The opinion
T.C. Memo. 2016-10
UNITED STATES TAX COURT
FAMILY CHIROPRACTIC SPORTS INJURY & REHAB CLINIC, INC.,
Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 29613-13R. Filed January 19, 2016.
Richard W. Leavitt (an officer) and Mark Eldridge (trustee), for petitioner.
Shawn P. Nowlan, for respondent.
MEMORANDUM OPINION
DAWSON, Judge: In this declaratory judgment proceeding under section
74761 petitioner challenges respondent’s September 16, 2013, final revocation
1
Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the period under consideration, and all Rule references
(continued...)
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[*2] letter determining that for its plan year ending June 30, 2003, and its
subsequent plan years, the Family Chiropractic Sports Injury & Rehab Clinic, Inc.
Employee Stock Ownership Plan (ESOP or plan) was not qualified under section
401(a) and that the related trust was not exempt from taxation under section
501(a). On brief respondent has limited his position to relying solely on the
ESOP’s qualification for its plan year ending June 30, 2010 (2010 plan year), and
subsequent plan years.2
The issue before us is whether there was an abuse of discretion in
respondent’s determination. To decide that question, we consider whether for its
2010 plan year and subsequent plan years the ESOP: (1) failed in operation to
satisfy the antialienation requirements of section 401(a)(13) and section 1.401(a)-
1
(...continued)
are to the Tax Court Rules of Practice and Procedure.
2
Respondent’s opening brief provides the following explanation:
The Certified Administrative Record contains references to several
other potential failures under I.R.C. sec. 401(a) that potentially
afflicted the ESOP in various plan years.
The respondent has written this brief to highlight and rely upon the
strongest and most unambiguous of these failures, and does not now
intend to argue about ESOP qualification in tax and/or plan years
other than the year ending June 30, 2010. Any other matters
discussed in the Certified Administrative Record are deemed waived
by the respondent.
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[*3] 13(b), Income Tax Regs. (when it transferred a participant’s fully vested plan
benefits) and (2) failed to follow its plan document in operation as required by
section 1.401-1(a)(2) and (b)(3), Income Tax Regs. (when it transferred a
participant’s fully vested plan benefits). As explained hereinafter, we conclude
that there was no abuse of discretion in respondent’s determination.
Background
The parties filed a joint motion to submit this case for decision under Rule
122. We granted the motion and decide this case on the basis of the pleadings and
the administrative record. See Rule 217(b)(2). We incorporate the administrative
record herein.
Family Chiropractic Sports Injury & Rehab Clinic, Inc., and the ESOP
Richard W. Leavitt (Richard) is a chiropractor. He married Heidi J. Westra
Leavitt (Heidi) on September 8, 1995. On October 21, 1999, Richard:
(1) incorporated Family Chiropractic Sports Injury & Rehab Clinic, Inc. (Family
Chiropractic), which elected to be taxed as an S corporation,3 in Iowa and
3
Family Chiropractic terminated the small business corporation election
effective July 1, 2005, becoming a “C” corporation.
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[*4] (2) established Family Chiropractic’s ESOP.4 Both Family Chiropractic and
the ESOP operate on a fiscal year ending June 30.
When it filed its timely petition, Family Chiropractic’s principal place of
business was in Iowa.
Richard and Heidi were full-time Family Chiropractic employees and were
the ESOP’s sole participants. Richard was Family Chiropractic’s president, and
Heidi was its director, vice president, and secretary.5
Under its articles of incorporation, Family Chiropractic is authorized to
issue two classes of common stock, class A and class B. Class A and class B
shareholders have equal voting rights, and both classes of stock have a par value
of $10 per share. Heidi and Richard jointly held one share of class A stock. As of
June 30, 2009, the individual separate ESOP accounts of Heidi and Richard each
held 14.95 shares of class B stock.
Plan Provisions
Family Chiropractic created the ESOP, designed to invest primarily in
Family Chiropractic’s qualified securities, for the benefit of its employees. Since
4
The trust agreement for the ESOP was later amended effective July 1, 2005.
5
Initially Heidi Westra Leavitt was the ESOP’s trustee. On December 27,
2005, Ryan Eldridge became the ESOP’s trustee. On July 1, 2008, Mark Eldridge
became the ESOP’s trustee.
