T.C. Memo. 1996-337
UNITED STATES TAX COURT
PARKER-HANNIFIN CORPORATION, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 22121-93. Filed July 24, 1996.
William R. Stewart, Kent L. Mann, Karen E. Rubin, Stephen F.
Gladstone, and Dena M. Kobasic, for petitioner.
Elsie Hall, Randall P. Andreozzi, and Katherine L.
Wambsgans, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Chief Judge: Respondent determined a deficiency of
$15,007,108 in petitioner’s 1987 Federal income tax. Unless
otherwise indicated, all section references are to the Internal
Revenue Code in effect for the year in issue, and all Rule
- 2 -
references are to the Tax Court Rules of Practice and Procedure.
The use of the term “reserve” in this opinion is for convenience
and is not conclusive as to characterization for tax purposes.
After a concession by respondent, the issue for decision is
whether and to what extent, if any, Parker-Hannifin Corporation
may deduct $32,498,684 in contributions it made to a welfare
benefit trust on June 30, 1987.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated
facts are incorporated herein by this reference.1 At the time
the petition in this case was filed, Parker-Hannifin Corporation
had its principal place of business in Cleveland, Ohio.
Petitioner is an accrual basis taxpayer and files its
Federal income tax return on a fiscal year ending June 30.
Petitioner filed timely its Form 1120, U.S. Corporation Income
Tax Return, and an associated amended return, Form 1120X, for its
taxable year ended June 30, 1987, with the Internal Revenue
Service Center at Cincinnati, Ohio.
Petitioner and its subsidiaries are engaged in, among other
things, the design, manufacture, and marketing of components and
systems for builders and users of durable goods, including
1
The stipulation contained objections to many documents
offered by respondent, and those objections were sustained during
trial. Nonetheless, respondent proposed findings and presented
arguments as if those documents were in evidence. Such conduct
makes our task more difficult and respondent’s brief less
reliable.
- 3 -
products controlling motion, flow, and pressure. On June 30,
1987, petitioner had approximately 28,708 employees, of whom
approximately 1,854 were represented by unions.
On June 30, 1987, petitioner established the Parker-Hannifin
Employees Welfare Benefit Trust (the VEBA Trust) with Ameritrust
Company National Association (Ameritrust) as trustee. The VEBA
Trust was to serve as the funding medium for certain employee
welfare benefit plans that petitioner intended to make up a
Voluntary Employees’ Beneficiary Association (VEBA). Petitioner
established the VEBA Trust pursuant to the terms of the Trust
Agreement Creating the Parker-Hannifin Corporation Voluntary
Employees’ Beneficiary Association (Trust Agreement).
The VEBA Trust was created to provide “health care,
disability, life, and other welfare benefits under the Plans to
Members, Dependents, and Beneficiaries, other than post-
retirement health care and life benefits for ‘key employees,’ as
that term is defined in Section 416(i) of the Code.” Under the
terms of the Trust Agreement:
The Corporation [petitioner intended] to make
contributions, on a sound actuarial basis, to the
Trustee, on or before the last day of the Corporation’s
fiscal year, in such amounts as determined to be
necessary to provide benefits required under the Plans.
The Corporation’s determination of such contributions
shall be final and conclusive upon all persons. * * *
The Trust Agreement also provided that “Notwithstanding any
provision of this Agreement to the contrary, in no event shall
the Corporation be required to continue to fund benefits under
any Plan through the Trust.” Contributions to the VEBA Trust
- 4 -
were irrevocable and could not revert to petitioner under the
terms of the Trust Agreement.
The VEBA Trust uses the cash method of accounting and has a
fiscal year ending June 30. The VEBA Trust qualifies as a
welfare benefit fund under section 419(e). The Parker-Hannifin
Group Insurance Plan and the Long-Term Disability Plan for
Salaried Employees of Parker-Hannifin Corporation were funded by
the VEBA Trust.
Pursuant to an administrative services agreement dated
February 24, 1981, Provident Life and Accident Insurance Company
(Provident) agreed to provide administrative services for certain
of petitioner’s employee benefits. Provident continued to
provide such services during the year in issue.
On June 30, 1987, petitioner contributed $42 million (the
1987 contribution) to the VEBA Trust. Effective July 1, 1987,
the maximum Federal corporate income tax rate decreased from 46
to 34 percent. Petitioner’s 1987 contribution to the VEBA trust
included the following amounts:
Incurred but unpaid medical, dental, &
1
short-term disability benefits $9,022,227
2
Administration fees 479,089
Long-term disability benefits 2,500,000
Union medical benefits 3,210,991
Postretirement benefits
Retirees 10,779,650
Active employees 16,133,508
3
Total $42,125,465
1
Respondent has allowed a deduction for this amount.
