Robert D. Booth and Janice Booth v. Commissioner

108 T.C. No. 25

UNITED STATES TAX COURT

ROBERT D. BOOTH AND JANICE BOOTH, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 2544-94, 2545-94, Filed June 17, 1997.
2546-94, 5754-94,
5755-94, 5893-94,
9229-94, 9230-94.

Secs. 419 and 419A, I.R.C., as enacted by the
Deficit Reduction Act of 1984, Pub. L. 98-369,
secs. 511(a), 512(a), 98 Stat. 494, 854, 862, limit an
employer's deductions for contributions made to a
welfare benefits fund for employees. These limitations
do not apply to a welfare benefits fund that is part of
a "10 or more employer plan" described in sec.
419A(f)(6), I.R.C. Under the Prime Plan, in which Ps

1
Cases of the following petitioners are consolidated
herewith: N.L. Booth & Son, Inc., docket No. 2545-94; John N.
Booth & Debra Booth, docket No. 2546-94; Young & Young, Ltd.,
docket No. 5754-94; Howard S. Young & Elaine P. Young, docket
No. 5755-94; Bruce E. Traegde & Patricia Traegde, docket No.
5893-94; Billy J. Johnson & Ruth Johnson, docket No. 9229-94; and
Johnson Systems, Inc., docket No. 9230-94.
 - 2 -

participated, each participating employer made a
one-time, nonrevertible contribution to a single trust,
equal to the amount necessary to fund the dismissal
wage and death benefits of its qualifying employees.
The trust segregated each contribution into a separate
account for payment of benefits to only the
contributing employer's qualifying employees. If an
employer's account did not have enough assets to pay a
promised benefit, the trustee could supplement the
account's assets with assets from a "suspense account"
that was funded primarily by actuarial gains and
amounts forfeited from the employers' accounts in
certain enumerated situations. Each employer selected
options under the Prime Plan, including participation
and vesting requirements. Except through the suspense
account, an employee had no right to receive benefits
from other than his or her employer's account.

Held: The Prime Plan is a "welfare benefit plan"
within the meaning of sec. 419, I.R.C.

Held, further: The Prime Plan is not within the
scope of sec. 419A(f)(6), I.R.C., because it is an
aggregation of separate plans each having an
experience-rating arrangement with the related
employer.

Held, further: None of the corporate Ps are
liable for the accuracy-related penalties determined by
R.

Charles A. Pulaski, Jr., Janet E. Barton, and Tim A. Tarter,

for petitioners.

Katherine H. Ankeny, Anne W. Durning, and Randall P.

Andreozzi, for respondent.

LARO, Judge: The docketed cases, consolidated for purposes

of trial, briefing, and opinion, consist of four groups of test

cases selected by the parties to resolve their disputes
 - 3 -

concerning the "Prime Financial Benefits Trust Multiple Employer

Welfare Benefit Plan and Trust".2 (We hereinafter refer to this

"plan" as the Prime Plan and the trust as the Trust.3) Each of

these four groups consists of a closely held corporation and one

or more of its owner/employees. In regard to each group, the

Commissioner of Internal Revenue (the Commissioner or respondent)

determined that the corporation could not deduct the amounts that

it reported as contributions to the Trust and that the

individual(s) had income to the extent that the contributions

benefited him or her (or them). Each petitioner petitioned the

Court to redetermine the Commissioner's determination of the

resulting deficiencies in Federal income tax, penalties, and, in

one case, an addition to tax. Respondent's notices of deficiency

listed the following deficiencies, addition to tax, and

penalties:4

2
We have obtained this name from the underlying trust
agreement, as originally drafted and as later amended on the
first two occasions. The third amended version of the trust
agreement used the name "Prime Financial Benefits Multiple
Employer Welfare Benefit Plan and Trust". The fourth and fifth
amended versions used the name "Prime Financial Multiple Employer
Welfare Benefit Plan and Trust". Our use of the original name
refers to all of these versions.
3
Although we use the word "plan" in the singular to refer
to the Prime Plan, we do not mean to suggest that the Prime Plan
is a single plan. As discussed below, we conclude it is not. We
use the word "plan" merely for clarity and convenience.
4
All of the years refer to the calendar year, except:
(1) N.L. Booth's 1989 and 1990 years refer to its taxable years
ended July 31, 1990 and 1991, respectively, and (2) Systems' 1990
(continued...)
 - 4 -

Robert D. Booth & Janice Booth (R&J Booth), docket No. 2544-94
Addition to Tax Penalty
Sec. Sec.
Year Deficiency 6651(a)(1) 6662(a)
1990 $15,180 --- $3,036
1991 8,920 --- 1,784

N.L. Booth & Son, Inc. (N.L. Booth), docket No. 2545-94
Addition to Tax Penalty
Sec. Sec.
Year Deficiency 6651(a)(1) 6662(a)
1989 $34,000 --- $6,800
1990 21,883 --- 4,377

John N. Booth & Debra Booth (J&D Booth), docket No. 2546-94
Addition to Tax Penalty
Sec. Sec.
Year Deficiency 6651(a)(1) 6662(a)
1990 $17,820 --- $3,564
1991 10,263 --- 2,053

Young & Young, Ltd.(Young & Young), docket No. 5754-94
Addition to Tax Penalty
Sec. Sec.
Year Deficiency 6651(a)(1) 6662(a)
1989 $12,744 $637 $2,549

Howard S. Young & Elaine P. Young (the Youngs),
docket No. 5755-94
Addition to Tax Penalty
Sec. Sec.
Year Deficiency 6651(a)(1) 6662(a)
1989 $14,008 --- $2,802

Bruce E. Traegde & Patricia Traegde (the Traegdes),
docket No. 5893-94
Addition to Tax Penalty
Sec. Sec.
Year Deficiency 6651(a)(1) 6662(a)
1989 $14,008 --- $2,802

4
(...continued)
year refers to its taxable year ended Sept. 30, 1991.
 - 5 -

Billy J. Johnson & Ruth Johnson (the Johnsons),
docket No. 9229-94
Addition to Tax Penalty
Sec. Sec.
Year Deficiency 6651(a)(1) 6662(a)
1990 $83,972 --- $16,794

Johnson Systems, Inc. (Systems), docket No. 9230-94
Addition to Tax Penalty
Sec. Sec.
Year Deficiency 6651(a)(1) 6662(a)
1990 $108,675 --- $21,735

We decide the following issues:

1. Whether the Prime Plan is a welfare benefit plan or a

plan deferring the receipt of compensation. We hold it is a

welfare benefit plan.5

2. Whether the Prime Plan is a 10 or more employer plan

described in section 419A(f)(6). We hold it is not.6

5
In light of a concession by respondent that amounts
attributable to contributions to the Prime Plan are not
includable in the gross income of the individual petitioners
under sec. 83 if the plan is determined to be a welfare benefit
plan, our holding on this issue makes it unnecessary to decide
certain other issues in dispute; namely: (1) Whether the Trust
maintains separate accounts for each employee under sec.
404(a)(5), (2) whether the employees' rights are subject to a
substantial risk of forfeiture under sec. 83, (3) whether the
Traegdes extended the period of limitation for assessment of tax
on income recognizable under sec. 83, and (4) whether the
petitioning individuals are liable for penalties under sec.
6662(a). We express no opinion on these issues.
6
Our holding on this issue moots another issue in dispute;
namely, whether contributions to the Prime Plan are current or
capital expenditures. We express no opinion on this issue.
 - 6 -

3. Whether the corporate petitioners are liable for the

penalties determined by respondent.7 We hold they are not.

Unless otherwise indicated, section references are to the

Internal Revenue Code applicable to the relevant years, Rule

references are to the Tax Court Rules of Practice and Procedure,

and dollar amounts are rounded to the nearest dollar.

FINDINGS OF FACT

I. Background

A. Prime Financial Partners, L.P. (Prime)

Prime is a master limited partnership that was traded on the

American Stock Exchange during most of the relevant years. Prime

was formed on April 16, 1987, under the laws of the State of

Delaware, to acquire the financial services and real estate

activities of a group of Prime's affiliated entities. Prime's

general partner is Prime Partners Limited Partnership (Limited),

an Arizona limited partnership, whose general partner is Prime

Financial Partners, Inc. (Financial), an Arizona corporation. On

December 31, 1988, the outstanding stock of Financial and the

limited partnership units of Limited were held by Thomas G.

Cummings, Jerry P. Franks, Anthony L. Tominac, Marvin D. Brody,

and Donald A. Waldman. Joel Boyarsky and a corporation joined

7
With respect to the addition to tax under sec. 6651(a)(1),
the parties stipulated that Young & Young filed its 1989 tax
return untimely. Given the additional fact that in petitioners'
brief they do not challenge respondent's determination of this
addition to tax, we sustain respondent's determination without
further discussion. Rule 142(a).
 - 7 -

this list of owners on December 31, 1989, as did William G.

Stalnaker on December 31, 1990. Mr. Tominac and the corporation

terminated their ownership interests in both entities during

1990, and Messrs. Franks and Stalnaker terminated their ownership

interests in the entities during 1991. On December 31, 1991, the

outstanding stock of Financial and the limited partnership units

of Limited were held by Messrs. Cummings, Brody, Waldman, and

Boyarsky.

During the relevant years, Prime was an investment banking

and financial services firm that earned revenues mostly by

investing and placing money. Prime also earned revenues from

commissions and administrative services generated by the Prime

Plan. Prime researched, developed, and began marketing the Prime

Plan in 1988. The Prime Plan provided death benefits and

dismissal wage benefits (DWB's) to qualifying employees of

participating employers.

On November 29, 1991, Prime filed for protection under

Chapter 11 of the U.S. Bankruptcy Code.

B. Development of the Prime Plan

Mr. Brody developed the concept of the Prime Plan in 1988 in

response to 1984, 1986, and 1987 tax legislation that limited the

tax benefits a small business owner derived from a pension plan.

Mr. Brody expected that the Prime Plan would provide meaningful

tax deferral to small businesses with few employees. The Prime

Plan purported to enable business owners to make tax deductible
 - 8 -

contributions for employee benefits, while allowing them to

accumulate wealth through the appreciation of assets purchased by

the plan with their contributions. The Prime Plan had some

similarities to a defined benefit pension plan, but the Prime

Plan had fewer limitations on funding, benefits, and

accessibility to funds.

Prime marketed the Prime Plan primarily to highly

compensated small business owners with five to six employees.

These business owners could expect to receive the following

benefits from the Prime Plan, as the plan was advertised to them:

1. The employer would currently deduct a one-time

contribution that it made to the Prime Plan to fund DWB's and

death benefits, and the contribution would not be taxable to the

employer's employees until received as benefits;

2. The employer could contribute to pension plans, as well

as to the Prime Plan, but, in the case of the Prime Plan, the

employer would not be subject to the rules limiting contributions

to pension plans;

3. Contributions to the Prime Plan would earn income

tax-free because the Trust, although not a tax-exempt entity,

would invest each employer's contributions in life insurance and

municipal bonds;

4. The employee/owners could reap personally most of the

benefits offered by the Prime Plan by basing an employee's

receipt of benefits on compensation and by using vesting
 - 9 -

schedules to limit the benefits payable to employees other than

the owners themselves;

5. Trust assets would be insulated from creditors;

6. Death benefits would not be subject to income tax or,

with minimal planning, estate tax.

As of December 31, 1994, approximately 800 employers had

participated in the Prime Plan. On that date, approximately

625 of these employers continued to participate in the Prime

Plan.

C. David Weiss

Mr. Weiss is an attorney who was employed during the

relevant years by the law firms of Streich Lang and Snell &

Wilmer. In early 1988, Prime contacted Mr. Weiss to help create

a welfare benefit plan subject to section 419A(f)(6) and to draft

a tax opinion that would be used to market the plan nationwide.

Mr. Weiss initially refused, believing there was insufficient

guidance on section 419A(f)(6) to allow him to create such a

plan. Mr. Weiss later agreed to do so. Mr. Weiss was a

principal architect of the Prime Plan and the Trust, and he wrote

a series of tax opinion letters related thereto. These letters

included opinions dated June 2, 1988, July 25, 1988, April 12,

1989, June 30, 1990, October 1, 1991, and April 1, 1993.

D. Dr. William L. Raby

Dr. Raby is an accountant with a national reputation in

areas related to the Prime Plan and the Trust. At the behest of
 - 10 -

Mr. Weiss, Streich Lang engaged Dr. Raby from February 1988 to

the beginning of 1990, to assist Mr. Weiss in forming the desired

plan and to express a concurring opinion on Mr. Weiss' tax

opinions related thereto. Prime informed Dr. Raby that it wanted

to develop a plan that offered a front-end reduction of taxes for

small employers and a deferral of income for their employees.

Dr. Raby and Mr. Weiss advised Prime that the plan needed an

element of risk-shifting to qualify for the desired benefits, and

that a "suspense account" could be used to accomplish the

required shifting of risk. Dr. Raby and Mr. Weiss later

presented Prime with different provisions for the Prime Plan,

some of which Prime found unacceptable for marketability

purposes. Dr. Raby and Mr. Weiss redrafted the unacceptable

provisions, and Prime found the redrafted provisions more to

their liking.

Dr. Raby wrote an opinion concurring with Mr. Weiss' tax

opinion dated June 2, 1988, and Dr. Raby concurred with

Mr. Weiss' opinion dated April 12, 1989. Dr. Raby's concurrences

were based on his understanding of the tax law including the

"possible purposes" of section 419A(f)(6). Dr. Raby's

concurrences, as well as Mr. Weiss' opinions that related

thereto, did not address any version of the Prime Plan that is at

issue herein; they discussed a hypothetical plan that evolved

into the instant versions. Dr. Raby's name was used to promote

versions of the Prime Plan that were marketed to the public.
 - 11 -

At Mr. Weiss' request, Dr. Raby performed services in

May and June 1993, in connection with respondent's consideration

of issues flowing from the Prime Plan. Dr. Raby's fees were paid

from the suspense account (the Suspense Account) that was part of

the Trust. The Suspense Account served primarily as the

depository for amounts forfeited by the employers and employee

groups connected to the Prime Plan.

