116 T.C. No. 13
UNITED STATES TAX COURT
KENNETH L. NORDTVEDT, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 670-99. Filed March 13, 2001.
P adjusted the basis in his retirement annuity by
an inflation factor, to take account of inflation
between the date of his contributions to the retirement
plan and the annuity starting date, for purposes of
calculating the amount of his pension annuity subject
to Federal income tax. P further adjusted the basis in
his retirement annuity to account for expected
inflation over his actuarial life for purposes of
calculating the amount of his pension annuity subject
to Federal income tax.
Held: P may not adjust the basis in his
retirement annuity to account for inflation for
purposes of calculating the amount of his pension
annuity subject to Federal income tax.
Kenneth L. Nordtvedt, pro se.
Virginia L. Hamilton, for respondent.
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OPINION
RUWE, Judge: Respondent determined a deficiency of $580 in
petitioner’s 1996 Federal income tax. The issues for decision
are: (1) Whether petitioner may adjust the basis in his
retirement annuity by an inflation factor, to take account of
inflation between the date of his contributions to the retirement
plan and the annuity starting date, thereby increasing his basis
from the amount of $36,734 to an adjusted basis of $57,972, for
purposes of calculating the amount of his pension annuity subject
to Federal income tax; and (2) whether petitioner may further
adjust the basis in his retirement annuity to take into account
expected inflation over his actuarial life for purposes of
calculating the amount of his pension annuity subject to Federal
income tax.
Background
The parties submitted this case fully stipulated pursuant to
Rule 122.1 The stipulation of facts and the attached exhibits
are incorporated herein by this reference. Petitioner resided in
Friday Harbor, Washington, at the time he filed his amended
petition.
Petitioner was employed by Montana State University from
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
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September of 1965 until he retired in July of 1988. Montana
State University participates in the Montana Teachers Retirement
System of the State of Montana (MTRS), a qualified defined
benefit pension plan under section 401(a).
During his employment, petitioner made mandatory after-tax
contributions to the MTRS. From July of 1985 to July of 1988,
petitioner made after-tax contributions in accordance with
Montana State law allowing for additional contributions to build
up a retirement base. Petitioner’s contributions to the MTRS
were as follows:
Year Taxed Contribution
1965-66 $350
1966-67 350
1967-68 611
1968-69 639
1969-70 793
1970-71 822
1971-72 922
1972-73 887
1973-74 1,131
1974-75 1,122
1975-76 1,613
1976-77 1,592
1977-78 1,814
1978-79 1,102
1979-80 1,774
1980-81 529
1981-82 1,838
1982-83 1,012
1983-84 2,893
1984-85 7,042
1987-88 7,898
Total 36,734
Petitioner’s nominal basis in his pension plan is $36,734. Since
petitioner’s retirement in July of 1988, he has been receiving a
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gross pension payment of $26,313 annually.
The formula used by the MTRS to determine the taxable
portion of petitioner’s pension based on his after-tax
contributions (the formula) is in accordance with the rules
prescribed by the regulations promulgated under the Internal
Revenue Code. See sec. 1.72-4, Income Tax Regs. According to
the formula, the portion of petitioner’s pension income that is
subject to tax in 1996, based on the nominal value of his after-
tax contributions and the age of petitioner at his retirement in
1988, is $24,843.
Petitioner reported $22,979 as the amount of his pension
that was subject to tax in 1996. To arrive at this figure,
petitioner first adjusted the basis in his retirement annuity by
an inflation factor to take account of inflation between the date
of his contributions to the retirement plan and the annuity
starting date. According to his calculation, petitioner’s basis
as of his retirement in 1988 was $57,972 instead of the nominal
basis of $36,734. Petitioner then adjusted the basis in his
annuity as of the date of his retirement to account for expected
inflation over his actuarial life.
Discussion
Petitioner’s total pension income in 1996 was $26,313.
Pursuant to the applicable regulation, which allows for recovery
of petitioner’s basis in the pension, the taxable portion of
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petitioner’s 1996 pension was $24,843. See sec. 1.72-4, Income
Tax Regs. Petitioner agrees that the determination of the
taxable portion of $24,843 is in accordance with the regulations.
However, petitioner maintains that the taxable amount should be
reduced by $1,864 for 1996 in order to take into account the
effect of inflation on his contributions.