2
Respondent has allowed a deduction for this amount.
3
Petitioner’s chief financial officer suggested
rounding the 1987 contribution to $42 million.
- 5 -
The person primarily responsible for the implementation and
funding of the VEBA Trust was Joseph B. Dorn (Dorn). Dorn was
director of taxation for petitioner on June 30, 1987. Dorn
computed the VEBA contribution and claimed deduction on a single
sheet of paper. Dorn is not an actuary.
The explanation of the calculation of each portion of the
1987 contribution follows below.
Incurred But Unpaid Medical, Dental, and Short-Term Disability
Benefits
Dorn contacted Provident to obtain an estimate of the
reserve for medical, dental, life, and short-term disability
expenses incurred but unpaid before June 30, 1987. Provident
provided Dorn with the amount of $9,022,227.
Expenses incurred but unpaid before June 30, 1987, for
employees covered under collective bargaining agreements were
included in the $9,022,227. Expenses estimated to be incurred
but unpaid after June 30, 1987, for employees covered under a
collective bargaining agreement were included in the $3,210,000
contribution for union medical benefits.
Petitioner's 1987 contribution included $9,022,227 for
incurred but unpaid medical, dental, and short-term disability
benefits.
Postretirement Benefits--Retirees
Reserve Computation
Dorn obtained the actual fiscal 1987 expenses incurred
through April 1987 for benefits paid to hourly and salaried
- 6 -
retired employees. Dorn annualized this number to take into
account the remainder of fiscal 1987 and arrived at expenses of
$2,093,462. Dorn then subtracted employee contributions of
$547,110 and $6,402 related to key employees. (Plans covering
key employees must be funded separately. See sec. 419A(d).) The
result of the above calculations was $1,539,950. At this point,
Dorn consulted with Harry A. Don (Don), an actuary with the Wyatt
Company. During a telephone conversation, Don told Dorn that the
use of a factor of 7 would be appropriate. Dorn multiplied
$1,539,950 by 7 and arrived at $10,779,650, which was used in
calculating the 1987 contribution.
Actual Expenditures
For its 1987, 1988, and 1989 fiscal years, petitioner’s
financial statements reported expenses for retiree health care
and life insurance benefits of $2,575,000, $2,494,000, and
$2,899,000, respectively. The following amounts were paid by
Provident, on behalf of the VEBA Trust, for postretirement
benefits and administrative expenses for retired employees:
Year Ended Amount1
June 30, 1988 $2,607,511
2
June 30, 1989 3,069,240
June 30, 1990 3,528,896
June 30, 1991 4,275,589
1
Because the VEBA Trust reimbursed
Provident for these payments, there is a
slight timing difference resulting from these
disbursements.
2
Expenses for July and August 1988
totaled $412,467.
- 7 -
Postretirement Benefits--Active Employees
Reserve Calculation
To calculate the postretirement reserve amount for active
employees, Dorn started with the $10,779,650 that he calculated
for retirees. He then divided by the number of current retired
employees (1,163) to get a cost per employee. Dorn once again
consulted with Don by telephone to ask for a factor to determine
the cost for covered active employees. Don told him to divide
the cost per retired employee by 10. Dorn followed Don’s
direction and arrived at $927. He then multiplied $927 by the
number of active employees (not including key employees),
resulting in $16,133,508. This amount was used in calculating
the 1987 contribution.
Medical Benefits for Union Members
Reserve Computation
Petitioner’s benefits department supplied Dorn with the
fiscal 1987 expenses through April 1987 for short-term disability
and medical, dental, and life insurance benefits paid under
collective bargaining agreements. Dorn looked at all of the
collective bargaining agreements in effect and determined the
remaining length of each contract after June 30, 1987. He then
annualized the expense amounts that were given to him by the
benefits department. This amount was then multiplied by the
remaining length of each contract to arrive at $3,210,991.
- 8 -
None of petitioner's collective bargaining agreements
required use of a welfare benefit fund or prefunding of the
negotiated benefits. Petitioner's 1987 contribution included
$3,210,991 for union medical benefits estimated to be incurred
but unpaid after June 30, 1987.
Actual Expenditures
The following amounts were paid by Provident, on behalf of
the VEBA Trust, for medical, short-term disability, dental and
life benefits, and administrative fees for employees covered by
collective bargaining agreements:
Year Ended Amount1
June 30, 1988 $2,881,637
June 30, 1989 3,869,076
June 30, 1990 5,728,512
June 30, 1991 4,189,156
1
These amounts include payments made
relative to contracts not in force on
June 30, 1987. Also, because the VEBA Trust
reimbursed Provident for these payments,
there is a slight timing difference resulting
from these disbursements.
