T.C. Memo. 1996-93
UNITED STATES TAX COURT
ESTATE OF JAMES F. HALL, JR., DECEASED, HARRIETT HALL, EXECUTRIX,
AND HARRIETT NIXON HALL, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 26270-92. Filed March 4, 1996.
Neal A. Sanders and Gerard J. Serzega, for petitioners.
Julia L. Wahl, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
RUWE, Judge: Respondent determined a deficiency of
$287,624.41 in petitioners' 1988 Federal income tax.
The issues for decision are whether petitioners properly
excluded from income the 1988 distribution from the Hadd-Too,
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Inc., Pension Plan under section 105(c)1 and, if not, whether
petitioner Harriett Nixon Hall is entitled to relief from
liability as an "innocent spouse" under section 6013(e).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and attached exhibits are incorporated
herein by this reference. At the time of the filing of the
petition in this case, petitioners resided in Carnegie,
Pennsylvania.2 Petitioner James F. Hall, Jr., died on January
12, 1994, after the petition was filed but before trial. His
estate filed a Motion for Substitution of Party and to Change
Caption, which was granted by the Court.
Together petitioners owned 100 percent of the stock of Hadd-
Too, Inc. (Hadd-Too). Hadd-Too adopted a defined benefit pension
plan (Plan or Hadd-Too Plan) and trust, effective January 1,
1981, which was subsequently amended and restated, effective
January 1, 1984. The Plan was a qualified plan within the
meaning of section 401(a). On November 19, 1986, Hadd-Too
resolved to terminate its Plan, effective December 31, 1986,
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
At the time they filed their petition herein, petitioners
were involved in divorce proceedings and did not reside together.
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because it believed that the Plan was overfunded and that by
terminating the Plan, it would permit the company to distribute
Plan assets without violating new funding limits under the Tax
Reform Act of 1986. However, the Plan assets were not completely
distributed until 1988.
During 1987 and 1988, the IRS audited the Hadd-Too Plan.
During the course of this audit, Hadd-Too and Mr. Hall were
represented by attorney Susan Foreman Jordan. Ms. Jordan
represented Mr. Hall and the company in pension matters from the
fall of 1984 until sometime after March 1989. The IRS determined
that Mr. Hall engaged in prohibited transactions with respect to
certain Plan assets and that Mr. Hall was required to make
restitution to the Plan or face liability for excise taxes. The
IRS agreed to resolve the audit issues by having the Plan
distribute all its assets to Mr. Hall, who was the sole
participant in the Plan in 1988, rather than requiring Mr. Hall
to pay actual restitution or excise taxes. The entire balance to
Mr. Hall's credit in the Plan was distributed to him in 1988.
The distribution consisted of cash and property in the amount of
$1,027,229.45. At the time of this distribution, the Plan was
still a qualified plan within the meaning of section 401(a).
The Plan provided for the payment of retirement benefits to
Hadd-Too employees. In addition to the payment of ordinary
retirement benefits, the Plan contained the following provision
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for the payment of retirement benefits in the event an employee
ceased employment with Hadd-Too due to total disability:
4.05 Disability: A participant whose service with the
Employer ceases due to a total disability for a period
of twelve (12) months or more, prior to his normal, or
where applicable, late retirement date, shall receive
the actuarial equivalent of his Accrued Benefit. A
participant is deemed disabled, if he is receiving
Social Security disability payments or is receiving
disability insurance payments from any duly organized
insurance company by reason of total disability as
defined by the payor of the disability benefit. * * *
A participant's "accrued benefit" was defined by the Plan as the
normal benefit as of normal retirement age multiplied by a
fraction, the numerator of which is the number of years of
participation in the Plan, and the denominator of which is the
number of years of participation if the participant had continued
to his normal retirement age.
At the time of the distribution to Mr. Hall, he had a
diseased foot, which later required amputation below the knee.
Mr. Hall essentially lost the use of his right foot prior to
1988. He remained employed with Hadd-Too until his retirement in
1988. As of December 31, 1988, Mr. Hall was fully vested in the
Plan.
In 1992, Mr. and Mrs. Hall separated, and Mrs. Hall
initiated divorce proceedings. They lived separate and apart
from 1992 until late 1993. At the time of Mr. Hall's death in
January 1994, however, Mrs. Hall had returned to live with and
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take care of Mr. Hall, and Mr. and Mrs. Hall were still legally
married.