E. The Trust

The Trust was a separate, taxable entity apart from Prime

and its affiliates. The Trust owned all of its assets, and it

was supervised by an independent trustee. The Trust's assets

consisted of the money and other property contributed by the

participating employers, and any earnings (or less any losses)

thereon, less payments made by the trustee.

The Trust's first trustee was Northern Trust Bank of

Arizona, N.A. (Northern). Northern was succeeded by Security

Pacific Bank Arizona (Security Pacific) on or about June 30,

1990. Firstar Metropolitan Bank & Trust (Firstar) succeeded

Security Pacific effective January 2, 1992. Firstar's trustee

fees included an asset management fee of 1 percent of the market

value up to $2 million per account, with 0.8 percent of the

market value on the balance, plus a $15 per item transaction

charge.

F. The Administrator of the Prime Plan
 - 12 -

The Prime Plan was overseen by an administrator. Improved

Funding Techniques, Inc. (IFTI), was the Prime Plan's first

administrator. On October 24, 1990, Financial's board of

directors approved a letter of intent with IFTI under which IFTI

would assume all plan administration together with related

overhead and expenses in return for existing and projected

administration fees. Prime entered into an administrative

services agreement with IFTI in July 1991. In consideration for

providing administrative services to the Prime Plan, IFTI billed

participating employers directly in accordance with the following

fee schedule:

New plan installation: $250
Annual service costs
First 5 participants: 1050
6 to 10 participants: 1450
11 & over: 1650 + $20 per
participant
Trustee's transaction fees: 15 per transaction
Individual benefit certification:
Vested participants: 50
Non-vested participants: 35
Plan amendments: 250
Plan terminations: 650 + $75 per
participant
Revised plan valuations: 750
Special projects & consulting: 150 per hour junior
250 per hour senior

Under the Agreement with IFTI, Prime received a percentage of

profits equal to 10 percent of IFTI's fees for administration of

each plan where the annual fees (net of actuarial costs) exceeded

$1,000 per plan and 20 percent of the fees for administration of
 - 13 -

each plan where the fees (net of actuarial costs) exceeded $1,500.

In 1992, Prime moved the bankruptcy court to terminate its

agreement with IFTI and to subcontract the administration

services to William M. Mercer, Inc.

II. The Trust Agreements

A. Overview

The Prime Plan and the Trust were established and operated

pursuant to the Prime Plan and Trust Agreement, effective

August 31, 1988, as subsequently amended and restated by various

versions of the agreement dated December 31, 1988, December 21,

1989, June 30, 1990, January 2, 1992, and November 1, 1993. (The

Prime Plan and Trust Agreement and each of these amended versions

are collectively referred to as the Trust Agreement and

separately referred to by the corresponding date.) Most of the

amendments were made to the language originally used in the

August 31, 1988, Trust Agreement in order to enhance the

marketability of the Prime Plan by increasing an employer's

control over its contributions (and income or loss thereon).

Other amendments were made to comply with changes in the law.

Employers became participants in the Prime Plan by

completing an agreement (Adoption Agreement) that enumerated the

key specifications of the plan and allowed each employer to

tailor the plan to its employees by selecting various options

that would apply to its employees. An employer could change the

options that applied to its employees, and modify the Adoption
 - 14 -

Agreement in any other regard (e.g., to increase DWB's, death

benefits, or both), with the permission of Prime and the trustee.

An employer's plan year was the 12-month period that was set

forth in the Adoption Agreement, and the employer listed in its

agreement the date that the Prime Plan became effective with

respect to its employees. Once an employer executed an Adoption

Agreement, the employer was bound to make a one-time contribution

to the Trust, equal to the amount determined by the Prime Plan’s

actuaries to be sufficient to fund the employer's employees'

vested DWB's and level of death benefits selected by the employer

in the Adoption Agreement, as well as to pay miscellaneous

charges on the transaction.8 The employer’s initial contribution

for DWB's was ascertained through actuarial assumptions developed

by the Prime Plan's actuaries. The actuaries generally employed

the following assumptions prior to 1991:

8
The Prime Plan's initial actuary was Laventhol & Horwath.
Deloitte & Touche replaced Laventhol & Horwath as the Prime
Plan's actuary in 1990.
 - 15 -

Interest: 7% per annum, compounded annually
Salary scale: Average annual salary increases of 7%
Mortality:
Pre-severance forfeiture age: None
Post-severance forfeiture age: Assumed rates of
mortality are based on
the Society of Actuaries
1951 Group Annuity
Mortality Table

Terminations: Each employee was assumed to terminate before
reaching the forfeiture age

The Trust used each employer's contributions to purchase

insurance products to fund the DWB's and death benefits promised

under the Prime Plan. The employer designated in its Adoption

Agreement the insurance company from which the insurance products

for its employees were to be purchased, as well as the type and

amount of these products. The employer could designate in its

Adoption Agreement vesting periods and percentages, which

determined the amount of DWB's that would be paid to its

employees. The employer could designate in its Adoption

Agreement its employees' "Year of Participation" and "Year of

Service", as those terms were defined in the Trust Agreement.

B. The August 31, 1988, Trust Agreement

1. Overview

Prime and Northern Trust entered into the August 31, 1988,

Trust Agreement, "establish[ing] a Multiple Employer Welfare

Benefit Fund and Trust for the exclusive benefit of the

participating Employers, their Employees, and in the case of life

benefits, their Beneficiaries". Under this agreement, each
 - 16 -

participating employer had its own "Employee Group" that

consisted of its employees (the Covered Employees) who met the

minimum age and service requirements set forth by the employer in

the Adoption Agreement.

The Trust Agreement designated each participating employer

as a "Plan Administrator". Generally, each Plan Administrator

exercised all discretionary and other authority to control and

manage the operation and administration of the Prime Plan. Under

the Trust Agreement, each Plan Administrator delegated to Prime

most of its duties and responsibilities with respect to the Prime

Plan, including: (1) Applying rules determining eligibility,

(2) calculating service and compensation credits, (3) preparing

employee communication material, benefit reports, and reports

required by governmental agencies, (4) calculating benefits,

(5) advising employees on their rights and options, (6) applying

contributions, (7) processing claims, (8) recommending decisions

on the Trust's administration and the maintenance of accounts,

and (9) maintaining an account for each Covered Employee.9 Prime

received a fee for performing these services.

9
The Trust Agreement generally required the maintenance of
separate accounts for each Covered Employee to assure each
participating employer that any contributions that it made to the
Prime Plan were segregated and considered assets of its Employee
Group.
 - 17 -

2. DWB's

A Covered Employee generally received a DWB upon termination

of his or her employment for a reason other than "cause". The

amount of the DWB, which was set forth by the employer in the

Adoption Agreement, was based on a percentage of the Covered

Employee's compensation in the calendar year immediately

preceding termination as well as his or her years of service at

the time of termination. In no case could a DWB exceed two times

compensation during the immediately preceding calendar year, and

a DWB could not be greater than the amount shown in the vesting

schedule set forth by the employer in the Adoption Agreement. If

an employee had severed his or her employment when the employer

made the initial contribution, the employee's DWB generally

equaled the amount shown as his or her "Vested Severance Benefit"

in that year's annual report.

Prime had the sole discretion to pay the DWB in a lump sum

or to pay the DWB in monthly installments not to exceed 24 months

after the Covered Employee's termination date. The payment of

DWB's was secured by the insurance company that issued insurance

policies on the life of each Covered Employee.

A Covered Employee's DWB generally was forfeited to the

Suspense Account if he or she: (1) Was discharged for "cause",

(2) terminated employment after attaining a stated age, or

(3) died while employed. Under the August 31, 1988, Agreement,

employment meant "working as an employee, partner or proprietor
 - 18 -

in the same occupation or profession", and a discharge for

"cause" occurred when the discharge resulted from "a proven

dishonest or criminal act committed in the course of the

Employee's employment with the Employer". The same agreement

defined: (1) The stated age as the "Forfeiture Age", which was

defined as "an age which is three years prior to a Covered

Employee's Normal Retirement Date", (2) the "Normal Retirement

Date" as a date set forth by the employer in the Adoption

Agreement, and (3) a "Termination of Employment" as "the earliest

of the date on which an Employee become [sic] Totally Disabled,

resigns or is discharged without Cause." The Normal Retirement

Age generally was set forth by the employers as (1) the later of

age 65 or completion of 10 years of participation in the Prime

Plan, or (2) if the participating employer had a qualified plan,

the definition given that term under the qualified plan. DWB's

that were forfeited due to death or the attainment of the

Forfeiture Age were segregated into the Suspense Account to be

used to increase that employer's Covered Employees' DWB's or

death benefits, to provide new welfare benefits, to provide

benefits for replacement employees, or to distribute to the

Covered Employees if and when the employer withdrew from the

Prime Plan.

Contributions made to fund DWB's were invested in flexible

premium adjustable life policies (universal life policies) or, in

the case of a Covered Employee who was determined to be
 - 19 -

uninsurable, in a tax-exempt money market fund. Prime maintained

commission-sharing arrangements with the insurance companies that

wrote these insurance policies. Prime usually earned a

commission equal to 22 percent of the amount paid for life

insurance and 1.2 percent of the amount paid to fund DWB's.

Employers typically contributed $50,000 to the Trust. Generally,

$6,000 of this amount was used to purchase life insurance and the

balance ($44,000) to fund DWB's.

3. Death Benefits

If a Covered Employee died while employed, a death benefit

became payable to his or her beneficiary in the amount set forth

by the employer in the Adoption Agreement. This amount was

generally stated as a percentage of the Covered Employee's

compensation or, if higher, a set minimum amount. For a Covered

Employee who was other than a standard underwriting risk, the

death benefit could be reduced or eliminated, depending on the

provisions of the employer's Adoption Agreement.

Death benefits were typically funded through universal life

policies. Under such a policy, the premiums in excess of the

amount necessary to fund current mortality and administrative

expenses are typically invested by the carrier at a fixed rate of

return. This rate of return may vary over time, although

carriers generally guarantee a specified minimum return.

The amounts paid by the Trust for the universal life

policies were generally separated into two amounts: (1) The
 - 20 -

target premium, which was the cost of the life insurance, and

(2) the excess premium, which was an amount placed into a side

fund for payment of DWB's. In the cases where second and

subsequent year contributions were made by an employer, the

contributions were usually made to pay a renewal premium on the

life insurance or to increase the side fund. Contributions were

also sometimes made in years subsequent to the first year to

purchase additional insurance for newly eligible employees or to

increase the amount of insurance for employees with salary

changes so that the plan remained within the terms of the

Adoption Agreement and the provisions of the Code that were

believed related thereto. If the employer failed to make the

required contributions to keep the policy in force, Prime was

required to make these contributions from assets allocable to the

employer's Employee Group.

Universal life policies offer a policy owner certain options

regarding the cash surrender value of the policy. Under one

option, the policy's cash surrender value is included in the face

amount paid to the beneficiary upon the insured's death. Under a

second option, the carrier pays both the face amount and cash

surrender value to the beneficiary upon the insured's death.

Under the Trust Agreement, the Trust had to elect the second

option for each universal life policy that it acquired. When the

insured died, the carrier paid the beneficiary the policy's face

amount, thus discharging the Prime Plan's obligation to pay the
 - 21 -

deceased employee's vested death benefit, and the carrier paid

the Trust the cash surrender value associated with the policy.

Under the universal life policies acquired by the Trust, the

Trust could obtain a policy's cash surrender value before the

insured died by surrendering the policy. The amount received was

usually reduced by a surrender charge during the first several

years of the policy.

A death benefit was not payable if a Covered Employee died

on or after the date he or she terminated employment or was

discharged for cause. In the case of an owner/employee, a death

benefit was not payable when he or she terminated his or her

employment. A death benefit also was not payable when the

owner/employee continued to work but reached the date that was

the later of age 70-1/2 or the 10th anniversary of his or her

participation in the plan.

Upon termination of employment, a Covered Employee could,

with Prime's approval, elect to convert to individual coverage or

purchase his or her life insurance policy for its cash surrender

value. Absent such an election, the policy was surrendered or

transferred to the life of another Covered Employee. The

forfeited proceeds from the sale or surrender of life insurance

were segregated into the Suspense Account and used to increase

the employer's Covered Employee's DWB's or death benefits, to

provide new welfare benefits, to provide benefits for replacement

employees, or to distribute to the Covered Employees if and when
 - 22 -

the employer withdrew from the Prime Plan. If an employee

severed employment without a vested DWB, the cash surrender value

of his or her life insurance policy, if surrendered, was added to

another policy in the Employee Group.

4. Obligations and Liabilities

An employer that participated in the Prime Plan was required

to make an actuarially determined contribution in any year in

which one of its employees became eligible for a DWB or the

employer elected to increase the amount payable to its Covered

Employees under the Adoption Agreement. An employer had no

obligation to make additional contributions to provide for the

payment of DWB's if there were insufficient assets in the Trust

allocable to its Employee Group. An employee's right to a DWB

extended only to his or her allocable share of Employee Group

assets. If there were insufficient assets allocable to an

Employee Group to pay a Covered Employee's DWB, procedures were

set forth to pay a smaller benefit commensurate with the

available assets.

The employer relinquished all rights to the contributions

made to the Trust, and no amounts could revert to the employer or

be used for purposes other than the benefit of the Covered

Employees or for the payment of taxes and expenses of the Trust's

administration. Neither the employer, Plan Administrator, Prime,

or the trustee had any liability to pay any benefits provided

under the Plan beyond the assets in the Trust allocable to the
 - 23 -

applicable Employee Group. Neither the employer, Plan

Administrator, Prime, or the trustee was responsible for

contributions that were required for any other participating

employer.

