Pumphrey v. Commissioner

T.C. Memo. 1995-469

UNITED STATES TAX COURT

C. MERRITT and DOROTHY PUMPHREY, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 13538-94. Filed October 3, 1995.

Jay Fred Cohen, 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
 - 2 -

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: Respondent determined a

deficiency in petitioners' Federal income tax for the taxable

year 1990 in the amount of $15,887. Respondent also determined

that petitioners are liable for an excise tax under section 4980A

for the taxable year 1990 in the amount of $5,514.2

The only issue for decision is whether the Transfer Refund

distribution received by petitioner C. Merritt Pumphrey in 1990

from the Maryland State Employees' Retirement System qualifies

for forward averaging under section 402(e)(1). The resolution of

this issue turns on whether the Transfer Refund distribution

constitutes a "lump sum distribution" within the meaning of

section 402(e)(4)(A).

Irrespective of how we decide the issue in dispute,

petitioner C. Merritt Pumphrey concedes that he is liable for the

excise tax under section 4980A. In contrast, respondent concedes

that petitioner Dorothy Pumphrey is not liable, by virtue of

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. 4980A imposes a 15-percent excise tax on excess
distributions from qualified retirement plans. This tax is
included within ch. 43 of the I.R.C. It is therefore subject to
the deficiency procedures set forth in subch. B of ch. 63 of the
I.R.C. See sec. 6211(a).
 - 3 -

having filed a joint income tax return, for such tax. Respondent

also concedes that if we decide the issue in dispute in

petitioners' favor, then the Transfer Refund distribution

qualifies for forward averaging under the more favorable 10-year

method, rather than the less favorable 5-year method utilized by

petitioners on their income tax return for 1990.

FINDINGS OF FACT

Some of the facts have been stipulated and they are so

found. Petitioners resided in Ellicott City, Maryland, at the

time their petition was filed with the Court.

Petitioner C. Merritt Pumphrey (petitioner) was the Clerk of

the Circuit Court for Howard County, Maryland. He was originally

appointed in 1966 to complete the term of the former clerk and

was thereafter elected to the position. Petitioner held office

until 1990, when he was defeated in the general election on

November 7, 1990. Petitioner remained in office until November

30, 1990, at which time his successor took the oath and assumed

the duties of the office.

As the clerk of a circuit court, petitioner was a member of

the Employees' Retirement System of the State of Maryland (the

Retirement System) until he elected to transfer to the Employees'

Pension System of the State of Maryland (the Pension System).

Petitioner elected to transfer from the Retirement System to the

Pension System on November 8, 1990, the day after he lost the

November 1990, general election. Petitioner's election to
 - 4 -

transfer from the Retirement System to the Pension System was

effective retroactively to the first of that month; i.e., to

November 1, 1990.3

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).

In 1990, petitioner received a Transfer Refund distribution

(the Transfer Refund) in the amount of $216,616.26 on account of

his election to transfer from the Retirement System to the

Pension System. The $216,616.26 Transfer Refund consisted of

$32,151.31 in previously taxed contributions made by petitioner

and $184,464.95 of earnings.4 The earnings represented interest,

computed based on an annually compounded rate of approximately

3
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).
4
So stipulated.
 - 5 -

15.9 percent, and constitute the taxable portion of the Transfer

Refund.

Petitioner did not roll over the Transfer Refund into either

an individual retirement account or an individual retirement

annuity.

When petitioner transferred from the Retirement System to

the Pension System, he had attained the age of 66. If petitioner

had not transferred to the Pension System but 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 have been entitled to

receive a Transfer Refund because a Transfer Refund is payable

only as a consequence of transferring from the Retirement System

to the Pension System.