For the taxable year 1988, Mr. and Mrs. Hall filed a joint
Federal income tax return. They reported a distribution in the
amount of $1,027,229 on line 17a of their return and stated that
no portion of the distribution was includable in income. The
return was signed by both Mr. and Mrs. Hall. Before signing the
return, Mrs. Hall briefly reviewed the first 2 pages of the
return. She noticed the $1,027,229 entry on line 17a, but she
did not question the entry.
Mrs. Hall knew that a large distribution was made from the
Plan to Mr. Hall during 1988. Of the cash distributed to Mr.
Hall, $474,768.81 was transferred from the pension trust account
to a newly opened bank account in 1988. The new account was held
jointly by Mr. and Mrs. Hall. Both Mr. and Mrs. Hall executed
the deposit agreement for the account. In addition, a
certificate of deposit held by the Plan was redeemed and the
proceeds used to purchase a money market certificate in the
amount of $125,331.63 held jointly by Mr. and Mrs. Hall. The
balance of the property distributed to Mr. Hall appears to have
consisted of real property.
OPINION
Section 105(a) provides generally that amounts received by
an employee through accident or health insurance for personal
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injuries or sickness are includable in gross income. Section
105(c), however, provides an exception to the general rule:
(c) Payments Unrelated to Absence from Work.--Gross
income does not include amounts referred to in
subsection (a) to the extent such amounts--
(1) constitute payment for the permanent loss or
loss of use of a member or function of the body, or the
permanent disfigurement, of the taxpayer, * * * and
(2) are computed with reference to the nature of
the injury without regard to the period the employee is
absent from work.
Respondent determined that the exception in section 105(c) does
not apply to Mr. Hall and that payments from the Plan constituted
income that should have been reported by petitioners in 1988.
Petitioners bear the burden of proving that they come within the
exception in section 105(c). Rule 142(a); Welch v. Helvering,
290 U.S. 111, 115 (1933).
Section 105(e) equates amounts received through accident or
health insurance with amounts received through an accident or
health plan. Section 1.105-5(a), Income Tax Regs., defines the
term "accident or health plan" broadly as
an arrangement for the payment of amounts to employees
in the event of personal injuries or sickness. A plan
may cover one or more employees, and there may be
different plans for different employees or classes of
employees. An accident or health plan may be either
insured or noninsured, and it is not necessary that the
plan be in writing or that the employee's rights to
benefits under the plan be enforceable. * * *
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Despite this broad definition, we have long held that the term
"accident or health plan" presupposes a predetermined course of
action and that it signifies something more than merely one or
more ad hoc benefit payments. Gordon v. Commissioner, 88 T.C.
630, 635 (1987); American Foundry v. Commissioner, 59 T.C. 231,
238-239 (1972), affd. in part and revd. in part 536 F.2d 289 (9th
Cir. 1976); Lang v. Commissioner, 41 T.C. 352, 356-357 (1963);
Estate of Kaufman v. Commissioner, 35 T.C. 663, 666 (1961), affd.
300 F.2d 128 (6th Cir. 1962).
Generally, deferred compensation plans and accident or
health plans serve distinct purposes. Deferred compensation
plans are designed to remunerate an employee for services
rendered over a substantial period of time. Accident or health
plans, on the other hand, provide payments to employees in the
event of illness or injury, without regard to such factors as
compensation, length of service, and company profitability.
Thus, in order to come within the scope of section 105,
petitioners must show by "clear indicia" that the deferred
compensation plan in question was intended to serve the dual
purpose of providing accident or health benefits as well as
retirement benefits. Berman v. Commissioner, 925 F.2d 936, 938-
939 (6th Cir. 1991), affg. T.C. Memo. 1989-654; Caplin v. United
States, 718 F.2d 544, 549 (2d Cir. 1983); Gordon v. Commissioner,
supra at 640.
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Several factors have been held relevant in determining
whether a deferred compensation plan was intended to provide
accident or health benefits, including: (1) A statement in a
written plan that its purpose is to qualify as an accident or
health plan within the meaning of the Internal Revenue Code and
that the benefits payable under it are eligible for income tax
exclusion; (2) specification in a plan that the benefits payable
are those amounts incurred for medical care in the event of
personal injury or sickness; (3) terms in a plan that limit the
benefits payable to legitimate medical expenses; and (4) a
provision allowing an employee to be compensated for specific
injuries or illness, such as the loss of a limb. Berman v.
