Emmons v. Commissioner

T.C. Memo. 1996-265

UNITED STATES TAX COURT

HAROLD E. EMMONS AND ANNA MAE EMMONS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 20303-94. Filed June 11, 1996.

Janet I. McCurdy, for petitioners.

Alan R. Peregoy, for respondent.

MEMORANDUM 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

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

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
 - 2 -

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 excise tax under section 4980A

for the taxable year 1991 in the amount of $35,308.2

After a concession by respondent,3 the only issue for

decision is whether the Transfer Refund distribution received by

petitioner Anna Mae Emmons in 1991 from the Maryland State

Employees' Retirement System is subject to the 15-percent excise

tax under section 4980A as an excess distribution from a

qualified plan. The resolution of this issue turns on whether

the Transfer Refund was paid from a defined benefit plan, as

respondent contends, or from a defined contribution component of

a defined benefit plan described in section 414(k), as

petitioners contend.

This case was submitted fully stipulated under Rule 122, and

the facts stipulated are so found. Petitioners resided in

Frederick, Maryland, at the time that their petition was filed

with the Court.

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. and is subject to the
deficiency procedures set forth in subch. B of ch. 63 of the
I.R.C. See sec. 6211(a).
3
Respondent concedes that petitioner Harold E. Emmons is
not liable for the deficiency in issue herein. See also infra
note 6.
 - 3 -

Background

Petitioner Anna Mae Emmons (petitioner) was an employee of

the Maryland State Department of Health and Mental Hygiene until

her retirement, effective March 1, 1991. As an employee of such

department, petitioner was a member of the Maryland State

Employees' Retirement System (the Retirement System) until she

transferred to the Maryland State Employees' Pension System (the

Pension System) on February 1, 1991.

The Retirement System and the Pension System

In determination letters dated April 19, 1965, and June 23,

1982, respondent determined that the Retirement System and the

Pension System, respectively, were qualified trusts under section

401(a), and that they were exempt from income tax under the

provisions of section 501(a).

The Retirement System requires mandatory nondeductible

employee contributions. In contrast, the Pension System does not

generally require such contributions. The State of Maryland

contributes to both the Retirement System and the Pension System

on behalf of the members of those systems.

All assets of the Retirement System are held in one of three

funds; namely, the Annuity Savings Fund, the Accumulation Fund,

and the Expense Fund. Md. Ann. Code, art. 73B, sec. 14 (1988 and

Supp. 1990). Retirement benefits are paid from the Annuity

Savings Fund and the Accumulation Fund. Md. Ann. Code, art. 73B,

sec. 14(1)(f) and (2)(a) (1988). Expenses, other than Retirement
 - 4 -

Benefits, are paid from the Expense Fund. Md. Ann. Code, art.

73B, sec. 14(3) (1988 and Supp. 1991).

The Annuity Savings Fund holds a participant's "accumulated

contributions", which consist of the participant's total

contributions plus "regular interest". Md. Ann. Code, art. 73B,

secs. 1(13), (23), 14(1)(a), (2)(c) (1988 and Supp. 1990).

Regular interest is credited to a participant's account annually.

Md. Ann. Code, art. 73B, sec. 14(2)(c) (1988). The rate of

regular interest is set by the Board of Trustees at a statutorily

prescribed rate of 4 percent.4 Md. Ann. Code, art. 73B, sec.

14(1)(a) (1988 and Supp. 1990). If a participant withdraws his

or her accumulated contributions, or if such contributions are

paid to the estate or designated beneficiary of a participant,

such amount is paid from the Annuity Savings Fund. Md. Ann.

Code, art. 73B, sec. 14(1)(f) (1988).

All interest and dividends earned on the funds of the

Retirement System are credited to the Accumulation Fund. Md.

Ann. Code, art. 73B, sec. 14(2)(c) (1988). Upon a participant's

retirement, the participant's accumulated contributions are

transferred from the Annuity Savings Fund to the Accumulation

Fund, and the participant's annuity is then paid from the

Accumulation Fund. Md. Ann. Code, art. 73B, sec. 14(1)(f) and

4
See also Md. Ann. Code, art. 73B, sec. 1(12) (1988). Each
year, after a participant's account in the Annuity Savings Fund
is credited with "regular interest", such interest is transferred
from the Accumulation Fund to the Annuity Savings Fund. Md. Ann.
Code, art. 73B, sec. 14(2)(c) (1988).
 - 5 -

(2)(a) (1988). Additionally, the Accumulation Fund holds all

reserves for the payment of all benefits, except for those

payable from the Annuity Savings Fund. Md. Ann. Code, art. 73B,

sec. 14(2)(a) (1988).

