T.C. Memo. 1998-318
UNITED STATES TAX COURT
HOWARD E. CLENDENEN, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18155-96R. Filed September 3, 1998.
Paul F. Christoffers, for petitioner.
Lawrence H. Ackerman, for respondent.
MEMORANDUM OPINION
TANNENWALD, Judge: This is an action for a declaratory
judgment regarding the qualification of petitioner's employee
stock ownership plan and trust. On May 22, 1996, respondent
issued a final revocation letter to petitioner stating that the
Howard E. Clendenen, Inc. Employee Stock Ownership Plan (the
- 2 -
ESOP) failed to meet the requirements of section 401(a)1 for the
plan years beginning after June 30, 1985, and that its related
trust (the trust) was not tax exempt under section 501(a) for
those years.
The issue for decision is whether amounts contributed to the
trust and allocated to one of the ESOP's participants exceed the
limitations in section 415, thereby causing the trust not to
constitute a qualified trust under section 401(a).
Background
Petitioner is a corporation with its principal place of
business located in West Des Moines, Iowa, at the time of the
filing of the petition in this case. It filed its Federal tax
returns for the years in issue with the Internal Revenue Service
Center in Kansas City, Missouri. Petitioner utilizes the accrual
method of accounting with a fiscal year ending June 30 as its
taxable year.
Petitioner was incorporated on July 15, 1983, and its
principal business activity is insurance consulting. It is the
employer and plan administrator with respect to the ESOP, a
defined contribution plan. It established the ESOP and the trust
on September 6, 1983, effective for plan years beginning on or
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code as in effect for the years in issue,
and all Rule references are to the Tax Court Rules of Practice
and Procedure.
- 3 -
after July 15, 1983, and amended the ESOP effective June 30,
1985, and July 1, 1989. Petitioner received favorable
determination letters with respect to the ESOP and trust dated
December 8, 1983, March 24, 1986, and March 22, 1990. The plan
year and limitation year of the ESOP and the trust are the fiscal
year ending June 30.
The trust is and has been petitioner's sole shareholder
since petitioner's incorporation. Petitioner issued shares of
its stock to the trust in payment of the contributions to the
trust and in exchange for cash.
Howard E. Clendenen (Mr. Clendenen) is and has been
petitioner's president. On June 28, 1986, petitioner's board of
directors resolved:
That Howard E. Clendenen has advised the Corporation
that he desires to forego [sic] one-half of his salary
and bonuses for the fiscal year ended June 30, 1986
with the understanding that said one-half of his salary
and bonuses shall be contributed to * * * [the trust].
It is further understood that this transaction shall be
considered an employee contribution.
On June 29, 1987, petitioner's board passed a resolution
identical to that of June 28, 1986, resolution except for the
1987 year.
The ESOP's records reflect the following contributions to
the trust allocated to petitioner's employees as shown:
- 4 -
Plan Employer Employee
Year Employee Contribution Contribution
1986 Howard E. Clendenen 0 $17,029.38
1987 Howard E. Clendenen $ 9,000.00 30,000.00
1988 Howard E. Clendenen 0 0
1989 Howard E. Clendenen 11,250.00 0
Paul Clendenen 1,949.82 0
1989 total 13,199.82 0
1990 Howard E. Clendenen 9,000.00 0
Paul Clendenen 3,299.88 0
1990 total 12,299.88 0
1991 Howard E. Clendenen 8,250.00 0
Paul Clendenen 3,975.00 0
1991 total 12,225.00 0
These contributions were reflected in the trust's Forms
5500-C Return/Report of Employee Benefit Plan for each of such
years.
Petitioner reported the following expenditures on its U.S.
Corporation Income Tax Returns:
Total Pension,
Compensa- profit-
tion of Salaries sharing,
Year Officers and Wages etc., plans
1986 $34,058.76 0 n/a
1987 36,697.01 0 $9,000.00
1988 0 0 0
1989 0 $12,998.80 13,199.82
1990 0 21,999.20 12,299.88
1991 0 26,500.00 12,225.00
- 5 -
In addition, petitioner reported the following expenses under
"Other Deductions":
Year Item Amount
1987 Sec. 401(k) bonuses $30,000.00
1989 Commission expenses 75,000.00
1990 Bonuses 60,000.00
1991 Commissions 41,660.28
Bonuses 55,000.00
For the calendar years 1986 and 1987, Mr. Clendenen filed
joint U.S. Individual Income Tax Returns. For 1988 through 1991,
he filed his returns with a filing status of single.2 Mr.
Clendenen's returns reflect the following:
Wages, Business
Year Salaries Income Type of Business
1986 $12,938 0
1987 30,000 0
1988 0 0
1989 0 $75,000 Insurance consulting
1990 0 60,000 Consultant
1991 0 55,000 Consultant
For the plan year ending June 30, 1986, and his taxable year
ending December 31, 1986, Mr. Clendenen treated $17,029.38 as an
elective deferral of compensation into the ESOP.
