Hall v. Comm'r

T.C. Memo. 1998-336

UNITED STATES TAX COURT

ROBERT A. HALL AND LAVERNE M. HALL, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 21526-95. Filed September 22, 1998.

Daniel A. Raas, for petitioners.

Christal W. Hillstead, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

DEAN, Special Trial Judge: This case was heard pursuant to

the provisions of section 7443A(b) and Rules 180, 181, and 182.1

Respondent determined a deficiency in petitioners' 1992

Federal income tax of $662.

1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable year in
issue. All Rule references are to the Tax Court Rules of
Practice and Procedure.
 - 2 -

Petitioners concede that they received in 1992 interest

income of $58 that they failed to report on their Federal income

tax return and that they are liable for the 10-percent premature

distribution tax on retirement distributions to petitioner

Laverne Hall in 1992. Petitioners also concede that if certain

retirement account distributions to petitioner Robert A. Hall

(petitioner) are includable in income, they too are subject to

the 10-percent tax on premature distributions.

The issue remaining for decision is whether retirement

account distributions to Robert A. Hall (petitioner) are not

subject to tax because they constitute income derived from Indian

fishing-rights-related activity.

All of the facts have been stipulated and along with the

attached exhibits are incorporated herein by reference.

FINDINGS OF FACT

Petitioners resided in Ferndale, Washington, at the time

they filed their petition in this case.

Petitioners Robert A. Hall and Laverne M. Hall were in 1992

and are still members of the Swinamish Indian Tribal Community

(Swinamish) and the Lummi Indian Tribe (Lummi), respectively,

federally recognized Tribes of American Indians. The Swinamish

and Lummi Tribes are each signatories of the Treaty of Point

Elliot, Jan. 22, 1855, U.S.--Tribes of Indians in Wash.

Territory, 12 Stat. 927 (1859), in which both tribes reserved
 - 3 -

fishing rights at all of their usual and accustomed fishing

grounds and stations.2

From 1979 through 1992, petitioner was employed by the Lummi

as a full-time worker in the tribal fish hatchery. The parties

agree that petitioner's work at the fish hatchery is treaty

fishing-rights-related activity as that term is used in section

7873.

The parties further agree that in 1992 all employees of the

hatchery received, in addition to wages, the choice to have an

extra $160 per month paid for their benefit either into a health

plan or a retirement account. Employees could not receive the

monthly additional $160 amount except by choosing one of the two

offered options.

The parties have stipulated transcripts of petitioner's

account with the Capital Guardian Trust Company, Investment

Company of America (Guardian). The transcripts show that

petitioner's Guardian account was established in September of

1988 and that contributions to the account, accrual of interest

to and withdrawals from the account have continued through 1992.

Contributions to the account are denominated in the transcript as

"employee contribution". The account summaries of the

transcripts for the years 1988 through 1990 refer to account

2
See also United States v. Washington, 520 F.2d 676 (9th
Cir. 1975).
 - 4 -

contributions as "IRA CONTRIBS:". In 1992, petitioner's employer

paid $1,920 into the Guardian account.

The Guardian account in 1992 made three payments to

petitioner, $750, $915.11 and $759.25, totaling $2,424.36. The

1992 account summary for the Guardian account describes a

premature distribution of $2,424.36, of which $12.67 was Form

1099 dividends. The 1992 account summary lists "Form 5498" ("IRA

Contribution Information") total contributions of $1,920, and a

remaining account value of $155.

Petitioner was not yet 59 1/2 at the time he received the

retirement account distributions from Guardian and from a second

account with Prudential Insurance Company of America

(Prudential). In 1992, the Prudential account paid to petitioner

a $268 retirement account distribution.

Petitioners reported on their 1992 Federal income tax return

as IRA distributions includable in income the retirement

distribution to petitioner from Guardian. Petitioners did not

deduct any amount as an IRA deduction. Petitioners did not

report the retirement distribution from Prudential or compute the

10 percent tax on premature distributions from either account.

