Flahertys Arden Bowl, Inc. v. Commissioner

115 T.C. No. 19

UNITED STATES TAX COURT

FLAHERTYS ARDEN BOWL, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 15223-98. Filed September 25, 2000.

F owns more than 50 percent of the stock of P. F
is a beneficiary of two retirement plans held by T.
Under the terms of the plans F is authorized to direct
the investments of the assets in his accounts in the
plans. F is a fiduciary under sec. 4975, I.R.C., and,
under that section, P is a “disqualified person”. Sec.
404(c) of the Employee Retirement Income Security Act
of 1974 (ERISA), Pub. L. 93-406, 88 Stat. 829, 877,
provides that if a plan beneficiary exercises control
over the plan’s assets in his account, the beneficiary
is not a fiduciary.

Held: ERISA sec. 404(c) does not modify the
definition of a fiduciary under sec. 4975, I.R.C., and
P is liable for the tax imposed by that section.
 - 2 -

Nick Hay, for petitioner.

James S. Stanis, for respondent.

OPINION

DAWSON, Judge: This case was assigned to Special Trial

Judge Carleton D. Powell pursuant to Rules 180, 181, and 183.

All Rule references are to the Tax Court Rules of Practice and

Procedure. The Court agrees with and adopts the opinion of the

Special Trial Judge, which is set forth below.

OPINION OF THE SPECIAL TRIAL JUDGE

POWELL, Special Trial Judge: Respondent determined

deficiencies in petitioner’s 1993 and 1994 Federal excise taxes

under section 4975(a)1 of $800 and $1,303, respectively.

Respondent also determined additions to tax under section

6651(a)(1) for 1993 and 1994 of $200 and $326, respectively. The

issues are (1) whether petitioner is a disqualified person under

section 4975(e), and, if so, (2) whether petitioner is liable for

the section 6651(a)(1) additions to tax.

At the time the petition was filed petitioner’s principal

place of business was located in Arden Hills, Minnesota.

1
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years in issue.
 - 3 -

Background

The facts may be summarized as follows. Flahertys Arden

Bowl, Inc. (petitioner), is a corporation organized under the

laws of Minnesota. Patrick F. Flaherty (Mr. Flaherty) owns 57

percent of the common stock of petitioner and is the secretary of

petitioner.

Mr. Flaherty is an attorney licensed to practice law in the

State of Minnesota. Beginning in 1968, Mr. Flaherty’s employer,

Moss & Barnett, P.A., maintained a qualified profit sharing plan.

Moss & Barnett, P.A., also maintained a qualified pension plan.

Both plans were trusts as defined in section 401(a) and were

exempt from tax under section 501(a). Mr. Flaherty participated

in both plans.

U.S. Bank, National Association, is the successor trustee of

both plans.2 Both plans were defined contribution plans and

provided segregated account balances for each participant. Both

plans permitted the participant to direct up to 100 percent of

the account assets.

During the period January 29, 1981, through June 15, 1982,

Mr. Flaherty directed the trustee of his profit sharing plan

2
First National Bank of Minneapolis was the original trustee
of both plans. In 1986, the trust department of First National
Bank of Minneapolis merged with First Trust Company of St. Paul.
First Trust Company of St. Paul became First Trust National
Association, which is now known as U.S. Bank, National
Association.
 - 4 -

account to lend $200,100 to petitioner. Mr. Flaherty also

directed the trustee of his pension plan account to lend

petitioner an additional $25,900. Mr. Flaherty, as an officer of

petitioner, executed notes payable to the plans in exchange for

the loans. The loans were payable upon demand and provided for

interest at a market rate plus 1 percent. Petitioner timely paid

interest on the loans. While the loans were outstanding, each

plan listed the notes as assets on its books and records. The

principal of both loans was repaid on April 5, 1994.

Before his direction to the plans, Mr. Flaherty contacted

Marvin Braun (Mr. Braun) at U.S. Bank, National Association, and

discussed the loans. Mr. Braun is a lawyer and has provided

services for qualified retirement plans since 1971. Mr. Flaherty

asked whether, under the plan agreements, he could direct that

the loans be made and whether section 4975 would apply to

petitioner. Mr. Braun advised him that the loans could be made

and that section 4975 would not apply. Mr. Braun was aware of

the relationship between Mr. Flaherty and petitioner. In

directing that the loans be made, Mr. Flaherty relied on Mr.

Braun’s advice.