Petitioner’s contention that he is entitled to adjust the
basis in his annuity pension to account for inflation is
incorrect. Section 61(a) provides that gross income includes all
income from whatever source derived, unless otherwise
specifically excluded. Section 61(a)(9) provides that gross
income includes income from annuities. The Supreme Court has
reasoned that Congress “intended ‘to use the full measure of its
taxing power’” when it created the income tax. Commissioner v.
Kowalski, 434 U.S. 77, 82 (1977) (quoting Helvering v. Clifford,
309 U.S. 331, 334 (1940)). The Court explained that Congress
intended “‘to tax all gains except those specifically exempted.’”
Id. at 82-83 (quoting Commissioner v. Glenshaw Glass Co., 348
U.S. 426, 429-430 (1955)). There is no statutory or regulatory
provision permitting petitioner to exempt gain which may be
attributable solely to inflation by adjusting the basis in his
annuity pension to account for such inflation.2
2
We note that when Congress intends for inflation to be
taken into account, it does so by providing for it by statute.
(continued...)
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The pension plan administered by the MTRS is a qualified
defined benefit pension plan as provided for in section 401(a).
The taxation of the distributee of such a plan is governed by
section 402(a). Section 402(a) provides that the amounts
distributed under a section 401(a) plan shall be taxable to the
distributee under section 72.
Section 72 provides in general that amounts received under
an annuity contract are includable in gross income except to the
extent that such amounts are considered to be a reduction or
return of consideration paid. Specifically, section 72(a)
provides that unless otherwise provided, gross income includes
any amount received as an annuity under an annuity contract.
Section 72(b), however, provides that a portion of the annuity
will be excluded from gross income. In particular, gross income
does not include that part of any amount received as an annuity
under an annuity contract which bears the same ratio to such
amount as the investment in the contract (as of the annuity
starting date) bears to the expected return under the contract
(as of such date). See sec. 72(b); sec. 1.72-4, Income Tax Regs.
This ratio is referred to as the “exclusion ratio.” Sec. 72(b);
sec. 1.72-4, Income Tax Regs. Section 72(c), as relevant here,
defines the investment in the contract to be the aggregate amount
2
(...continued)
See, e.g., secs. 1(f), 151(d)(4); Bartley v. Commissioner, T.C.
Memo. 1998-322 n.10.
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of premiums or other consideration paid for the contract (or in
the instant case, petitioner’s after-tax basis). The “expected
return” amount is determined by multiplying, at the commencement
of the annuity, the total of the annuity payments to be received
annually by a multiple based on the annuitant’s age and, for
contributions prior to 1986, on the annuitant’s sex. Sec. 1.72-
5(a)(1), Income Tax Regs.
The application of the “exclusion ratio” to each annuity
payment determines the amount excluded from the gross income of
the annuitant and, thus, not subject to Federal income tax. This
excluded amount represents that part of the annuity payment which
accounts for the return of the annuitant’s investment in the
annuity.
In the relevant statutes governing the determination of the
taxable amount of a pension plan annuity, there is no provision
for, or mention of, any adjustment to an annuitant’s basis or
investment in his annuity to take account of inflation from the
date the annuitant first began to contribute to the annuity to
the annuity starting date. Nor is there any provision permitting
an adjustment to take account of inflation via a discount factor
from the date of the commencement of the annuity until the
nontaxable basis has been fully repaid to the annuitant.
When a statute is clear on its face, we require clear
unequivocal evidence of legislative purpose before construing a
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statute to override the plain meaning of the words used therein.
See Hirasuna v. Commissioner, 89 T.C. 1216, 1224 (1987);
Huntsberry v. Commissioner, 83 T.C. 742, 747-748 (1984). The
legislative history of the statutes relevant to this case
contains no evidence that Congress intended that there be any
adjustment to account for inflation.
As with the statutes, the regulations also contain no
mention of inflation adjustments. The regulations under section
72 are interpretative regulations. Such regulations must be
upheld “unless unreasonable and plainly inconsistent with the
revenue statutes”. Commissioner v. South Tex. Lumber Co., 333
U.S. 496, 501 (1948). The regulations under section 72 are not
unreasonable and are not plainly inconsistent with the statute
with respect to the issue presented in the instant case.
The regulations promulgated under section 72 are of long
standing, originally adopted on November 14, 1956, by T.D. 6211,
1956-2 C.B. 29. While there have been numerous amendments to the
regulations, none have affected the issue at bar. With respect
to the longevity of these regulations, the Supreme Court has
stated that long-standing rules should not be overruled except
for weighty reasons. See Commissioner v. Sternberger’s Estate,
348 U.S. 187, 199 (1955). As discussed below, there are no such
weighty reasons in the instant case.
