Roblene, Inc. v. Commissioner

T.C. Memo. 1999-161

UNITED STATES TAX COURT

ROBLENE, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 21576-95R. Filed May 13, 1999.

Paul M. Thielking, for petitioner.

Lawrence H. Ackerman, Judith M. Picken, and Gregory J.

Stull, for respondent.

MEMORANDUM OPINION

HAMBLEN, Judge: This is an action for a declaratory

judgment regarding the qualification of petitioner's employee

stock ownership plan and trust. On August 7, 1995, respondent

issued a final revocation letter to petitioner stating that the

Roblene, Inc. Employee Stock Ownership Plan (the ESOP) failed to
 - 2 -

meet the requirements of section 401(a)1 for the plan years

beginning after July 31, 1986, and that its related trust (the

trust) was not tax exempt under section 501(a) for trust years

ending with or within the affected plan years. Respondent also

revoked the prior determination letter to petitioner dated August

20, 1990.

The issue for decision is whether the ESOP violated the

qualification requirements of section 401(a)(16) in operation,

preventing its related trust from being exempt from income tax

under section 501(a), because amounts contributed to the trust

and allocated to the accounts of the ESOP's participants exceeded

the section 415 limitations for the limitation years that ended

July 31, 1987, through July 31, 1990.2

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.
2
We note that petitioner alleged, in its second amended
petition, that respondent issued the final revocation letter
after the expiration of the applicable statute of limitations.
We further note that petitioner abandoned this claim as
petitioner does not address this issue in its brief or in its
reply brief.

Moreover, the present action now before this Court is a
declaratory judgment action concerning the qualification of
petitioner's ESOP. This action does not involve the imposition
or collection of tax. There is no applicable statute of
limitations with regard to the issuance of revocation of
qualification letters, as they do not involve the imposition of
tax. Sec. 6501(a) provides:
(continued...)
 - 3 -

We hold that the commissions paid to Robert and Charlene

Peers as independent contractors are not includable in

"participant's compensation" for purposes of the section 415

limitations. Furthermore, we hold that the elective salary

deferrals are employer contributions and as such are not included

in "participant's compensation" for section 415 limitation

purposes. Consequently, we hold that the ESOP failed to meet the

requirements of section 401(a) for the plan years beginning after

July 31, 1986, and that the related trust is not a qualified

trust under section 401(a) for the plan years beginning after

July 31, 1986.

Background

Petitioner is an Iowa corporation with its principal place

of business located in 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 maintains its tax

records on the accrual method of accounting with a fiscal year

ending July 31 as its taxable year.

2
(...continued)

(a) General Rule.--except as otherwise provided in this
section, the amount of any tax imposed by this title shall
be assessed within 3 years after the return was
filed * * * and no proceeding in court without
assessment for the collection of such tax shall be begun
after the expiration of such period.
 - 4 -

Petitioner was incorporated on August 9, 1985, and its

principal business activity is real estate sales. It is the

employer and plan administrator with respect to the ESOP, a

defined contribution plan. Petitioner established the ESOP and

the trust as of August 12, 1985, effective for plan years

beginning on and after August 12, 1985. The plan years and

limitation years of the ESOP and the trust are the fiscal years

ending July 31. Petitioner amended and restated the plan

document on November 7, 1989, effective August 1, 1989. On

August 20, 1990, respondent issued a favorable determination

letter to petitioner stating that the ESOP, as amended and

restated, was in form qualified under section 401(a) and

consequently the trust was entitled to tax exempt status under

section 501(a). This determination letter applied to plan

year(s) beginning after July 31, 1989.

The ESOP contains a salary reduction cash or deferred

arrangement feature, under which an ESOP participant is permitted

to reduce his cash compensation or to forgo an increase in cash

compensation conditioned upon the employer's making a pretax

contribution in the same amount to the ESOP to the participant's

account.

Apart from the 10 shares of petitioner's stock issued to

Robert and Charlene Peers on August 9, 1985, the ESOP's trust is

and has been the sole shareholder of petitioner since its
 - 5 -

incorporation on August 9, 1985. Petitioner issued shares of its

stock to the trust in payment of the contributions to the trust.

Robert and Charlene Peers were, during the taxable years

that ended July 31, 1987, through 1990, and are the founders and

sole officers of petitioner. Robert Peers was and is its

president, and Charlene Peers was and is the trustee of the

ESOP's trust. Robert and Charlene Peers also have been the only

participants in the ESOP.

Petitioner reported the following deductions on its U.S.