The Transfer Refund

On January 11, 1991, petitioner elected to transfer from the

Retirement System to the Pension System, effective February 1,

1991. As a result of the election to transfer, petitioner

received a distribution (the Transfer Refund) from the Retirement

System in the amount of $390,513.91. The Transfer Refund

consisted of $12,460.05 in previously taxed contributions made by

petitioner, $374,918.36 of earnings, $2,732.09 of employer "pick-

up contributions",5 and $403.41 of interest on the employer pick-

up contributions. The earnings, pick-up contributions, and

interest on the pick-up contributions; i.e. $378,053.86,

constitute the taxable portion of the Transfer Refund.

The rate of earnings paid as part of the Transfer Refund was

not the rate of regular interest of 4 percent, but was an amount

based on the average interest rate for the 5 years preceding the

year of transfer, compounded annually. Md. Ann. Code, art. 73B,

sec. 11B(5) (1988). The interest rate for each of the 5 years

was computed as the sum of the investment income and the realized

gains and losses, divided by the book value of the total

investments of the Retirement System. Id.

5
See sec. 414(h).
 - 6 -

When petitioner transferred from the Retirement System to

the Pension System, she had attained the age of 61. If

petitioner had not transferred to the Pension System but had

remained a member of the Retirement System, she would have been

entitled to retire and receive a normal service retirement

benefit, including a regular monthly annuity, at age 60. She

would not have been entitled to receive a Transfer Refund because

a Transfer Refund is payable only as a result of transferring

from the Retirement System to the Pension System.

As a result 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

her salary and her creditable years of service, specifically

including those years of creditable service recognized under the

Retirement System. However, because petitioner received the

Transfer Refund on account of transferring from the Retirement

System to the Pension System, petitioner's monthly annuity is

less than the monthly annuity she would have received if she had

not transferred to the Pension System but had retired under the

Retirement System.

In 1991, petitioner received annuity payments from the

Pension System in the total amount of $6,814, of which $6,798 was

the taxable amount.
 - 7 -

Petitioners' Federal Income Tax Return

On their Federal income tax return (Form 1040) for 1991,

petitioners reported the taxable portion of the Transfer Refund

and the taxable portion of petitioner's annuity payments as

ordinary income. In the notice of deficiency, respondent

characterized petitioner's retirement distributions over $150,000

as an excess distribution from a qualified retirement plan.6

Respondent then determined that petitioners were liable for the

excise tax under section 4980A.7

Discussion

The only issue for decision is whether petitioners are

liable for the 15-percent excise tax for an excess retirement

distribution under section 4980A. The resolution of this issue

turns on whether the Transfer Refund was paid from a defined

benefit plan, as respondent contends, or from a defined

contribution component of a defined benefit plan described in

section 414(k), as petitioners contend.

6
The Forms 1099-R (Total Distributions From Profit-Sharing
Plans, Individual Retirement Arrangements, Insurance Contracts,
Etc.) issued by the Maryland State Retirement Agency indicate
that the taxable portion of the Transfer Refund was $378,585.
Petitioners reported the taxable portion of the Transfer Refund
on their 1991 income tax return consistent with the Forms 1099-R.
Likewise, respondent determined the amount of the excess
distribution based on the taxable portion reported on the Forms
1099-R. However, the parties stipulated that the taxable portion
of the Transfer Refund was $378,053.86. The parties' stipulation
appears to account for an error on one of the Forms 1099-R. In
any event, we give effect to the stipulation.
7
See supra note 3 regarding respondent's concession as to
petitioner Harold E. Emmons.
 - 8 -

Generally, retirement plans fall into one of two categories:

(1) Defined contribution plans, and (2) defined benefit plans. A

defined contribution plan is a plan under which a separate

account is maintained for each plan participant and where income,

expenses, gains and losses are allocated to each participant's

account. Sec. 414(i).8 Under a defined contribution plan, the

employee is not guaranteed a particular benefit, but is instead

provided with the account balance upon retirement. Thus, the

retirement benefit provided by a defined contribution plan

depends on the investment performance of the contributions made

by the employer and the participant, and the participant bears

the risk of loss if the plan's investments do not perform as well

as expected.

