the $31,426.65 of salaries and wages.
Since petitioner paid $0 in compensation to officers and $0 in
salaries and wages for 1988, 1989, and 1990, it would appear that
this income is from another employer. For 1990, a Form W-2 is
attached to the tax return of Robert and Charlene Peers
indicating that First Realty Ltd. paid $40,040 to Robert and
Charlene Peers.
Discussion
Prior to discussing the respective arguments of the parties
regarding the qualification of petitioner's ESOP as exempt from
taxation, a brief summary of the pertinent statutes is helpful.
Section 501(a) provides that a trust described in section 401(a)
is generally exempt from taxation. Section 401(a) discusses the
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requirements that a trust must meet in order to constitute a
"qualified trust," and sets forth certain restrictions that
preclude qualification of a trust. Section 401(a)(16) sets forth
the restriction in issue in the instant case. Section 401(a)(16)
provides:
A trust shall not constitute a qualified trust under
this section if the plan of which such trust is a part
provides for benefits or contributions which exceed
the limitations of section 415.
Section 415(a)(1) provides that a trust which is part of a
pension, profit-sharing, or stock bonus plan shall not constitute
a qualified trust under section 401(a) if--
(B) in the case of a defined contribution plan,
contributions and other additions under the plan
with respect to any participant for any taxable
year exceed the limitation of subsection (c) * * *
Section 415(c)(1) provides:
(1) In general.--Contributions and other additions with
respect to a participant exceed the limitation of this
subsection if, when expressed as an annual addition (within
the meaning of paragraph (2)) to the participant's account,
such annual addition is greater than the lesser of--
(A) $30,000,[3] or
(B) 25 percent of the participant's compensation.
3
Sec. 415(c)(1)(A) was amended by the Tax Reform Act of 1986
(TRA 1986), Pub. L. 99-514, sec. 1106(a), 1106(i), 100 Stat.
2420, 2425, effective for years beginning after Dec. 31, 1986, to
read $30,000 (or, if greater, 1/4 of the dollar limitation
[$90,000] in effect under subsection (b)(1)(A))". It was further
amended to eliminate the parenthetical language effective for
years commencing after Dec. 31, 1994. See Uruguay Round
Agreements Act, Pub. L. 103-465, sec. 732(b)(2), 108 Stat. 5005
(1994).
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Section 415(c)(2) provides that "annual addition" means the
sum for any year of--:
(A) employer contributions,
(B) the lesser of--
(i) the amount of the employee contributions in
excess of 6 percent of his compensation, or
(ii) one-half of the employee contributions,[4]
and
(C) forfeitures.
The dispute in this case focuses on whether amounts
contributed to the trust and allocated to the accounts of Robert
and Charlene Peers exceeded the section 415 limitations. The
parties disagree as to what constitutes "participant's
compensation" for purposes of section 415 and as to whether
elective salary deferrals constitute employee or employer
contributions.
Petitioner asserts that the commissions it paid Robert and
Charlene Peers as independent contractors constitute
"participant's compensation" for purposes of section 415.
Petitioner also asserts that the amounts of elective salary
deferrals are employee contributions and should be included in
"participant's compensation." Thus, petitioner maintains that
the limitations of section 415(c)(1) have not been exceeded with
4
Sec. 415(c)(2)(B) was amended by the TRA 1986 sec.
1106(e)(1), 1106(i), 100 Stat. 2424, 2425, for the years
beginning after Dec. 31, 1986, to include the entire employee
contribution in the computation of the annual addition.
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the result that the ESOP and trust were qualified during the
years at issue.