Corporation Income Tax Returns, Forms 1120:

Pension
Compensation Salaries Profit-sharing,
of Officers and Wages etc., plans
Year (Line 12) (Line 13) (Line 24)

1987 $0 $801.01 $45,000
1988 0 0 17,000
1989 0 0 10,050
1990 0 0 9,870

The deductions for "Pension, Profit-sharing, etc., plans" were

reflected as contributions to the trust in the trust's Forms

5500-C, Return/Report of Employee Benefit Plan, for each of such

years.

In addition, petitioner included the following commissions,

paid to nonemployees who were treated by petitioner as

independent contractors, on line 26, "Other deductions":
 - 6 -

Year Commissions

1987 $45,000
1988 68,000
1989 67,000
1990 65,800

Robert and Charlene Peers filed joint U.S. Individual Income

Tax Returns. Their returns reflect the following:

Wages, Salaries, Business Principal
Year tips, etc. Income Business
(Form 1040-Line 7) (Schedule C) (Schedule C)

1987 $0 $32,922 --
1988 0 53,718 Real Estate Sales
1989 31,426.65 57,271.12 Real Estate Sales
1990 40,040 60,543 Realtor

For 1989, we note that no W-2 is included in the record to

determine the source of the $31,426.65 of salaries and wages.

Since petitioner paid $0 in compensation to officers and $0 in

salaries and wages for 1988, 1989, and 1990, it would appear that

this income is from another employer. For 1990, a Form W-2 is

attached to the tax return of Robert and Charlene Peers

indicating that First Realty Ltd. paid $40,040 to Robert and

Charlene Peers.

Discussion

Prior to discussing the respective arguments of the parties

regarding the qualification of petitioner's ESOP as exempt from

taxation, a brief summary of the pertinent statutes is helpful.

Section 501(a) provides that a trust described in section 401(a)

is generally exempt from taxation. Section 401(a) discusses the
 - 7 -

requirements that a trust must meet in order to constitute a

"qualified trust," and sets forth certain restrictions that

preclude qualification of a trust. Section 401(a)(16) sets forth

the restriction in issue in the instant case. 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
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:

(1) In general.--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.

3
Sec. 415(c)(1)(A) was amended by the Tax Reform Act of 1986
(TRA 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. See Uruguay Round
Agreements Act, Pub. L. 103-465, sec. 732(b)(2), 108 Stat. 5005
(1994).
 - 8 -

Section 415(c)(2) provides that "annual addition" means the

sum for any year of--:

(A) employer contributions,
(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 whether amounts

contributed to the trust and allocated to the accounts of Robert

and Charlene Peers exceeded the section 415 limitations. The

parties disagree as to what constitutes "participant's

compensation" for purposes of section 415 and as to whether

elective salary deferrals constitute employee or employer

contributions.

Petitioner asserts that the commissions it paid Robert and

Charlene Peers as independent contractors constitute

"participant's compensation" for purposes of section 415.

Petitioner also asserts that the amounts of elective salary

deferrals are employee contributions and should be included in

"participant's compensation." Thus, petitioner maintains that

the limitations of section 415(c)(1) have not been exceeded with

4
Sec. 415(c)(2)(B) was amended by the TRA 1986 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.
 - 9 -

the result that the ESOP and trust were qualified during the

years at issue.

Petitioner asserts, in its brief, that the participant's

compensation, contributions to the ESOP, and annual additions are

as follows:

Year Participant's Annual
Ended Compensation Contributions Additions

7/31/87
Commissions $45,000
Elective
Deferrals 45,000 $45,000 $22,500
90,000 22,500 sec. 415
limit
0 Excess

7/31/88
Commissions $68,000 $10,000
Elective
Deferrals 7,000 7,000 $17,000
75,000 17,000 17,000 sec. 415
limit
0 Excess

7/31/89
Commissions $67,000 $10,050 $10,050
16,750 sec. 415
limit
(6,700) Excess

7/31/90
Commissions $65,800 $9,870 $9,870
(6,700) prior year
excess
3,170 net annual
additions
16,450 sec. 415
limit
(13,280) Excess
 - 10 -

We note that petitioner included only one-half of the elective

deferrals in "Annual Additions" for the year ended July 31, 1987,

since petitioner asserts the elective deferrals are employee

contributions and not employer contributions. We also note that

petitioner computed the section 415 limit for the year ended July

31, 1988, based only on the commissions ($68,000 × 25 percent).

For the year ended July 31, 1987, however, petitioner based the

section 415 limit on both the commissions and elective deferrals

($90,000 × 25 percent).