Petitioner did not file a Form 5330, Excise Tax Return, for

either of the years in issue. Respondent determined that

petitioner was a disqualified person within the meaning of

section 4975(a), that the loans were prohibited transactions
 - 5 -

under section 4975(c)(1)(B), and that excise taxes were due under

section 4975(a). Respondent also determined that petitioner

failed to file Forms 5330 to report its liability for the excise

taxes and that petitioner was liable for the additions to tax

under section 6651(a)(1).

Discussion

I. Liability Under Section 4975

A. The Statutes

Section 4975 was added to the Internal Revenue Code by title

II of the Employee Retirement Income Security Act of 1974

(ERISA), Pub. L. 93-406, sec. 2003, 88 Stat. 829, 971. ERISA was

enacted to

protect * * * the interests of participants in employee
benefit plans and their beneficiaries, by requiring the
disclosure and reporting to participants and beneficiaries
of financial and other information with respect thereto, by
establishing standards of conduct, responsibility, and
obligation for fiduciaries of employee benefit plans, and by
providing for appropriate remedies, sanctions, and ready
access to the Federal courts. [ERISA sec. 2(b), 29 U.S.C.
sec. 1001(b) (1988).]

The statutory framework of ERISA contains four separate

titles. We deal with Titles I and II. Title I of ERISA contains

the “labor provisions” codified as amended in 29 U.S.C. secs.

1001-1461 (1988). The labor provisions were designed to give the

Department of Labor broad remedial powers over employee benefit

plans. Title II of ERISA contains the “tax provisions” including

section 4975. The tax provisions, contained in the Internal
 - 6 -

Revenue Code, provide the statutory framework for the tax laws

governing employee benefit plans and generally are administered

by the Department of the Treasury. See Rutland v. Commissioner,

89 T.C. 1137, 1143 n.4 (1987).

There are many areas where the labor provisions coincide

with or overlap the tax provisions. While much of the statutory

terminology is similar, there are instances in which the statutes

are different. At issue in this case is one of those

inconsistencies.

Section 4975(a) provides:

SEC. 4975(a). Initial Taxes on Disqualified Person.--
There is hereby imposed a tax on each prohibited
transaction. The rate of tax shall be equal to 5 percent of
the amount involved with respect to the prohibited
transaction for each year (or part thereof) in the taxable
period. The tax imposed by this subsection shall be paid by
any disqualified person who participates in the prohibited
transaction (other than a fiduciary acting only as such).

The definition of a prohibited transaction includes “any direct

or indirect lending of money or other extension of credit between

a plan and a disqualified person”. Sec. 4975(c)(1)(B). For our

purposes, section 4975(c) is similar to ERISA section 406, 29

U.S.C. section 1106(a)(1)(B), except that the term “disqualified

person” is changed to “a party in interest”. A disqualified

person and a party in interest are defined as, inter alia, a

“fiduciary”. Sec. 4975(e)(2)(A); ERISA sec. 3(14)(A), 29 U.S.C.

sec. 1002(14)(A). Section 4975(e)(2)(G) and ERISA section

3(14)(G), 29 U.S.C. 1002(14)(G), further provide that a
 - 7 -

corporation in which a fiduciary owns 50 percent or more of the

stock is also a disqualified person or party in interest.

Section 4975(e)(3) provides:

For purposes of this section, the term “fiduciary” means any
person who–-

(A) exercises any discretionary authority or
discretionary control respecting management of such
plan or exercises any authority or control respecting
management or disposition of its assets

ERISA section 3(21)(A)(i), 29 U.S.C. section 1002(21)(A)(i),

contains virtually the same language.

If this were the end of the statutory framework, petitioner

would clearly be a “disqualified person” and liable for the

excise tax imposed by section 4975(a). Mr. Flaherty is a

fiduciary because he directs the management of the plans’ assets,

more than 50 percent of petitioner’s stock is owned by Mr.

Flaherty, and the plans lent money to petitioner.

The labor provisions of ERISA, however, provide an exception

to the definition of fiduciary:

In the case of a pension plan which provides for
individual accounts and permits a participant or beneficiary
to exercise control over the assets in his account, if a
participant or beneficiary exercises control over the assets
in his account (as determined under regulations of the
Secretary)--

(A) such participant or beneficiary shall not be
deemed to be a fiduciary by reason of such exercise,
and

(B) no person who is otherwise a fiduciary shall
be liable under this part for any loss, or by reason of
any breach, which results from such participant's or
 - 8 -

beneficiary's exercise of control. [ERISA sec.
404(c)(1), 29 U.S.C. sec. 1104(c)(1).]