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[*5] the inception of the plan in 1999, the only asset in the ESOP has been Family
Chiropractic’s stock. The applicable provisions in the plan document are as
follows:
7.4 DETERMINATION OF BENEFITS UPON TERMINATION
(a) If a Participant’s employment with the Employer is
terminated for any reason other than death or retirement, then such
Participant shall be entitled to such benefits as are provided
hereinafter pursuant to this Section 7.4.
If a portion of a Participant’s Account is forfeited,
Company Stock allocated to the Participant’s Company Stock
Account must be forfeited only after the Participant’s Other
Investments Account has been depleted. * * *
Distribution of the funds due to a Terminated Participant
shall be made on the occurrence of an event which would result
in the distribution had the Terminated Participant remained in
the employ of the Employer (upon the Participant’s death or
Normal Retirement). However, at the election of the
Participant, the Administrator shall direct the Trustee that the
entire Vested portion of the Terminated Participant’s Account
to be payable to such Terminated Participant as soon as
administratively feasible after termination or employment.
***
(b) The Vested portion of any Participant’s Account shall be a
percentage of the total amount credited to the Participant’s Account
determined on the basis of the Participant’s number of Years of
Service according to the following schedule:
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[*6] Vesting Schedule
Years of Service Percentage
Less than 2 0%
2 20%
3 40%
4 60%
5 80%
6 100%
* * * * * * *
(e) A Participant with at least (3) Years of Service as of the
expiration date of the election period may elect to have the
nonforfeitable percentage computed under the Plan without regard to
such amendment and restatement. If a Participant fails to make such
election, then such Participant shall be subject to the new vesting
schedule. The Participant’s election period shall commence on the
adoption date of the amendment and shall end 60 days after the latest
of:
(1) the adoption date of the amendment,
(2) the effective date of the amendment, or
(3) the date the Participant receives written notice of the
amendment from the Employer or Administrator. * * *
7.5 DISTRIBUTION OF BENEFITS
(a) The Administrator, pursuant to the election of the
Participant, shall direct the Trustee to distribute to a Participant or
such Participant’s Beneficiary any amount to which the Participant is
entitled under the Plan in one or more of the following methods:
(1) One lump-sum payment.
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[*7] (2) Payments over a period certain in monthly, quarterly,
semiannual, or annual installments. The period over which
such payment is to be made shall not extend beyond the earlier
of the Participant’s life
expectancy * * *.
* * * * * * *
11.2 ALIENATION
(a) Subject to the exceptions provided below, and as otherwise
permitted by the Code and Act, no benefit which shall be payable out
of the Trust Fund to any person (including a Participant or the
Participant’s Beneficiary) shall be subject in any manner to
anticipation, alienation, sale, transfer, assignment, pledge,
encumbrance, or charge, and any attempt to anticipate, alienate, sell,
transfer, assign, pledge, encumber, or charge the same shall be void;
and no such benefit shall in any manner be liable for, or subject to,
the debts, contracts, liabilities, engagements, or torts of any such
person, nor shall it be subject to attachment or legal process for or
against such person, and the same shall not be recognized by the
Trustee, except to such extent as may be required by law.
(b) Subsection (a) shall not apply to a “qualified domestic
relations order” defined in Code Section 414(p), and those other
domestic relations orders permitted to be so treated by the
Administrator under the provisions of the Retirement Equity Act of
1984. The Administrator shall establish a written procedure to
determine the qualified status of domestic relations orders and to
administer distributions under such qualified orders. Further, to the
extent provided under a “qualified domestic relations order,” a former
spouse of a Participant shall be treated as the spouse or surviving
spouse for all purposes under the Plan.
On June 12, 2003, the Internal Revenue Service sent a favorable
determination letter regarding the ESOP.
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[*8] Divorce and Reallocation of ESOP Shares
On April 5, 2007, Richard and Heidi divorced. Pursuant to the final divorce
decree filed in the Seventh Judicial District Court, County of Muscatine, State of
Iowa, each was awarded 50% of Family Chiropractic’s shares of stock, ownership,
and management.6 The decree is silent as to the ESOP.
