Petersen v. Comm'r of Internal Revenue

FILED
United States Court of Appeals
PUBLISH Tenth Circuit

UNITED STATES COURT OF APPEALS May 15, 2019

Elisabeth A. Shumaker
FOR THE TENTH CIRCUIT Clerk of Court
_________________________________

STEVEN M. PETERSEN; PAULINE
PETERSEN,

Petitioners - Appellants,

v. No. 17-9003

COMMISSIONER OF INTERNAL
REVENUE,

Respondent - Appellee.

–––––––––––––––––––––––––––––––––––

JOHN E. JOHNSTUN; LARUE A.
JOHNSTUN,

Petitioners - Appellants,

v. No. 17-9004

COMMISSIONER OF INTERNAL
REVENUE,

Respondent - Appellee.
_________________________________

Appeal from the United States Tax Court
(CIR Nos. 015184-14 & 015185-14)
_________________________________

Michael C. Walch, Kirton McConkie, Lehi, Utah, for Petitioners-Appellants.

Jennifer M. Rubin (Bruce R. Ellisen, with her on the brief), Department of Justice, Tax
Division, Washington, D.C., for Respondent-Appellee.
_________________________________
Before HARTZ, PHILLIPS, and EID, Circuit Judges.
_________________________________

HARTZ, Circuit Judge.
_________________________________

This appeal concerns the propriety of the timing of deductions by a Subchapter S

corporation for expenses paid to employees who participate in the corporation’s

employee stock ownership plan (ESOP). Stephen and Pauline Petersen and John and

Larue Johnstun (Taxpayers) appeal the decision of the United States Tax Court holding

them liable for past-due taxes arising out of errors in their income-tax returns caused by

premature deductions for expenses paid to their Corporation’s ESOP. Taxpayers contend

that the Tax Court misinterpreted the Internal Revenue Code (IRC) and, even if its

interpretation was correct, miscalculated the amounts of alleged deficiencies. The

Commissioner agrees that a recalculation is necessary. Exercising jurisdiction under 26

U.S.C. § 7482(a), we affirm Taxpayers’ liability but remand for recalculation of the

deficiencies.

I. BACKGROUND

Taxpayers were majority shareholders in Petersen Inc. (the Corporation), a

Subchapter S corporation.1 The disputed liabilities arise from Taxpayers’ income-tax

returns for 2009 (offset in small part by corrections in their favor for their 2010 returns).

Because the Corporation is a Subchapter S corporation, it is a pass-through entity for

income-tax purposes—that is, the Corporation does not itself pay income taxes, but its

1
Larue Johnstun was not a shareholder in the Corporation, but is a party in this case
because she filed her income-tax return jointly with her husband John.

2
taxable income, deductions, and losses are passed through to its shareholders. See 26

U.S.C. § 1366. For 2009 and most of 2010, Taxpayers owned 79.6% of the

Corporation’s stock. The remaining stock was held by the Corporation’s ESOP. In

October 2010 the ESOP acquired all of Taxpayers’ stock, becoming the 100% owner.

The ESOP is an employee-benefit plan governed by the Employee Retirement

Income Security Act (ERISA). Employee-benefit plans that qualify under the detailed

requirements of ERISA, see 26 U.S.C. § 401(a), are exempt from income taxes, see id.

§ 501. An ESOP is a type of qualified employee-benefit plan in which an employer

contributes shares of its own stock, or cash to purchase shares of its stock, into a trust,

and those shares are allocated to individual employee accounts. See 26 U.S.C. § 4975

(e)(7); 29 U.S.C. § 1107(d)(6); Donovan v. Cunningham, 716 F.2d 1455, 1459 (5th Cir.

1983). ESOPs provide employee participants the opportunity to gain ownership in shares

of the employer corporation. As the Supreme Court has recently noted:

“The Congress, in a series of laws [including ERISA] has made clear its
interest in encouraging [ESOPs] as a bold and innovative method of
strengthening the free private enterprise system which will solve the dual
problems of securing capital funds for necessary capital growth and of
bringing about stock ownership by all corporate employees.”

Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409, 416 (2014) (quoting Tax Reform Act

of 1976, § 803(h), 90 Stat. 1590 (brackets added by Supreme Court)). A corporation’s

contributions paid to its ESOP are tax deductible. See 26 U.S.C. § 404(a)(3); Brindle v.

Wilmington Trust, N.A., 919 F.3d 763, 769 (4th Cir. 2019). There is no dispute that the

Corporation’s ESOP is qualified under ERISA.

3
 The Corporation is an accrual-basis taxpayer and its ESOP-participant employees

are cash-basis taxpayers. As a general rule, an accrual-basis taxpayer may deduct

ordinary and necessary business expenses in the year when “all events have occurred

which determine the fact of liability and the amount of such liability can be determined

with reasonable accuracy.” 26 U.S.C. § 461(h)(4). But § 267 of the IRC restricts the

timing of deductibility when the accrued expense is to be paid to a cash-basis taxpayer

that is “related to” the taxpayer. See id. § 267(a)(2). Such expenses cannot be deducted

until the amount of the payment becomes gross income of the related taxpayer. See id.

Consider, for example, an employee on the Corporation’s payroll who is “related to” the

Corporation (we will call such employees “related employees”), works during the last

eight days of the calendar year, but does not receive a paycheck until early the following

year. Although the Corporation accrues the payroll expense in the year that the employee

worked the eight days, it must delay the deduction until the next year, when the related

employee receives the payment of wages.

Here, the Corporation deducted expenses for ESOP participants in the year that the

expenses accrued even though it did not pay the expenses until the next year. Among

those accrued expenses were wages and salaries (paid every second Friday) and unused

vacation time rolled over by employees from one year to the next. If a payday fell early

in January 2010, the Corporation could accrue during 2009 up to two weeks of unpaid

payroll that the employee would not receive until 2010; and the expense of vacation days

could be accrued many months before the employee used the benefit. These accrued but

4
unpaid expenses should not have been deducted by the Corporation at the time of accrual

if the payment would go to a related employee.

The Internal Revenue Service (IRS) audited Taxpayers and decided that

employees of the Corporation who participated in its ESOP were related to the

Corporation. It therefore disallowed deductions taken for the 2009 tax year based on

expenses accrued in that year but not paid to the related employees until 2010.

Taxpayers unsuccessfully contested the alleged deficiencies in the United States Tax

Court and now appeal to this court.

II. DISCUSSION

“We review tax court decisions in the same manner and to the same extent as

decisions of the district courts in civil actions tried without a jury. The Tax Court’s legal

conclusions are subject to de novo review, and its factual findings can be set aside only if

clearly erroneous.” Katz v. C.I.R., 335 F.3d 1121, 1125–26 (10th Cir. 2003) (citation and

internal quotation marks omitted). We proceed to discuss the applicable statutory

provisions and explain why the challenges by Taxpayers are unpersuasive.

A. IRC § 267

We begin with IRC § 267. Paragraph 267(a)(2) is entitled “Matching of deduction

and payee income item in the case of expenses and interest.” It provides that if the

taxpayer and a person to whom the taxpayer is to make a payment are related—that is,

“are persons specified in any of the paragraphs of subsection (b) [of § 267],” id.

§ 267(a)(1) (emphasis added)—then the amount of the payment cannot be deducted until

5
it is paid or is includible in the recipient’s gross income, see id. § 267(a)(2)2. This

provision keeps taxpayers from exploiting differences in accounting methods between the

payer (who deducts the payment) and the recipient (who treats the payment as income) to

artificially evade, or at least delay, income taxes. It was enacted “to require related

persons ‘to use the same accounting method with respect to transactions between

themselves in order to prevent the allowance of a deduction without the corresponding

inclusion in income.’” Tate & Lyle, Inc. v. C.I.R., 87 F.3d 99, 103 (3d Cir. 1996) (quoting

H.R. Supp. Rep. 998-432, Part 2, at 1578, reprinted in 1984 U.S.C.C.A.N. 697, 1205)