Respondent examined petitioners' return and made adjustments

including a determination that the Prudential distribution is

includable in gross income and that retirement distributions to
 - 5 -

petitioner from both the Prudential and Guardian accounts are

premature.

OPINION

Positions of the Parties

Petitioner argues that he should not have to include any of

the Prudential distribution in income and that he made a mistake

by including the Guardian distributions in income because

distributions from both accounts are exempt from taxation as

income derived by an Indian from fishing-rights-related activity

under section 7873.

Section 7873 provides in relevant part:

(a) In General.--

(1) Income and self-employment taxes.--No tax
shall be imposed by subtitle A on income derived--

(A) by a member of an Indian tribe
directly or through a qualified Indian
entity, or

(B) by a qualified Indian entity, from a
fishing rights-related activity of such
tribe.

(2) Employment taxes.--No tax shall be imposed by
subtitle C on remuneration paid for services performed
in a fishing rights-related activity of an Indian tribe
by a member of such tribe for another member of such
tribe or for a qualified Indian entity.

(b) Definitions.--For purposes of this section--

(1) Fishing rights-related activity.--The term
"fishing rights-related activity" means, with respect
to an Indian tribe, any activity directly related to
harvesting, processing, or transporting fish harvested
in the exercise of a recognized fishing right of such
 - 6 -

tribe or to selling such fish but only if substantially
all of such harvesting was performed by members of such
tribe.

(2) Recognized fishing rights.--The term
"recognized fishing rights" means, with respect to an
Indian tribe, fishing rights secured as of March 17,
1988, by a treaty between such tribe and the United
States or by an Executive order or an Act of Congress.

(3) Qualified Indian entity.--

(A) In general.--The term "qualified
Indian entity" means, with respect to an
Indian tribe, any entity if--

(i) such entity is engaged in
a fishing rights-related activity
of such tribe,

(ii) all of the equity
interests in the entity are owned
by qualified Indian tribes, members
of such tribes, or their spouses,

(iii) except as provided in
regulations, in the case of an
entity which engages to any extent
in any substantial processing or
transporting of fish, 90 percent or
more of the annual gross receipts
of the entity is derived from
fishing rights-related activities
of one or more qualified Indian
tribes each of which owns at least
10 percent of the equity interests
in the entity, and

(iv) substantially all of the
management functions of the entity
are performed by members of
qualified Indian tribes.

For purposes of clause (iii), equity interests owned by
a member (or the spouse of a member) of a qualified
Indian tribe shall be treated as owned by the tribe.
 - 7 -

(B) Qualified Indian tribe.--For
purposes of subparagraph (A), an Indian tribe
is a qualified Indian tribe with respect to
an entity if such entity is engaged in a
fishing rights-related activity of such
tribe.

The "temporary deposit" of income exempt from tax under

section 7873 into a retirement account, argue petitioners, does

not change the character of the funds. Therefore, they conclude,

distributions that represent a return of originally tax exempt

funds are not subject to tax. Petitioners make no argument,

however, that interest accumulated in an account is exempt when

withdrawn.

Respondent argues that section 7873 was intended by Congress

to exempt from income tax only the wages of native people derived

from fishing-rights-related activity, that the payments into the

Guardian account were in addition to wages, that the source of

the payments into the Prudential account is unknown, and that

even if the source of the funds contributed to the retirement

accounts initially rendered them tax exempt, the distributions

from the accounts are not.

Respondent's determinations are generally presumed correct.