During fiscal 1988, 1989, and 1990, Provident, on behalf of the
VEBA Trust, paid the following amounts for medical, short-term
disability, dental and life benefits, and administrative fees for
employees covered by collective bargaining agreements in effect
on June 30, 1987:
- 9 -
Year Ended Amount1
June 30, 1988 $2,474,363
June 30, 1989 797,211
June 30, 1990 243,086
Total $3,514,660
1
These amounts have been rounded to the
nearest whole dollar. Also, because the VEBA
Trust reimbursed Provident for these
payments, there is a slight timing difference
resulting from these disbursements.
Petitioner commingled its $3,210,991 VEBA contribution for union
medical benefits with all other VEBA assets.
Long-Term Disability
Reserve Computation
William H. Mercer (Mercer) was an employee benefit
compensation and actuarial consulting firm. In 1986, petitioner
asked Terrence McManamon (McManamon), a principal with the
Cleveland office of Mercer, to perform calculations to quantify
the disabled life reserve for long-term disability coverage for
salaried and nonunion hourly employees. Using source information
from petitioner, McManamon was able to determine the net monthly
and annual benefits payable to petitioner’s then currently
disabled employees. McManamon then took into account offsets for
Social Security and workers’ compensation and offsets received by
any other employer-sponsored program or State disability
programs. McManamon’s calculations assumed that all currently
disabled employees included in the calculation would continue to
receive benefits until age 65. The calculation did not take into
- 10 -
account employees who might recover from their disability or die
in the interim and stop receiving payments.
Petitioner’s benefits department forwarded the fiscal 1986
reserve amount that was calculated by Mercer to Dorn. After Dorn
reviewed how employees went on and came off long-term disability,
which he felt was infrequently, Dorn determined that the 1986
reserve adjusted by some factor would be acceptable as a 1987
reserve. Dorn increased the reserve by 6 percent and arrived at
$2.5 million. Mercer confirmed that 6 percent was a conservative
factor to use in the adjustment. Dorn used the $2.5 million that
he calculated for long-term disability reserves in calculating
the 1987 contribution.
Actual Expenditures
The cost of benefits and administrative fees actually paid
by Provident, on behalf of petitioner, for long-term disability
claims of its employees during its 1986 year was $338,486. The
cost of benefits and administrative fees actually paid by
Provident, on behalf of petitioner, for long-term disability
claims of its employees during its 1987 year was $442,198. The
amount of long-term disability benefits and administrative fees
actually paid by Provident, on behalf of the VEBA Trust, through
August 31, 1988, with respect to employees who were disabled as
of June 30, 1987, was $487,651. The VEBA Trust reimbursed
Provident for such payments, and, thus, there is a slight timing
difference.
- 11 -
The following amounts of long-term disability benefits and
administrative fees were paid by Provident, on behalf of the VEBA
Trust:
Year Ended Amount1
June 30, 1988 $ 529,543
June 30, 1989 574,034
June 30, 1990 694,697
June 30, 1991 739,874
June 30, 1992 871,953
June 30, 1993 926,162
June 30, 1994 1,158,574
1
Because the VEBA Trust reimbursed
Provident for these payments, there is a
slight timing difference resulting from these
disbursements.
Petitioner’s long-term disability plan required any disability
payments payable by petitioner to be offset by any amounts
received by claimants from Social Security or other listed third-
party sources.
In a July 2, 1987, letter to Adrian V. Wallace, vice
president of Ameritrust, petitioner’s treasurer, W.C. Young,
stated:
Disbursements from this Trust will take the form of
wire transfers to the Provident Insurance Company on
Wednesday of each week and will run between $500,000
and $1,000,000 per transfer. Based on such a schedule
it is anticipated that the $42,000,000 deposited in the
Trust will be paid out within 12 to 18 months. * * *
Beginning in September 1987, petitioner deposited into the
VEBA Trust amounts withheld from its employees for their share of
the cost of providing the covered benefits. The VEBA Trust used
its assets, consisting solely of the 1987 contribution, employee
- 12 -
contributions, and interest income, to pay the current cost of
providing benefits to petitioner’s employees and retirees as
benefits came due during fiscal 1988 and the first 2 months of
fiscal 1989. Beginning in August 1988, the VEBA Trust used its
assets, consisting solely of amounts that were currently
contributed and currently deducted by petitioner along with
employee contributions, to pay the current cost of providing
benefits to petitioner’s employees and retirees as benefits
became due.