(House Report); see also House Report at 1578–79 (“The failure to use the same

accounting method with respect to one transaction involves unwarranted tax benefits,

especially where payments are delayed for a long period of time, and in fact may never

2
The pertinent part of § 267(a)(2) states:

If--

(A) by reason of the method of accounting of the person to whom the payment is to be
made, the amount thereof is not (unless paid) includible in the gross income of such
person, and

(B) at the close of the taxable year of the taxpayer for which (but for this paragraph) the
amount would be deductible under this chapter, both the taxpayer and the person to
whom the payment is to be made are persons specified in any of the paragraphs of
subsection (b),

then any deduction allowable under this chapter in respect of such amount shall be
allowable as of the day as of which such amount is includible in the gross income of the
person to whom the payment is made (or, if later, as of the day on which it would be so
allowable but for this paragraph). . . .

6
be paid.”); Metzger Trust v. C.I.R., 76 T.C. 42, 75 (1981) (Congress enacted § 267 “to

prevent the use of differing methods of reporting income for Federal income tax purposes

in order to obtain artificial deductions for interest and business expenses.”). For example,

absent the limitations of § 267, an accrual-basis taxpayer indebted to a closely related

cash-basis taxpayer could, as interest became due on the debt, report the interest as a

deduction without making the payment to the cash-basis taxpayer, who would report no

income at the time and might never report income if payment was arranged to arrive

when the cash-basis taxpayer had offsetting losses. See Metzger Trust, 76 T.C. at 75.

Subsection 267(b), entitled “Relationships,” lists a number of relationships

covered by this provision of the statute, such as “[m]embers of a family” and “[a] grantor

and a fiduciary of any trust,” 26 U.S.C. § 267(b)(1), (4). Relevant here, however, is

subsection (e), which provides “[s]pecial rules for pass-thru entities.” It states that “an S

corporation [and] any person who owns (directly or indirectly) any of the stock of such

corporation” are to be “treated as persons specified in a paragraph of subsection (b).”

26 U.S.C. § 267(e)(1) (emphasis added)3. In other words, an S corporation and a

3
§ 267(e) states in full:

Special rules for pass-thru entities.--

(1) In general.--In the case of any amount paid or incurred by, to, or on behalf of, a pass-
thru entity, for purposes of applying subsection (a)(2)--

(A) such entity,

(B) in the case of--

7
shareholder of that S corporation are related to one another for purposes of § 267.

Because the Corporation ESOP owned much—later, all—of the shares of the

Corporation, the Corporation and the Corporation ESOP were related.

Also relevant here is § 267(c), entitled “Constructive ownership of stock.” It

provides, “For purposes of determining, in applying subsection (b), the ownership of

stock—(1) Stock owned, directly or indirectly, by or for a corporation, partnership, state,

or trust shall be considered as being owned proportionately by or for its shareholders,

partners, or beneficiaries.” 26 U.S.C. § 267(c)(1) (emphasis added). If the stock held by

an ESOP is held in a trust within the meaning of § 267(c)(1), and if the employees

participating in the ESOP are beneficiaries of that trust, then the Corporation employees

(i) a partnership, any person who owns (directly or indirectly) any capital interest or
profits interest of such partnership, or

(ii) an S corporation, any person who owns (directly or indirectly) any of the stock of
such corporation,

(C) any person who owns (directly or indirectly) any capital interest or profits interest of
a partnership in which such entity owns (directly or indirectly) any capital interest or
profits interest, and

(D) any person related (within the meaning of subsection (b) of this section or section
707(b)(1)) to a person described in subparagraph (B) or (C),

shall be treated as persons specified in a paragraph of subsection (b). Subparagraph (C)
shall apply to a transaction only if such transaction is related either to the operations of
the partnership described in such subparagraph or to an interest in such partnership.
(2) Pass-thru entity.ab--For purposes of this section, the term “pass-thru entity” means--
(A) a partnership, and

(B) an S corporation.

(Emphasis added.)