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

Furthermore, every item of a person's gross income is subject to

Federal income tax unless there is a statute or some rule of law

that exempts the person or the item from gross income. HCSC-

Laundry v. United States, 450 U.S. 1, 5 (1981). Tax exemptions,
 - 8 -

including those affecting native peoples are not granted by

implication. If Congress intends to exempt certain income it

must do so expressly. Critzer v. United States, 220 Ct. Cl. 43,

597 F.2d 708 (1979), and cases cited therein.

Section 7873 Income

The parties agree that the wages earned in 1992 by

petitioner for his work for the Tribe are income derived

"directly or through a qualified Indian entity * * * from a

fishing rights-related activity". Sec. 7873(a)(1). Petitioner

alleges that he "designated $160 per month to be deducted from

his salary and contributed to his retirement accounts" in 1992

and that in prior years he contributed a portion of his earnings

to the Prudential account. But both parties have stipulated that

in 1992 the $160 monthly amount contributed to his Guardian

retirement account was "in addition to wages" and would not have

been available to petitioner as a cash payment; he had to chose

to have it contributed to either a health plan or a retirement

plan.

Despite respondent's argument to the contrary, section

7873(a)(1) provides that "income", not just wages,3 derived by a

member of an Indian tribe directly or through a qualified Indian

entity from a fishing-rights-related activity is not subject to

3
With respect to wages earned from services performed in a
fishing-rights-related activity, no employment tax is to be
imposed by subtitle C. Sec. 7873(a)(2).
 - 9 -

income tax. For purposes of section 7873, income derived from

"fishing rights-related activity" means income derived from

activity "directly related" to harvesting, processing,

transporting, or selling fish in the exercise of recognized

fishing rights of an Indian Tribe. Sec. 7873(b).

Special Provisions for Individual Retirement Accounts

To determine whether, under the facts of this case, the

"temporary deposit" of income exempt from tax into a retirement

account changes its character requires an examination of the

retirement plan provisions. Special tax provisions apply to a

"qualified retirement plan," as that term is used in section

4974(c), including an individual retirement account.

A trust created or organized in the United States that is

for the exclusive benefit of an individual or his beneficiaries

is an "Individual Retirement Account" (IRA) if it meets certain

statutory requirements under section 408(a). Any IRA is

generally exempt from income tax. Sec. 408(e). An individual is

generally allowed to deduct "qualified retirement contributions"

made for the taxable year. Sec. 219(a). The deduction is

limited to the lesser of $2,000 or the amount of compensation

includable in the taxpayer's gross income for the taxable year.

Sec. 219(b).

"[Q]ualified retirement contributions" include amounts paid

for the taxable year by or "on behalf of an individual" to an IRA
 - 10 -

for the individual's benefit. Sec. 219(e). Any amount paid by

an employer to an IRA "shall be treated as payment of

compensation to the employee", includable in gross income for the

taxable year, whether or not the payment is deductible under

section 219(a). Sec. 219(f)(5).

IRA Distributions Taxable as Annuities

An amount paid out of an IRA must generally be included in

gross income by the distributee in the manner provided under

section 72, annuities, as modified by section 408(d)(1) and (2).

An individual's gross income includes amounts received as annuity

payments. Sec. 61(a)(9). In general, section 72 amounts are

includable in income except to the extent they are considered to

be a reduction or return of premiums or other consideration paid.

Sec. 72(a) and (b); sec. 1.72-1(a), Income Tax Regs.

To determine the extent to which distributed amounts are a

reduction or return of premiums or other consideration paid,

section 72 distinguishes between "amounts received as an annuity"

and "amounts not received as an annuity". Sec. 1.72-1(b)-(d),

Income Tax Regs.

Amounts are "received as an annuity" if they meet the

requirements of section 1.72-2(b)(2) or (3), Income Tax Regs.,

including the requirement that the amounts be payable in periodic

installments at regular intervals. Any other amounts to which

section 72 applies are considered "amounts not received as an
 - 11 -

annuity". Sec. 1.72-1(b), Income Tax Regs. The transcript of

account shows that the payments received by petitioner were not

periodic or regular. Petitioner's payments were section 72

payments not received as an annuity.

Petitioners distributions were received before the section

72(c)(4) "annuity starting date". For payments not received as

an annuity, section 72(e)(2)(B) provides that, for distributions

received before the annuity starting date, the distributee is

entitled to exclude from income any part of the distribution that

is allocable to the "investment in the contract" as defined in

section 72(e)(6). Amounts allocable to income on the contract

are on the other hand, includable in gross income. Sec.