The following table reflects the deposits, earnings, and
withdrawals affecting the VEBA Trust for fiscal 1987, 1988, 1989,
and 1990:
Fiscal Years
1987 1988 1989 1990
Employer
1 2
contributions $42,000,000.00 -0- $40,737,374.59 $50,783,404.03
Employee
contributions -0- $ 1,555,626.86 1,841,554.51 2,505,955.35
3
Interest earned 773.98 1,749,030.80 78,641.10 -0-
Benefits paid -0- 39,153,640.83 48,808,587.03 53,289,359.38
Ending balance 42,000,773.98 6,151,016.83 -0- -0-
1
Represents the total of petitioner’s monthly contributions to the VEBA Trust.
2
Represents the total of petitioner’s monthly contributions to the VEBA Trust.
3
The amounts to which the parties have stipulated in later years ignore this amount.
In August 1988, petitioner filed Form 1024, Application for
Recognition of Exemption, for the VEBA. Unaudited financial
statement information for petitioner’s 1988 year that was
included with the application indicated that, on June 30, 1988,
the VEBA Trust had a balance of $6,378,125.82. Benefits paid
were shown as $42,450,649.30. The only contributions to the VEBA
Trust were those from employees and from investment income.
- 13 -
Petitioner received a determination letter from the District
Director of the Internal Revenue Service on November 29, 1988,
stating that the application for recognition of exemption under
section 501(c)(9) had been approved. The determination letter
states: “No opinion is expressed or implied as to whether
employer contributions to * * * [the VEBA Trust] are deductible
under the Code.”
Petitioner did not generate a contemporaneous census of its
employees for whom benefits were to be provided through the VEBA
Trust. Such a census would have included the date of birth,
gender, family coverage, and date of hire for each employee for
purposes of funding the VEBA in petitioner’s 1987 fiscal year.
Petitioner reflected $33.6 million of the 1987 contribution
on its balance sheet as a “prepaid expense” under the category of
current assets and $8.4 million of the 1987 contribution on its
balance sheet as an “other asset”.
The Financial Accounting Standards Board Statement No. 81
relating to "Disclosure of Postretirement Health Care and Life
Insurance Benefits" (FASB 81) was in effect during the years in
issue. FASB 81 required that, at a minimum, the following
information be disclosed: (1) A description of the benefits
provided and the employee groups covered; (2) a description of
the accounting and funding policies followed for those benefits;
(3) the cost of those benefits recognized for the period, unless
the provisions of paragraph 7 apply; and (4) the effect of
- 14 -
significant matters affecting the comparability of the costs
recognized for all periods presented. FASB 81 provided several
illustrative disclosures, including the following to be used
where benefits are annually funded based on estimated accruals:
In addition to providing pension benefits, the
company and its subsidiaries provide certain health
care and life insurance benefits for retired employees.
Substantially all of the company's employees, including
employees in foreign countries, may become eligible for
those benefits if they reach normal retirement age
while working for the company. The estimated cost of
such benefits is accrued over the working lives of
those employees expected to qualify for such benefits
as a level percentage of their payroll costs. Accrued
costs are funded annually and were $XXX for 19X4.
FASB 81 also provided the following illustrative disclosure
for use where benefit costs are expensed when paid:
In addition to providing pension benefits, the
company and its subsidiaries provide certain health
care and life insurance benefits for retired employees.
Substantially all of the company's employees, including
employees in foreign countries, may become eligible for
those benefits if they reach normal retirement age
while working for the company. The cost of retiree
health care and life insurance benefits is recognized
as expense as claims are paid. For 19X4, those costs
totaled $XXX.
Petitioner's 1987 financial statement stated the following
regarding its provision of health care and life insurance
benefits:
In addition to providing pension benefits, the Company
provides certain health care and life insurance
benefits for retired employees. Substantially all of
the Company's employees may become eligible for those
benefits if they become eligible for retirement while
working for the Company. The cost of retiree health
care and life insurance benefits is recognized as
expense as claims are paid. * * *
- 15 -
Petitioner never notified any of the labor unions, or
representatives thereof, that represented employees of petitioner
or its subsidiaries of the existence of the VEBA Trust,
petitioner’s contribution to the VEBA Trust, or the existence of
any reserves of the VEBA Trust. Petitioner never notified any of
its employees or retirees of the existence of the VEBA Trust,
petitioner’s 1987 contribution to the VEBA Trust, or the
existence of any reserves of the VEBA Trust, except for
petitioner’s employees who were involved in the implementation of
the VEBA Trust. Petitioner never disclosed the existence of the
VEBA Trust or any reserves of the VEBA Trust on any of the
summary plan descriptions provided by petitioner to its employees
to notify them of its pension and retirement plans.