Petitioner asserts, in its brief, that the participant's
compensation, contributions to the ESOP, and annual additions are
as follows:
Year Participant's Annual
Ended Compensation Contributions Additions
7/31/87
Commissions $45,000
Elective
Deferrals 45,000 $45,000 $22,500
90,000 22,500 sec. 415
limit
0 Excess
7/31/88
Commissions $68,000 $10,000
Elective
Deferrals 7,000 7,000 $17,000
75,000 17,000 17,000 sec. 415
limit
0 Excess
7/31/89
Commissions $67,000 $10,050 $10,050
16,750 sec. 415
limit
(6,700) Excess
7/31/90
Commissions $65,800 $9,870 $9,870
(6,700) prior year
excess
3,170 net annual
additions
16,450 sec. 415
limit
(13,280) Excess
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We note that petitioner included only one-half of the elective
deferrals in "Annual Additions" for the year ended July 31, 1987,
since petitioner asserts the elective deferrals are employee
contributions and not employer contributions. We also note that
petitioner computed the section 415 limit for the year ended July
31, 1988, based only on the commissions ($68,000 × 25 percent).
For the year ended July 31, 1987, however, petitioner based the
section 415 limit on both the commissions and elective deferrals
($90,000 × 25 percent).
Respondent contends that the commissions petitioner paid to
Robert and Charlene Peers did not constitute "participant's
compensation" for purposes of section 415. Furthermore,
respondent asserts that elective salary deferrals constitute
employer, not employee, contributions and thus, cannot be
included in "participant's compensation" for purposes of
calculating section 415 limitations. Consequently, respondent
contends that the limits of section 415(c)(1) were exceeded, and
the ESOP and trust were not qualified during the years at issue.
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Respondent asserts that the participant's compensation,
contributions to the ESOP, and annual additions are as follows:
Year Participant's Annual
Ended compensation Contributions additions
7/31/87
Commissions
Charlene Peers $0
Robert Peers 0
0
Elective
Deferrals
Charlene Peers $0 $22,500 $22,500
Robert Peers 0 22,500 22,500
0 45,000 45,000
0 sec. 415
limit
45,000 Excess
7/31/88
Commissions
Charlene Peers $0
Robert Peers 0
0
Elective
Deferrals
Charlene Peers $0 $8,500 $8,500
Robert Peers 0 8,500 8,500
0 17,000 17,000
0 sec. 415
limit
17,000 Excess
1
62,000 Cum.
excess
7/31/89
Commissions
Charlene Peers $0 $5,025 $5,025
Robert Peers 0 5,025 5,025
0 10,050 10,050
0 sec. 415
limit
10,050 Excess
2
72,050 Cum.
excess
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7/31/90
Commissions
Charlene Peers $0 $4,935 $4,935
Robert Peers 0 4,935 4,935
0 9,870 9,870
0 sec. 145
limit
9,870 Excess
3
81,920 Cum.
excess
1
This represents the cumulative excess in the trust for both
participants.
2
See supra note 1.
3
See supra note 1.
We note that respondent included the full amount of elective
deferrals as "Annual Additions" for the year ended July 31, 1987,
since respondent asserts the elective deferrals are employer
contributions, and not employee contributions.
Respondent contends that for the limitation years ended July
31, 1987, 1988, 1989, and 1990, the section 415 limitations were
exceeded in the respective amounts of $22,500, $31,000, $36,025,
and $40,960 for each participant.
I. Commissions
Petitioner seeks to include in "participant's compensation"
the amounts that petitioner paid Robert and Charlene Peers as
independent contractors for the years ended July 31, 1987,
through 1990. Petitioner's corporate income tax returns, Forms
1120, for the years that ended July 31, 1987, through 1990,
indicate that the compensation paid to the officers for each year
was zero dollars. These returns also indicate that during the
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same period the salaries and wages paid to employees for each
year was zero dollars, with the exception of 1987 in which
petitioner reported $801.01 as salaries and wages. Thus,
petitioner reported that it did not pay either Robert or Charlene
Peers any compensation for their services as officers of
petitioner, and that petitioner paid only $801.01 as salaries and
wages for the years at issue.
Rather than treating the remuneration of Robert and Charlene
Peers as compensation paid to officers or as salaries and wages
paid to employees, petitioner treated payments to the Peerses as
commissions paid to independent contractors. Petitioner's
corporate income tax returns, Forms 1120, for the years at issue,
indicate that the commissions paid to nonemployees who were
treated by petitioner as independent contractors for each year
were as follows:
Year Commissions
1987 $45,000
1988 68,000
1989 67,000
1990 65,800
We note that petitioner alleged no facts in its petition, its
amended petition, or its second amended petition to challenge the
treatment of the amounts as payments to independent contractors,
which treatment was clearly described in respondent's final
revocation letter.