A defined benefit plan is any plan that is not a defined

contribution plan. Sec. 414(j). The retirement benefit provided

by a defined benefit plan is fixed, typically by reference to a

formula based on salary and years of service. Thus, if the plan

does not perform as well as expected, the employer bears the risk

of loss because the employer is contractually obligated to pay

the retirement benefit specified in the plan.

8
Sec. 414(i) provides:

(i) Defined Contribution Plan.-- * * * the term
"defined contribution plan" means a plan which provides for
an individual account for each participant and for benefits
based solely on the amount contributed to the participant's
account, and any income, expenses, gains and losses, and any
forfeitures of accounts of other participants which may be
allocated to such participant's account.
 - 9 -

A defined benefit plan may contain a variable component

based on investment performance. In this respect, a defined

benefit plan can, in part, resemble a defined contribution plan.

In such instances, section 414(k) creates a "hybrid" plan and

provides that the portion of the plan that resembles a defined

contribution plan will be treated as a defined contribution plan

for certain purposes. As relevant herein, section 414(k)

provides:

(k) Certain Plans. -- A defined benefit plan which
provides a benefit derived from employer contributions which
is based partly on the balance of the separate account of a
participant shall --

(1) for purposes of section 410 * * * be treated as a
defined contribution plan,

(2) for purposes of sections 72(d) * * * 411(a)(7)(A)
* * * 415 * * * and 401(m) * * * be treated as consisting of
a defined contribution plan to the extent benefits are based
on the separate account of a participant and as a defined
benefit plan with respect to the remaining portion of
benefits under the plan, and

(3) for purposes of section 4975 * * * be treated as a
defined benefit plan. [Emphasis added.]

In order to satisfy the reference to "separate account" in

section 414(k), the separate account must be more than a mere

bookkeeping account; it must maintain the characteristics of a

defined contribution plan, including the allocation of gains and

losses to a participant's account. Malbon v. United States, 43

F.3d 466 (9th Cir. 1994); Montgomery v. United States, 18 F.3d

500 (7th Cir. 1994); see Green v. Commissioner, T.C. Memo. 1994-

340; but see Guilzon v. Commissioner, 985 F.2d 819 (5th Cir.
 - 10 -

1993), affg. on other grounds 97 T.C. 237 (1991).

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

distributions from qualified retirement plans. Sec. 4980A(a).

As relevant herein, an "excess distribution" is defined as the

aggregate amount of the "retirement distributions"9 with respect

to any individual during any calendar year to the extent that

such amount exceeds $150,000. Sec. 4980A(c)(1). The definition

of an excess distribution is modified, however, for a "lump sum

distribution" to which a forward averaging election under section

402(e)(4)(B) applies. Thus, as relevant herein, if the

retirement distributions with respect to any individual include a

lump sum distribution to which an election under section

402(e)(4)(B) applies, an "excess distribution" exists to the

extent that the retirement distributions exceed $750,000; i.e.,

five times the amount of the limitation otherwise provided by

section 4980A(c)(1). Sec. 4980A(c)(4).

For purposes of section 4980A(c), the aggregate amount of

petitioner's retirement distributions was $384,851.86; i.e.,

$378,053.86 plus $6,798. See sec. 4980A(e)(1), (c)(2).

In view of the foregoing, what is determinative in this case

9
As relevant herein, retirement distributions are defined
as the amount distributed to an individual under an individual
retirement plan or any "qualified employer plan" with respect to
which such individual is or was the employee. Sec. 4980A(e)(1).
A qualified employer plan is any plan described in sec. 401(a)
that includes a trust exempt from tax under sec. 501(a). Sec.
4980A(e)(2)(A). Certain distributions are excluded in
calculating an individual's aggregate retirement distributions.
See sec. 4980A(c)(2).
 - 11 -

for purposes of section 4980A is whether the Transfer Refund

constituted a "lump sum distribution" within the meaning of

section 402(e)(4)(A). Petitioners contend: (1) The Transfer

Refund was a lump sum distribution, (2) petitioner was entitled

to and did elect forward averaging under section 402(e),10 and

(3) there was no excess distribution because petitioner's lump

sum distribution and annuity payments did not exceed $750,000.