Also, as a consequence of transferring from the Retirement

System to the Pension System, petitioner became, and presently

is, a member of the Pension System. As a member of the Pension

System, petitioner is entitled to receive 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.5 However, because

petitioner received the Transfer Refund on account of

5
Petitioner became a member of the Retirement System in
1966 and therefore had been a member of the Retirement System for
some 24 years at the time of his election to transfer to the
Pension System.
 - 6 -

transferring from the Retirement System to the Pension System,

petitioner's monthly annuity is less than the monthly annuity

that he would have received if he had not transferred to the

Pension System but had retired under the Retirement System.6

Petitioner received a Form W-2P from the Maryland State

Retirement Agency for 1990. The Form W-2P reported the

distribution of the Transfer Refund in the amount of $216,616.26.

The form also reported that the taxable portion of the Transfer

Refund was $186,758.54.7

On their income tax return for 1990, petitioners reported as

income the taxable portion of the Transfer Refund, as set forth

on the Form W-2P, and elected 5-year forward averaging under

section 402(e)(1). In this regard, petitioners attached Form

4972 (Tax on Lump-Sum Distributions) to their income tax return

and reported on said form ordinary income in the amount of

$186,759; i.e., the taxable portion of the Transfer Refund as set

forth on the Form W-2P. Petitioners then computed the tax on

6
Petitioner estimated that his monthly annuity under the
Pension System is approximately one-half of what it would have
been if he had retired under the Retirement System. However, as
previously indicated, petitioner would not have received the
Transfer Refund if he had retired under the Retirement System.
The inducement to accept a less generous monthly annuity under
the Pension System was the Transfer Refund.
7
The discrepancy between the taxable portion of the
Transfer Refund as reported on the Form W-2P, i.e., $186,758.54,
and the taxable portion of the Transfer Refund as stipulated by
the parties, i.e., $184,464.95, is unexplained in the record. We
will give effect to the parties' stipulation.
 - 7 -

said amount and included such tax as part of their total income

tax liability on page 2 of their Form 1040.

In the notice of deficiency, respondent determined that

petitioners did not qualify for 5-year forward averaging.

Accordingly, respondent treated the Transfer Refund, in the

amount of $186,758.54, as subject to the regular income tax.

Respondent contends that the Transfer Refund does not qualify for

forward averaging because it does not constitute a "lump sum

distribution" within the meaning of section 402(e)(4)(A).

OPINION

As a general rule, a distribution from a qualified plan,

such as the Retirement System, is taxed to the recipient in the

year distributed under the rules relating to annuities. Sec.

402(a)(1); see sec. 72. However, section 402(e)(1) provides for

a preferential forward averaging method of computing the tax on

certain such distributions. The parties agree that petitioners

are entitled to this preferential method of computing the tax on

the Transfer Refund if the Transfer Refund constitutes a "lump

sum distribution" within the meaning of section 402(e)(1)(A).8

8
The Tax Reform Act of 1986 replaced the 10-year forward
averaging method with a 5-year forward averaging method for lump
sum amounts distributed after Dec. 31, 1986, in taxable years
ending after such date. Tax Reform Act of 1986, Pub. L. 99-514,
sec. 1122(a)(2), (h)(1), 100 Stat. 2085, 2466, 2470. However,
the Tax Reform Act of 1986, secs. 1122(h)(5) and 1124, provide
transitional rules under which lump sum distributions made after
Dec. 31, 1986, will nevertheless continue to qualify, under
certain limited circumstances, for the more generous 10-year
(continued...)
 - 8 -

A lump sum distribution, for purposes of section 402, is

defined in section 402(e)(4)(A) as follows:

(A) Lump Sum Distribution.--For purposes of this
section * * * , the term "lump sum distribution" means
the distribution or payment within one taxable year of
the recipient of the balance to the credit of an
employee which becomes payable to the recipient--
(i) on account of the employee's death,
(ii) after the employee attains age 591/2,
(iii) on account of the employee's separation from the
service, or
(iv) after the employee has become disabled * * *
from a trust which forms a part of a plan described in
section 401(a) and which is exempt from tax under
section 501 * * *. For purposes of this subsection,
the balance to the credit of the employee does not
include the accumulated deductible employee
contributions under the plan (within the meaning of
section 72(o)(5)). [Emphasis added.]