The plans permitted Mr. Flaherty to exercise control over

the assets in the accounts, and petitioner maintains that, since

Mr. Flaherty is not a fiduciary under the provisions of ERISA

section 404, 29 U.S.C. section 1104, he is not a fiduciary under

section 4975. On the other hand, respondent argues that Mr.

Flaherty is a fiduciary for purposes of section 4975 even though

he may not be a fiduciary under ERISA section 404. We,

therefore, must decide whether ERISA section 404(c)(1) is

incorporated into section 4975(e).

B. Principles of Statutory Construction and the Legislative
History

The starting point for the interpretation of a statute is

the language itself. See Consumer Prod. Safety Commn. v. GTE

Sylvania, Inc., 447 U.S. 102, 108 (1980). If the language of the

statute is plain, the function of the court is to enforce the

statute according to its terms. See United States v. Ron Pair

Enters., Inc., 489 U.S. 235, 240-241 (1989). All parts of a

statute must be read together, and each part should be given its

full effect. See McNutt-Boyce Co. v. Commissioner, 38 T.C. 462,

469 (1962), affd. per curiam 324 F.2d 957 (5th Cir. 1963). When

identical words are used in different parts of the same act, they

are intended to have the same meaning. See Commissioner v.

Keystone Consol. Indus., Inc., 508 U.S. 152, 159 (1993). On the
 - 9 -

other hand, “Where language is included in one section of a

statute but omitted in another section of the same statute, it is

generally presumed that the disparate inclusion and exclusion was

done intentionally and purposely.” United States v. Lamere, 980

F.2d 506, 513 (8th Cir. 1992); see also 2B Singer, Sutherland

Statutory Construction, sec. 51.02, at 122-123 (5th ed. 1992)

(“where a statute, with reference to one subject contains a given

provision, the omission of such provision from a similar statute

concerning a related subject is significant to show that a

different intention existed”).

ERISA section 404 pertains to fiduciary duties. Under ERISA

section 404(a) a fiduciary shall discharge his duties with the

care of a prudent man and diversify the investments. It is

against this background that we must read ERISA section

404(c)(1), which provides that (1) the participant, who exercises

control of the assets, is not deemed to be a fiduciary and,

therefore, is not subject to ERISA section 404(a), and (2) any

other fiduciary is not liable “under this part for any loss * * *

which results” from the participant’s exercise of control of the

assets.

“[T]his part” refers to part 4, Fiduciary Responsibility,

subchapter I, subtitle B, Regulatory Provisions, encompassing

ERISA sections 401 through 414, 29 U.S.C. sections 1101 through

1114, and includes provisions for fiduciary liability contained
 - 10 -

in ERISA section 409, 29 U.S.C. section 1109. It would appear

that in a participant-directed plan ERISA section 404(c)(1)

exculpates from part 4 potential liability a participant

exercising control over the account assets, and any person who

would otherwise be considered a fiduciary is relieved from the

liability under part 4 of ERISA for any loss resulting from the

participant’s exercise of control. In the context of this case,

ERISA section 404(c)(1) serves to insulate the participant (Mr.

Flaherty) and the U.S. Bank, National Association, from the

potential liability arising from any violation of the prudent man

standard of care contained in ERISA section 404(a), 29 U.S.C.

section 1104(a). See H. Conf. Rept. 93-1280, at 305 (1974),

1974-3 C.B. 415, 466.

To the contrary, section 4975(e)(3) contains the definition

of a fiduciary “For purposes of this section”. There is no

exception in the language of section 4975(e)(3) similar to that

of ERISA section 404(c)(1) for the section 4975 liability of a

disqualified person. Applying the rules of statutory

construction discussed supra p. 8, we, therefore, assume that

Congress intended a different result with respect to the section

4975 liability.

Petitioner contends, however, that the legislative history

indicates a clear intent of Congress not only that the

definitions of part 4 of ERISA and of the Internal Revenue Code
 - 11 -

should be as similar as possible, but also that they should

operate together. Petitioner relies on various statements from

the report of the conference committee. See H. Conf. Rept. 93-

1280, supra at 295, 1974-3 C.B. at 456-457 (“To the maximum

extent possible, the prohibited transaction rules are identical

in the labor and tax provisions, so they will apply in the same

manner to the same transaction.”); id. at 308, 1974-3 C.B. at 469

(“The conferees intend that the labor and tax provisions are to

be interpreted in the same way and both are to apply to income

and assets. The different wordings are used merely because of

different usages in the labor and tax laws.”).