As reflected in several corporate documents, on May 27, 2009, Heidi agreed
to “relinquish her retirement value” in the ESOP “in accordance with the divorce
decree” and resigned as Family Chiropractic’s director, vice president, and
secretary. As of June 30, 2009, the ESOP’s summary of participant accounts
reflected that each ESOP account of Heidi and Richard included 14.95 class B
stock shares at a total value of $286,904.53 and that all the shares were 100%
vested.7 Heidi’s ESOP shares were subsequently reallocated to Richard’s account,
as recorded in the June 30, 2010, report, rendering her account with zero shares
6
The divorce decree states in relevant part:
9. Family Chiropractic Sports Injury and Rehab Clinic, P.C. Heidi
Westra Leavitt is awarded 50% of the shares of stock, ownership and
management of Family Chiropractic Sports Injury and Rehab Clinic,
P.C., and Richard Leavitt is awarded 50% of the shares of stock,
ownership and management of Family Chiropractic Sports Injury and
Rehab Clinic, P.C.
7
Heidi’s completion of more than six years of service rendered her 100%
vested pursuant to the plan.
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[*9] 0% vested. The June 30, 2010, report reflects that Richard had a
$482,851.138 account balance with 29.9 class B stock shares. During its 2010
plan year the ESOP did not distribute any assets to Heidi.
Family Chiropractic employed Heidi from its incorporation until June 27,
2009. Richard continued working for Family Chiropractic after Heidi’s
resignation.
Final Revocation Letter
On September 16, 2013, respondent issued a final revocation letter, Letter
1757, which revoked the favorable determination letter of June 12, 2003. The
explanation of revocation, which accompanied the final revocation letter,
described three bases leading to the revocation of the ESOP’s qualified status
under section 401(a): (1) the 2010 reallocation of shares from Heidi’s ESOP
account to Richard’s ESOP account caused the ESOP to fail the section 401(a)(13)
requirements for its 2010 plan year and for all subsequent plan years; (2) by
transferring Heidi’s ESOP benefit to Richard at her termination, the ESOP failed
to follow its written terms in operation and therefore failed to be a qualified plan
within the meaning of section 401(a) for its 2010 plan year and for all subsequent
8
The final balance resulted from the beginning balance minus the stock
value losses for the year.
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[*10] plan years; and (3) the ESOP violated section 401(a)(16) by exceeding the
limits under section 415(c).9
Discussion
Section 7476(a) authorizes this Court to render the requested declaratory
judgment, subject to the limitations of subsection (b). Neither party disputes that
those limitations have been met in this case, and we are satisfied that we have
jurisdiction over the petition. See, e.g., Efco Tool Co. v. Commissioner, 81 T.C.
976 (1983).
In this declaratory judgment proceeding we review respondent’s
determination that the plan was not qualified. The standard for our review was
enunciated in Buzzetta Constr. Corp. v. Commissioner, 92 T.C. 641, 648 (1989),
as follows:
When reviewing discretionary administrative acts, however, this
Court may not substitute its judgment for that of the Commissioner.
The exercise of discretionary power will not be disturbed unless the
Commissioner has abused his discretion, i.e., his determination is
unreasonable, arbitrary, or capricious. Whether the Commissioner
has abused his discretion is a question of fact, and petitioner’s burden
of proof of abuse of discretion is greater than that of the usual
preponderance of the evidence. Estate of Gardner v. Commissioner,
82 T.C. 989, 1000 (1984); Oakton Distributors, Inc. v. Commissioner,
73 T.C. 182, 188 (1979).
9
Respondent subsequently conceded issue (3). See supra note 2.
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[*11] Further, “[i]n order for a plan to be qualified, both its terms and its
operations must meet the statutory requirements.” Id. at 646.
Respondent’s determination is presumed to be correct, and the burden of
proof is on Family Chiropractic. See Rule 142(a). To prevail, Family
Chiropractic must prove that respondent abused his discretion. See Buzzetta
Constr. Corp. v. Commissioner, 92 T.C. at 648. Family Chiropractic has failed to
do so.
Section 401(a) enumerates requirements which must be met in order for a
trust to be considered a qualified trust entitled to preferential tax treatment under
section 501(a). See Michael C. Hollen, D.D.S., P.C. v. Commissioner, T.C.