There is no dispute that the distribution in issue was

received by petitioner after he attained the age of 591/2, nor is

there any dispute that the Retirement System is a plan described

in section 401(a) and that the trust forming a part thereof is

exempt from tax under section 501. Moreover, there is no dispute

that the Transfer Refund distribution was made within a single

taxable year. Therefore, the only issue in dispute is whether

petitioner received the "balance to the credit" when he received

the Transfer Refund.

8
(...continued)
forward averaging method, id., 100 Stat. 2085, 2471, 2475.
Because of his age, petitioner falls within the scope of the
transitional rules, provided, of course, that the Transfer Refund
qualifies as a lump sum distribution. See pages 2-3, supra,
describing respondent's concession in this regard.
 - 9 -

In support of her determination that petitioner did not

receive the "balance to the credit" when he transferred from the

Retirement System to the Pension System, respondent relies on the

fact that petitioner's years of creditable service under the

Retirement System carried over to the Pension System, see Md.

Ann. Code, art. 73B, sec. 115(4) (1988), and that those years of

service increased the monthly annuity benefit to which petitioner

is entitled.

By contrast, petitioners contend that petitioner received

the entire account balance from the Retirement System when he

received the Transfer Refund.9 Therefore, petitioners conclude

that the "balance to the credit" requirement of section

402(e)(4)(A) is satisfied.

We begin our analysis with section 402(e)(4)(C). That

section provides, in relevant part, as follows:

(C) Aggregation of Certain Trusts and Plans.--For
purposes of determining the balance to the credit of an
employee under subparagraph (A)--

(i) all trusts which are part of a plan shall
be treated as a single trust, all pension
plans maintained by the employer shall be
treated as a single plan * * * [Emphasis
added.]

9
Respondent appears to concede implicitly that the
Transfer Refund included all of petitioner's contributions and
the earnings thereon. Cf. Wheeler v. Commissioner, T.C. Memo.
1993-561 (a member of the Retirement System did not receive the
"balance to the credit" upon receiving a Transfer Refund; a
portion of the member's contributions was transferred from the
Retirement System to the Pension System).
 - 10 -

During the years in issue, the State of Maryland maintained

both the Retirement System, in which petitioner participated,

and the Pension System, to which petitioner transferred effective

as of November 1, 1990. Accordingly, in order to decide whether

petitioner received the "balance to the credit", we must treat

the Retirement System and the Pension System as a single pension

plan. Sec. 402(e)(4)(C).

Under Maryland law, petitioner's annuity under the Pension

System is calculated by taking into account petitioner's "average

final compensation" and petitioner's years of "creditable

service". Md. Ann. Code, art. 73B, sec. 117(2) (1988). Because

section 402(e)(4)(C) requires that we treat the Retirement System

and the Pension System as a single pension plan, we conclude

that, by transferring from the Retirement System to the Pension

System, petitioner did not forfeit his right to a future monthly

annuity, but simply elected to receive an initial single payment

to be followed by a reduced monthly annuity. Effectively,

petitioner's transfer allowed him to receive the "balance to the

credit" in two parts, an initial single payment to be followed by

a reduced monthly annuity, based on all of his years of

creditable service and on his salary during those years. See

Green v. Commissioner, T.C. Memo. 1994-340.

The testimony of petitioner at trial reflects the foregoing.

Thus:
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Q: Now, Mr. Pumphrey, you did ultimately retire,
and I believe your testimony has been that you retired
from the Pension System. Is that correct?

A: Well, it has to be correct, yes, sir, because
I had no other choice.

Q: And you are currently receiving an annuity
from that Pension System?

A: Yes, Sir.

Q: Do you understand based on what that annuity
is calculated?