5. Separate Accounting

Prime was required to maintain separate accounts reflecting

the share of each Employee Group and to determine the December 31

value of the insurance contracts and tax-exempt money market bond

fund allocable to each Employee Group. Prime was required to

keep accurate and detailed accounts of all transactions,

investments, receipts, and disbursements. Prime was required to

file a written report of this information with each employer

within 60 days after each December 31st.

At the end of each plan year, the Prime Plan's actuaries

were required to calculate experience gains and losses with

respect to each Employee Group, whether or not any gains or

losses had actually occurred. Experience gains and losses were

measured by comparing each employee's theoretical compensation to

actual compensation and by comparing the expected rate of return

on the assets held in the Employee Group account with the actual

rate of return on these assets. To the extent that the

theoretical compensation exceeded actual compensation, or the

expected rate of return exceeded the actual rate of return, an

experience gain resulted and the amount of the experience gain

had to be forfeited to the Suspense Account.
 - 24 -

Neither Prime nor its actuaries ever implemented the Trust

provisions requiring an annual calculation of experience gains

and losses. Prime changed its method of calculating experience

gains and losses effective June 30, 1990, because the unexpected

number of accounts which incurred experience gains created a

significant concern among the plan participants and their

advisers. Prime believed that this could potentially create non-

recoverable Suspense Account assets and alarm plan participants.

Prime wanted to reduce the amount of experience gain subject to

forfeiture and find a way to allow Suspense Account distribution

on withdrawal.

6. Employer Withdrawal From the Prime Plan

Employers could withdraw from the Prime Plan at any time by

submitting written notification to Prime, accompanied by

documentation showing that the necessary ownership interest of

the employer had approved the withdrawal. The necessary

ownership interest was the percentage listed by that employer in

its Adoption Agreement. If an employer failed to pay Prime's

annual administrative fee, Prime had the sole discretion to force

that employer to withdraw from the Prime Plan.

Upon an employer's withdrawal, assets were distributed to

all living Covered Employees who were employed during the period

that began 18 months before Prime's receipt of the notice.

Excess assets remaining in the Trust allocable to the Employee

Group after payment of all benefits and the employer's share of
 - 25 -

the Trust's tax liability were distributed pro rata using the

aggregate compensation received by each Covered Employee over the

period not to exceed 5 years that was listed by the employer in

the Adoption Agreement.

For an owner/employee who anticipated employment beyond the

Forfeiture Age, the Trust Agreement did not prohibit that owner

from withdrawing his or her company from the Prime Plan and

receiving a withdrawal distribution. For an owner-employee who

anticipated retiring, the Trust Agreement did not prohibit that

owner from withdrawing his or her company from the Prime Plan and

receiving a withdrawal distribution. Prime's actuaries assumed

that no employee would forfeit benefits upon retirement, and no

employee ever forfeited a DWB because he or she retired or stayed

employed beyond the Forfeiture Age. Prime's actuaries assumed

that no payments would come from the Suspense Account to

supplement the payment of benefits from the Trust.

7. Amendment and Termination of the Prime Plan

Prime retained the right to amend, modify, or delete any

provision of the Trust Agreement. Prime retained the right to

terminate the Prime Plan in certain circumstances, one of which

was if the plan failed to satisfy section 419A(f)(6).

8. The Trustee

The trustee was compensated under the terms of a written

agreement that it entered into with Prime. All reasonable costs

incurred by the trustee in performance of its duties were paid
 - 26 -

from the Trust, as was the case with all taxes levied or assessed

against the Trust. The trustee and insurer withheld any taxes

that were required to be withheld from any payment to a Covered

Employee and/or beneficiary.

C. The December 31, 1988, Trust Agreement

Prime amended the Trust Agreement on or about December 31,

1988. In relevant part, the following amendments were made.

First, Prime deleted the requirement that forfeited DWB's

and forfeited proceeds from the sale or surrender of life

insurance policies be segregated into the Suspense Account to be

used to provide benefits to the corresponding employer's Covered

Employees. Prime replaced this requirement with a provision

stating that these forfeitures would be experience gains subject

to the existing provisions, except as otherwise modified by the

amendments. One of these amendments required experience gains to

be allocated annually to the Suspense Account and allowed Prime

to direct the trustee to invest these amounts in tax exempt

securities or leave the amounts in each applicable Employee Group

subject to a lien.

Second, Prime was given the power to use the Suspense

Account assets in any manner consistent with a purpose or

objective of the Prime Plan, including supplementing the payment

of DWB's to an Employee Group with insufficient assets to pay

projected benefits due to experience losses suffered by that

Employee Group. Another new provision provided that neither
 - 27 -

Prime nor the Trustee had any liability to a Covered Employee for

the manner in which Suspense Account assets were used or

allocated among the Employee Groups.

Third, Prime removed the obligation of an employer to make

an actuarially determined contribution in any subsequent year in

which an employee became eligible for a DWB. Prime replaced this

obligation with an obligation to do so only if the employer

notified Prime that the employer intended to make such a

contribution.

D. The December 21, 1989, Trust Agreement

Prime amended the Trust Agreement a second time on or about

December 21, 1989. Prime made these amendments primarily to

reflect matters affecting the trustee. None of these amendments

are relevant to our discussion herein.

E. The June 30, 1990, Trust Agreement

Prime amended the Trust Agreement a third time on or about

June 30, 1990. In relevant part, Prime made the following

amendments.

First, Prime inserted Security Pacific as the successor

trustee.

Second, Prime added a provision allowing DWB's to be funded

through the purchase of a second to die life insurance policy.

Another new provision allowed the funding of death benefits

through the purchase of term insurance and second to die life

insurance policies.
 - 28 -

Third, Prime added a requirement that an employer had to

make actuarially determined contributions in any subsequent year

in which the employer notified Prime that the employer intended

to make a contribution for an employee who was entitled to a

greater vested percentage of his or her DWB than in the year the

Adoption Agreement was executed.

Fourth, Prime expanded the Trust's existing provisions to

state that the trustee would not be liable to a Covered Employee

or beneficiary with respect to shortfalls in any of the benefits.

The existing provisions were further expanded to provide that

neither Prime nor the trustee would be liable to a Covered

Employee or beneficiary as to decisions on the use of Suspense

Account assets to supplement or not to supplement a DWB. Other

new provisions reflected limits on the Trust's liability and

stated that Prime's maintenance of separate accounts was not a

separate trust fund.

Fifth, Prime replaced the term "experience gain" with the

term "Asset Gains, Liability Gains and Overfunded Gains", and set

forth a "measurable event" method of allocating gains to the

Suspense Account. Prime defined a measurable event as: a

severance, death, or attainment of Forfeiture Age of one or more

Covered Employees, or the withdrawal of the Employee Group.

Prime set forth another new provision that provided an objective

formula under which Prime was allowed to release a portion of the

Suspense Account when a measurable event occurred and an Employee
 - 29 -

Group had insufficient assets to pay DWB's, or an Employee Group

withdrew from the Trust. This formula was stated as follows:

fair market theoretical actuarial actual employer
value of liability for employee group contributions
suspense x theoretical actuarial x theoretical
account on liability for Trust employer
valuation Date contributions

Prime added other provisions that defined the relevant terms in

the formula and gave Prime the absolute discretion not to use the

formula if using it would be inconsistent with a purpose of the

Prime Plan.

Sixth, Prime added a provision that specified that a

withdrawing employer's written notice must list a withdrawal date

no later than 90 days after Prime received the notice. Prime

added another new provision specifying that it would deliver to

the employer within 60 days of Prime's receipt of the notice an

accounting of the employer's account in the Prime Plan.

Seventh, Prime listed the asset allocation procedures that

it would use to distribute assets to employees of a withdrawing

employer.

Eighth, Prime listed the trustee's rights and duties to

include: (1) The right to be reimbursed for the employment of

experts that it considered necessary to carry out its

obligations, (2) the right to be held harmless from and against

any loss, liability, or expense incurred without gross

negligence, breach of trust, or violation of the Employee

Retirement Income Security Act of 1974 (ERISA), Pub. L. 93-406,
 - 30 -

88 Stat. 829, arising out of its administration of the Trust, and

(3) the ability to reimburse itself, in certain circumstances,

from amounts held in the Trust, starting with the Suspense

Account.

F. The January 2, 1992, Trust Agreement

Prime amended the Trust Agreement a fourth time on or about

January 2, 1992. In relevant part, the following amendments were

made.

First, Prime inserted Firstar as the successor trustee.

Second, Prime added a provision requiring forfeiture of a

DWB upon actual retirement rather than upon reaching the

Forfeiture Age. Another new provision defined the term

"retirement" to mean "a Covered Employee's severance from service

with an Employer other than for Cause, Death or Total Disability,

where such Covered Employee cannot show proof of subsequent

employment or an attempt to obtain subsequent gainful employment

to Prime". Another new provision set forth the allocation of

"Employer Withdrawal Gains" to the Suspense Account.

G. The November 1, 1993, Trust Agreement

Prime amended the Trust Agreement a fifth time on or about

November 1, 1993. In relevant part, the following amendments

were made.

First, Prime added a provision stating that the amount of

gains allocated to the Suspense Account at the time of a

measurable event would equal the total gains multiplied by the
 - 31 -

ratio of an employer's total contributions made to the Prime Plan

as of December 31 over the total of all contributions which the

employer should have made to fully fund its Employee Group's

benefits. Prime also amended the measurable event formula to

read as follows:

fair market actual employer
value of actual employer contributions contributions
suspense x total employer contributions x theoretical
account on to the Trust employer
valuation date contributions

Another new provision gave Prime the sole discretion not to use

the measurable event formula wherever Prime concluded that the

formula would give a Covered Employee a larger benefit upon an

employer's withdrawal than he or she would have received as a

DWB.

Second, Prime replaced the phrase "terminated his employment

with the Employer on account of Retirement" with the phrase

"remained in the employ of the Employee Group beyond his

Forfeiture Age".

Third, Prime added a provision allowing the use of Suspense

Account assets to pay all fees and costs incurred in litigating

with the Commissioner issues related to the Prime Plan.

Permissible fees and costs included those of attorneys,

accountants, actuaries, and expert witnesses. Before this

amendment, Prime had spent $215,000 from the Suspense Account to

pay for legal services rendered mainly by Mr. Weiss and Mr. Brody

in defense of the Commissioner's challenge of the deductibility
 - 32 -

of employers' contributions to the Prime Plan. Mr. Weiss had

authorized the payment of these amounts.

III. Prime's Duties in Operation of the Prime Plan

Prime implemented the provisions of each employer's account

in the Prime Plan, issued annual reports and generated tax

filings on each account, and dealt with insurance providers.

Prime's responsibilities also included tracking money by Employee

Group, reviewing advertisements and sales materials, assisting

with tax audits, responding to legal issues, and assisting in

interpreting the Trust's provisions.

Prime computed each Covered Employee's vested DWB by

multiplying: (1) That employee's compensation listed on his or

her Form W-2 (Wage and Tax Statement) for the year before the

year the employer made the contribution, by (2) the accrual

percentage, by (3) the years of service (or the maximum accrual

years, if applicable), by (4) the employee's vesting percentage

as determined in accordance with the vesting schedule selected by

the employer in the Adoption Agreement. The accrual percentage

was a "plug" in that the percentage was based on how much money

the employer believed it could afford to spend for a certain

benefit.
 - 33 -

IV. The Trust's Financial Information

A. Overview

The Trust began accepting contributions from employers in

November 1988. As of June 30, 1992, the Trust had received

$92,273,952 in contributions, broken down as follows:

$15,852,213 in 1988, $29,453,541 in 1989, $25,281,057 in 1990,

$14,178,375 in 1991, and $7,508,766 in 1992.

Prime never valued the Trust as a whole, and Prime never

filed a Form 5500 (Annual Return/Report of Employee Benefit Plan)

for the Prime Plan as a whole. Neither the Prime Plan nor the

Trust had a 1988 Form 1041 (U.S. Fiduciary Income Tax Return)

filed on its behalf. Norstar Trust Co. of Rochester, New York,

filed 1989 and 1990 Forms 1041 that reported the following items

of income and expense for a complex trust named "Prime Financial

Benefits Trust--New York" (E.I.N. XX-XXXXXXX) (the New York

Trust):

1989 1990

Tax-exempt income $10,905 $64,477
Total income - 0 - - 0 -
Fiduciary fees 500 10,623
Total deductions - 0 - - 0 -
Taxable income - 0 - - 0 -
Total tax - 0 - - 0 -

Security Pacific filed 1990 through 1994 Forms 1041 that reported

the following items of income and expense for the Trust, listed
 - 34 -

on the forms as a complex trust named "Prime Financial Benefits

Trust" (E.I.N. XX-XXXXXXX):10

1990 1991 1992 1993 1994

Interest income $232,158 $372,992 $351,722 $106,927 $92,464
Other income: forfeitures --- 9,453 --- --- ---
Other income: refund trustee fees --- --- --- --- 4,012
Tax exempt income 55,467 34,812 295,340 118,797 14,498
Total income 232,158 382,445 351,722 106,927 96,476
Taxes 10,306 - 0 - 13,572 - 0 - 7,519
Fiduciary fees 53,836 63,293 22,994 - 0 - - 0 -
Attorney, accountant 13,247 136,440 96,205 104,764 173,804
Other deductions 3,500 - 0 - 16 1,761 10,547
Other deductions: mgmt/admin fees - 0 - - 0 - 173,550 79,263 128,000
Exemption 100 100 100 100 100
Taxable Income 164,781 199,276 (20,428) (22,898)(182,687)
Total tax 46,139 61,017 - 0 - - 0 - - 0 -

The Trust paid no benefits in 1988. From 1989 through 1994,

the Trust paid $30,420,770 in employer withdrawal benefits and

DWB's as shown below:
1989 1990 1991 1992 1993 1994 Total
DWB's (number) 0 6 50 57 87 56 256

Withdrawal dist. $468,274 $2,292,366 $3,848,663 $10,732,521 $6,227,028 $4,117,684 $27,686,536
DWB's (amount) 0 11,985 682,394 640,125 727,947 671,783 2,734,234
Total 468,274 2,304,351 4,531,057 11,372,646 6,954,975 4,789,467 30,420,770

B. Suspense Account transactions

The first Suspense Account transaction was a deposit of a

$37,841 death forfeiture on December 21, 1990. The following

chart is a summary of all Suspense Account activity through

October 31, 1994:

10
We are unable to determine whether the New York Trust is
the same entity as the Trust. The entities have different
E.I.N.'s, and the New York Trust's Forms 1041 reported that it
was created on Aug. 1, 1988, while the Trust's Forms 1041
reported that it was created on Aug. 31, 1988. The 1990 Form
1041 filed for the Trust also reported that the "OLD NAME OF
FIDUCIARY" was "NORTHERN TRUST BANK OF ARIZONA N.A.". Our
Opinion is not affected by whether the New York Trust and the
Trust are the same or different entities.
 - 35 -

Total Out Total In

Accounting fees $4,184 ---
Actuarial gains --- $252,977
Administrative fees 192,000 ---
Death benefit 3,398 ---
Death forfeitures --- 474,839
Expense allocations 22,939 ---
Interest earned --- 48,581
Legal fees 387,990 256
Miscellaneous 2,011 ---
Trustee fees 4,203 ---
Unrealized loss 17,035 ---
Totals 633,760 776,653

Mr. Weiss approved of the use of Suspense Account assets to

pay legal fees, administrative fees, and trustee fees.