Respondent contends that the commissions petitioner paid to

Robert and Charlene Peers did not constitute "participant's

compensation" for purposes of section 415. Furthermore,

respondent asserts that elective salary deferrals constitute

employer, not employee, contributions and thus, cannot be

included in "participant's compensation" for purposes of

calculating section 415 limitations. Consequently, respondent

contends that the limits of section 415(c)(1) were exceeded, and

the ESOP and trust were not qualified during the years at issue.
 - 11 -

Respondent asserts that the participant's compensation,

contributions to the ESOP, and annual additions are as follows:

Year Participant's Annual
Ended compensation Contributions additions

7/31/87
Commissions
Charlene Peers $0
Robert Peers 0
0

Elective
Deferrals
Charlene Peers $0 $22,500 $22,500
Robert Peers 0 22,500 22,500
0 45,000 45,000
0 sec. 415
limit
45,000 Excess
7/31/88

Commissions
Charlene Peers $0
Robert Peers 0
0

Elective
Deferrals
Charlene Peers $0 $8,500 $8,500
Robert Peers 0 8,500 8,500
0 17,000 17,000
0 sec. 415
limit
17,000 Excess
1
62,000 Cum.
excess
7/31/89
Commissions
Charlene Peers $0 $5,025 $5,025
Robert Peers 0 5,025 5,025
0 10,050 10,050
0 sec. 415
limit
10,050 Excess
2
72,050 Cum.
excess
 - 12 -

7/31/90
Commissions
Charlene Peers $0 $4,935 $4,935
Robert Peers 0 4,935 4,935
0 9,870 9,870
0 sec. 145
limit
9,870 Excess
3
81,920 Cum.
excess
1
This represents the cumulative excess in the trust for both
participants.

2
See supra note 1.

3
See supra note 1.

We note that respondent included the full amount of elective

deferrals as "Annual Additions" for the year ended July 31, 1987,

since respondent asserts the elective deferrals are employer

contributions, and not employee contributions.

Respondent contends that for the limitation years ended July

31, 1987, 1988, 1989, and 1990, the section 415 limitations were

exceeded in the respective amounts of $22,500, $31,000, $36,025,

and $40,960 for each participant.

I. Commissions

Petitioner seeks to include in "participant's compensation"

the amounts that petitioner paid Robert and Charlene Peers as

independent contractors for the years ended July 31, 1987,

through 1990. Petitioner's corporate income tax returns, Forms

1120, for the years that ended July 31, 1987, through 1990,

indicate that the compensation paid to the officers for each year

was zero dollars. These returns also indicate that during the
 - 13 -

same period the salaries and wages paid to employees for each

year was zero dollars, with the exception of 1987 in which

petitioner reported $801.01 as salaries and wages. Thus,

petitioner reported that it did not pay either Robert or Charlene

Peers any compensation for their services as officers of

petitioner, and that petitioner paid only $801.01 as salaries and

wages for the years at issue.

Rather than treating the remuneration of Robert and Charlene

Peers as compensation paid to officers or as salaries and wages

paid to employees, petitioner treated payments to the Peerses as

commissions paid to independent contractors. Petitioner's

corporate income tax returns, Forms 1120, for the years at issue,

indicate that the commissions paid to nonemployees who were

treated by petitioner as independent contractors for each year

were as follows:

Year Commissions

1987 $45,000
1988 68,000
1989 67,000
1990 65,800

We note that petitioner alleged no facts in its petition, its

amended petition, or its second amended petition to challenge the

treatment of the amounts as payments to independent contractors,

which treatment was clearly described in respondent's final

revocation letter.
 - 14 -

Section 415(c)(3)(A) defines "participant's compensation" as

"the compensation of the participant from the employer for the

year." Petitioner argues that Robert and Charlene Peers'

respective compensation was their earned income as self-employed

persons. In advancing its argument that the self-employment

income, which Robert and Charlene Peers reported on their

Schedule C, constitutes "participant's compensation" for purposes

of determining the section 415 limitations of the ESOP,

petitioner cites a portion of a pre-ERISA regulation in the

following manner:

Treatment of a self-employed individual as an employee.
(1) For purposes of section 401, a self-employed
individual who receives earned income from an
employer during a taxable year of such employer
beginning after December 31, 1962, shall be
considered an employee of such employer for such
taxable year. * * * [Sec. 1.401-10(b)(1), Income Tax Regs.]

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. See

Howard E. Clendenen, Inc. v. Commissioner, T.C. Memo. 1998-318.