A: Yes, sir, my years of service and the tie-ins,
the salary.

Q: And do those years of service include the
years of service that you earned under the Retirement
System?

A: Yes, sir, absolutely.

Q: So that, when you received your pension
annuity, pursuant to the plan provisions, your annuity
is calculated on all the years of service under both
the retirement system and the pension system, correct?

A: Right, absolutely. * * *

Later during the trial, in a colloquy with the Court,

petitioner testified as follows:

The Court: * * * Now, the pension that you
actually received and presumably are continuing to
receive to this day was based on your entire employment
tenure as the Clerk of Court of Howard County, I mean,
going all the way back to 1966 [and] through your
retirement?

The Witness: I certainly assume so. * * *

Petitioners also argue that their case "is different than

all of the reported cases because it deals with an elected

official that was separated from employment because of the loss
 - 12 -

of an election and not as a result of any voluntary separation."

The distinction that petitioners draw, however, represents a

distinction without a difference because the fact that

petitioners rely on so heavily is simply not relevant to the

controlling law, i.e., the aggregation provisions of section

402(e)(4)(C).

In view of the foregoing, we hold that the Transfer Refund

did not constitute a lump-sum distribution within the meaning of

section 402(e)(4)(A) because petitioner did not receive the

"balance to the credit" when he transferred from the Retirement

System to the Pension System. Accordingly, the Transfer Refund

received by petitioner does not qualify for forward averaging

under section 402(e)(1). See Hamilton v. Commissioner, T.C.

Memo. 1994-633 (addressing whether a taxpayer had received the

"balance to the credit" in the context of whether the taxpayer

was entitled to compute tax on a transfer refund using the 10-

year forward averaging method set forth in section 402(e)(1));

Hoppe v. Commissioner, T.C. Memo. 1994-635 (same); see also

Dorsey v. Commissioner, T.C. Memo. 1995-97 (addressing whether a

taxpayer had received the "balance to the credit" in the context

of whether a Transfer Refund distribution qualified for tax-free

rollover treatment under section 402(a)(5); Brown v.

Commissioner, T.C. Memo. 1995-93 (same); cf. supra with T.C.

Memo. 1993-561.
 - 13 -

In closing, we note that in a case decided earlier this

year, the United States District Court for the District of

Maryland reached the same conclusion in respect of the lump sum

distribution issue that this Court has reached. Sites v. United

States, 75 AFTR 2d 95-2504, 95-1 USTC par. 50,280 (D. Md. 1995).

The final paragraph of the District Court's analysis deserves to

be quoted as follows:

The Court believes that the statutory analysis and
reasoning of Hoppe [v. Commissioner, T.C. Memo. 1994-
635] is sound. Because the Retirement System and
Pension System were both maintained by Taxpayer's
employer, the State of Maryland, they are to be
aggregated for purposes of determining the "balance to
the credit" of an employee under section 402(e)(4)(A).
Whereas Taxpayer received a refund of his contributions
and the accumulated interest, his service credits were
transferred to and remained within the Pension System.
By choosing to transfer to the Pension System, * * *
[Taxpayer] opted * * * to receive a refund of his
contributions and accumulated interest along with
reduced annuity payments in the future. Thus, in
effect, Taxpayer elected to receive the "balance to the
credit" of his account in two-parts: the refund payment
and the future annuity payments. Consequently, he did
not receive the "balance to the credit" of his account
on * * * [the Transfer Refund date]. Id. [75 AFTR 2d
95-2504, at 95-2507, 95-1 USTC par. 50,280, at 88,031].

In order to give effect to our disposition of the disputed

issue, the parties' concessions, and the parties' stipulation

referenced in supra notes 4 and 7,10

10
It would appear that such stipulation would also affect
the amount of the excise tax under sec. 4980A. We leave this
matter to the parties as part of the Rule 155 computation.
- 14 -

Decision will be entered

pursuant to Rule 155.