We agree with petitioner that the legislative history

indicates a general intent of Congress that the language of the

provisions be read together. The legislative history does not,

however, preclude the existence of separate definitions or

separate scopes in the two provisions. As we noted in O’Malley

v. Commissioner, 96 T.C. 644, 650-651 (1991), affd. 972 F.2d. 150

(7th Cir. 1992):

The basis for the liability of a disqualified person
for the excise tax under section 4975(a) * * * is not the
same as the basis for liability of a fiduciary under section
406(a), ERISA. See, e.g., H. Rept 93-1280 (Conf.) at 306-
307 (1974), 1974-3 C.B. 415, 467-468. A fiduciary is liable
under section 406(a), ERISA, if he or she knowingly caused
the plan to engage in a transaction which is described in
section 406(a)(1), ERISA. * * *

Under section 4975(a) and (b), a disqualified person is
liable for the excise tax if he or she participates in the
transaction. Participation in section 4975 occurs any time
 - 12 -

a disqualified person is involved in a transaction in a
capacity other than as a fiduciary acting only as such. * *
*

Furthermore, the conference report indicates that Congress

intended that the definition of “party-in-interest” in the labor

provisions not coincide in every respect with the definition of a

“disqualified person” in the tax provisions. It states:

Under the tax provisions, the same general categories
of persons are disqualified persons, with some differences.
Although fiduciaries are disqualified persons under the tax
provisions, they are to be subject to the excise tax only if
they act in a prohibited transaction in a capacity other
than that of a fiduciary. Also, only highly-compensated
employees are to be treated as disqualified persons, not all
employees of an employer, etc. [H. Conf. Rept. 93-1280,
supra at 323, 1974-3 C.B. at 484.]

Under the labor provisions the potential liability runs

directly to the fiduciary for breaches of his or her duties.

Under section 4975, however, the liability runs not to a

fiduciary as such but to disqualified persons and applies whether

or not a fiduciary breached his duties under ERISA section

404(a). See Westoak Realty and Inv. Co., Inc. v. Commissioner,

999 F.2d 308, 311 (8th Cir. 1993), affg. T.C. Memo. 1992-171;

Leib v. Commissioner, 88 T.C. 1474, 1481 (1987). We do not find,

therefore, that the legislative history alters our conclusion

that the exception contained in ERISA section 404(c)(1) is not

incorporated into the section 4975 definition of a fiduciary.
 - 13 -

C. Regulations

As pointed out above, Congress intended a bifurcated

enforcement of ERISA. President Carter issued Reorganization

Plan No. 4 of 1978 (the 1978 Plan), 3 C.F.R. 332 (1979), 92 Stat.

3790. The 1978 Plan allocates the responsibility of

administering the provisions of ERISA between the Secretary of

the Treasury and the Secretary of Labor. Section 102 of the 1978

Plan gives the Secretary of Labor authority with respect to

regulations, rulings, opinions, and exemptions under section
4975 * * *

EXCEPT for (i) subsections 4975(a), (b), (c)(3), * * *
(e)(1), and (e)(7) of the Code; (ii) to the extent necessary
for the continued enforcement of subsections 4975(a) and (b)
* * *; and (iii) exemptions with respect to transactions
that are exempted by subsection 404(c) of ERISA from the
provisions of part 4 of Subtitle B of Title I of ERISA * * *

Section 102 of the 1978 Plan also provides that the Secretary of

the Treasury shall still have responsibility to audit qualified

retirement plans and to enforce the section 4975 excise tax as

provided in section 105 of the 1978 Plan. Section 105 of the

1978 Plan binds the Secretary of Treasury to the “regulations,

rulings, opinions, and exemptions issued by the Secretary of

Labor”.

In October of 1992 the Department of Labor issued final

regulations that provide:

Prohibited Transactions. The relief provided by section
404(c) of the Act and this section applies only to the
provisions of part 4 of title I of the Act. Therefore,
nothing in this section relieves a disqualified person from
 - 14 -

the taxes imposed by sections 4975(a) and (b) of the
Internal Revenue Code with respect to the transactions
prohibited by section 4975(c)(1) of the Code. [29 C.F.R.
sec. 2550.404c-1(d)(3) (1993).]