Petitioner made no specific disclosure to its shareholders
or the public that it prefunded the VEBA Trust. Petitioner
disclosed to its shareholders and to the public the prefunding of
certain future employee benefits under the heading “Other” in
petitioner’s Annual Reports for 1987, 1988, and 1989. The
explanation of "Other" in petitioner's 1987 Annual Report stated:
Other increases in assets included an increase in
"Prepaid expenses" and "Investment in joint ventures
and other assets" as a result of prefunding certain
future employee benefits. "Excess cost of investments"
increased primarily as a result of the acquisition of
United Aircraft Products, Inc.
On its Form 1120 for 1987, petitioner deducted the full
amount of the 1987 contribution to the VEBA Trust. Petitioner
also claimed a deduction on its 1987 return for the actual cost
- 16 -
of providing employee medical and life insurance, long-term
disability benefits, and union medical benefits during 1987.
In the notice of deficiency, respondent allowed petitioner
partial deductions in the amount of $9,022,227 for incurred but
unpaid medical, dental, and short-term disability benefits and
$353,624 for administrative expenses, none of which are at issue
in this case. Respondent has conceded that petitioner is
entitled to a deduction in the amount of $125,465 for additional
administrative expenses. The amount of the 1987 contribution
remaining in dispute is $32,498,684.
OPINION
Section 419 limits the deduction for contributions paid or
accrued by an employer to a welfare benefit fund to the
“qualified cost” for the taxable year. Sec. 419(b). “Qualified
cost” includes the qualified direct cost for the taxable year and
any addition to a qualified asset account for the taxable year,
subject to the section 419A(b) limitation. Sec. 419(c)(1).
Section 419A provides rules governing additions to the qualified
asset account. “Qualified asset account” is defined as “any
account consisting of assets set aside to provide for the payment
of (1) disability benefits, (2) medical benefits, (3) SUB
[supplemental unemployment compensation benefit] or severance pay
benefits, or (4) life insurance benefits.” Sec. 419A(a).
Additions to the qualified asset account are constrained by the
account limit, as defined by section 419A(c). Sec. 419A(b).
- 17 -
The legislative history of section 419A states the
following:
Limitations on qualified asset account.--The
conference agreement includes substantial modifications
to the provisions setting forth the limitation on
additions to a qualified asset account. Such an
account consists of assets set aside for the payment of
disability benefits, medical benefits, supplemental
unemployment or severance pay benefits, and life
insurance or death benefits.
In general, the account limit is the amount
estimated to be necessary under actuarial assumptions
that are reasonable in the aggregate, to fund the
liabilities of the plan for the amount of claims
incurred but unpaid, for benefits described in the
previous paragraph and administrative costs of such
benefits, as of the close of the taxable year. Claims
are incurred only when an event entitling the employee
to benefits, such as a medical expense, a separation, a
disability, or a death actually occurs. The allowable
reserve includes amounts for claims estimated to have
been incurred but which have not yet been reported, as
well as those claims which have been reported but have
not yet been paid. * * * [H. Conf. Rept. 98-861, at
1155-1156 (1984), 1984-3 C.B. (Vol. 2) 1, 409-410.]
Relevant to our determination herein, the account limit
includes: (1) The “amount reasonably and actuarially necessary
to fund” certain claims incurred but unpaid and the related
administrative costs, sec. 419A(c)(1); and (2) an additional
“reserve funded over the working lives of the covered employees
and actuarially determined on a level basis (using assumptions
that are reasonable in the aggregate) as necessary” for
postretirement medical and life insurance benefits, sec.
419A(c)(2). No account limit applies to any qualified asset
account for a separate welfare benefit fund maintained pursuant
to a collective bargaining agreement. Sec. 419A(f)(5)(A); sec.
- 18 -
1.419A-2T, Temporary Income Tax Regs., 50 Fed. Reg. 27428
(July 3, 1985).
Postretirement Benefits
Section 419A(c)(2) provides for an additional reserve for
postretirement medical and life insurance benefits:
(2) Additional reserve for post-
retirement medical and life insurance
benefits.--The account limit for any taxable
year may include a reserve funded over the
working lives of the covered employees and
actuarially determined on a level basis
(using assumptions that are reasonable in the
aggregate) as necessary for--
(A) post-retirement medical
benefits to be provided to covered
employees (determined on the basis
of current medical costs), or
(B) post-retirement life
insurance benefits to be provided
to covered employees.