While there are no cases directly on point dealing with
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pension plans or annuities,3 the issue decided in Hellermann v.
Commissioner, 77 T.C. 1361 (1981), involved the same principles.
In Hellermann v. Commissioner, supra, the taxpayers argued that
gain that was realized from the sale of property should be
adjusted to take into account the inflation that occurred during
the ownership of the property. We disagreed.
First, we relied upon “the well-established doctrine that
Congress has the power and authority to establish the dollar as a
unit of legal value with respect to the determination of taxable
income, independent of any value the dollar might also have as a
commodity.” Id. at 1364. For this proposition, we relied upon
3
This Court has consistently denied taxpayers deductions for
losses due to inflation and has repeatedly rejected the argument
that inflation is a proper ground for failing to report income.
See Sibla v. Commissioner, 68 T.C. 422, 430-431 (1977), affd. 611
F.2d 1260 (9th Cir. 1980); Gajewski v. Commissioner, 67 T.C. 181,
195 (1976), affd. without published opinion 578 F.2d 1383 (8th
Cir. 1978); Bartley v. Commissioner, T.C. Memo. 1998-322; Ruben
v. Commissioner, T.C. Memo. 1987-277; Downing v. Commissioner,
T.C. Memo. 1983-97; Warren v. Commissioner, T.C. Memo. 1982-696;
Notter v. Commissioner, T.C. Memo. 1982-96; Cunninghman v.
Commissioner, T.C. Memo. 1981-365; Milkowski v. Commissioner,
T.C. Memo. 1981-225; Crossland v. Commissioner, T.C. Memo. 1976-
59. Other courts have reached the same conclusions when faced
with similar situations. See Stelly v. Commissioner, 804 F.2d
868, 870 (5th Cir. 1986) (“The * * * [taxpayers’] contention that
they are entitled to an inflation adjustment to their interest
income is plainly incorrect.”); Birkenstock v. Commissioner, 646
F.2d 1185, 1186 (7th Cir. 1981) (“The market price of gold in
terms of dollars is * * * irrelevant to the determination of * *
* taxable income”), affg. T.C. Memo. 1979-201; Bates v. United
States, 108 F.2d 407, 408 (7th Cir. 1939) (attaching no
“significance to the statutory gold content of the dollar as a
factor in the determination of gain from the sale of capital
assets”); Daugherty v. United States, 1 Cl. Ct. 216, 218 (1983)
(taxpayer not entitled to “inflation factor” deduction).
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cases upholding Congress’ right to provide for a currency having
a uniform legal value that did not necessarily correspond to the
market value of gold bullion which backed the currency. See
Perry v. United States, 294 U.S. 330 (1935); Nortz v. United
States, 294 U.S. 317 (1935); Norman v. Baltimore & Ohio R.R. Co.,
294 U.S. 240 (1935); Legal Tender Cases, 79 U.S. (12 Wall.) 457
(1870).
As a second ground for rejecting the taxpayers’ position in
Hellermann v. Commissioner, supra, we relied upon the doctrine of
common interpretation; i.e., defining income on the basis of the
understanding of a lay person, not an economist. See id. at
1366. Under this doctrine, the taxpayers’ gain must be measured
on the basis of the nominal gain on the sale of property, not on
the basis of a gain reduced by an inflation factor, or the real
gain in an economic sense. See id. “[N]either the Constitution
nor tax laws ‘embody perfect economic theory.’” Id. (quoting
Weiss v. Weiner, 279 U.S. 333, 335 (1929)).
In Hellermann v. Commissioner, supra, the taxpayers were
arguing that the Government’s failure to take inflation into
account to determine gain or loss resulted in the taxation of
return of capital. This is the essence of petitioner’s argument
in the instant case. However, as previously stated, the
applicable statutes and regulations do not provide that
petitioner may take inflation into account. See secs. 72, 401,
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and 402; Hellermann v. Commissioner, supra at 1363; secs. 1.72,
1.401, and 1.402, Income Tax Regs. Accordingly, we hold that
petitioner may not adjust the basis in his retirement annuity to
account for inflation for purposes of calculating the amount of
his pension annuity subject to Federal income tax.
Decision will be entered for
respondent.