Commissioner, supra at 939; Caplin v. United States, supra.
The Hadd-Too Amended and Restated Plan contains only two
references to the provision of benefits in the event of
disability. The summary description of the Plan states:
The basic purpose of the Plan continues to be to
give retirement income to the employees to supplement
the benefits they will receive under the Social
Security laws. The plan gives an additional measure of
security to participants and their beneficiaries by
providing benefits which help to insure against loss
caused by disability. In addition, the Plan provides
for payments to employees, under certain circumstances,
if they die or terminate their employment prior to
their retirement. * * *
The second reference appears in the Plan itself:
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4.05 Disability: A participant whose service with the
Employer ceases due to a total disability for a period
of twelve (12) months or more, prior to his normal, or
where applicable, late retirement date, shall receive
the actuarial equivalent of his Accrued Benefit. * * *
None of the indicia listed above appear in the Plan, and there is
no proof that there was any definite program to provide accident
or health coverage that would rise to the level of an accident or
health plan.
The defined benefit plan at issue in Berman v. Commissioner,
supra, is remarkably similar to the Hadd-Too Plan. In Berman,
the defined benefit plan provided for the payment of the present
value of a participant's accrued benefit if the participant
became totally and permanently disabled for a 6-month period.
Id., at 937. The summary description of the defined benefit plan
stated: "The purpose of the Plan is to reward eligible employees
for long and loyal service to the Company by providing for their
financial security at retirement. It may also provide some
additional protection in the event of death, disability, or other
termination of employment." Id. at 939. The Court of Appeals
for the Sixth Circuit affirmed this Court's holding that the plan
did not constitute a dual purpose plan; rather, the permanent
disability provision was merely one of several provisions that
could trigger a participant's claim to accrued retirement
benefits. Id. at 940. The Court of Appeals for the Sixth
Circuit noted that the statement in the summary description was
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ambiguous and did not provide clear indicia of a dual purpose.
Id. at 939.
Petitioners rely on Wood v. United States, 590 F.2d 321 (9th
Cir. 1979) and Masterson v. United States, 478 F. Supp. 454 (N.D.
Ill. 1979), both holding that distributions from pension plans
were excludable from income under section 105(c). These cases,
however, are not controlling. See Caplin v. United States, 718
F.2d at 547-548; Gordon v. Commissioner, 88 T.C. at 636-638 (both
rejecting the application of these cases under similar facts).
In Wood, the status of the plan as an accident or health plan had
been conceded by the Government and was not in dispute. Wood v.
United States, supra at 323.3 In Masterson, the court simply
proceeded on the assumption that the distributing profit-sharing
plan was a dual purpose plan without any analysis. The court
relied on a statement in Wood that the precise nature and taxable
status of these payments is uncertain until the funds are
disbursed. Because the taxpayer received the payments after he
became disabled, the court concluded that they represented
compensation for a disability. Masterson v. United States, supra
at 455. However, this conclusion has been criticized by this and
3
In Beisler v. United States, 814 F.2d 1304, 1308 (9th Cir.
1987), affg. T.C. Memo. 1985-25, the Court of Appeals for the
Ninth Circuit subsequently clarified its holding in Wood v.
United States, 590 F.2d 321 (9th Cir. 1979). In Beisler, the
Court of Appeals for the Ninth Circuit stated "The Wood court
itself recognized that it was not addressing the entire body of
section 105(c) law. See 590 F.2d at 323 (court assumes for
purposes of litigation that plan qualifies as accident or health
plan)." Beisler v. United States, supra.
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other courts. Caplin v. United States, supra at 547; Gordon v.
Commissioner, supra at 637-638.
We conclude that the disability provision in the Hadd-Too
Plan was merely one of several events that could trigger a
participant's claim to accrued retirement benefits. Petitioners
have simply failed to meet their burden of proving by "clear
indicia" that the Plan was intended to serve the dual purpose of
providing accident or health benefits as well as retirement
benefits. Accordingly, the $1,027,229.45 distribution received
by Mr. Hall is taxable as deferred compensation and not
excludable from gross income as accident or health benefits under
section 105.