Petitioner included $10,779,650 in its 1987 contribution for
postretirement benefits for retirees. The 1987 contribution
included $16,133,508 for postretirement benefits for active
employees. Respondent disallowed the deduction of these
contributions on petitioner’s fiscal 1987 Federal income tax
return.
Petitioner argues that section 419A(c)(2) allows a reserve
funded over the working lives of covered employees for
postretirement benefits to be included in the account limit
without requiring that specific assets be set aside or that a
separate account be created. Petitioner contends that the
- 19 -
“account limit” under section 419A(c) is only a mathematical
computation that limits the deduction, not a requirement that a
segregated reserve be included in the welfare benefit fund.
However, the VEBA Trust did not retain even general assets
that were sufficient to fund the reserves claimed by petitioner.
Thus, petitioner's position has the same shortcomings as the
position that the Court considered and rejected in General Signal
Corp. & Subs. v. Commissioner, 103 T.C. 216 (1994). In General
Signal, the taxpayer corporation argued that section 419A(c)(2)
did not require the establishment of a funded reserve in order
for an amount to be included in the account limit. Id. at 240.
Because of the taxpayer corporation’s “vehement assertion” that
“reserve funded” did not have a commonly understood meaning, the
Court looked to the legislative history of section 419A(c)(2) for
guidance and determined “that Congress intended section
419A(c)(2) to permit the accumulation of funds for purposes of
funding postretirement benefits.” Id.
The legislative history of section 419A states, in part:
Prefunding of life insurance, death benefits, or
medical benefits for retirees.--The qualified asset
account limits allow amounts reasonably necessary to
accumulate reserves under a welfare benefit plan so
that the medical benefit or life insurance (including
death benefit) payable to a retired employee during
retirement is fully funded upon retirement. These
amounts may be accumulated no more rapidly than on a
level basis over the working life of the employee, with
the employer of each employee. * * * The conferees
intend that the Treasury Department prescribe rules
requiring that the funding of retiree benefits be based
on reasonable and consistently applied actuarial cost
methods, which take into account experience gains and
- 20 -
losses, changes in assumptions, and other similar
items, and be no more rapid than on a level basis over
the remaining working lifetimes of the current
participants (reduced on the basis of reasonable
turnover and mortality assumptions). [H. Conf. Rept.
98-861, supra at 1157, 1984-3 C.B. (Vol. 2) at 411;
emphasis added.]
The legislative history of section 419A thus indicates that an
accumulation of assets, not just a calculation, is intended in a
qualified asset account. See also National Presto Indus., Inc.
v. Commissioner, 104 T.C. 559, 569-574 (1995).
Petitioner made no disclosure of the establishment of
reserves for postretirement benefits in its financial reporting
for its 1987 year. Only those employees involved in the
implementation of the VEBA were informed about the existence of
the VEBA.
A letter signed by petitioner’s treasurer states that the
1987 contribution was expected to be depleted by benefit payments
over the 12 to 18 months following the creation of the VEBA. By
the second month of petitioner’s 1989 year, the 1987 contribution
had been depleted. Petitioner made no contribution during its
1988 year, and, in the following years, petitioner contributed to
the VEBA through monthly contributions approximating the benefits
paid. The ending balance of the VEBA for each of the years 1989
and 1990 was zero. Petitioner’s Form 1024, Application for
Recognition of Exemption, did not indicate the establishment of
reserves. While disclosure is not required by the applicable
Code and regulations, the lack of disclosure, along with
- 21 -
petitioner’s other actions regarding the VEBA Trust, shows that
petitioner did not accumulate assets in the VEBA Trust for the
purpose of funding a reserve for postretirement benefits. See
General Signal Corp. & Subs. v. Commissioner, supra at 239.
In General Signal, the Court acknowledged that there was no
requirement of a separate account. Petitioner argues that the
suggestion that money must be maintained in a fund in at least
the amount of the deduction is inconsistent with the Court’s
position in General Signal. There is no such inconsistency. In
General Signal, the Court stated:
With respect to petitioner’s argument that
respondent’s interpretation of section 419A(c)(2) would
require a separate accounting requirement, respondent
contends that it is sufficient that the reserve
required by section 419A(c)(2) be funded with general
rather than specific assets. This interpretation
appears consistent with legislative intent and requires
only that the overall balance maintained in the VEBA be
sufficient to support the postretirement reserve. It
does not appear to require that a separate account be
established with respect to the reserve. [Id. at 246.]
