T.C. Memo. 2001-234
UNITED STATES TAX COURT
BEALS BROS. MANAGEMENT CORP., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10871-99R. Filed September 6, 2001.
David R. Rhein, for petitioner.
Michael J. Roach and James S. Stanis, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Judge: Respondent determined that the employee stock
ownership plan (MGMT ESOP) operated by petitioner did not meet
the requirements of section 401(a)(3) or (4)1 for its plan year
1
Unless otherwise indicated, section references are to
sections of the Internal Revenue Code in effect for the years in
issue. Rule references are to the Tax Court Rules of Practice
and Procedure.
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ended June 30, 1987, and subsequent years. Respondent also
determined that the trust that constituted a part of the MGMT
ESOP was consequently not exempt from taxation under section
501(a) for the same years. Following these determinations,
respondent revoked a favorable determination letter previously
issued to petitioner with respect to the MGMT ESOP.
Petitioner timely invoked the Court’s jurisdiction under
section 7476. Petitioner seeks a declaratory judgment that
respondent erred in his determination that the MGMT ESOP does not
meet the requirements of section 401. We hold that respondent
did not err as averred.
FINDINGS OF FACT2
When the petition was filed, petitioner maintained a
principal place of business in Des Moines, Iowa. Petitioner was
incorporated to provide management and advisory services to Beals
Brothers Manufacturing Co. (MFG). At all relevant times,
petitioner’s officers and directors consisted of one or more of
the following persons: Richard Faye Beals, Donald Wayne Beals,
Fay J. Beals (collectively, the Bealses), and Gayle D. Isaac
(collectively with the Bealses, the management officers).
Petitioner had no other officers or employees during that time.
2
Some of the facts have been stipulated and are so found.
The exhibits accompanying the stipulation of facts and the
stipulated administrative record are incorporated by this
reference.
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Nor during that time did petitioner pay its officers any
compensation.
Petitioner established the MGMT ESOP on February 1, 1987.
By way of a trust agreement of the same day, petitioner also
established under Iowa law a trust (ESOT) that was part of the
MGMT ESOP. Under the MGMT ESOP, petitioner made contributions to
the ESOT for the purpose of distributing the trust’s corpus and
income to petitioner’s employees or their beneficiaries in
accordance with the MGMT ESOP. Under the trust agreement, the
ESOT’s corpus and income could not be used for purposes other
than the exclusive benefit of petitioner’s employees or their
beneficiaries. At all relevant times, the only participants of
the MGMT ESOP were the management officers.
The MGMT ESOP owned all of petitioner’s stock as of June 30,
1987.
On July 8, 1987, petitioner purchased all of the stock of
MFG from its then-current shareholders. MFG is an Iowa
corporation engaged in the business of manufacturing wood
products. MFG operates a sawmill and manufactures commercial
packaging wood products, such as pallets and crating materials.
It also finishes graded lumber used for the construction of
furniture and other finished items. During MGMT ESOP’s plan year
ended June 30, 1987, MFG had at least 45 employees, 39 of whom
were part time and at least 6 of whom were full time. The full-
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time employees included the Bealses, Jeffrie Beals, Jack D.
Richard, and Daryl W. Sable. During MGMT ESOP’s plan year ended
June 30, 1988, MFG had 43 employees, 36 of whom were part time
and 7 of whom were full time. The full-time employees were the
management officers, Jeffrie Beals, Jack D. Richard, and Daryl W.
Sable.
OPINION
Respondent argues that the MGMT ESOP failed to meet the
requirements of: (1) Section 401(a)(3) (a plan must satisfy the
minimum participation standards of section 410), (2) section
401(a)(4) (contributions to and benefits of a plan may not
discriminate in favor of highly compensated employees), and (3)
section 415 (contributions may not exceed a certain percentage of
compensation.) Only the first two grounds were mentioned
specifically in the notice of revocation. Because we agree with
respondent that the MGMT ESOP does not meet the requirements of
section 401(a)(3) for plan years ended June 30, 1987, and
thereafter, we do not consider the other arguments which
respondent has advanced to support his determination.3
Petitioner bears the burden of going forward and the burden of
persuasion in disproving respondent’s determinations. Rule
217(c)(1)(A).