Respondent contends that the Transfer Refund was not a lump sum

distribution, and that there was an excess distribution to the

extent petitioner's retirement distributions exceeded $150,000.

A "lump sum distribution" 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

10
We note that petitioners did not elect 10-year forward
averaging under sec. 402(e) on their Form 1040 for 1991.
Although petitioners contend on brief that they elected forward
averaging on an amended return (Form 1040X), the record contains
no such evidence. Rule 143(b). See 2 Bittker & Lokken, Federal
Taxation of Income, Estates and Gifts, par. 61.13.7, at 61-171
(2d ed. 1990); 370-2d Tax Mgmt (BNA), Qualified Plans -- Taxation
of Distributions, VII, C, 1, at A-107 (2d ed. June 27, 1994).
 - 12 -

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 Transfer Refund was received by

petitioner after she attained the age of 591/2, nor is there any

dispute that the Transfer Refund was distributed within a single

taxable year. Moreover, for purposes of deciding whether

petitioner received a lump sum distribution, there is no dispute

that the Retirement System is a plan described in sections

401(a), and that the trust forming a part of the Retirement

System is exempt from tax under section 501.

In determining a taxpayer's "balance to the credit", section

402(e)(4)(C) provides in relevant part:

(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, all profit-sharing
plans maintained by the employer shall be
treated as a single plan * * * . [Emphasis
added.]

This Court has previously held that section 402(e)(4)(C)

requires that we treat the Retirement System and the Pension

System as a single pension plan. 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,
 - 13 -

T.C. Memo. 1994-633; see Wheeler v. Commissioner, T.C. Memo.

1993-561; see also Sites v. United States, 75 AFTR 2d 95-2504,

95-1 USTC par. 50,280 (D. Md. 1995). Thus, as a consequence of

aggregating the Retirement System and the Pension System, we have

held that a taxpayer's transfer from the Retirement System to the

Pension System allowed the taxpayer to receive the balance to his

or her credit in two parts, an initial single payment (the

Transfer Refund) and a reduced monthly annuity (based on all of

the taxpayer's years of creditable service and on the taxpayer's

salary during those years). Thus, we have held that a Transfer

Refund did not constitute a taxpayer's entire "balance to the

credit" in the Retirement and Pension Systems, and was therefore

not a lump sum distribution within the meaning of section

402(e)(4)(A).

Notwithstanding the foregoing authority, petitioners contend

that petitioner received the balance to her credit when she

received the Transfer Refund. In this regard, petitioners argue

that the Retirement System is a defined benefit plan that

contains a defined contribution component, and that the

Retirement System therefore constitutes a hybrid plan under

section 414(k). Petitioners also argue that petitioner's

mandatory contributions were held in a separate account in the

Annuity Savings Fund and that the Retirement System and Pension

System provided a benefit (the Transfer Refund) based partly on
 - 14 -

the balance of petitioner's separate account. Thus, petitioners

argue that, pursuant to section 414(k), petitioner's separate

account in the Annuity Savings Fund should be treated as a

defined contribution plan. Petitioners further argue that this

defined contribution component constituted a profit-sharing plan,

and that the Transfer Refund was paid from such profit-sharing

plan. Finally, petitioners argue that because profit-sharing

plans are not aggregated with pension plans under section

402(e)(4)(C), petitioner received the balance to her credit from

a profit-sharing plan when she received the Transfer Refund.

We have carefully considered petitioners' contention, and we

reject it for two reasons.

First, the Retirement System did not provide a benefit based

"partly on the balance of the separate account" of petitioner

under section 414(k). As discussed earlier, in order to satisfy

the "separate account" requirement in section 414(k),

petitioner's separate account must have maintained the

characteristics of a defined contribution plan; namely, the

allocation of investment gains and losses to petitioner's

separate account. Here, the Annuity Savings Fund held

petitioner's accumulated contributions. Pursuant to Maryland

law, petitioner's account in the Annuity Savings Fund was

credited with "regular interest" annually. Md. Ann. Code, art.