Approximately $280,000 of the legal fees were paid to Snell &

Wilmer and Streich Lang.

V. Young & Young

A. Overview

The Youngs are husband and wife, and they resided in Sedona,

Arizona, when they petitioned the Court. The Youngs owned 100

percent of the stock of Young & Young, a corporation providing

medical care in and around Sedona, during the relevant years.

Young & Young's principal place of business was in Arizona, when

it petitioned the Court.

During the relevant years, Howard Young was a radiologist

working out of a hospital through a partnership in which

Young & Young was a 50-percent partner. Elaine Young was a

dermatologist with her own practice. Carleen Garcia was the

nurse and office manager of Elaine Young's practice.
 - 36 -

Young & Young reported its operations for Federal income tax

purposes on a calendar year, and it used the cash receipts and

disbursements method on its relevant Federal income tax returns.

These returns reported the following information:

1988 1989 1990 1991 1992

Total income $440,673 $571,125 $672,543 $622,323 $639,859
Compensation of officers 164,000 327,000 450,000 315,000 367,000
Salaries & wages 86,551 36,600 42,656 23,247 - 0 -
Pension, profit-sharing, plans 73,462 77,769 93,556 160,351 102,506
Employee benefit programs 17,368 56,230 6,761 9,418 5,425
Taxable loss 2,444 12,549 24,327 20,945 1,875

Of the reported compensation, Howard Young received $111,500,

$163,500, $225,000, $167,500, and $166,000 during the respective

years.

The Youngs filed timely a joint 1989 Federal income tax

return. On January 7, 1994, the Commissioner mailed them a

notice of deficiency reflecting a determination that the Youngs'

1989 taxable income was increased by $50,030 on account of a

taxable transfer of property from Young & Young under section 83.

The notice also stated that the Youngs were liable for a $2,802

accuracy-related penalty under section 6662(a) because the

underpayment of tax was due to negligence.

On the same day, the Commissioner mailed Young & Young a

notice of deficiency reflecting a determination that its 1989

taxable income was increased by $50,030 because its contribution

to the Trust was governed by subpart D.11 Young & Young had

11
Subpart D refers to subpart D of subchapter D of chapter
(continued...)
 - 37 -

filed its 1989 tax return on March 23, 1990, 8 days after the due

date. The notice of deficiency also stated that Young & Young

was liable for: (1) A $637 addition to tax for delinquency under

section 6651(a)(1), and (2) a $2,549 accuracy-related penalty

under section 6662(a) because its underpayment of income tax was

due to a substantial understatement.

B. Young & Young's Introduction to the Prime Plan

Donald A. Waldman was the Youngs' tax adviser. In

December 1989, Mr. Waldman introduced the Youngs to the Prime

Plan, advising Howard Young that the plan provided life insurance

as well as tax deferral. Howard Young viewed the Prime Plan as a

"wise business investment for the company" because it provided

life insurance, which he needed at that time, and because of "the

tax deferment." Howard Young relied on Mr. Waldman in choosing

to participate in the Prime Plan and in reporting the tax

ramifications that flowed therefrom. Mr. Waldman was competent

to give an opinion on the Prime Plan.

C. Young & Young's Adoption of the Prime Plan

Young & Young joined the Prime Plan by executing an Adoption

Agreement dated and effective as of December 1, 1989, and by

making a $50,030 contribution to the Trust approximately 16 days

later. Young & Young's $50,030 contribution was applied to the

full accrual of DWB's for its Covered Employees ($42,526) and the

11
(...continued)
I of subtitle A of the Code.
 - 38 -

cost of their death benefits ($7,500). Young & Young deducted

the full contribution on its 1989 tax return.

Young & Young's three employees (the Youngs and Carleen

Garcia) became Covered Employees under the Prime Plan as of

December 1, 1989. On January 14, 1992, Elaine Young executed an

addendum to Young & Young's Adoption Agreement electing

retroactively to waive her right to participate in the Prime

Plan. In all, Young & Young executed the following Adoption

Agreements during its participation in the Prime Plan:
Date effective 12/01/89 12/01/89 12/01/89 12/01/89 12/01/89
DWB percentage Not listed Not listed 1.55% 1.907% 3.814%
Years of service Not listed Not listed 10 10 10
Vesting schedule 4/40 4/40 4/40 4/40 4/40
Normal retirement age 55 55 55 55 65
Death benefit multiple Not listed Not listed 2.320 3.330 3.330
Date executed 12/01/89 12/01/89 4/06/90 06/23/92 12/30/92

D. Administration of Young & Young's Account in the Prime
Plan

Improved Funding Techniques, Inc. (IFTI), prepared the 1989

annual report for Young & Young's account in the Prime Plan, and

IFTI delivered the report to Howard Young on December 27, 1991.

The report included an actuarial valuation signed by Deloitte &

Touche and provided the following calculation of vested DWB's for

Young & Young's Covered Employees:
1988 Accrual Years of Vesting Vested
Compensation percentage Service percent DWB

Howard Young $111,500 3.814% 10 100% $42,526
Carleen Garcia 11,332 3.814 2 - 0 - - 0 -

The 1989 report addressed only Young & Young's Employee

Group, and it did not provide any information concerning the

Trust as a whole. The report used a 3.814 accrual percentage for
 - 39 -

the DWB's which had been unstated in any of the Adoption

Agreements executed by Young & Young before the report was

prepared. On December 30, 1992, Young & Young executed an

Adoption Agreement allowing for the 3.814 percent accrual

percentage.

Other annual reports prepared for Young & Young's account

reported the following relevant information:

1989 1990 1991

Fund value at yearend $50,018 $46,185 $48,015
Policy values - 0 - 46,005 48,026
Surrender value N/A 38,026 40,446
Additional contribution available (4) 1,467 3,866
Date of report 12/27/91 12/27/91 02/12/93

On March 16, 1990, Prime forwarded to Young & Young a copy

of the 1989 summary plan description required by section 102 of

ERISA. The description was later restated to reflect the

amendments to the Trust Agreement through January 1992.

E. Forms 5500-C/R (Return/Report of Employee Benefit Plan)

Forms 5500-C/R filed with the Commissioner for Young &

Young's account in the Prime Plan included the following

information:

1989 1990 1991 1992 1993

Yearend assets $100,018 $38,204 $40,435 $43,066 $43,256
Income 103 2,853 3,930 4,362 1,913
Expenses 114 14,667 1,699 1,731 1,723
Contributions 100,030 - 0 - - 0 - - 0 - - 0 -

These forms also reported the payment of insurance commissions of

zero, $7,793, zero, zero, and zero in the respective years from

1989 through 1993.
 - 40 -

F. Young & Young's Withdrawal From the Prime Plan

On August 8, 1994, Howard Young requested that an estimate

be calculated for Young & Young's withdrawal from the Prime Plan.

VI. N.L. Booth

A. Overview

Robert and Janice Booth (R&J Booth) are husband and wife,

and they resided in Scottsdale, Arizona, when they petitioned the

Court. John and Debra Booth (J&D Booth) are husband and wife,

and they resided in Scottsdale, Arizona, at the time of their

petition. During the relevant years, Robert Booth was vice

president and secretary of N.L. Booth, a corporation engaged in

the construction business in Phoenix, Arizona, and he owned 11.1

percent of N.L. Booth's stock. John Booth was N.L. Booth's

president and treasurer, and he owned 25 percent of N.L. Booth's

stock. N.L. Booth's remaining stock was owned by Phyllis Booth,

the mother of John and Robert Booth.

N.L. Booth's principal place of business was in Arizona when

it petitioned the Court. N.L. Booth reported its operations for

Federal income tax purposes on a fiscal year ending July 31, and

it used an accrual method on its relevant tax returns. These

returns reported the following information:

Taxable year ended 07/31/89 07/31/90 07/31/91 07/31/92 07/31/93
Total income $612,603 $1,230,318 $1,009,373 $1,235,227 $889,174
Compensation of officers 176,300 274,600 451,200 437,892 239,200
Salaries & wages 49,649 74,655 37,767 52,014 53,296
Pension, profit-shar. plans 40,000 8,500 43,261 152,464 150,696
Employee benefit programs - 0 - 100,000 56,739 - 0 - - 0 -
Taxable income 69,279 478,098 95,100 231,648 101,792
 - 41 -

Of the reported compensation, Robert Booth received $92,600,

$139,600, $228,000, $119,746, and $122,000 during his 1989

through 1993 taxable years, respectively, and John Booth received

$85,300, $134,800, $224,800, $314,946, and $117,200 during the

same respective years.

R&J Booth filed timely joint 1990 and 1991 Federal income

tax returns. On November 16, 1993, the Commissioner mailed them

a notice of deficiency reflecting a determination that R&J

Booth's taxable income for 1990 and 1991 was increased by $46,000

and $26,100, respectively, on account of taxable transfers of

property from N.L. Booth under section 83. The notice also

stated that R&J Booth were liable for $3,036 and $1,784 in

accuracy-related penalties under section 6662(a) for the

respective years.

On the same day, the Commissioner mailed to J&D Booth a

notice of deficiency reflecting her determination that J&D

Booth's 1990 and 1991 taxable income was increased by $54,000 and

$30,639, respectively, on account of taxable transfers of

property from N.L. Booth under section 83. J&D Booth had timely

filed a joint Federal income tax return for each of these years.

The notice also stated that J&D Booth were liable for $3,564 and

$2,053 in accuracy-related penalties under section 6662(a) for

the respective years.

The Commissioner also mailed a notice of deficiency to N.L.

Booth on that date, reflecting a determination that its 1989 and
 - 42 -

1990 taxable income was increased by $100,000 and $56,739,

respectively. The notice stated that N.L. Booth's contribution

to the Prime Plan was governed by subpart D. The notice also

stated that N.L. Booth was liable for $6,800 and $4,377 in

accuracy-related penalties under section 6662(a) for the

respective years because its underpayments of income tax were due

to substantial understatements. N.L. Booth filed timely 1989 and

1990 tax returns.

B. N.L. Booth's Introduction to the Prime Plan

Barclay D. Schultz was N.L. Booth's insurance agent for the

Prime Plan. On July 17, 1990, Mr. Schultz contacted Prime about

N.L. Booth's possible participation in the Prime Plan. Sixteen

days later, Joseph P. Waters, N.L. Booth's certified public

accountant, furnished N.L. Booth with computations of projected

earnings from participating in the Prime Plan. Robert and John

Booth (collectively, the Booths), individually and in their

capacity as officers of N.L. Booth, relied upon competent and

informed tax and investment advisers before joining the Prime

Plan and in reporting the tax ramifications that flowed

therefrom.

C. N.L. Booth's Adoption of the Prime Plan

N.L. Booth joined the Prime Plan by executing an Adoption

Agreement dated and effective as of July 31, 1990, and by

contributing $25,030 to the Trust 37 days later. N.L. Booth was

required to make a remaining contribution of $75,000 to the Trust
 - 43 -

by October 15, 1990. N.L. Booth made this contribution, without

interest, on January 30, 1991. N.L. Booth's 1989 tax return

claimed a $100,000 deduction for accrued contributions owed the

Trust.

N.L. Booth's 1990 tax return claimed a $56,739 deduction for

accrued contributions owed the Trust. On February 14, 1992, N.L.

Booth paid Firstar Metropolitan Bank & Trust (Firstar) $55,000 of

this amount; N.L. Booth never paid the remaining $1,739.

Generally, the $55,000 contribution was applied as follows:

(1) An increase in DWB's resulting from the change in the accrual

percentage, (2) an increase in vesting, and (3) the cost of a

death benefit.