8
participating in the ESOP must be considered owners of stock of the Corporation under

§ 267(c). In our view, both of those conditions are met. To support that conclusion, we

need to examine both trust law and ERISA.

B. Trust Law and ERISA

The term trust is not defined in § 267. The Restatement (Third) of Trusts § 2

(2003) (hereinafter Restatement Third) broadly defines the term as “a fiduciary

relationship with respect to property, arising from a manifestation of intention to create

that relationship and subjecting the person who holds title to the property to duties to deal

with it for the benefit of charity or for one or more persons, at least one of whom is not

the sole trustee.” A trust generally has the following elements: (1) trust property (real or

personal, tangible or intangible) which the trustee holds subject to the rights of another,

(2) a trustee (an individual or entity charged with holding the trust property for the

benefit of another), and (3) a beneficiary (the person for whose benefit the trustee holds

the trust property). See Amy M. Hess et al., Bogert’s Trust and Trustees § 1 (2018)

(Bogert). Essentially the same concept is reflected in the IRC regulations: “Generally

speaking, an arrangement will be treated as a trust under the Internal Revenue Code if it

can be shown that the purpose of the arrangement is to vest in trustees responsibility for

the protection and conservation of property for beneficiaries who cannot share in the

discharge of this responsibility and, therefore, are not associates in a joint enterprise for

the conduct of business for profit.” 26 C.F.R. § 301.7701-4(a).

One purpose of ERISA is to protect employees from abuse and mismanagement of

funds designated for employee-benefit plans. See Massachusetts v. Morash, 490 U.S.

9
107, 112 (1989) (“ERISA was passed . . . to safeguard employees from the abuse and

mismanagement of funds that had been accumulated to finance various types of employee

benefits.”); Firestone Tire and Rubber Co. v. Bruch, 489 U.S. 101, 113 (1989). To this

end, ERISA establishes minimum standards for benefit plans by “imposing reporting and

disclosure mandates, participation and vesting requirements, funding standards, and

fiduciary responsibilities for plan administrators. It envisions administrative oversight,

imposes criminal sanctions, and establishes a comprehensive civil enforcement scheme.”

New York State Conference of Blue Cross & Blue Shield Plans v. Travelers Ins. Co., 514

U.S. 645, 651 (1995) (citations omitted). The safeguard relevant here is that it mandates

that assets of employee-benefit plans be held in trust. See 29 U.S.C. § 1103(a) (absent

exceptions not relevant here, “all assets of an employee benefit plan shall be held in trust

by one or more trustees”); Restatement Third § 2 cmt. a (“The term ‘trust’ . . . includes

. . . private pension-fund arrangements in trust form.”).

Although ERISA trusts are not governed by the common law of trusts established

by state law, see Shaw v. Delta Air Lines, Inc., 463 U.S. 85, 104 (1983) (“Congress

applied the principle of pre-emption in its broadest sense to foreclose any non-Federal

regulation of employee benefit plans, creating only very limited exceptions . . . .”

(internal quotation marks omitted)), the federal statutory requirements mirror the law

regarding a common-law trust. The trust property consists of all the assets of the

employee-benefit plan. The trust must have trustees. See 29 U.S.C. § 1103(a). The trust

property must be managed for the exclusive benefit of plan participants and beneficiaries.

See 29 U.S.C. § 1103(c)(1) (absent exceptions not relevant here, “the assets of a plan

10
shall never inure to the benefit of any employer and shall be held for the exclusive

purposes of providing benefits to participants in the plan and their beneficiaries and

defraying reasonable expenses of administering the plan.”). Indeed, citing the provision

that “assets of an employee benefit plan shall be held in trust,” 29 U.S.C. § 1103(a), the

Supreme Court observed that “rather than explicitly enumerating all of the powers and

duties of trustees and other fiduciaries, Congress invoked the common law of trust to

define the general scope of their authority and responsibility.” Central States, Southeast

and Southwest Areas Pension Fund v. Central Transport, Inc., 472 U.S. 559, 570 (1985);

see also Firestone, 489 U.S. at 110 (“ERISA abounds with the language and terminology

of trust law.”). Also, although a participant or beneficiary of an ERISA plan cannot seek

relief under state trust law, see Pilot Life Ins. Co. v. Dedeaux, 481 U.S. 41, 54 (1987)