3
On brief, petitioner did not address respondent’s argument
that MFG and MGMT were members of a controlled group.
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In relevant part, section 401(a) provides:
SEC. 401(a). Requirements for Qualification.--A
trust created or organized in the United States and
forming part of a stock bonus, pension, or profit-
sharing plan of an employer for the exclusive benefit
of his employees or their beneficiaries shall
constitute a qualified trust under this section--
* * * * * * *
(3) if the plan of which such trust is a
part satisfies the requirements of section
410 (relating to minimum participation
standards); * * *
Section 410(b)(1)(A), as applicable for plan years beginning
before January 1, 1989,4 generally provided that a trust was not
a qualified trust under section 401(a) unless the trust benefited
either 70 percent or more of all employees or 80 percent or more
of the employees who were eligible to benefit under the plan if
70 percent or more of all the employees were eligible to benefit
under the plan.5 Section 414(b) and (m) provides:
4
The coverage requirement under sec. 410(b) was amended by
the Tax Reform Act of 1986 (TRA), Pub. L. 99-514, sec. 1112(a)
and (e), 100 Stat. 2440, 2445, effective for plan years beginning
after Dec. 31, 1988.
5
Sec. 410(b)(1)(B), as in effect before the enactment of
the TRA amendments in 1986, provided that a plan can
alternatively meet the coverage requirements by benefiting such
employees as qualify under a classification set up by the
employer and found by the Secretary not to be discriminatory in
favor of employees who are officers, shareholders, or highly
compensated. Such provision is not relevant here inasmuch as
there is no evidence that petitioner set up a separate
classification of employees to be covered by the MGMT ESOP or
that the Secretary approved any such designation as
nondiscriminatory.
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SEC. 414(b). Employees of Controlled Group of
Corporations.--For purposes of sections 401, 408(k),
410, 411, 415, and 416, all employees of all
corporations which are members of a controlled group of
corporations (within the meaning of section 1563(a),
determined without regard to section 1563(a)(4) and
(e)(3)(C)) shall be treated as employed by a single
employer. With respect to a plan adopted by more than
one such corporation, the applicable limitations
provided by section 404(a) shall be determined as if
all such employers were a single employer, and
allocated to each employer in accordance with
regulations prescribed by the Secretary. [Emphasis
added.]
* * * * * * *
(m) Employees of an Affiliated Service Group.
(1) In general.--For purposes of the
employee benefit requirements listed in
paragraph (4), except to the extent otherwise
provided in regulations, all employees of the
members of an affiliated service group shall
be treated as employed by a single employer.
* * * * * * *
(4) Employee benefit requirements.--For
purposes of this subsection, the employee
benefit requirements listed in this paragraph
are--
(A) paragraphs (3), (4), (7),
and (16) of section 401(a),
(B) sections 408(k), 410, 411,
415, and 416,
* * * * * * *
(5) Certain organizations performing
management functions.--For purposes of this
subsection, the term “affiliated service
group” also includes a group consisting of--
(A) an organization the
principal business of which is
performing, on a regular and
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continuing basis, management
functions for 1 organization (or
for 1 organization and other
organizations related to such 1
organization), and
(B) the organization (and
related organizations) for which
such functions are so performed by
the organization described in
subparagraph (A).
For purposes of this paragraph, the term
“related organizations” has the same meaning
as the term “related persons” when used in
section 144(a)(3).
(6) Other definitions.--For purposes of
this subsection--
(A) Organization defined.--The
term “organization” means a
corporation, partnership, or other
organization.
(B) Ownership.--In determining
ownership, the principles of
section 318(a) shall apply.
[Emphasis added.]