In all, N.L. Booth executed the following Adoption

Agreements relating to its participation in the Prime Plan:

Date effective 07/31/90 07/31/90 01/01/91 07/31/90
Dismissal wage benefit percentage 4.196 2.84 6.54 4.196
Years of service 10 10 10 10
Vesting schedule 4/40 4/40 4/40 4/40
Normal retirement age Same as 401(a) Same Same Same
Death benefit multiple 4.122 2.692 4.122 4.122
Date executed 07/31/90 07/31/90 07/30/91 10/01/91

D. Administration of N.L. Booth's Account in the Prime Plan

On August 12, 1991, IFTI forwarded the 1990 annual report

for N.L. Booth's account in the Prime Plan to John Booth. The

report pertained only to N.L. Booth's Employee Group. The report

included an actuarial valuation signed by Deloitte & Touche and

provided the following calculations of vested DWB's:
 - 44 -
1989 Accrual Years of Vesting Vested
Compensation percent Service percent DWB

John Booth $84,900 4.196 10 100 $35,624
Robert Booth 84,900 4.196 10 100 35,624
Andrew Alvis 36,900 4.196 2 - 0 - - 0 -
Thomas Geary 37,674 4.196 4 40 2,529
Trevor Naugle 39,900 4.196 10 100 16,742

The report did not provide any information on the Trust as a

whole.

On September 14, 1992, IFTI forwarded the 1991 annual report

for N.L. Booth's account to John Booth. This report included

another actuarial valuation signed by Deloitte & Touche. In

order to accommodate the 1991 contribution, the accrual

percentage for DWB's was increased to 6.54 percent.

In all, the annual reports for N.L. Booth's account in the

Prime Plan included the following information:
1990 1991 1992 1993 1994

Fund value at yearend $100,281 $151,615 $150,370 $160,563 $169,572
Contribution in transit - 0 - 55,000 - 0 - - 0 - - 0 -
Policy values - 0 - 96,219 149,983 160,176 169,181
Surrender value N/A 90,412 141,438 151,632 160,636
Additional contrib. available 3,976 4,263 15,647 23,058 35,386
Date of report 08/12/91 09/14/92 02/23/94 12/08/94 01/16/96

E. Forms 5500-C/R

Forms 5500-C/R for N.L. Booth's account in the Prime Plan

included the following information:

1990 1991 1992 1993

Yearend assets $100,282 $145,808 $141,825 $152,019
Income 252 47,025 3,892 10,194
Expenses - 0 - 1,499 7,875 1,215
Contributions 100,030 55,000 - 0 - - 0 -

These forms did not list any insurance commissions paid from 1990

through 1993.
 - 45 -

VII. Systems

A. Overview

The Johnsons are husband and wife, and they resided in Waco,

Texas, when they petitioned the Court. Systems' principal place

of business was in Waco, Texas, when it petitioned the Court.

Since 1990, Systems' only employees have been the Johnsons and

Robert J. Carr. Mr. Carr, a certified public accountant

(C.P.A.), is Systems' controller.

Mr. Johnson initially owned 49 percent of Systems' common

stock, and Mrs. Johnson owned the rest. On December 1, 1990,

Systems canceled the shares of stock initially issued to the

Johnsons and reissued 21 shares to Mr. Carr, 39 shares to

Mr. Johnson, and 40 shares to Mrs. Johnson. On February 2, 1991,

Mr. Johnson held 79 shares of Systems' stock through a

partnership known as Chief Smokey, Ltd., and Mr. Carr owned the

remaining shares.

Systems reported its operations for Federal income tax

purposes on a fiscal year ending on September 30, and it used the

cash method on its relevant tax returns. These returns included

the following information:
Taxable year ended 09/30/90 09/30/91 09/30/92 09/30/93
Total income $51,643 $725,000 $606,132 $909,028
Compensation of officers - 0 - 303,200 102,200 143,000
Salaries & wages 20,481 1,000 1,000 7,855
Pension, profit-sharing, plans - 0 - - 0 - - 0 - - 0 -
Employee benefit programs - 0 - 301,150 300,000 700,000
Taxable income (loss) (24,159) 35,132 145,384 7,518

Of the reported compensation, Mr. Johnson received zero,

$150,000, $142,500, $120,000, and $130,000 during his respective
 - 46 -

taxable years from 1989 through 1993, and Ms. Johnson received

zero, $9,000, $16,900, $15,500, and $13,000 during the same

respective years.

Johnson Roofing, Inc. (Roofing) is an affiliate of Systems.

Roofing's relevant tax returns included the following

information:
Taxable year ended 10/31/89 10/31/90 10/31/91 10/31/92
Total income $1,865,045 $1,939,495 $1,582,097 $1,893,945
Compensation of officers 233,988 300,600 10,200 - 0 -
Salaries & wages 50,495 429,644 535,298 603,235
Pension, profit-sharing, plans - 0 - - 0 - - 0 - - 0 -
Employee benefit programs 1,087 - 0 - - 0 - - 0 -
Taxable income (loss) 114,719 123,189 (197,520) (471,113)

Of the reported compensation, Mr. Johnson received $73,000,

$234,988, and $288,000 in his respective taxable years from 1988

through 1990. Ms. Johnson received $20,580, $31,200, and $15,600

during the same respective years. Neither of the Johnsons

received any compensation from Roofing during their 1991 through

1993 taxable years.

The Johnsons filed timely their joint 1990 Federal income

tax return. On March 3, 1994, the Commissioner mailed them a

notice of deficiency reflecting a determination that the

Johnsons' 1990 taxable income was increased by $297,299 on

account of a taxable transfer of property from Systems under

section 83.12 The notice also stated that the Johnsons were

liable for a $16,794 accuracy-related penalty under section

12
The notice also increased the Johnsons' 1990 income by
$184,099 on account of "Agreed Items".
 - 47 -

6662(a) because the underpayment of tax attributable to section

83 was due to negligence.

On the same day, the Commissioner mailed Systems a notice of

deficiency reflecting a determination that its 1990 taxable

income was increased by $300,000 because its contribution to the

Trust was governed by subpart D. Systems filed timely its 1990

tax return. The notice also stated that Systems was liable for a

$21,735 accuracy-related penalty under section 6662(a) because

its underpayment of income tax was due to a substantial

understatement.

B. Systems' Introduction to the Prime Plan

Max Chapman, Systems' independent C.P.A., introduced the

Johnsons to the Prime Plan, stating that it would be "useful in

tax planning". Mr. Carr was also involved in meetings concerning

Systems' decision to join the Prime Plan, and he reviewed some of

the plan's literature. One of the main selling features of the

Prime Plan from Mr. Carr's perspective was the "very thick

opinion letter". Mr. Johnson, individually and on behalf of

Systems, relied upon competent and informed tax and investment

advisers before joining the Prime Plan and in reporting the tax

ramifications that flowed therefrom.

C. Systems' Adoption of the Prime Plan

Systems joined the Prime Plan by executing an Adoption

Agreement dated and effective as of December 20, 1990, and by

making a $300,000 contribution to the Trust 6 days later. The
 - 48 -

contribution funded the full accrual of DWB's for Systems' three

employees ($264,000), as well as their death benefits ($36,000).

When Mr. Johnson made that contribution, he believed the money

could not be lost to an employee of another Employee Group.

Systems' three employees became Systems' Covered Employees in

1990.

On March 12, 1991, Mr. Johnson, on behalf of Systems,

amended the 1990 Adoption Agreement effective as of December 31,

1990, to change the DWB accrual percentage to 176 percent and the

years of service multiple to one. No change was made to the

vesting schedule.

In all, Systems submitted the following Adoption Agreements

relating to its participation in the Prime Plan:
Date Effective 12/20/90 12/20/90 12/20/90 12/20/90
Dismissal wage benefit percentage 176 176 176 200
Years of service 1 1 1 5
Vesting schedule Immediate Immediate Immediate 4/40
Normal retirement age not listed 65 65 Not listed 65
Death benefit multiple 16.275 16.275 16.275 15.695
Date executed Not Not Not 12/20/90
executed executed dated

On December 2, 1991, IFTI sent Systems copies of substitute pages

1 and 5 for its Adoption Agreement. These pages changed the

employer yearend to September 30, the Normal Retirement Date to

65, and the death benefit multiple to 16.275.

D. Administration of Systems' Account in the Prime Plan

The 1989 annual report on Systems' account in the Prime Plan

pertained only to Systems' Employee Group, and it did not provide

any information regarding the Trust as a whole.
 - 49 -

On March 6, 1991, IFTI forwarded the 1990 annual report for

Systems' account to Mr. Johnson. The report included an

actuarial valuation signed by Deloitte & Touche and provided the

following calculations of vested severance benefits for Systems'

Covered Employees:
1989 Accrual Years of Vesting Vested
Compensation percent Service percent Severance

Mr. Johnson $140,000 176 1 100 $246,400
Ms. Johnson 9,000 176 1 100 15,840
Mr. Carr 1,000 176 1 100 1,760

In the 1990 annual report, the Prime Plan's actuary used a DWB of

176 percent, 1 year of service, 100 percent vesting, and a 16.275

death benefit multiple. These numbers were different from those

set forth in the Adoption Agreements. Adoption Agreements with

the percentages and multiples used in the 1990 annual report were

prepared, but never executed by Systems. IFTI contacted Systems

on numerous occasions in 1991 and 1992, stating that Systems

needed to provide the executed Adoption Agreements. Mr. Carr

executed, but failed to date, an Adoption Agreement with the

correct percentages and multiples.

The annual reports for Systems' account in the Prime Plan

included the following information:
 - 50 -
1990 1991 1992 1993 1994

Fund value at yearend $300,000 $304,342 $317,443 $326,944 $338,487
Policy values - 0 - 303,424 316,513 327,064 338,607
Surrender value N/A 240,440 255,413 269,293 283,222
Additional contribution available - 0 - 17,312 29,863 44,164 57,460
Date of report 3/06/91 11/16/92 2/23/94 8/15/94 6/28/95

E. Forms 5500-C/R

Forms 5500-C/R filed with the Commissioner on Systems'

account in the Prime Plan reported the following information:
1990 1991 1992 1993 1994

Yearend Assets $300,081 $241,358 $256,343 $269,173 $283,102
Income 81 21,588 26,324 26,091 24,134
Expenses - 0 - 80,311 11,339 13,261 10,205
Contributions 300,000 - 0 - - 0 - - 0 - - 0 -

These forms also reported the payment of zero, $38,546, zero,

zero, and zero in insurance commissions during the respective

years.

VIII. On-Site Project Management, Inc. (On-Site)

A. Overview

The Traegdes are husband and wife, and they resided in

Tempe, Arizona, when they petitioned the Court. On-Site is an

S corporation that was incorporated on July 2, 1984. Mr. Traegde

was its president, and he owned 98.4022 percent of its stock on

December 31, 1989. Ms. Traegde was On-Site's vice president, and

she owned the rest of its stock on that date. The 1989 Federal

income tax returns of On-Site and the Traegdes were filed timely.
 - 51 -

On-Site reported its operations for Federal income tax

purposes on a calendar year, and it used the cash method on its

relevant tax returns. These returns included the following data:
1988 1989 1990 1991 1992

Total income $1,130,895 $1,108,792 $923,488 $114,270 $603,522
Compensation of officers 120,910 213,985 219,621 71,011 135,519
Salaries & wages 234,900 387,389 122,142 135,724 86,660
Pension, profit-sharing, plans 104,296 47,300 1,585 - 0 - - 0 -
Employee benefit programs - 0 - - 0 - - 0 - 1,711 4,116
Ordinary income (loss) 471,158 232,440 371,926 (230,453) 213,508

Of the reported compensation, Mr. Traegde received $117,536,

$201,956, $205,870, $56,808, and $125,207 during the respective

years.

B. On-Site's Introduction to the Prime Plan

Thomas J. Connelly was the Prime Plan's sales agent for

On-Site. Mr. Connelly introduced Mr. Traegde to the Prime Plan

in late 1988. Mr. Connelly had observed that Mr. Traegde did not

have a succession plan for his business or any estate planning,

that the Prime Plan offered death benefits for Mr. Traegde, and

that the Prime Plan would give Mr. Traegde a source of funds to

close his business when he decided to leave.

On October 4, 1988, Mr. Connelly wrote to On-Site's C.P.A.,

Thomas P. Joynt, explaining the Prime Plan. On November 7, 1988,

Mr. Joynt replied with certain questions about the Prime Plan, as

well as On-Site's possible participation therein. On

November 17, 1988, Mr. Connelly responded to Mr. Joynt's letter.

Mr. Connelly discussed the Prime Plan with Mr. Traegde.

Based on these conversations, and after reading the promotional
 - 52 -

literature on Prime, Mr. Traegde concluded that the risks

involved in the Prime Plan were minimal. Mr. Traegde expected to

get his DWB if he sold or closed his business, and he knew that

he could withdraw On-Site from the Prime Plan at any time.

Mr. Traegde also discussed Mr. Weiss' opinion letter on the Prime

Plan with Mr. Joynt, and Mr. Traegde relied on Mr. Joynt's advice

with respect thereto.

C. On-Site's Adoption of the Prime Trust

On-Site joined the Prime Plan by executing an Adoption

Agreement on December 28, 1988, effective as of December 31,

1988, and by contributing $100,026 to the Trust on the same day.

On-Site's contribution was applied primarily as follows: $89,645

to the full accrual of DWB's for its Covered Employees and

$10,340 to the cost of their death benefits. As of December 31,

1988, On-Site's Covered Employees were Mr. Traegde and four other

employees. Other On-Site employees became Covered Employees

during 1989, and still others became Covered Employees in

subsequent years. On December 29, 1989, On-Site made an

additional contribution of $50,030 to the Prime Plan. On-Site

made no contributions to the Prime Plan in 1990, 1991, or 1992.

On-Site submitted the following Adoption Agreements relating

to its participation in the Prime Plan:
 - 53 -
Date effective 12/31/88 12/31/88 11/01/89 12/31/89
DWB percentage 25.07 25.54 N/A 23.82
Years of service 7 7 N/A 8
Vesting schedule 4/40 4/40 N/A 4/40
Normal retirement date Same as 401(a) Same as 401(a) Same as 401(a) Same as 401(a)
Death benefit multiple 5.36 5.36 2.86 2.231
Date executed 12/28/88 12/28/88 11/01/89 12/28/89

Date effective 09/04/90 12/31/88 01/01/89
DWB percentage 24 25.54 27.220
Years of service 8 7 7
Vesting schedule N/A 4/40 4/40
Normal retirement date Same as 401(a) Same as 401(a) Same as 401(a)
Death benefit multiple N/A 2.86 2.86
Date executed 10/18/90 02/11/92 02/11/92

On-Site's agreement dated November 1, 1989, also reduced the

minimum death benefit from $50,000 to $25,000.