73B, sec. 14(2)(c) (1988). We do not think that the crediting of
 - 15 -

statutory interest by itself creates a separate account under

section 414(k) because a statutorily mandated rate of interest

does not represent the investment performance of a participant's

contributions. See Rev. Rul. 79-259, 1979-2 C.B. 197.11

Consequently, the regular interest credited to petitioner's

account did not create a separate account under section 414(k).12

Petitioners also contend that the earnings paid as part of

the Transfer Refund reflected the investment performance of

petitioner's contributions, and that the option to receive such

earnings in a Transfer Refund constituted a benefit from a

separate account. Although the rate of earnings utilized in

computing the amount of the Transfer Refund was determined on a

basis that considered overall gains and losses in the Retirement

System, such rate considered the investment performance only for

11
It is clear that revenue rulings are not binding
precedent. Estate of Lang v. Commissioner, 64 T.C. 404, 406-407
(1975), affd. on this issue 613 F.2d 770, 776 (9th Cir. 1980).
However, it is equally clear that we may adopt a ruling's
reasoning if it is persuasive. Neuhoff v. Commissioner, 669 F.2d
291 (5th Cir. 1982), affg. 75 T.C. 36 (1980).
12
It would appear that the Annuity Savings Fund is little
more than a bookkeeping account used to keep track of a
participant's accumulated contributions in the event that a
participant terminates employment prior to retirement and
withdraws his or her accumulated contributions. Indeed, if a
participant works until retirement (and does not receive a
Transfer Refund), then such participant's accumulated
contributions are transferred from the Annuity Savings Fund to
the Accumulation Fund in order to fund the participant's
retirement annuity, and a record of a participant's accumulated
contributions is no longer maintained because such information is
not relevant in determining the participant's retirement benefit.
 - 16 -

the 5 years preceding the Transfer Refund election. Md. Ann.

Code, art. 73B, sec. 11B(5)(b) (1988). The rate of earnings was

then applied retroactively, starting from petitioner's date of

employment, and was compounded annually as if such rate had been

actually earned during each year of service by petitioner. Thus,

the rate of earnings utilized in computing the amount of the

Transfer Refund had no relationship to the actual earnings of

petitioner's contributions, and therefore cannot be considered a

benefit based in part on the separate account of petitioner under

section 414(k).

Second, we reject petitioners' contention because the

existence of a separate account under section 414(k) is

irrelevant for purposes of determining "the balance to the credit

of an employee" under section 402(e)(4)(A). Section 414(k)

provides that a defined benefit plan with a defined contribution

component will be treated, in part, as a defined contribution

plan for purposes of sections 410, 72(d), 411(a)(7)(A), 415, and

401(m). We note that section 414(k) does not specify section

402(e)(4)(C) as one of the sections for purposes of which a

defined benefit plan will be treated as a defined contribution

plan. Therefore, even if petitioner's mandatory contributions

constituted a separate account under section 414(k), this fact

would have no effect in determining petitioner's balance to the

credit. See Green v. Commissioner, T.C. Memo. 1994-340, wherein
 - 17 -

the Court stated that "'the balance to the credit of an employee'

was intended to include all sums payable to the employee and that

there should be no separation of accounts for this purpose."

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 she transferred from the Retirement

System to the Pension System. Accordingly, petitioners are not

entitled to the increased threshold amount; i.e. $750,000, set

forth in section 4980A(c)(4) in determining the amount of

petitioner's excess distributions for purposes of the excise tax

under section 4980A.

We now turn to petitioners' alternative argument.

Petitioners contend that the Retirement System is not a

"qualified employer plan" under section 4980A(e)(2) because it

provides for the distribution of employee contributions and

earnings thereon prior to a participant's retirement. Thus,

petitioners argue that there were no "retirement distributions"

under section 4980A(e)(1) and therefore no "excess distributions"

for purposes of section 4980A(a).

We have previously considered and rejected petitioners'

alternative contention in Montgomery v. Commissioner, T.C. Memo.

1996-263. We see no need to revisit the issue. Therefore, for

the reasons stated in Montgomery v. Commissioner, supra, we hold
 - 18 -

that petitioner received retirement distributions under section

4980A(e)(1) in the aggregate amount of $384,851.86.

In order to give effect to our disposition of the disputed

issue, as well as respondent's concession and the parties'

stipulation,

Decision will be entered

under Rule 155.