Section 401(c)(4) provides that "An individual who owns the

entire interest in an unincorporated trade or business shall be

treated as his own employer." Furthermore, the definition of
 - 15 -

employer set forth in section 1.401-10(e), Income Tax Regs.,

provides:

(e) Definition of employer. (1) For purposes of section 401,
a sole proprietor is considered to be his own employer, and
the partnership is considered to be the employer of
each of the partners. * * *

The Peerses received their remuneration as independent

contractors. Petitioner reported the commissions paid to the

Peerses on its corporate income tax returns, Forms 1120, not as

line 12, "Compensation of officers", or as line 13 "Salaries and

wages". Rather, petitioner included the commissions on line 26,

"Other deductions". Likewise, the Peerses reported the

commissions on their Schedule C for each of the years at issue as

independent contractors and enjoyed the ability to offset that

income with deductions unreduced by the 2 percent of adjusted

gross income offset applicable to miscellaneous deductions on

Schedule A.

Petitioner paid the Peerses as independent contractors. The

direct consequence of structuring its affairs in this manner, is

that the remuneration which Robert and Charlene Peers received

from the petitioner as independent contractors, which they

reported on Schedule C, does not constitute "participant's

compensation" for purposes of computing the section 415

limitations for each of the limitation years at issue.
 - 16 -

II. Elective Deferrals

Petitioner argues that the amounts of the elective salary

deferrals, which the participant chose not to receive as cash but

rather to have contributed to the ESOP, are employee

contributions and are includable in "participant's compensation".

Robert and Charlene Peers elected salary deferrals for the 1987

and 1988 taxable years in the respective amounts of at least

$45,000 and $7,000.5

Section 402(a)(8)6 provides:

(8) Cash or deferred arrangements.--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.

In addition, section 1.415-2(d)(2)(i),7 Income Tax Regs.,

provides that compensation does not include:

5
We note that respondent contends that Robert and Charlene
Peers elected $17,000 in elective salary deferrals for 1988.
This difference is immaterial to the outcome.
6
Sec. 402 was amended by sec. 521(a) of the Unemployment
Compensation Amendments of 1992, Pub. L. 102-318, 106 Stat. 290,
300-310. The above-quoted language is currently found in sec.
402(e)(3).
7
This provision was renumbered as sec. 1.415-2(d)(3)(i),
Income Tax Regs., effective for years after Jan. 1, 1987. See
T.D. 8361, 1991-2 C.B. 310, 318.
 - 17 -

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 includible 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:

(ii) Treatment of elective contributions as employer
contributions. 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
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

Howard E. Clendenen, Inc. v. Commissioner, T.C. Memo. 1998-318;

Steel Balls, Inc. v. Commissioner, T.C. Memo. 1995-266, affd. per

curiam without published opinion 89 F.3d 841 (8th Cir. 1996).8

We rejected the same arguments presented herein and concluded

that respondent's position was clearly supported by the statute

8
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. See 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.
 - 18 -

and regulations. We reach the same conclusion herein and hold

that the elective deferrals are employer contributions and not

included in "participant's compensation". Since the elective

deferrals are employer contributions, the full amounts of the

elective deferrals are included in annual additions.9 See sec.

415(c)(2).

III. Conclusion

We now determine whether the annual additions on behalf of

Robert and Charlene Peers exceed the section 415(c) limitations.

We hold that the commissions paid to Robert and Charlene Peers as

independent contractors are not includable in "participant's

compensation" for purposes of the section 415 limitations.

Furthermore, we hold that the elective salary deferrals are

employer contributions and are not included in "participant's

compensation" for section 415 limitation purposes. The record is

not clear as to the exact amounts of salaries and wages paid to

Robert and Charlene Peers for the year ended July 31, 1987.10 We

9
For the year ended July 31, 1987, no more than one-half of
the employee contribution would have been included. See sec.
415(c)(2)(B); supra note 4.
10
The amount deducted by petitioner for "Salaries and wages"
($801.01) for the taxable year ending July 31, 1987, does not
match that reported by Robert and Charlene Peers as "Wages,
Salaries, tips, etc." ($0) on their joint individual income tax
returns for their taxable year ending Dec. 31, 1987. While this
could be due to the different tax years involved (year ending
July 31 versus Dec. 31), respondent, in the revocation letter and
(continued...)
 - 19 -

need not make any findings with respect to the exact figures,

however, for regardless of which amount we use, the annual

additions allocated to Robert and Charlene Peers during each of

the plan years that ended July 31, 1987, through July 31, 1990,

clearly exceed the section 415 limitations. 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.

Consequently, we hold that the ESOP failed to meet the

requirements of section 401(a) for the plan years beginning after

July 31, 1986, and that the related trust is not a qualified

trust under section 401(a) for the plan years beginning after

July 31, 1986.

Decision will be entered

for respondent.

10
(...continued)
in his briefs, uses the $0 figure appearing on Robert and
Charlene Peers' individual return.