Memo. 2011-2, aff’d per curiam, 437 F. App’x 525 (8th Cir. 2011); Ronald R.
Pawlak, P.C. v. Commissioner, T.C. Memo. 1995-7. Its terms and its operations
must meet the statutory requirements. Buzzetta Constr. Corp. v. Commissioner,
92 T.C. at 646. If a qualified plan meets all of the section 401(a) requirements,
then the plan is exempt from taxation under section 501(a). See Michael C.
Hollen, D.D.S., P.C. v. Commissioner, T.C. Memo. 2011-2. We need not discuss
specifically the qualification of the related trust under section 501(a) because the
exemption of the trust under section 501(a) follows from the qualification of the
plan under section 401(a). See id.
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[*12] Failure to meet one of the section 401(a) requirements disqualifies the plan.
See, e.g., DNA Pro Venture, Inc. v. Commissioner, T.C. Memo. 2015-195.
A qualified plan must meet the section 401(a) requirements in both form
and operation. Ludden v. Commissioner, 620 F.2d 700, 702 (9th Cir. 1980), aff’g
68 T.C. 826 (1977); sec. 1.401-1(b)(3), Income Tax Regs. A form failure occurs
when a plan document does not contain required language or terms. See Michael
C. Hollen, D.D.S., P.C. v. Commissioner, T.C. Memo. 2011-2. An operational
failure occurs when: (1) a plan, in operation, does not meet the section 401(a)
requirements, see Martin Fireproofing Profit-Sharing Plan & Tr. v. Commissioner,
92 T.C. 1173 (1989), and (2) a plan fails to follow the terms of the plan document,
see Michael C. Hollen, D.D.S., P.C. v. Commissioner, T.C. Memo. 2011-2. A
plan that does not follow the terms of the plan document is not a “definite written
program” as required by section 1.401-1(a)(2), Income Tax Regs.
In general, a qualification failure pursuant to section 401(a) is a continuing
failure because allowing a plan to requalify in subsequent years would be to allow
a plan “to rise phoenix-like from the ashes of such disqualification and become
qualified for that year.” Pulver Roofing Co. v. Commissioner, 70 T.C. 1001, 1015
(1978); see also Martin Fireproofing Profit-Sharing Plan & Tr. v. Commissioner,
92 T.C. at 1184-1189.
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[*13] As explained below, the ESOP failed to satisfy the section 401(a)
requirement in two separate ways, either of which is sufficient for the plan to not
be qualified. See secs. 401(a), 4975(e)(7). Clearly, respondent has not abused his
discretion.
Whether the ESOP Failed the Sec. 401(a)(13) Prohibition on Assignment or
Alienation of Benefits
Section 401(a)(13)(A) states that “[a] trust shall not constitute a qualified
trust under this section unless the plan of which such trust is a part provides that
benefits provided under the plan may not be assigned or alienated.” See also sec.
1.401(a)-13(b)(1), Income Tax Regs. “Assignment” and “alienation” include any
arrangement providing for the payment to the employer of plan benefits which
otherwise would be due the participant under the plan and any direct or indirect
arrangement (revocable or irrevocable) whereby a party acquires from a
participant or beneficiary a right or interest enforceable against the plan in all or
any part of a plan benefit payment payable to a participant or beneficiary. See sec.
1.401(a)-13(c)(1), Income Tax Regs.
We clearly described the antialientation procedures under the Employee
Retirement Income Security Act of 1974 (ERISA), Pub. L. No. 93-406, 88 Stat.
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[*14] 829, 29 U.S.C. sec. 1001 (2006), and the Internal Revenue Code in Gallade
v. Commissioner, 106 T.C. 355, 361 (1996), as follows:
ERISA was enacted to establish “a comprehensive federal
scheme for the protection of pension plan participants and their
beneficiaries.” American Tel. & Tel. Co. v. Merry, 592 F.2d 118, 120
(2d Cir. 1979). ERISA was intended to assure that American workers
“may look forward with anticipation to a retirement with financial
security and dignity, and without fear that this period of life will be
lacking in the necessities to sustain them as human beings within our
society.” S. Rept. 93-127, at 13 (1974), 1974-3 C.B. (Supp.) 1, 13.