(ERISA’s civil enforcement remedies are exclusive; remedies under state law are not

available.), ERISA itself provides robust remedies for violations of fiduciary duties, see

Varity Corp. v. Howe, 516 U.S. 489 (1996) (construing 29 U.S.C. § 1132, entitled “Civil

enforcement”); see also Garratt v. Walker, 164 F.3d 1249, 1253 (10th Cir. 1998) (“The

civil enforcement mechanism . . . of ERISA, specifically 29 U.S.C. § 1132(a)(1)(B),

allows a plan participant to bring a civil action not only for recovery of plan benefits and

enforcement of plan rights, but also to clarify his rights to future benefits under the terms

of the plan.”).

To be sure, although courts in the ERISA context “are to apply common-law trust

standards, [they must] bear[] in mind the special nature and purpose of employee benefit

plans.” Varity, 516 U.S. at 506 (internal quotation marks omitted). But that does not

11
change the essential nature of an ERISA trust as a trust. After all, even common-law

trusts regularly contain provisions departing from the default common-law standards.

See Restatement Third § 4 cmt. a(1) (“[M]ost (but not all) of trust law consists of ‘default

rules,’ as opposed to mandatory or restrictive rules . . . .”) Here, Congress authorizes the

courts to recognize the need for special standards in this context.

We therefore conclude that the Corporation’s ESOP trust is a trust within the

meaning of § 267 and that the Commissioner properly applied that section to Taxpayers.

Taxpayers’ brief has a jumble of arguments that an ESOP trust is not a “trust” within the

meaning of the term in IRC § 267. But to the extent that we can understand these

arguments, they are unconvincing. We consider them in turn.

Taxpayers argue that an ERISA trust is distinguishable from a common-law trust

(and thus is not covered by § 267) because it protects the interests of “participants,” who

are distinguished from “beneficiaries” in ERISA. But this argument relies on semantics

rather than substance. As previously noted, a beneficiary “is the person for whose benefit

the trustee holds the trust property.” Bogert § 1. The property in an ERISA trust “shall

be held for the exclusive purposes of providing benefits to participants in the plan and

their beneficiaries and defraying reasonable expenses of administering the plan.”

29 U.S.C. § 1103(c)(1). Both participants in the plan and their beneficiaries satisfy the

definition of beneficiary in trust law. All ERISA does is use different terminology to

describe two distinct classes of beneficiaries—those employees or former employees who

participate in the plan, and the beneficiaries whose interests derive from a participant.

See 29 U.S.C. § 1002(7) (defining participant), (8) (defining beneficiary as “a person

12
designated by a participant, or by terms of an employee benefit plan, who is or may

become entitled to a benefit thereunder.”). The common law of trusts allows for different

beneficiaries “whose interests may be enjoyable concurrently or successively.”

Restatement Third § 44 cmt. a. ERISA’s use of the term participant to describe certain

beneficiaries does not remove ERISA trusts from the IRC definition of trusts. The term

beneficiary in § 267 has been interpreted quite broadly, see Wyly v. United States, 662

F.2d 397, 402 (5th Cir. 1981) (taxpayers were beneficiaries of trust even though they

would receive nothing unless their four children died without issue); and in any event,

there is no need for such a broad construction here, since every participant easily satisfies

the common-law definition of beneficiary.

Taxpayers also argue that ERISA trusts are not true trusts because they are called

“qualified trusts.” They cite various provisions of the Internal Revenue Code that do not

treat ESOPs the same way as they treat other trusts. But all that shows is that an ESOP

trust is a special type of trust, with special tax consequences for which it “qualifies.” For

example, such a trust pays no income tax. See 26 U.S.C. § 501(a). The very reason why

the term trust is preceded by the adjective “qualified” is that special conditions must be

met for the trust to qualify. That adjective does not signal that the entity is not a true

trust; the term is not “quasi-trust.” To say that calling the entity a “qualified trust” means

that it is not a true “trust” would be like saying that an All Star baseball player is not a

real baseball player. We reject Taxpayers’ suggestion that when the IRC uses the stand-

alone term trust, it intends to exclude ESOP “qualified trusts.”