Even if the Hadd-Too Plan had constituted a dual purpose
plan, the distribution in question fails to meet the requirement
of section 105(c)(2) that the amount of any payment be computed
with reference to the nature of the injury. This requirement is
met only if the plan varies the benefits according to the type
and severity of the taxpayer's injury. Berman v. Commissioner,
925 F.2d at 940; Rosen v. United States, 829 F.2d 506, 509-510
(4th Cir. 1987); Beisler v. Commissioner, 814 F.2d 1304, 1308
(9th Cir. 1987), affg. T.C. Memo. 1985-25; Hines v. Commissioner,
72 T.C. 715, 720 (1979).
Rather than computing benefits with reference to the type
and severity of the injury, the Hadd-Too Plan, upon a showing of
a total disability, determines the benefits solely on the basis
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of the participant's accrued benefit. The Plan makes no attempt
to distinguish among the various "total disabilities", even
though the types and severity of such injuries can vary greatly.
Thus, the Plan fails to compute the amount of the disability
payments with reference to the nature of the injury as required
by section 105(c)(2).
Petitioners argue that Mr. Hall had lost the use of his
right foot prior to the distribution from the Plan in 1988, and
that the Plan administrators were aware of his loss and made the
distribution to Mr. Hall because of it. However, the actual
disability is irrelevant to a determination of whether a plan
computes the amount of disability benefits with reference to the
nature of the injury. Rather, "the instrument or agreement under
which the amounts are paid must itself provide specificity as to
the permanent loss or injury suffered and the corresponding
amount of payments to be provided." Rosen v. United States,
supra at 509 (emphasis added).4
4
On brief, as support for their claim that the payment was
computed with reference to the nature of the injury, petitioners
refer to a document entitled "Informal Action and Consent in
Writing by Board of Directors", dated Jan. 10, 1988, wherein the
board of directors of Hadd-Too determined that Mr. Hall had
presented evidence of a total disability as required under the
Plan and stated that "in evaluating the degree and severity of
the disability of James F. Hall, Jr., it is hereby determined
that the total value of James F. Hall, Jr.'s accrued benefits in
the Plan shall be paid as a disability payment from the Plan".
The document was not actually prepared until March 1989, well
over 1 year after its purported execution and long after the
distribution to Mr. Hall. In any event, in light of our holding
that the Plan itself must calculate the benefits with reference
to the nature of the injury, we find the document to be
irrelevant.
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Because we find that petitioners improperly excluded from
income the 1988 distribution, the next issue we must decide is
whether petitioner Harriett Nixon Hall is entitled to relief from
liability as an "innocent spouse" under section 6013(e).
Section 6013(d)(3) provides that when a joint return is
filed, the parties are jointly and severally liable for the
amount of the tax due. One exception to this rule is the
innocent spouse provision contained in section 6013(e) which
provides:
(e) Spouse Relieved of Liability in Certain Cases.--
(1) In General.--Under regulations prescribed by
the Secretary, if--
(A) a joint return has been made under this
section for a taxable year,
(B) on such return there is a substantial
understatement of tax attributable to grossly
erroneous items of one spouse,
(C) the other spouse establishes that in
signing the return he or she did not know, and had
no reason to know, that there was such substantial
understatement, and
(D) taking into account all the facts and
circumstances, it is inequitable to hold the other
spouse liable for the deficiency in tax for such
taxable year attributable to such substantial
understatement,
then the other spouse shall be relieved of liability
for tax (including interest, penalties, and other
amounts) for such taxable year to the extent such
liability is attributable to such substantial
understatement.
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Petitioners bear the burden of proving that Mrs. Hall satisfies
each statutory requirement of section 6013(e). Stevens v.
Commissioner, 872 F.2d 1499, 1504 (11th Cir. 1989), affg. T.C.
Memo. 1988-63; Purcell v. Commissioner, 826 F.2d 470, 473 (6th
Cir. 1987), affg. 86 T.C. 228 (1986); Bokum v. Commissioner, 94
T.C. 126, 138 (1990), affd. 992 F.2d 1132 (11th Cir. 1993). The
parties agree that the requirements of section 6013(e)(1)(A) and
(B) have been met. At issue are the knowledge and inequity
requirements of section 6013(e)(1)(C) and (D).