The regulations are effective “with respect to transactions

occurring on or after the first day of the second plan year

beginning on or after October 13, 1992.” Id. sec. 2550.404c-

1(g)(1). Both parties agree that the loans at issue were repaid

before the effective date of the regulations and the regulations

do not apply to the transactions in this case. Nonetheless, it

should be noted that the result attained by the regulations

coincides with our reasoning.

Furthermore, this provision of the regulations has its

genesis in proposed regulations issued in 1987 and 1991. In

1987, the Department of Labor issued proposed regulations

regarding participant-directed plans. See 52 Fed. Reg. 33508

(Sept. 3, 1987). The preamble to the proposed regulations

provided, in part:

Prohibited transactions. Finally, the proposed regulation
makes it clear that * * * the relief provided by section
404(c)(2) extends only to the provisions of part 4 of Title
I of ERISA (relating to fiduciary responsibility).
Therefore, even if a prohibited transaction is a direct and
necessary consequence of a participant's exercise of
control, nothing in section 404(c) of ERISA would relieve a
"disqualified person" described in section 4975(e)(2) of the
Code (including a fiduciary) from liability for the taxes
imposed by sections 4975 (a) and (b) of the Code with
respect to such prohibited transaction. [Id. at 33513.]

In 1991, the Department of Labor issued new proposed

regulations regarding participant-directed plans. See id. at
 - 15 -

10734. The 1991 proposed regulations took the same position with

respect to ERISA section 404(c). The 1991 proposed regulations

noted that “There is no provision in the Internal Revenue Code

corresponding to section 404”. Id. at 10734. Proposed

regulations are not authoritative. On the other hand, “proposed

regulations can be useful as guidelines where they closely follow

the legislative history of the act.” Van Wyk v. Commissioner,

113 T.C. 440, 444 (1999).

Petitioner contends that since the Department of Labor

failed to issue final regulations until 1992, the exception to

the definition of a fiduciary provided by ERISA section 404(c),

29 U.S.C. section 1104(c), should apply throughout ERISA

including the tax provisions. Because the Department of Labor

failed to issue final regulations on this point until 1992,

petitioner contends that respondent is not in a position to argue

that separate definitions of a fiduciary apply for the two

titles. However, the absence of final regulations does not

render the provisions of section 4975 inoperative. Cf.

Occidental Petroleum Corp. v. Commissioner, 82 T.C. 819, 829

(1984).

II. Additions to Tax Under Section 6651(a)(1)

The parties agree that, if petitioner is liable for the

excise taxes under section 4975, excise tax returns should have

been filed. Section 6651(a) imposes an addition to tax for
 - 16 -

failing to file a timely income tax return, unless such failure

to file is due to reasonable cause and not due to willful

neglect. The addition to tax is 5 percent of the amount required

to be reported on the return for each month or fraction thereof

during which such failure to file continues, not to exceed 25

percent in the aggregate. See sec. 6651(a)(1); United States v.

Boyle, 469 U.S. 241 (1985).

There is, and we do not understand respondent to argue

otherwise, no evidence indicating that petitioner’s failure to

file was the result of willful neglect. Thus, the question is

whether petitioner has demonstrated reasonable cause for the

failure. The failure to file flows directly from Mr. Braun’s

advice that petitioner incurred no liability from the loan

transactions.

Petitioner argues that its reliance on that advice

constituted reasonable cause. We have held in various situations

that reliance on expert advice constitutes reasonable cause.

See, e.g., Citrus Valley Estates, Inc. v. Commissioner, 99 T.C.

379, 463 (1992); see also United States v. Boyle, supra at 250-

251. Mr. Braun is a lawyer with extensive experience in the area

of retirement plans. He was fully aware of all of the relevant

facts. He researched the issue and advised petitioner that he

believed the loans would not violate any of the provisions of

ERISA or cause any tax liability under section 4975. The ERISA
 - 17 -

provisions involved are highly complex, and the fact that his

conclusion was erroneous does not mean that petitioner’s reliance

was not reasonable. Consequently, we conclude that petitioner

has established reasonable cause for not filing the returns and,

therefore, the additions to tax under section 6651(a)(1) are

inappropriate.

Decision will be entered for

respondent with respect to the

deficiencies, and for petitioner

with respect to the additions to

tax under section 6651(a)(1).