Respondent argues that the MGMT ESOP failed to meet the
minimum participation standards mandated by section 410 beginning
with its plan year ended June 30, 1987. Respondent relies on
MGMT’s affiliation with MFG and the special rules contained in
section 414. Generally, in the case of affiliated service groups
and controlled groups, section 414 requires that all employees of
the members of the group be treated as employed by a single
employer for the purpose of the section 410 minimum participation
standards. Sec. 414(b), (m).
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In the plan year ended June 30, 1987, respondent determined
that MGMT and MFG were members of an affiliated group. Section
414(m)(5) provides that an affiliated service group includes a
group consisting of an organization the principal business of
which is performing, on a regular and continuing basis,
management functions for one organization and the one
organization for which such management functions are provided.
The parties stipulate that MGMT was established on February 1,
1987, to provide management services to MFG. Respondent
determined MFG and MGMT were members of an affiliated service
group, and petitioner introduced no evidence that would indicate
that the determination was incorrect. Indeed, petitioner even
acknowledges on brief that the record is barren of any evidence
as to the nature of petitioner’s principal business or business
activities. We sustain respondent’s determination that
petitioner and MFG were members of an affiliated service group
for the year ended June 30, 1987. As a consequence, section 410
applies as if MFG and petitioner were a single employer. For
that plan year, only four of six (66.6 percent) of the eligible
employees were covered by the MGMT ESOP. Because less than 70
percent of the combined employees of petitioner and MFG were
participants in the MGMT ESOP, the MGMT ESOP did not satisfy the
requirements of section 410(b).
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In plan years after June 30, 1987, petitioner owned all of
the issued shares in MFG. Therefore petitioner and MFG are
members of a controlled group,6 and the provisions of section 410
again apply as if MFG and petitioner were a single employer.
See, e.g., Achiro v. Commissioner, 77 T.C. 881, 906 (1981). The
combined number of eligible employees of the two companies was
seven for the plan year commencing July 1, 1987. The MGMT ESOP
covered only four of seven (57.1 percent) of the eligible
employees. Because less than 70 percent of the combined
employees of petitioner and MFG were participants in the MGMT
6
The definition of a controlled group for these purposes is
contained in sec. 1563(a). Sec. 1563(a) in relevant part
provides:
SEC. 1563(a). (a) Controlled Group of Corporations.--
For purposes of this part, the term “controlled group of
corporations” means any group of–-
(1) Parent-subsidiary controlled
group.--One or more chains of corporations connected
through stock ownership with a common parent corporation
if–-
(A) stock possessing at least
80 percent of the total combined
voting power of all classes of
stock entitled to vote or at least
80 percent of the total value of
shares of all classes of stock of
each of the corporations, except
the common parent corporation, is
owned (within the meaning of
subsection (d)(1)) by one or more
of the other corporations; * * *
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ESOP, the MGMT ESOP did not satisfy the requirements of section
410(b).
We conclude that respondent’s revocation of the MGMT ESOP’s
qualification was justified.7 We note in passing that two or
more plans may sometimes be aggregated so that the number of
participants benefiting in both plans may be taken into
consideration when determining whether minimum participation
standards have been met. Sec. 410(b)(6)(B). Petitioner has
failed to produce credible evidence that the MGMT ESOP can be
aggregated with the MFG ESOP for this purpose. Nor has
petitioner produced, and the record does not contain, evidence
that would support a conclusion that the MGMT ESOP would qualify
for subsequent plan years.
To reflect the foregoing,
Decision will be entered
for respondent.
7
Our holding complies with the intent of Congress in
enacting sec. 414(b) as expressed in H. Rept. 93-779, at 49
(1974), 1974-3 C.B. 244, 292:
The committee, by this provision, intends to make it
clear that the coverage and antidiscrimination
provisions cannot be avoided by operating through
separate corporations instead of separate branches of
one corporation. For example, if managerial functions
were performed through one corporation employing highly
compensated personnel, which has a generous pension
plan, and assembly-line functions were performed
through one or more other corporations employing lower-
paid employees, which have less generous plans or no
plans at all, this would generally constitute an
impermissible discrimination.* * *