An interpretation of section 419A(c) that requires such a
reserve to be established, petitioner argues, could prevent the
fund from paying current benefits because the reserves would be
required to be maintained. Petitioner also believes that such an
interpretation would also result in the imposition of minimum
funding as is required under section 412 for qualified plans.
Petitioner further argues that “funded over the working lives”
describes the manner in which the reserves are to be computed and
- 22 -
does not require separate funding or funding over the actual
working lives of the covered employees.
Petitioner also argues that respondent cannot add
requirements to section 419A(c)(2) when respondent has failed to
prescribe regulations as required by section 419A(i). Petitioner
contends that it took steps to determine the reasonable and
necessary amount it could deduct as a contribution based on the
guidance provided by the Code.
These remaining arguments relate to the amount of funding
and the level of funding of the VEBA Trust. Because petitioner
failed to meet the minimum requirement of establishing a reserve
funded over the working lives of the covered employees, we do not
reach the question of the actuarial correctness of the 1987
contributions and do not discuss the parties’ expert testimony
relating to that issue.
Petitioner’s situation is not distinguishable from that of
the taxpayer in General Signal. We decline petitioner’s
invitation to reconsider General Signal. Therefore, respondent’s
determination that the contribution for postretirement benefits
is not deductible will be sustained.
Medical Benefits for Union Members
No account limit applies in the case of a qualified asset
account under a separate welfare benefit fund under a collective
bargaining agreement. Sec. 419A(f)(5)(A). Prior law called for
the Treasury Department to issue regulations to establish special
- 23 -
reserve limit principles for collectively bargained plans.
Before final regulations were issued, current section
419A(f)(5)(A) was enacted, eliminating the need for such
regulations. See Tax Reform Act of 1986, Pub. L. 99-514, sec.
1851(a)(13), 100 Stat. 2862.
Respondent argues that petitioner should not be allowed to
deduct the portion of the contribution related to collectively
bargained employees because a separate fund was not created.
This argument arises out of the language of section 419A(f)(5)
that refers to any “qualified asset account under a separate
welfare benefit fund * * * under a collective bargaining
agreement”. Emphasis added. Respondent’s position is that
“separate” means distinct and different from welfare benefits for
noncollectively bargained employees. Because petitioner
commingled the assets that were contributed for collectively
bargained employees with those for noncollectively bargained
employees, respondent argues that petitioner should not be
allowed to deduct the portion of the 1987 contribution for union
medical benefits.
Petitioner asserts that the use of “separate” means that the
funds in the VEBA should be separate from the general assets of
petitioner and beyond the reach of petitioner’s creditors. Under
the terms of the VEBA Trust, such reversion of petitioner’s
contributions was expressly prohibited.
- 24 -
On June 30, 1987, petitioner had 28,708 employees, of whom
approximately 1,854, or 6.46 percent, were represented by unions.
The plan was not the result of collective bargaining or required
by any agreement with the union. Petitioner attempts to
distinguish between the union and nonunion contributions under
the VEBA by calculating the respective contributions in
isolation. The plan itself, however, does not make that
distinction and cannot as a whole reasonably be characterized as
a welfare benefit fund maintained pursuant to a collective
bargaining agreement.
Because the contribution for collectively bargained
employees does not meet the requirements of section 419A(f)(5),
the deductibility of the contribution for union medical benefits
must be tested under section 419A(c)(1). The analysis of the
treatment of the contribution for medical benefits to union
members and of the contribution for long-term disability claims
is combined below.
Medical Benefits for Union Members and Long-Term Disability
Claims
In addition to the medical benefits for union members,
petitioner included $2.5 million in the 1987 contribution for
long-term disability claims. Petitioner alleges that the
long-term disability claims were incurred but unpaid as of the
close of its 1987 fiscal year.
Section 419A(c)(1) provides the account limit for claims
described in section 419A(a), including disability benefits, sec.
- 25 -
419A(a)(1), and medical benefits, sec. 419A(a)(2), that are
incurred but unpaid. Section 419A(c)(1) provides:
(1) In general.--Except as otherwise
provided in this subsection, the account
limit for any qualified asset account for any
taxable year is the amount reasonably and
actuarially necessary to fund--
(A) claims incurred but unpaid
(as of the close of such taxable
year) for benefits referred to in
subsection (a), and
(B) administrative costs with
respect to such claims.
Petitioner asserts that, in General Signal Corp. & Subs. v.