Petitioners failed to include the distribution in their
reported gross income because they erroneously believed that it
fell within the provisions of section 105(c). However, it is
clear that when the grossly erroneous items giving rise to an
understatement of tax are unreported gross income, the knowledge
contemplated by section 6013(e)(1)(C) is knowledge of the
transaction itself as opposed to knowledge of the tax
consequences of the transaction. Purcell v. Commissioner, supra
at 474; Quinn v. Commissioner, 524 F.2d 617, 626 (7th Cir. 1975),
affg. 62 T.C. 223 (1974); Bokum v. Commissioner, supra at 146;
Smith v. Commissioner, 70 T.C. 651, 672-673 (1978).
We have found that Mrs. Hall knew of the distribution that
was made to Mr. Hall from the Plan during 1988. Mrs. Hall's
claim that she qualifies as an innocent spouse stems from her
misapprehension of the tax consequences and not from ignorance of
the fact of the distribution. Mrs. Hall knew of the
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circumstances giving rise to the substantial understatement and,
thus, does not qualify as an innocent spouse under section
6013(e)(1)(C).
Moreover, we find that Mrs. Hall failed to meet the inequity
requirements of section 6013(e)(1)(D). Whether it is inequitable
to hold a spouse liable is to be determined on the basis of all
the facts and circumstances. Sec. 6013(e)(1)(D); sec. 1.6013-
5(b), Income Tax Regs. Although section 6013(e), as amended, no
longer specifically requires us to determine whether a spouse
significantly benefited from the omitted income, this factor is
still to be taken into account in determining whether it is
inequitable to hold a spouse liable. Estate of Krock v.
Commissioner, 93 T.C. 672, 678 (1989). Mrs. Hall bears the
burden of proving that she did not significantly benefit from the
omitted income. Id.
Mrs. Hall argues that it would be inequitable to hold her
liable, because she did not receive any benefit from the
distribution in the form of better day-to-day living conditions.
Mrs. Hall's day-to-day living conditions do not appear to have
improved as a result of the distribution. However, of the cash
distributed from the Plan in 1988, $474,768.81 was transferred to
an account held jointly by Mr. and Mrs. Hall. Both Mr. and Mrs.
Hall executed the deposit agreement for the account. In
addition, a certificate of deposit held by the Plan was redeemed
and the proceeds were used to purchase a money market certificate
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in the amount of $125,331.63 held jointly by Mr. and Mrs. Hall.
As a result, Mrs. Hall had over $500,000 of the distribution
proceeds available to her in the form of joint accounts. No
evidence was presented reflecting the ultimate disposition of the
funds in these accounts.5
The acquisition of joint saving or investment assets has
been held to constitute a significant benefit, thereby precluding
innocent spouse relief. Purificato v. Commissioner, 9 F.3d 290,
294 (3d Cir. 1993), affg. T.C. Memo. 1992-580. We believe the
facts here indicate that significant funds from the distribution
were available to Mrs. Hall via these joint accounts, and,
therefore, she has failed to demonstrate that she did not
significantly benefit from the omitted income.
Furthermore, where the understatement results from a
misapprehension of the tax laws by both spouses, then both
spouses are perceived to be "innocent", and there is no inequity
in holding them both to joint liability. Bokum v. Commissioner,
992 F.2d 1132, 1134-1135 (11th Cir. 1993), affg. 94 T.C. 126,
156-157 (1990); Hayman v. Commissioner, 992 F.2d 1256, 1262 (2d
Cir. 1993), affg. T.C. Memo. 1992-228; Lessinger v. Commissioner,
85 T.C. 824, 838 (1985), revd. on other grounds 872 F.2d 519 (2d
Cir. 1989); McCoy v. Commissioner, 57 T.C. 732, 734-735 (1972).
The record indicates that both Mr. and Mrs. Hall were aware
5
The balance of the distribution appears to have consisted
of real property. No evidence was offered by petitioners to show
who held title to this real property after the distribution.
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of the distribution of $1,027,229.45 from the Plan, that they
both relied on professional advice when they filed their 1988
income tax return, and that neither of the Halls was aware of the
correct tax consequences flowing from the distribution from Mr.
Hall's pension plan. Accordingly, we perceive no inequity in
holding both Mr. and Mrs. Hall liable for their misapprehension
of the tax laws.
Decision will be entered
for respondent.