D. Administration of On-Site's Account in the Prime Plan

On August 15, 1989, Prime forwarded to On-Site a 1988

actuarial valuation for On-Site's account in the Prime Plan,

signed by Laventhol & Horwath. On March 11, 1991, IFTI forwarded

a 1988 annual report for On-Site's account in the Prime Plan to

Mr. Traegde. This report included an actuarial valuation signed

by Deloitte & Touche and provided the following calculations of

vested severance benefits for On-Site's Covered Employees:
1987 Accrual Years of Vesting Vested
Employee Compensation percent Service percent Severance

Mr. Traegde $156,000 25.54 5 45 $89,645
Larry French 36,400 25.54 1 - 0 - - 0 -
Erik Kallstrom 35,984 25.54 1 - 0 - - 0 -
Jeanne Sharon 21,840 25.54 1 - 0 - - 0 -
Norman Burke - 0 - 25.54 N/A N/A N/A
Richard Murphy - 0 - 25.54 N/A N/A N/A
Michael Brandt - 0 - 25.54 N/A N/A N/A
K. Diane Small - 0 - 25.54 N/A N/A N/A
Denise Minix - 0 - 25.54 N/A N/A N/A
Steve Boyles - 0 - 25.54 N/A N/A N/A

The 1988 report did not refer to another participating Employee

Group, and it did not provide any information on the Trust as a

whole. The report related only to the On-Site's Employee Group.
 - 54 -

On March 11, 1991, IFTI forwarded the 1989 annual report for

On-Site's account in the Prime Plan to Mr. Traegde. This report

included an actuarial valuation signed by Deloitte & Touche, and

it listed nine other employees of On-Site, none of whom qualified

for a 1989 vested severance benefit. In order to accommodate On-

Site's 1989 contribution, the accrual percentage for DWB's was

increased from 25.54 percent to 27.220 percent. The 1989 report

acknowledged a $50,000 contribution from On-Site, and applied the

$50,000 amount to the increase in DWB's allowed because of the

change in the accrual percentage, the increase due to the

increased vesting of Mr. Traegde, and the increase due to the

cost of death benefits.

The annual reports for On-Site's account in the Prime Plan

listed the following relevant data:
1988 1989 1990 1991

Fund value at yearend $99,996 $138,653 $158,161 $167,047
Policy values 99,996 138,653 157,814 167,055
Surrender value Unstated Unstated 136,959 147,056
Addit. contr. available (11) 2 61,519 128,443
Date of report 03/11/91 03/11/91 07/10/91 01/20/93

1992 1992 1993 1993 1994

Fund value at yearend $177,095 $177,095 $184,012 $176,364 $148,625
Policy values 177,103 177,103 186,612 178,964 177,545
Surrender value 157,104 157,104 166,613 161,097 162,772
Addit. contr. available 202,263 197,155 248,761 243,663 296,318
Date of report 09/94 03/95 09/94 03/95;10/95 10/95

On March 31, 1989, Prime forwarded to On-Site its 1988

summary plan description. On April 4, 1990, Prime forwarded to

On-Site its 1989 summary plan description. On February 24, 1993,

Prime forwarded to On-Site its summary plan description with

amendments through January 1992.
 - 55 -

E. Forms 5500-C/R

Forms 5500-C/R filed with the Commissioner on On-Site's

account in the Prime Plan included the following information:

1989 1990 1991 1992 1993

Yearend assets $138,653 $137,306 $147,048 $157,095 $164,013
Income 38,867 14,163 13,054 13,087 12,434
Expenses 241 15,510 3,312 3,076 5,516
Contributions 50,030 - 0 - - 0 - - 0 - 670

These forms also reported the payment of $11,858, $13,797, $54,

zero, and zero in insurance commissions during the respective

years.

OPINION

We must determine the tax consequences flowing from the

Prime Plan, a purported multiple employer welfare benefit plan

that has been marketed nationwide by its promoters as a viable

tax planning device and subscribed to by hundreds of entities

whose employee/owners have sought primarily the promised tax

benefits. The designers of the Prime Plan struggled to comply

with section 419A(f)(6)'s exception to the applicability of

subpart D. The designers followed the evolution of subpart D

through the Congressional committees, and they aspired to create

a valid welfare benefit plan that met the legislative intent for

section 419A(f)(6). The designers were familiar with the tax and

labor provisions of employee benefit law.

Based on their understanding of the genesis of subpart D,

the drafters concluded that section 419A(f)(6) covered their
 - 56 -

design for the Prime Plan. One of the designers, Mr. Weiss,

requested a ruling from the Commissioner that the Prime Plan

qualified under section 419A(f)(6). The Commissioner did not

issue a ruling in reply to Mr. Weiss' ruling request, and, to

date, the Commissioner has not issued regulations construing

section 419A(f)(6). On May 1, 1995, the Commissioner released

Notice 95-34 (the Notice), 1995-1 C.B. 309, to provide guidance

on "the significant tax problems" raised by certain trust

agreements being promoted as multiple employer welfare benefit

funds exempt from the limits of sections 419 and 419A. Id.

Although the Notice did not mention the Prime Plan by name, the

Notice indicated that the Commissioner disagreed with Prime that

its plan was within section 419A(f)(6).

Having failed in their attempt to receive the Commissioner's

assurance that the Prime Plan was a 10 or more employer plan

under section 419A(f)(6), Prime nevertheless began marketing the

plan in 1988, relying on the designers' opinions as to the

validity of the promised tax benefits that Prime believed flowed

from the Prime Plan. The Commissioner now challenges these tax

benefits in the instant litigation. The Commissioner argues

primarily that the Prime Plan is a plan of deferred compensation.

Petitioners argue that the Prime Plan provides merely welfare

benefits. The Commissioner argues alternatively that the Prime

Plan is actually an aggregation of plans that is outside the

scope of section 419A(f)(6). Petitioners argue that the Prime
 - 57 -

Plan is a single 10 or more employer plan within section

419A(f)(6).

We must resolve these disputes. We do so with the benefit

of a comprehensive and detailed evidentiary record developed by

the parties up to, including, and after trial, as well as with

the aid of the parties' briefs and other voluminous submissions

that have focused on issues which have been in dispute at one

time or another throughout this proceeding. We analyze the law

that applies to the issues at hand, giving due regard to all

arguments made by the parties with respect to these issues.

1. Type of Plan: Welfare Benefit or Deferred Compensation

We pass first on whether the Prime Plan is a plan of welfare

benefit or deferred compensation. If the Prime Plan is a

deferred compensation plan, section 404(a)(5) prohibits a

participating employer from deducting a contribution until the

year in which an amount attributable to the contribution is

includable in the gross income of employees participating in the

plan, assuming that separate accounts are maintained for each

employee. If a separate account is not maintained for each

employee, section 404(a)(5) does not allow an employer to deduct

the contribution even in the year in which an attributable amount

is included in the gross income of an employee. See also sec.

1.404(a)-12(b)(3), Income Tax Regs. If, on the other hand, the

Prime Plan is a welfare benefit plan, subpart D generally limits

the employer's deduction for its contributions to the amount that
 - 58 -

would have been deductible had it provided the benefits directly

to its employees. Subpart D's limitations are inapplicable when

section 419A(f)(6) applies. Section 419A(f)(6) generally lets an

employer fully deduct its contributions in the year made,

although its employees may not have to report these contributions

as income until a later year.

We agree with petitioners that the Prime Plan was a welfare

benefit fund. See sec. 419(e)(1), (2)(B), (3)(B); sec. 1.162-10,

Income Tax Regs; see also Schneider v. Commissioner, T.C. Memo.

1992-24; Moser v. Commissioner, T.C. Memo. 1989-142, affd. on

other grounds 914 F.2d 1040 (8th Cir. 1990). Mr. Weiss testified

credibly that he designed the Prime Plan intending entirely to

provide employees with "real" welfare benefits that would not be

subject to abuse, and we read the record to support his

testimony. The DWB's under the Trust Agreement also are not

payable upon the happening of a certainty, but more closely

resemble insurance payable only in the case of an uncertainty.

See Harry A. Wellons, Jr., M.D., S.C. v. Commissioner, 31 F.3d

569 (7th Cir. 1994), affg. T.C. Memo. 1992-704. Although the

Prime Plan had features of deferred compensation (e.g., the

payment of DWB's upon an employee's termination from employment

based on his or her compensation and length of service, the

presence of vesting schedules), these features were swallowed up

by the Prime Plan's valid welfare benefit purpose so as to make
 - 59 -

the deferred compensation features incidental and meaningless for

purposes of our analysis.

Respondent argues that this Court's jurisprudence provides

that the DWB's were deferred compensation, citing mainly

Grant-Jacoby, Inc. v. Commissioner, 73 T.C. 700 (1980); New York

Seven-Up Bottling Co. v. Commissioner, 50 T.C. 391, 398 (1968);

New York Post Corp. v. Commissioner, 40 T.C. 882, 888 (1963); and

Harry A. Wellons, Jr., M.D., S.C. v. Commissioner, T.C. Memo.

1992-704. We disagree. The plan at issue in each of the cases

cited by respondent is distinguishable from the Prime Plan. Such

is also true with respect to the benefits provided under each

plan.

Nor do we agree with respondent's reading of the Seventh

Circuit's opinion in Harry A. Wellons, Jr., M.D., S.C. v.

Commissioner, 31 F.3d 569 (7th Cir. 1994), to provide that the

DWB's were deferred compensation because the Prime Plan had some

indicia of a deferred compensation plan. All welfare benefit

plans bear some element of deferred compensation, see Wheeler v.

United States, 768 F.2d 1333, 1336 (Fed. Cir. 1985); Greensboro

Pathology Associates, P.A. v. United States, 698 F.2d 1196, 1200

(Fed. Cir. 1982), and respondent's reading of the Seventh

Circuit's opinion emasculates the right of a taxpayer to avail

itself of the tax attributes of a welfare benefit plan. Unlike

the Prime Plan, the plan at issue in Wellons was "more akin to a

deferred compensation plan than the sort of 'welfare benefits'
 - 60 -

arrangement contemplated by the regulations". Harry A. Wellons,

Jr. M.D., S.C. v. Commissioner, 31 F.3d at 572.

Nor do we agree with respondent's claim that the DWB's were

deferred compensation because an employer could voluntarily

terminate its participation in the Prime Plan. We are unable to

find any requirement in the applicable statutory and regulatory

provisions that would limit welfare benefits to cases in which an

employer could not voluntarily terminate its participation in a

plan. We find in the statutory text that the Congress knew how

to say "involuntary separation" when it wanted. See, e.g., sec.

501(c)(17)(D), which is referenced in sec. 419A(f)(1)(A). In the

absence of a legislative pronouncement that limits severance

benefits to cases where an employer could not voluntarily

terminate its participation in a plan, we refuse to adopt such a

pronouncement here. Although respondent is concerned that the

ability of a participating employer to terminate voluntarily its

participation in the Prime Plan allows the employer to control

the timing of income to its employees, we regard that concern as

misplaced. Respondent's concern could also be expressed with

respect to the pension plan of a corporation owned by a single

shareholder. Although the shareholder may be the only employee,

it does not necessarily follow that such a pension plan provides

for receipt of deferred compensation merely because the

owner/shareholder has the ability to terminate the pension plan

at will.
 - 61 -

We hold for petitioners on this issue.

2. 10 or More Employer Plan; Experience-Rating Agreements

We turn to the second issue; namely, whether the Prime Plan

is a "10 or more employer plan" that lacks "experience-rating

arrangements with respect to individual employers." See sec.

419A(f)(6). Petitioners assert that the Prime Plan is within

section 419A(f)(6); i.e., the Prime Plan is a single plan that

covers more than 10 employers, no one of which made more than 10

percent of the Trust's total contributions, and the plan has no

experience-rating arrangements with respect to individual

employers. Respondent asserts that the Prime Plan is outside the

scope of section 419A(f)(6); i.e., the Prime Plan is an

aggregation of plans that has experience-rating arrangements with

respect to all participating employers.

We agree with respondent that the Prime Plan does not meet

the requirements of section 419A(f)(6). The Prime Plan is an

aggregation of separate welfare benefit plans, each of which has

an experience-rating arrangement with the contributing employer.

We start our analysis with a discussion of the history of subpart

D.13 Subpart D, which consists of sections 419 and 419A, was

enacted by the Congress as part of Deficit Reduction Act of 1984,

Pub. L. 98-369, secs. 511(a) and 512(a), 98 Stat. 484, 854-862.

13
In National Presto Indus., Inc. v. Commissioner, 104 T.C.
559 (1995), and General Signal Corp. v. Commissioner, 103 T.C.
216 (1994), supplemented by 104 T.C. 248 (1995), this Court
addressed other issues under subpart D.
 - 62 -

Subpart D limits an employer's deduction for contributions to a

welfare benefit plan. The Congress enacted subpart D because it

was concerned with the law under which employers received current

deductions for contributions to welfare benefit plans, while the

benefiting employees excluded these amounts from their current

income. As stated by the House Ways and Means Committee, in

proposing a change to the prior law,

The committee has concluded that the favorable tax
treatment of employer contributions to welfare benefit
plans, as compared with employer payments of wages and
salary, is inappropriate in view of the favorable tax
treatment already provided to employees, i.e., the
exclusion of many of these benefits from adjusted gross
income. In addition, the committee believes that the
current rules under which employers may take deductions
for plan contributions far in advance of when the
benefits are paid allows excessive tax-free
accumulation of funds.