72(e)(2)(B), (5)(D), (8)(A) and (B). In order to determine the

investment in the contract, the premiums or other consideration

paid for the contract must be calculated. Sec. 72(e)(6).

Premiums or Other Consideration Paid

Under section 72(f), employees generally are given credit

only for nondeductible premiums or other consideration that they

have contributed for purposes of computing the "investment in the

contract" under section 72(e)(6).4 See Campbell v. Commissioner,

108 T.C. 54, 66 (1997); Patrick v. Commissioner, T.C. Memo. 1998-

30. Amounts, however, contributed by the employer are also to be

4
Under prior law, an individual would never have an
"investment in the contract" or "basis" in an IRA. See Campbell
v. Commissioner, 108 T.C. 54, 64-66 (1997).
 - 12 -

included as premiums or other consideration paid by the employee5

if the amounts were taxable to the employee when contributed by

the employer or:

(2) if such amounts had been paid directly to the
employee at the time they were contributed, they would
not have been includible in the gross income of the
employee under the law applicable at the time of such
contribution. [Sec. 72(f)(2).]

An example of such amounts is certain payments excludible

from income under section 911(a) that were contributed by an

employer before 1963. Sec. 1.72-8(a)(2), Income Tax Regs. But

the language of section 72(f) is clearly broad enough to include

other types of income not subject to taxation, such as income

exempt by reason of section 7873.

In the absence of legislative indications to the contrary,

we are required to apply statutory provisions as we find them in

accordance with their plain meaning. United States v. American

Trucking Associations, Inc., 310 U.S. 534, 543-544 (1940);

Campbell v. Commissioner, supra at 62. We find that we must

include all contributions made by the Tribe, which are

denominated "employee" contributions by the trustee of the

5
It does not appear that petitioner's IRA is a simplified
employee pension (SEP) under sec. 408(k). All employees of the
hatchery received the same amount, $160 a month, for contribution
to a health or pension plan. SEP's, among other requirements,
must have a formulary relationship between contributions and
compensation. Sec. 408(k)(3)(C), (k)(5).
 - 13 -

Guardian IRA, as petitioner's investment in the IRA contract.

Cf. Wimbish v. United States, 267 F. Supp. 597 (W.D. Ky. 1967).

Amounts Allocated to Investment and Income

Generally, for distributions of amounts not received as

annuities, before the annuity starting date, the amount of a

distribution allocable to the investment in the contract and thus

distributed tax free, is the portion of the amount received that

bears the same ratio to the amount received as the investment in

the contract bears to the account balance. Sec. 72(e)(8)(A) and

(B).

The operation of section 72(e)(8) is, however, modified in

the case of an IRA by section 408(d)(2). The latter section

requires for section 72 purposes that we treat all IRA's as one,

all distributions in 1992 as one distribution, and that we

compute the value, income, and investment in the contract as of

the end of 1992; the value of the contract includes the amount of

any distributions during the calendar year (flush language

following section 408(d)(2)(C)).

Petitioner has failed to provide any evidence as to the

source, year, or amount of the contributions to the Prudential

account. Without such evidence we cannot find that any amount

distributed to petitioner from the Prudential account is a return

of his investment in the account.
 - 14 -

We therefore find that under section 72, as modified by

section 408(d)(1) and (2), part of petitioner's retirement

account distributions represents a nontaxable return to him of

his investment in the contract and part represents accrued

income, which petitioner agrees is taxable to him.

Return of Contributions

Before we apply section 72 as modified by section 408(d)(1)

and (2), however, we must consider the effect of section

408(d)(4) and (5). Under these provisions, nondeductible amounts

contributed to an IRA for a taxable year, and later withdrawn,

are not treated as taxable distributions.6 Contributions

withdrawn by the individual by April 15 of the year following the

taxable year, for which no deduction is allowed with respect to

the contribution, are not taxable upon distribution. Sec.