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Section 415(c)(3)(A) defines "participant's compensation" as
"the compensation of the participant from the employer for the
year." Petitioner argues that Robert and Charlene Peers'
respective compensation was their earned income as self-employed
persons. In advancing its argument that the self-employment
income, which Robert and Charlene Peers reported on their
Schedule C, constitutes "participant's compensation" for purposes
of determining the section 415 limitations of the ESOP,
petitioner cites a portion of a pre-ERISA regulation in the
following manner:
Treatment of a self-employed individual as an employee.
(1) For purposes of section 401, a self-employed
individual who receives earned income from an
employer during a taxable year of such employer
beginning after December 31, 1962, shall be
considered an employee of such employer for such
taxable year. * * * [Sec. 1.401-10(b)(1), Income Tax Regs.]
Petitioner is correct that for a self-employed individual
"participant's compensation" is the participant's earned income.
See sec. 415(c)(3)(B). What petitioner fails to recognize is
that a sole proprietor is considered to be his own employer. See
Howard E. Clendenen, Inc. v. Commissioner, T.C. Memo. 1998-318.
Section 401(c)(4) provides that "An individual who owns the
entire interest in an unincorporated trade or business shall be
treated as his own employer." Furthermore, the definition of
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employer set forth in section 1.401-10(e), Income Tax Regs.,
provides:
(e) Definition of employer. (1) For purposes of section 401,
a sole proprietor is considered to be his own employer, and
the partnership is considered to be the employer of
each of the partners. * * *
The Peerses received their remuneration as independent
contractors. Petitioner reported the commissions paid to the
Peerses on its corporate income tax returns, Forms 1120, not as
line 12, "Compensation of officers", or as line 13 "Salaries and
wages". Rather, petitioner included the commissions on line 26,
"Other deductions". Likewise, the Peerses reported the
commissions on their Schedule C for each of the years at issue as
independent contractors and enjoyed the ability to offset that
income with deductions unreduced by the 2 percent of adjusted
gross income offset applicable to miscellaneous deductions on
Schedule A.
Petitioner paid the Peerses as independent contractors. The
direct consequence of structuring its affairs in this manner, is
that the remuneration which Robert and Charlene Peers received
from the petitioner as independent contractors, which they
reported on Schedule C, does not constitute "participant's
compensation" for purposes of computing the section 415
limitations for each of the limitation years at issue.
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II. Elective Deferrals
Petitioner argues that the amounts of the elective salary
deferrals, which the participant chose not to receive as cash but
rather to have contributed to the ESOP, are employee
contributions and are includable in "participant's compensation".
Robert and Charlene Peers elected salary deferrals for the 1987
and 1988 taxable years in the respective amounts of at least
$45,000 and $7,000.5
Section 402(a)(8)6 provides:
(8) Cash or deferred arrangements.--For purposes of this
title, contributions made by an employer on behalf of an
employee to a trust which is a part of a qualified cash or
deferred arrangement(as defined in section 401(k)(2)) shall
not be treated as distributed or made available to the
employee nor as contributions made to the trust by the
employee merely because the arrangement includes provisions
under which the employee has an election whether the
contribution will be made to the trust or received by the
employee in cash.
In addition, section 1.415-2(d)(2)(i),7 Income Tax Regs.,
provides that compensation does not include:
5
We note that respondent contends that Robert and Charlene
Peers elected $17,000 in elective salary deferrals for 1988.
This difference is immaterial to the outcome.
6
Sec. 402 was amended by sec. 521(a) of the Unemployment
Compensation Amendments of 1992, Pub. L. 102-318, 106 Stat. 290,
300-310. The above-quoted language is currently found in sec.
402(e)(3).
7
This provision was renumbered as sec. 1.415-2(d)(3)(i),
Income Tax Regs., effective for years after Jan. 1, 1987. See
T.D. 8361, 1991-2 C.B. 310, 318.