The committee's concern has been caused by recent
discussion among tax practitioners as to the tax-
shelter potential of welfare benefit plans.
Commentators have pointed out that the combination of
advance deductions for contributions and the
availability of tax exemption for certain employee
benefit organizations (such as the voluntary employees'
beneficiary association or VEBA) provides tax treatment
very similar to that provided to qualified pension
plans, but with far fewer restrictions. * * *

In one article on the use of employee benefit
plans as a tax shelter, an example is given of how a
small professional corporation may utilize the tax
benefits of a severance pay plan funded by a VEBA. In
this example, the employees of the corporation are two
doctors, ages 50 and 55, with annual salaries of
$150,000 and $200,000, respectively, and three other
workers, ages 20 to 36, with annual salaries of $10,000
to $18,000. The example indicates that the corporation
could make tax deductible annual contributions to a
tax-exempt VEBA of more than $55,000 annually under
terms that would make it unlikely that the three lower-
 - 63 -

paid employees would receive substantial benefits from
the plan. * * *

Thus, the committee is concerned that substantial
advance funding of welfare benefits will ultimately
lead to an unacceptable tax burden for many taxpayers
who do not participate in these programs. * * *
[H. Rept. 98-432 (Part 2), at 1275-1276 (1984).]

As reflected in the report of the conference, the Congress

enacted subpart D with the understanding that subpart D's

principal purpose was “to prevent employers from taking premature

deductions, for expenses that 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. The conference report states that

"While in many cases welfare benefit funds are designed
to function in a manner similar to insurance
arrangements, the conference [was] concerned that there
[were] no clear standards of limitations applicable to
such funds that [prevented] their utilization for
substantial nonqualified deferred compensation funding
outside the general pension plan funding, accrual and
vesting rules." [Id. at 1155.]

The conference report commented as follows on the meaning of the

term "funds":

a retired life reserve or premium stabilization account
ordinarily is to be considered a fund or part of a
fund, since such an account is maintained for an
individual employer and that employer has a
determinable right to have the amount in such an
account applied against that employer's future costs of
benefit claims or insurance premiums. A similar
situation exists with respect to premium arrangements,
under which an employer may, in some cases, pay an
insurance company more in a year than the benefit costs
incurred in that year and the employer has an
 - 64 -

unconditional right in a later year to a refund or
credit of the excess of payments over benefit costs.
In contrast, an ordinary disability income policy under
which an employer pays a premium so that employees who
become disabled in that year may collect benefit
payments for the duration of disability is not a fund,
since the employer has no right to recover any part of
the premium payment and the future benefit payments to
an employee whose disability occurs during the period
for which the premium is paid is not contingent on any
further payments by the employer. * * * [Id. at 1155.]

The rules of subpart D, however, do not apply to a

multiemployer plan described in section 419A(f)(6). Section

419A(f)(6) provides:

(6) Exception for 10-or-More Employer Plans.--

(A) In general.--This subpart shall not
apply in the case of any welfare benefit fund
which is part of a 10 or more employer plan.
The preceding sentence shall not apply to any
plan which maintains experience-rating
arrangements with respect to individual
employers.

(B) 10 or more employer plan.--For
purposes of subparagraph (A), the term "10 or
more employer plan" means a plan--

(i) to which more than 1
employer contributes, and

(ii) to which no employer
normally contributes more than 10
percent of the total contributions
contributed under the plan by all
employers.

According to the conferees, this exception was prescribed

"because under such a plan, the relationship of a participating

employer to the plan often is similar to the relationship of an
 - 65 -

insured to an insurer." H. Conf. Rept. 98-861, at 1159; 1984-3

C.B. (Vol. 2) at 413. The conferees went on to explain that:

"notwithstanding compliance with the 10-percent rule,
and consistent with the discussion above on definition
of a fund, a plan is not exempt from the deduction
limits if the liability of any employer who maintains
the plan is determined on the basis of experience
rating because the employer's interest with respect to
such a plan is more similar to the relationship of an
employer to a fund than an insured to an insurer."
[Id. at 1159.]

Petitioners argue that the Prime Plan is within this

exception, and that any uncertainty should be resolved in their

favor because respondent has not issued proper guidance under

section 419A(f)(6). Petitioners assert that Mr. Weiss asked the

Commissioner for a ruling on the Prime Plan, and that the

Commissioner refused to accommodate him. Petitioners assert that

Mr. Weiss was forced to withdraw his request for ruling 18 months

after he submitted it because he was led to believe that the

Commissioner would never rule on his request. We understand

petitioners to argue that the Commissioner should have issued

Mr. Weiss guidance under section 419A(f)(6), and that the

Commissioner should now be penalized for failing to do so.

Petitioners rely on Gould v. Gould, 245 U.S. 151, 153 (1917), for

the proposition that any doubts as to the reach of section

419A(f)(6) must be resolved in their favor.

We do not agree with petitioners that any ambiguity is to be

resolved in their favor. See Helvering v. Stockholms Enskilda
 - 66 -

Bank, 293 U.S. 84, 93 (1934). Subsequent to the Gould case, the

Supreme Court stated as follows:

We are not impressed by the argument that, as the
question here decided is doubtful, all doubts should be
resolved in favor of the taxpayer. It is the function
and duty of courts to resolve doubts. We know of no
reason why that function should be abdicated in a tax
case more than in any other. * * * [White v. United
States, 305 U.S. 281, 292 (1938).]

See United States v. Stewart, 311 U.S. 60, 71 (1940) ("those who

seek an exemption from a tax must rest it on more than a doubt or

ambiguity. Exemptions from taxation cannot rest upon mere

implications. * * * Exemptions from taxation are not to be

enlarged by implication if doubts are nicely balanced";

(citations and internal quotation marks omitted)).

Section 419A(f)(6) may be interpreted in light of all

pertinent evidence, textual and contextual, as to its meaning.

See Commissioner v. Soliman, 506 U.S. 168, 173 (1993); Crane v.

Commissioner, 331 U.S. 1, 6 (1947); Old Colony R. Co. v.

Commissioner, 284 U.S. 552, 560 (1932); see also Trans City Life

Ins. Co. v. Commissioner, 106 T.C. 274, 300 (1996). A statute

speaks for itself, and its legislative history will help us

discern the meaning of the words therein when the words are

"'inescapably ambiguous'". Garcia v. United States, 469 U.S. 70,

76 n.3 (1984)(quoting Schwegmann Bros. v. Calvert Distillers

Corp., 341 U.S. 384, 395 (1951) (Jackson, J., concurring)); see

also Ex parte Collett, 337 U.S. 55 (1949). Legislative history

will also help us to discern text, which is otherwise
 - 67 -

unambiguous, when the text's plain meaning defeats the statute's

stated purpose. As observed recently by the Court of Appeals for

the Ninth Circuit, the circuit in which an appeal of this case

lies:

We may not adopt a plain language interpretation of a
statutory provision that directly undercuts the clear
purpose of the statute. In Brooks v. Donovan, 699 F.2d
1010 (9th Cir. 1983), we refused to adopt a plain
language interpretation of a statute governing pension
funds. We reasoned that the "court must look beyond
the express language of a statute where a literal
interpretation 'would thwart the purpose of the overall
statutory scheme or lead to an absurd or futile
result.'" Brooks, 699 F.2d at 1011 (quoting
International Tel. & Tel. Corp. v. General Tel. & Elec.
Corp., 518 F.2d 913, 917-918 (9th Cir. 1975)). In
reaching our conclusion, we followed the Supreme
Court's approach in United States v. American Trucking
Associations, 310 U.S. 534, 60 S.Ct. 1059, 84 L.Ed.
1345 (1940). There the Court noted that "[w]hen [a
given] meaning has led to absurd results * * * this
Court has looked beyond the words to the purpose of the
act. Frequently, however, even when the plain meaning
did not produce absurd results but merely an
unreasonable one 'plainly at variance with the policy
of the legislation as a whole,' this Court has followed
that purpose, rather than the literal words." American
Trucking Associations, 310 U.S. at 543. * * *
[Albertson's, Inc. v. Commissioner, 42 F.3d 537, 545
(9th Cir. 1994), affg. 95 T.C. 415 (1990).]

Accordingly, in interpreting section 419A(f)(6), we look to

the statute as written by the legislators, and we consult the

statute's legislative history to learn its intended purpose and

to resolve ambiguity in the words used therein. Landgraf v. USI

Film Prods., 511 U.S. 244 (1994); Consumer Prod. Safety Commn. v.

GTE Sylvania, Inc., 447 U.S. 102, 108 (1980). Petitioners must

prove that the Prime Plan falls within the scope of section
 - 68 -

419A(f)(6), which, as they read it, removes the Prime Plan's

participating employers from the bowels of subpart D. Rule

142(a); Welch v. Helvering, 290 U.S. 111 (1933); see also

Interstate Transit Lines v. Commissioner, 319 U.S. 590, 593

(1943). Deductions are strictly construed and allowed only when

a "'clear provision'" allows for one. INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992)(quoting New Colonial Ice Co.

v. Helvering, 292 U.S. 435, 440 (1934)); Deputy v. du Pont, 308

U.S. 488, 493 (1940).

Petitioners argue that the Prime Plan is a single plan.

Petitioners assert that the word "plan" is construed broadly, and

that the need for the Trust to have a single pool of funds would

make the phrase "experience-rating arrangements with respect to

individual employers" surplusage. Petitioners assert that the

Congress enacted section 419A(f)(6) "to encourage small employers

to provide on a tax-advantaged basis welfare benefits to their

employees, who, generally speaking, had not received such

benefits in the past." Petitioners assert that the Prime Plan

satisfies Congressional intent.

Petitioners also argue that the Prime Plan lacked

"experience-rating arrangements with respect to individual

employers". Petitioners define the relevant phrase by reference

to a footnote in the House committee report; the footnote

indicates that the term "purely experience-rated" means "the

employer is entitled to an automatic rebate if the amount paid
 - 69 -

exceeds the benefit claims and is liable if the benefit claims

exceed the amount paid". H. Rept. 98-432 (Part 2), supra at 1280

n.18. Petitioners also look to section 1851(a)(8)(B) of the Tax

Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2860, which

describes an experience-rated insurance policy to mean "the

employer has a contractual right to a refund or dividend based

solely upon the experience of such employer". Petitioners assert

that the conferees' use of the word "often" in their explanation

of section 419A(f)(6) means that the Prime Plan did not have to

function as a risk-distributing insurer in order to fall within

that section. Petitioners assert that the Suspense Account

satisfied any risk shifting requirement inherent in section

419A(f)(6) because actuarial gains were pooled to supplement

underfunded benefits of other employers.

We disagree with petitioners' assertion that the Prime Plan

is a single plan for purposes of subpart D. The Prime Plan is

nothing more than an aggregation of individual, unique plans

formed by separate employers who have: (1) Delegated to a common

administrator their (the employers') duties and responsibilities

with respect to the respective plans that each employee/owner has

tailored personally for his or her business and (2) contributed

funds to a trust overseen by a common trustee that was required

to disburse each employer's contributions, and earnings thereon,

primarily for the benefit of the contributing employer's

employees. The fact that Prime structured the Prime Plan to have
 - 70 -

one administrator, one Trust, and a Suspense Account with some

commonality among all employers does not change the fact that

each of the employers separately had the unbridled authority to

select many of the relevant terms under which its employees would

collect benefits from the Prime Plan, that no Employee Group had

a right to any contributions, or earnings thereon, which had been

made by the employer of another Employee Group, and that a

severed employee could end up receiving less than his or her

promised benefit, even though the Prime Plan, as a whole, had

enough assets to compensate the employee for this shortage.

We reject petitioners' claim that the Prime Plan is a "10 or

more employer plan" based on the language and Congressional

purpose of subpart D and section 419A(f)(6). We interpret the

word "plan" to mean that there must be a single pool of funds for

use by the group as a whole (e.g., to pay the claims of all

participants), and we interpret the phrase "10 or more employer

plan" to mean that 10 or more employers must contribute to this

single pool. We do not interpret the statutory language to

include a program like the instant one where multiple employers

have contributed funds to an independent party to hold in

separate accounts until disbursed primarily for the benefit of

the contributing employer's employees in accordance with unique

terms established by that employer. We are unpersuaded that the

word "plan", as it appears in section 419A(f)(6), is satisfied by

Prime's attempt to aggregate multiple plans as a single plan.
 - 71 -

In arguing that the Prime Plan is a unitary "plan" for 10 or

more employers within the scope of section 419A(f)(6),

petitioners rely on the following features: (1) The Prime Plan

had a common administrator, and the Trust had a single trustee,

neither of whom was accountable to or controlled by any one

participating employer; (2) participating employers irrevocably

delegated to Prime the responsibility for a variety of

administrative and other functions; (3) Prime exercised

unreviewable authority over the calculation of employer

contributions, as well as the determination of benefit

distributions and forfeitures to the Suspense Account; (4) Prime

was responsible for determining the amount of all disbursements

from the Suspense Account in accordance with an objective formula

set forth in the Trust Agreement; and (5) the Suspense Account

served a limited common interest of all participating employers.

We conclude, however, that the foregoing features are outweighed

by the following features that point to the result that we reach

today: (1) Prime was required to maintain separate accounts and

a separate accounting for each Employee Group; (2) the Trust

Agreement limited an employee's right to benefits under the Prime

Plan to the assets of his or her Employee Group; (3) an annual

valuation was performed for each Employee Group's account, and an

annual valuation has never been performed for the Trust as a

whole; (4) the summary plan description required by section 102

of ERISA was prepared separately for each Employee Group; (5) the
 - 72 -

arrangement and the adoption agreement signed by each employer

were very similar to an arrangement and adoption agreement used

by separate employers' establishing a separate plan under the

terms of a master plan; (6) each employer selected its employees'

level of benefits, vesting schedule, and minimum participation

requirements, separate and apart from the selections made by the

other employers; (7) each employer's contribution benefited

primarily its employees, and not the employees of other

employers; (8) the Trust Agreement provided rules under which an

employee's benefits would be reduced in the event of a shortfall,

and without subsidy from the Trust as a whole; and (9) the Prime

Plan did not pool all claim risks within the Trust.