Commissioner, 103 T.C. 216 (1994), the inclusion of incurred but
unpaid long-term disability claims and union medical benefits in
the account limit was not an issue. Petitioner argues that the
subsequent history of claims supports Dorn’s calculation of these
portions of the 1987 contribution.
Petitioner's contribution for medical benefits for union
members fails to meet the requirement of section 419A(c)(1) that
it fund claims incurred but unpaid as of June 30, 1987. By
petitioner's own admission, the contribution for medical benefits
for union members included expenses estimated to be incurred but
unpaid after June 30, 1987. Assuming, however, that this
contribution had met the above requirement, the contribution
would nonetheless be nondeductible for the reasons discussed
below with respect to long-term disability benefits.
- 26 -
Under section 419A(a), “‘qualified asset account’ means any
account consisting of assets set aside to provide for the payment
of” certain benefits. In order to qualify as a deductible
contribution to a welfare benefit fund under section 419(a),
petitioner’s contribution must not exceed the qualified cost of
the fund, i.e., the qualified direct costs plus any qualified
asset account. Qualified asset accounts are generally subject to
an account limit, which for these purposes is the amount
reasonably and actuarially necessary to fund claims incurred but
unpaid as of the close of the taxable year in which the
contribution is made, and the related administrative costs. For
petitioner’s 1987 year, no benefits were paid out of the VEBA
Trust, and, thus, no qualified direct costs were incurred.
Petitioner argues that the $2.5 million contribution for
long-term disability is a qualified asset account and is
deductible.
The parties disagree as to the meaning of the phrase “assets
set aside” in the definition of qualified asset account.
Petitioner contends that the phrase does not require that a
“reserve” be established, pointing out that “reserve” is used
only in the context of postretirement benefits in section 419A.
Respondent argues that petitioner must actually set aside the
assets to include them in the qualified asset account and to
deduct the contribution.
- 27 -
Petitioner has pointed to several other provisions of the
Code that require assets to be “set aside” as examples of
language that Congress would have used if it had intended for the
set-aside of assets. See secs. 419A(d)(1), 512(a)(3)(E). In an
analogous context in General Signal Corp. & Subs. v.
Commissioner, supra at 244, we stated:
However, if the language of section 419A(c)(2) is read
to require the creation of a reserve funded with
general assets rather than segregated assets, the
language of these other provisions would not have been
appropriate. More importantly, this argument is simply
not sufficient to overcome the unambiguous statements
of the legislative history regarding the accumulation
of assets and the funding of benefits.
The same analysis and conclusion apply here.
Although section 419A(c)(1) does not use the term “reserve”,
in order for a taxpayer to be entitled to a deduction, the assets
must be set aside. An interpretation that the requirements of
section 419A are purely computational would ignore the
legislative history of section 419A, which states, in part:
the conferees wish to emphasize that the principal
purpose of this provision of the bill is to prevent
employers from taking premature deductions, for
expenses which have not yet been incurred, by
interposing an intermediary organization which holds
assets which are used to provide benefits to the
employees of the employer. * * * [H. Conf. Rept.
98-861, at 1155 (1984), 1984-3 C.B. (Vol. 2) 1, 409
(1984).]
Petitioner has ignored this requirement and has focused instead
on the reasonableness of the amount of the contribution for
long-term disability.
- 28 -
As in the case of the postretirement benefits, petitioner
did not disclose the establishment of reserves for long-term
disability benefits in its financial reporting for its 1987 year.
Only those employees involved in the implementation of the VEBA
were informed about the existence of the VEBA. By making the
contribution for long-term disability benefits, petitioner
received a substantial tax savings. Petitioner’s treasurer
estimated in a July 1987 letter that the 1987 contribution would
be depleted in 12 to 18 months after the VEBA was established.
The 1987 contribution was depleted by the second month of
petitioner’s 1989 year. Petitioner made no contribution for
long-term disability benefits that were incurred but unpaid
during its 1988 year, and, in the following years, petitioner
contributed to the VEBA through monthly contributions
approximating the benefits that were paid. No indication of
reserves was shown on petitioner’s Form 1024, Application for
Recognition of Exemption. Again, while disclosure is not
required by the applicable Code and regulations, the lack of
disclosure, along with petitioner’s other actions regarding the
VEBA Trust, shows that petitioner did not accumulate assets in
the VEBA Trust for the purpose of setting aside assets for the
payment of future long-term disability benefits that were
incurred but unpaid.
We cannot conclude that these assets were set aside for the
above-stated purposes, and, thus, we need not address the
- 29 -
reasonableness of the contributions and the related expert
testimony.
To reflect the foregoing and a concession by respondent,
Decision will be entered
under Rule 155.