Discussion
Section 401(a)(16) provides:
A trust shall not constitute a qualified trust under
this section if the plan of which such trust is a part
2
Mr. Clendenen was divorced on Jan. 11, 1988.
- 6 -
provides for benefits or contributions which exceed the
limitations of section 415.
Section 415(a)(1) provides that a trust which is part of a
pension, profit-sharing, or stock bonus plan shall not constitute
a qualified trust under section 401(a) if--
(B) in the case of a defined contribution
plan, contributions and other additions under the
plan with respect to any participant for any
taxable year exceed the limitation of subsection
(c) * * * [.]
Section 415(c)(1) provides:
Contributions and other additions with respect to a
participant exceed the limitation of this subsection
if, when expressed as an annual addition (within the
meaning of paragraph (2)) to the participant's account,
such annual addition is greater than the lesser of --
(A) $30,000,[3] or
(B) 25 percent of the participant's compensation.
Section 415(c)(2) provides that "annual addition" means the sum
for any year of--
(A) employer contributions,
3
Sec. 415(c)(1)(A) was amended by the Tax Reform Act of
1986, Pub. L. 99-514, sec. 1106(a), 1106(i), 100 Stat. 2420,
2425, effective for years beginning after Dec. 31, 1986, to read
"$30,000 (or, if greater, 1/4 of the dollar limitation [$90,000]
in effect under subsection (b)(1)(A))". It was further amended
to eliminate the parenthetical language effective for years
commencing after Dec. 31, 1994. Uruguay Round Agreements Act,
Pub. L. 103-465, sec. 732(b)(2), 108 Stat. 5005 (1994).
- 7 -
(B) the lesser of--
(i) the amount of the employee contributions
in excess of 6 percent of his compensation, or
(ii) one-half of the employee
contributions,[4] and
(C) forfeitures.
The dispute in this case focuses on the amount of the
contributions to the trust allocated to Mr. Clendenen. The
parties disagree as to what constitutes participant compensation
and as to whether elective deferral amounts constitute employee
or employer contributions. It is petitioner's position that the
amounts of elective deferrals are employee contributions and
should be included in "participant's compensation". Petitioner
also asserts that "participant's compensation" includes amounts
petitioner paid as commissions and bonuses to Mr. Clendenen as an
independent contractor. As a consequence, petitioner maintains
that the limitations of section 415(c)(1) have not been exceeded
with the result that the plan and trust were qualified during the
years at issue.
Respondent asserts that the amounts of elective deferrals
constitute employer, not employee, contributions and that these
amounts and the commissions and bonuses do not constitute
4
Sec. 415(c)(2)(B) was amended by the Tax Reform Act of
1986, Pub. L. 99-514, sec. 1106(e)(1), 1106(i), 100 Stat. 2424,
2425, for the years beginning after Dec. 31, 1986, to include the
entire employee contribution in the computation of the annual
addition.
- 8 -
"participant's compensation". Such being the case, respondent
contends that the limits of section 415(c)(1) were exceeded, and
the plan and trust were not qualified during the years at issue.
Section 415(c)(3)(A) simply defines participant's
compensation as "the compensation of the participant from the
employer for the year." However, section 402(a)(8) provides:
For purposes of this title, contributions made by an
employer on behalf of an employee to a trust which is a
part of a qualified cash or deferred arrangement (as
defined in section 401(k)(2)) shall not be treated as
distributed or made available to the employee nor as
contributions made to the trust by the employee merely
because the arrangement includes provisions under which
the employee has an election whether the contribution
will be made to the trust or received by the employee
in cash. [Emphasis added.]
Also, section 1.415-2(d)(2)(i), Income Tax Regs.,5 provides that
compensation does not include "Contributions made by the employer
to a plan of deferred compensation to the extent that, before the
application of the section 415 limitations to that plan, the
contributions are not includable in the gross income of the
employee for the taxable year in which contributed."
Furthermore, section 1.401(k)-1(a)(4)(ii), Income Tax Regs.,
provides:
Except as provided in paragraph (f) of this section,
[dealing with the correction of excess contributions]
elective contributions under a qualified cash or
deferred arrangement are treated as employer
5
This provision was renumbered as sec. 1.415-2(d)(3)(i),
Income Tax Regs., effective for years after Jan. 1, 1987. T.D.
8361, 1991-2 C.B. 310, 318.
- 9 -
contributions. Thus, for example, elective
contributions are treated as employer contributions for
purposes of sections 401(a) and 401(k), 402, 404, 409,
411, 412, 415, 416, and 417.