Petitioners' argument focuses mainly on the fact that a

single trust serviced multiple employers. Their argument ignores

the fact that the account of each participating employer was kept

separate from that of every other employer, and, most

importantly, that an employer's contributions benefited primarily

its own Employee Group. The applicability of section 419A(f)(6)

does not rest on whether more than nine employers contribute to a

single trust. Section 419A(f)(6) requires a single plan, the

existence of which is not established by Prime's sponsorship of a

program under which multiple employers contribute to a single

trust. But for the fact that a single promoter formed a common

trust and offered many employers the ability to enroll in a

program that was administered by a common overseer, we find
 - 73 -

little meaningful commonality among each participating employer's

participation in the Prime Plan.

Contrary to petitioners' assertion, our interpretation of

the term "10 or more employer plan" does not make surplusage of

the phrase "experience-rating arrangements with respect to

individual employers". The phrase has meaning, for example, when

a multiple employer trust maintains a single pool of assets from

which all claims could be paid and charges each group of

participants a different premium. If one were to look solely at

physicians and construction workers, two of the vocations of

employees covered by the Prime Plan, and assume that the turnover

rate of these two groups is different, the Prime Plan, if

structured with a single pool of assets, would almost certainly

have to charge different premiums to the different groups based

on each group's turnover rate in order to lure them into and

retain them in the plan. In the context of the Prime Plan,

however, a single pool was simply not desirable because

prospective participating employers did not want to accept the

risk that their contributions would be used to pay the severance

claims of other employers' employee groups that possessed

different levels of severance risk.

We find additional support for our interpretation in the

testimony of Charles C. DeWeese, F.S.A., M.A.A.A., an expert on

multiple employer plans, who concluded that each Employee Group

was a separate plan. Mr. DeWeese testified that the typical
 - 74 -

multiple employer trust allows a participant to collect benefits

from 100 percent of the trust's assets, and petitioners' expert,

E. Paul Barnhart, F.S.A., M.A.A.A., did not disagree.14 Mr.

Barnhart testified that the attributes described by Mr. DeWeese

were found typically in a multiple employer trust, and that,

except for the Trust, he (Mr. Barnhart) had never seen a multiple

employer trust that did not possess those attributes. Mr.

DeWeese and Mr. Barnhart both testified that the Prime Plan was

dissimilar to a traditional multiple employer plan, mainly

because of its lack of these attributes.

We disagree with petitioners' reading of the legislative

history to indicate that the Congress enacted section 419A(f)(6)

to encourage plans such as the Prime Plan. We read this history

to point to a legislative intent that is contrary to the intent

espoused by petitioners. The House committee articulated its

concern about the tax-shelter potential of welfare benefit plans

and about the ability of small business owners to achieve the

effect of a qualified pension plan, but with fewer limitations.

H. Rept. 98-432 (Part 2), supra at 1275. The committee also

noted that "substantial advance funding of welfare benefits will

14
We were not impressed with the testimony of petitioners'
other expert, Kenneth D. Klingler, F.S.A. We find his testimony
at trial unpersuasive and unhelpful, and we do not rely on it.
Sammons v. Commissioner, 838 F.2d 330, 334 (9th Cir. 1988), affg.
in part and revg. in part on another issue T.C. Memo. 1986-318;
Christ's Estate v. Commissioner, 480 F.2d 171, 174 (9th Cir.
1973), affg. 54 T.C. 493 (1970); Trans City Life Ins. Co. v.
Commissioner, 106 T.C. 274, 301-302 (1996).
 - 75 -

ultimately lead [inappropriately] to an unacceptable tax burden

for many taxpayers who do not participate in these programs."

Id. at 1276. Bearing these expressions of legislative intent in

mind, we are unable to agree with petitioners that the Congress

was encouraging the type of tax planning techniques promoted in

the Prime Plan.

We also disagree with petitioners' assertion that the Prime

Plan lacked "experience-rating arrangements with respect to

individual employees". The legislative history of subpart D sets

forth the House committee's intent to disallow the tax benefits

which petitioners claim flow from the Prime Plan, and the

examples of abuse that the House committee cited in its report

describe precisely what Prime is attempting to accomplish through

the Prime Plan. The legislative history states that section

419A(f)(6) was enacted because the relationship of a

participating employer to a 10 or more employer plan typically

resembles the relationship of an insured to an insurer. H. Conf.

Rept. 98-861, supra at 1159; 1984-3 C.B. (Vol. 2) at 413. The

legislative history states further that a 10 or more employer

plan is outside the scope of section 419A(f)(6) if "the liability

of any employer who maintains the plan is determined on the basis

of experience rating because the employer's interest with respect

to such a plan is more similar to the relationship of an employer

to a fund than an insured to an insurer." H. Conf. Rept. 98-861,

supra at 1159; 1984-3 C.B. (Vol. 2) at 413.
 - 76 -

The term "experience-rated" means generally that premiums

(contributions) are adjusted to reflect experience. See also

United States v. American Bar Endowment, 477 U.S. 105, 107 (1986)

("experience rated * * * means that the cost of insurance to the

group is based on that group's claims experience, rather than

general actuarial tables"). The Congress knew this, as evidenced

by the fact that the House committee defined the term "purely

experience-rated" in its report. Yet, the Congress declined to

inscribe the term "experience-rated" in section 419A(f)(6),

choosing, instead, to use the term "experience-rating

arrangements". We believe that the scope of the term

"experience-rating arrangements" is wider than that of

"experience-rated". The conferees stated that a plan is outside

the scope of section 419A(f)(6) if any employer's liability "is

determined on the basis of experience rating". If the conferees

had meant to equate the term "experience-rating arrangements"

with the term "experience rated", they could (and we believe

would) have said that a plan is outside the scope of section

419A(f)(6) if any employer's liability "is experience rated".

The conferees did not. Nor did the Congress provide in section

419A(f)(6)(A) that the first sentence therein "shall not apply to

any plan * * * [that is experience rated] with respect to

individual employers."

The essence of experience rating is the charging back of

employee claims to the employer's account. The Prime Plan
 - 77 -

accomplished the same result by adjusting the employees' benefits

to equal its employer's contributions. The Prime Plan charged

back the employees' claims to their employers' accounts by

carrying the accounts' yearend balances over to future years and

limiting an employee's benefits to the amount in his or her

employer's account. This was an experience-rating arrangement.

Mr. DeWeese concluded that experience-rating may occur by

adjusting benefits, rather than premiums, and Mr. Barnhart

agreed. Mr. Barnhart also acknowledged that the term

"experience-rating" means that, over time, the premiums less

expenses equal the benefits. This credible expert testimony

supports our view that the Prime Plan had experience-rating

arrangements with respect to all participating employers.

We also conclude that the Prime Plan had experience-rating

arrangements because each employer's relationship to the Trust

was more akin to the relationship of an employer to a fund, than

of an insurer to an insured. In the typical setting of a self-

funded welfare benefit plan, an employer contributes to a fund

from which all of its employees' claims are paid; another

employer's employees may not recover amounts from the first

employer's fund. An insurer in the typical insurer/insured

relationship, on the other hand, usually collects premiums from

many employers and pays the claims of each of the employer's

employees. The insurer typically spreads the risk of claims
 - 78 -

among all employers by charging each employer a premium

commensurate with its covered risk.

The relationship of the Trust to each participating employer

more closely mirrored self-funding than insurance. As a matter

of fact, the Trust Agreement provided that each employee's claim

could be funded only from the account of the employee's employer,

and that an employee did not have recourse against the employer,

the Trust, or any other person, to the extent of any shortfall.

It also is relevant that: (1) Prime accounted for each

employer's account separately; (2) the Trust Agreement provided

rules under which an employee's benefits would be reduced in the

event of a shortfall; (3) the Trust held and invested an

employer's contributions until benefits had to be paid to its

employees; (4) the Prime Plan did not pool all claim risk within

the Trust; and (5) an employer's contributions to the Trust could

pay its employees' claims after the year's end, while an insurer

will not return an insured's premiums to it at the end of the

policy.

Petitioners argue that the Suspense Account provided the

risk shifting necessary for the Prime Plan to qualify under

section 419A(f)(6). We do not agree. Notwithstanding the

reasons asserted by petitioners for the Suspense Account, the

record shows clearly that the Suspense Account's primary purpose

was to pay fees and expenses, and that only a de minimis amount

of funds was actually disbursed from the Suspense Account to
 - 79 -

satisfy employee claims. The record also demonstrates that

amounts were not transferred into the Suspense Account based on

exposure to risk, and that the Suspense Account did not serve to

spread among the participating employers the risk of incurring

DWB's.

Even if one were to assume arguendo that the Suspense

Account did serve to shift some risk, our view would not change.

We are unable to find that any such shift would have been

meaningful. As a point of fact, the risk of severance never

shifted from the employers to the Trust.15 The Trust never

assumed any risk of loss for any amount placed therein.

Contributions never provided a meaningful benefit to persons

other than the contributing employer's employees. Although it is

true that actuarial gains were pooled in the Suspense Account to

supplement underfunded benefits of other employers, we do not

believe that this pooling technique shifted risk significantly.

As a point of fact, less than 0.1 percent of the benefits came

from the Suspense Account.

Accordingly, we hold that the Prime Plan is not within the

requirements of section 419A(f)(6). Thus, the participating

15
In this regard, we disagree with Mr. Barnhart, who
testified that he believed the Suspense Account operated to share
the risk of severance among employers. Relying on this belief,
Mr. Barnhart concluded that the Suspense Account operated to make
the Prime Plan a single plan. Mr. Barnhart agreed, however,
that, absent the shift of severance through the Suspense Account,
the Prime Plan would be an aggregation of separate plans.
 - 80 -

employers are subject to subpart D. Under section 419, each

employer's deduction for its contribution to its separate plan is

limited to the plan's "qualified cost" for the year, less the

plan's after-tax income. Sec. 419(a), (b), and (c); see also

National Presto Indus., Inc. v. Commissioner, 104 T.C. 559,

566-567 (1995). An employer's qualified cost equals the

qualified direct cost for the taxable year, plus an addition to a

qualified asset account. Sec. 419(c)(1).

Respondent has proffered to the Court calculations of each

corporation's qualified cost and allowable deduction with respect

to its plan. These calculations show that Young & Young is

entitled to deduct $11 for 1989, and that no other corporation is

allowed a deduction with respect to its plan. Petitioners do not

dispute the mechanics of respondent's calculations, and

petitioners have not supplied the Court with alternative

calculations of qualified cost. Petitioners' position, which we

have rejected, is that the corporations can deduct their

contributions in full.

We have reviewed respondent's calculations, and we are

satisfied that they are correct. Accordingly, we sustain

respondent's determination that the corporations are not allowed

any deduction for the subject years with respect to their
 - 81 -

contributions to the Prime Plan, except for Young & Young which

may deduct $11 for 1989.16

3. Penalties

Respondent determined that each corporate petitioner was

liable for a penalty under section 6662(a) because it

substantially understated its Federal income tax. See sec.

6662(b)(2). As relevant herein, section 6662(a) imposes an

accuracy-related penalty equal to 20 percent of an underpayment

that is due to a substantial understatement of income tax. In

the case of a corporation, a substantial understatement exists if

its income tax was understated by the greater of 10 percent of

the tax required to be shown on the return or $10,000. Sec.

6662(d)(1)(A). For this purpose, tax is not understated to the

extent that the treatment of an item is based on substantial

authority or is adequately disclosed in the return or in a

statement attached to the return. Sec. 6662(d)(2)(B).

Substantial authority exists when the weight of authority

supporting the treatment of an item is substantial when compared

to the weight of authority supporting contrary treatment. Sec.

1.6662-4(d)(3)(i), Income Tax Regs. To determine whether

substantial authority is present, all authorities which are

16
Respondent determined, and petitioners do not dispute,
that Young & Young was a qualified personal service corporation
taxable at a single rate of 34 percent. See sec. 11(b)(2).
Accordingly, Young & Young's $11 deduction reduces its deficiency
by $4.
 - 82 -

relevant to the tax treatment of an item, including those

authorities pointing to a contrary result, are taken into

account. Id. Examples of authority include statutory and

regulatory provisions, legislative history, and administrative

interpretations of the Commissioner. Sec. 1.6662-4(d)(3)(iii),

Income Tax Regs. Legal opinions are not authority. The

authorities underlying a legal opinion, however, may give rise to

substantial authority for the tax treatment of an item. Id.

We conclude that the corporate petitioners are not liable

for the penalties in dispute. We have agreed with petitioners

that the Prime Plan is not a plan of deferred compensation and

whether the Prime Plan is within the scope of section 419A(f)(6)

is a novel question. Although we decide the latter question in

favor of respondent, we are persuaded that petitioners' position

is supported by a well-reasoned construction of the relevant

statutory provisions. Sec. 1.6662-4(d)(3)(iii), Income Tax Regs.

We decline to uphold respondent's determination of the penalties

against the corporate petitioners in the circumstances herein.
 - 83 -

We have considered all arguments made by the parties for

contrary holdings and, to the extent not discussed above, find

them to be irrelevant or without merit.

To reflect the foregoing,

Decision will be entered for

petitioners in docket Nos. 2544-94,

2546-94, 5755-94, 5893-94, and

9229-94; decision will be entered

for respondent with respect to the

deficiencies and for petitioners

with respect to the penalties in

docket Nos. 2545-94 and 9230-94; an

appropriate decision for respondent

will be entered in docket No.

5754-94 as to the deficiency and

the addition to tax under section

6651(a)(1) and for petitioner with

respect to the penalty.