To this end, ERISA requires that plans provide that benefits may not
be assigned or alienated. H. Rept. 93-807, at 68 (1974), 1974-3 C.B.
(Supp.) 236, 303. This provision is included in both the I.R.C. and
ERISA section 206(d)(1), which state that a pension plan will not be
qualified if its benefits can be assigned or alienated. Sec. 401(a)(13);
29 U.S.C. sec. 1056(d)(1) (1994).
In addition, once a participant’s benefit becomes vested, it is nonforfeitable
under ERISA. Bd. of Trs. of the Sheet Metal Workers’ Nat’l Pension Fund v.
Commissioner, 117 T.C. 220, 228 (2001), aff’d, 318 F.3d 599 (4th Cir. 2003). In
sum, a participant in a section 401(a) plan may not assign or alienate his or her
benefit, and at the same time, he or she has a nonforfeitable right to that same
benefit. Id.
Pursuant to the May 27, 2009, corporate documents, and relying upon the
divorce decree, Heidi transferred 100% of her ESOP shares and relinquished any
rights she had under the ESOP. The ESOP’s June 30, 2009 and 2010, reports
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[*15] reflect that 100% of the shares allocated to Heidi on June 30, 2009, were
reallocated to Richard’s account as of June 30, 2010.
Before April 5, 2007, Richard and Heidi, husband and wife, were also
Family Chiropractic’s sole employees and ESOP participants. Although the 2007
divorce decree dissolved the Leavitt marriage, it is insufficient to allow the
transfer of plan assets that transpired in this case.10 See, e.g., Rodoni v.
Commissioner, 105 T.C. 29 (1995). Transferring the vested shares from Heidi’s
account to Richard’s caused Heidi’s ESOP account to become alienated from her
after it became fully vested. By violating section 401(a)(13), the plan ceased to be
qualified. Accordingly, we hold that respondent did not abuse his discretion in
disqualifying the ESOP for its 2010 plan year and for subsequent plan years.
Whether the ESOP Failed Section 401(a) Requirements by Violating Plan Terms
in Allowing the Transfer of Vested Benefits
The ESOP plan terms were clearly violated. First, under section 7.4(a) of
the plan document a terminated participant was entitled to all vested benefits in his
or her account, and it was to be paid “as soon as administratively feasible” after
termination of employment if the participant so elected (or otherwise upon her
10
Family Chiropractic admits that the divorce decree did not address Heidi’s
benefits under the ESOP. Accordingly, we need not discuss sec. 414(p) qualified
domestic relations orders, which are an exception to the antialienation provisions.
See sec. 401(a)(13)(B).
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[*16] death or what would have been her normal retirement). Pursuant to section
7.4(b) of the plan document Heidi was fully vested in her ESOP account in 2009.
Section 7.5(a) of the plan document allowed her to choose the form of payment
(either a lump-sum payment or periodic payments over time) she would receive.
Heidi’s benefits were not so distributed to her. Second, section 11.2(a) of the plan
document incorporated the section 401(a)(13) prohibition on alienation or
assigning benefits. Nevertheless, the ESOP transferred 100% of Heidi’s
$286,904.53 of vested plan assets to Richard’s ESOP account in contravention of
the plan document’s terms.
Because the ESOP failed to abide by the document’s distribution and
antialienation rules, an operational failure occurred in 2010 and the ESOP was not
a “definite written program” and therefore was not a section 401(a) qualified plan.
Because the failure to follow the plan document’s terms is a continuing one, the
ESOP was also not qualified for subsequent plan years.
We hold that respondent did not abuse his discretion in determining that
because the ESOP failed to follow the plan document in operation, the ESOP was
not a section 401(a) qualified plan for its 2010 plan year and for all subsequent
plan years.
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[*17] Conclusion
We conclude that there was no abuse of discretion in respondent’s
determination that the plan was not qualified under section 401(a) for its 2010
plan year and its subsequent plan years and that the related trust was not exempt
under section 501(a).
Any contentions we have not addressed are irrelevant, moot, or meritless.
To reflect the foregoing,
Decision will be entered
for respondent.