The issue in respect of elective deferrals has been before
this Court under substantially identical circumstances. See
Steel Balls, Inc. v. Commissioner, T.C. Memo. 1995-266, affd.
without published opinion 89 F.3d 841 (8th Cir. 1996).6 We
rejected the same argument presented herein and concluded that
respondent's position was clearly supported by the statute and
regulations. We reach the same conclusion herein and hold that
the elective deferrals are employer contributions and not
included in "participant's compensation". Consequently, the
amounts of the elective deferrals are included in annual
additions.7 Sec. 415(c)(2).
Petitioner also seeks to include in "participant's
compensation" the amounts of the commissions or bonuses that
6
The Small Business Job Protection Act of 1996, Pub. L.
104-188, sec. 1434(a), 110 Stat. 1807, added sec. 415(c)(3)(D)
which includes certain deferrals in participant's compensation,
effective for years beginning after Dec. 31, 1997. This
amendment does not apply to the instant case. We note, however,
that the legislative history makes clear that Congress considered
the provisions of the then-existing law as requiring the result
reached herein and specifically intended to change the law for
future years. H. Rept. 104-586 at 112 (1996), 1996-3 C.B. 331,
450; S. Rept. 104-281 at 80 (1996); H. Conf. Rept. 104-737 at
245-246 (1996), 1996-3 C.B. 741, 985-986.
7
Since the years involving the elective deferrals are
fiscal years ending June 30, 1986, and June 30, 1987, only a
portion of the employee contributions would have been included.
Sec. 415(c)(2)(B); see supra note 4.
- 10 -
petitioner paid Mr. Clendenen as an independent contractor for
the years 1989 through 1991. Petitioner argues that Mr.
Clendenen's compensation was his earned income as a self-employed
person. Petitioner is correct that for a self-employed
individual, "participant's compensation" is the participant's
earned income. See sec. 415(c)(3)(B). What petitioner fails to
recognize is that a sole proprietor is considered to be his own
employer. Sec. 401(c)(4); sec. 1.401-10(e), Income Tax Regs.
Mr. Clendenen, thus, had at least two employers during 1989,
1990, and 1991, himself and petitioner.
While an individual can be an employee with respect to more
than one business or employer, each employer is considered
separately and only the income the employee earns from the
employer sponsoring the plan may be taken into account for
purposes of that employer's plan. Sec. 415(c)(3)(A)
(compensation "from the employer"); sec. 1.401-10(b), Income Tax
Regs. Accordingly, section 1.415-2(d)(2)(i),8 Income Tax Regs.,
provides:
For purposes of applying the limitations of section
415, the term "compensation" includes * * * --
(i) The employee's wages, salaries, fees for
professional services, and other amounts received * * *
for personal services actually rendered in the course
of employment with the employer maintaining the plan to
the extent that the amounts are includable in gross
income * * * . [Emphasis added.]
8
See supra note 5.
- 11 -
For purposes of petitioner's plan, Mr. Clendenen is covered as an
employee of petitioner and thus, only with respect to the
compensation received as petitioner's employee. We do not
dispute petitioner's argument that Mr. Clendenen was an officer
of petitioner and that an officer is an employee. But the fact
of the matter is that petitioner adopted an arrangement whereby
Mr. Clendenen was not compensated for whatever services he may
have rendered as an officer-employee but for his services as an
independent contractor. We hold, therefore, that the amounts
petitioner paid to Mr. Clendenen as an independent contractor are
not includable in compensation.
We now determine whether the annual additions on behalf of
Mr. Clendenen exceed the section 415(c) limits. With the
exception of 1988, for which the parties agree Mr. Clendenen's
compensation was $0, the record is not clear as to the exact
amounts of compensation paid to Mr. Clendenen.9 We need not make
any findings with respect to the exact figures, however, for
9
The amounts deducted by petitioner as officer
compensation on its returns for 1986 and 1987 do not match those
reported by Mr. Clendenen on his individual returns. While this
could be due to the different tax years involved (year ending
June 30 versus December 31), respondent, in the revocation letter
and in his briefs, uses the lower figures appearing on Mr.
Clendenen's returns due to lack of substantiation. Petitioner
does not address the difference for 1986, and for 1987, uses the
lower figure in its brief. For 1989 through 1991, respondent
treats the amounts shown as salaries and wages on petitioner's
corporate returns as compensation paid to Paul Clendenen.
Petitioner does not argue that these amounts were paid to Mr.
Clendenen.
- 12 -
regardless of which amounts we use, the annual additions
allocated to Mr. Clendenen during each of the plan years 1986,
1987, 1989, 1990, and 1991, exceed the section 415 limits.
Petitioner has not argued or established that any corrective
measures were taken to reduce these additions. See sec. 1.415-
6(b)(6), Income Tax Regs.
We hold that the trust is not a qualified trust under
section 401(a) beginning with the plan year 1986.
Decision will be entered
for respondent.