408(d)(4); Childs v. Commissioner, T.C. Memo. 1996-267.

Petitioner was employed by the Tribe in Indian fishing-

rights-related activity. Payments to petitioner for such Indian

fishing-rights-related services were not includable in his gross

income. Sec. 7873. The contributions made on his behalf to

Guardian by the Tribe were made due to his Indian fishing-rights-

related services and are considered as "compensation" under

6
A contribution distributed before the due date of the
return must be accompanied by the amount of net income
attributable to such contribution which net income is includable
in gross income. Sec. 408(d)(4).
 - 15 -

section 219(f). Therefore, the additional $160 monthly

compensation was derived "directly or through a qualified Indian

entity * * * from a fishing rights-related activity". Sec.

7873(a)(1). All of petitioner's compensation for the year 1992

was derived from Indian fishing-rights-related activity. And

since none of petitioner's compensation for the year was

includable in gross income, all of petitioner's IRA contributions

for the year are nondeductible. Secs. 219(b), 408(o).

Contributions are deemed to have been made to an IRA on the

last day of the preceding taxable year if the contribution is

made for that taxable year and is made by the due date of the

return for the taxable year. Sec. 219(f)(3). The parties agree

that petitioner had $1,920 of IRA contributions paid for tax year

1992.

Since under section 408(d)(4) the distribution to petitioner

of nondeductible contributions paid during the taxable year7 is

not subject to section 72, we find that $1,920 of the total

distribution from the Guardian account of $2,424.36 in 1992 was a

7
Sec. 408(o)(4)(A)(ii) requires an individual who receives
any amount from an IRA for any taxable year to include certain
information on his tax return for the year. A taxpayer who
without reasonable cause fails to provide the prescribed
information form for designated nondeductible contributions may
be subject to a fine of $50. Sec. 6693(b)(2). This issue was
not raised by respondent.
 - 16 -

nontaxable return of contributions.8 A portion of the remaining

balance of $504.36 is an amount of net income attributable to the

contributions for the 1992 taxable year. See sec. 408(d)(4);

sec. 1.408-4(c)(2)(ii) and (iii), Income Tax Regs. This amount

is includable in gross income in 1992 and as the parties have

agreed, is subject to the 10 percent premature distribution tax

under section 72(t).

Distributions Subject to Section 72 Computation

The balance of $504.36, reduced by the amount of net income

attributable to withdrawn contributions for 1992, is subject to

the computation under section 72(e)(8) as modified by section

408(d)(1) and (2). After reduction by the amount of net income

attributable to withdrawn contributions, the balance of the

amount distributed to petitioner in 1992 that is not taxable is

determinable by the section 72(e)(8)(B) formula as modified by

section 408(d)(1) and (2):

Total Nondeductible Contributions1
x Distribution
Amount
Total IRA Account Balances + Distribution Amount

8
Respondent has published notice that when using the sec.
72(e)(8) fraction to determine the amount of a premature
distribution to be includable in income, "Neither the numerator
nor the denominator of the above equation shall include amounts
previously withdrawn pursuant to section 408(d)(4) of the Code."
Notice 87-16, 1987-1 C.B. 446, 452. Taxpayers are entitled to
rely on and the Internal Revenue Service states that it will be
bound by substantive and procedural guidance provided by notices
or announcements. Rev. Rul. 90-91, 1990-2 C.B. 262.
 - 17 -

1
Total nondeductible contributions means all contributions prior
to the distribution date minus amounts received before such date to
the extent excludible from gross income. Sec. 72(e)(6).

The remainder of petitioner's distribution after

determination of the nontaxable amount represents the payment to

him of income and as the parties have agreed is subject to the

10-percent premature distribution tax under section 72(t). We

direct that these computations be made by the parties and

submitted under Rule 155.

To reflect the foregoing,

Decision will be entered

under Rule 155.