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Contributions made by the employer to a plan of
deferred compensation to the extent that, before
the application of the section 415 limitations to
that plan, the contributions are not includible in
the gross income of the employee for the taxable
year in which contributed.
Furthermore, section 1.401(k)-1(a)(4)(ii), Income Tax Regs.,
provides:
(ii) Treatment of elective contributions as employer
contributions. Except as provided in paragraph (f) of
this section, [dealing with the correction of excess
contributions] elective contributions under a qualified
cash or deferred arrangement are treated as employer
contributions. Thus, for example, elective contributions
are treated as employer contributions for purposes of
sections 401(a) and 401(k), 402, 404, 409, 411, 412, 415,
416, and 417.
The issue in respect of elective deferrals has been before
this Court under substantially identical circumstances. See
Howard E. Clendenen, Inc. v. Commissioner, T.C. Memo. 1998-318;
Steel Balls, Inc. v. Commissioner, T.C. Memo. 1995-266, affd. per
curiam without published opinion 89 F.3d 841 (8th Cir. 1996).8
We rejected the same arguments presented herein and concluded
that respondent's position was clearly supported by the statute
8
The Small Business Job Protection Act of 1996, Pub. L. 104-
188, sec. 1434(a), 110 Stat. 1807, added sec. 415(c)(3)(D) which
includes certain deferrals in participant's compensation,
effective for years beginning after Dec. 31, 1997. This
amendment does not apply to the instant case. We note, however,
that the legislative history makes clear that Congress considered
the provisions of the then-existing law as requiring the result
reached herein and specifically intended to change the law for
future years. See H. Rept. 104-586 at 112 (1996), 1996-3 C.B.
331, 450; S. Rept. 104-281 at 80 (1996); H. Conf. Rept. 104-737
at 245-246 (1996), 1996-3 C.B. 741, 985-986.
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and regulations. We reach the same conclusion herein and hold
that the elective deferrals are employer contributions and not
included in "participant's compensation". Since the elective
deferrals are employer contributions, the full amounts of the
elective deferrals are included in annual additions.9 See sec.
415(c)(2).
III. Conclusion
We now determine whether the annual additions on behalf of
Robert and Charlene Peers exceed the section 415(c) limitations.
We hold that the commissions paid to Robert and Charlene Peers as
independent contractors are not includable in "participant's
compensation" for purposes of the section 415 limitations.
Furthermore, we hold that the elective salary deferrals are
employer contributions and are not included in "participant's
compensation" for section 415 limitation purposes. The record is
not clear as to the exact amounts of salaries and wages paid to
Robert and Charlene Peers for the year ended July 31, 1987.10 We
9
For the year ended July 31, 1987, no more than one-half of
the employee contribution would have been included. See sec.
415(c)(2)(B); supra note 4.
10
The amount deducted by petitioner for "Salaries and wages"
($801.01) for the taxable year ending July 31, 1987, does not
match that reported by Robert and Charlene Peers as "Wages,
Salaries, tips, etc." ($0) on their joint individual income tax
returns for their taxable year ending Dec. 31, 1987. While this
could be due to the different tax years involved (year ending
July 31 versus Dec. 31), respondent, in the revocation letter and
(continued...)
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need not make any findings with respect to the exact figures,
however, for regardless of which amount we use, the annual
additions allocated to Robert and Charlene Peers during each of
the plan years that ended July 31, 1987, through July 31, 1990,
clearly exceed the section 415 limitations. Petitioner has not
argued or established that any corrective measures were taken to
reduce these additions. See sec. 1.415-6(b)(6), Income Tax Regs.
Consequently, we hold that the ESOP failed to meet the
requirements of section 401(a) for the plan years beginning after
July 31, 1986, and that the related trust is not a qualified
trust under section 401(a) for the plan years beginning after
July 31, 1986.
Decision will be entered
for respondent.
10
(...continued)
in his briefs, uses the $0 figure appearing on Robert and
Charlene Peers' individual return.