13
 Taxpayers further contend that an ESOP trust does not satisfy the IRS definition of

trust in 26 C.F.R. § 301.7701–4(a). They point to the following sentence in the

regulation:

In general, the term “trust” as used in the Internal Revenue Code refers to
an arrangement created either by a will or by an inter vivos declaration
whereby trustees take title to property for the purpose of protecting or
conserving it for the beneficiaries under the ordinary rules applied in
chancery or probate courts . . . .

26 C.F.R. § 301.7701–4(a). As they see it, an ESOP trust is distinct from the trusts

described in that sentence because it is not created by a will or an inter vivos declaration

and is not “generally subject to the rules of chancery or probate courts.” Aplt. Br. at 20.

But Taxpayers ignore the words “[i]n general” at the beginning of the quoted

sentence; the language that follows those words is clearly intended to be illustrative, not

exhaustive. And they ignore the language three sentences later in the regulation:

“Generally speaking, an arrangement will be treated as a trust under the Internal Revenue

Code if it can be shown that the purpose of the arrangement is to vest in trustees

responsibility for the protection and conservation of property for beneficiaries who

cannot share in the discharge of this responsibility and, therefore, are not associates in a

joint enterprise for the conduct of business for profit.” 26 C.F.R. § 301.7701–4(a). We

have already explained how ERISA trusts fulfill those requirements. One should not

make too much of the statement that trusts generally are created “either by will or by an

inter vivos declaration” (which apparently does not include trusts created by

corporations). Id. Similar language appears in the Restatement Third. Section 3(1)

states: “The person who creates a trust is the settlor,” and comment a to the section

14
states: “The term ‘settlor’ includes a person who creates a trust by will as well as a

person who creates a trust inter vivos.” But that language does not exclude trusts created

by others, such as corporations. Comment e to § 3 states, “The term ‘person’ includes

corporations and unincorporated associations.” Cf. Restatement Third § 10 cmt. b. (“A

trust may also be created by statute.”).

Nor is it material that the terms of an ERISA trust cannot be enforced in chancery

or probate courts. Federal-court remedies provided in ERISA itself reflect the common

law of trusts and are an adequate substitute. Besides, the regulation does not say that the

rules governing a trust must be enforced in chancery or probate courts; it just says that

such a trust should be subject to the “ordinary rules applied” in those courts. 26 C.F.R.

§ 301.7701–4(a). Also, we think it informative that the regulation notes certain entities

(but notably not ERISA trusts) that are known as trusts but not treated as trusts for

purposes of the IRC because they do not satisfy the requirements of an ordinary trust.

See id. § 301.7701–4(b) (business trusts), (c) (investment trusts). We are confident that

an ERISA trust satisfies the requirements of the regulation.

Taxpayers also claim support in Revenue Ruling 89-52, which includes the

statement, “The term ‘trust’ is not a term of art or of fixed content, and its meaning for

the purposes of employee trusts under section 401(a) of the Code [which sets forth the

requirements for an employee-benefit trust to qualify for exemption from taxation under

26 U.S.C. § 501(a)] is not necessarily the same as under state law or as under other

sections of the Internal Revenue Code.” See Rev. Rul. 89-52, 1989-1 C.B. 110. But read

in the context of the entire ruling, the point of the sentence is that additional requirements

15
may be imposed on employee trusts that are not imposed on trusts in general. The next

paragraph of the Ruling makes this clear:

Generally, for a trust to be qualified under section 401(a) of the Code, the
trust must be a valid trust under the law of the jurisdiction in which the trust
is located. However, even if the trust is valid under local law, the
arrangement may be required to satisfy certain other requirements in order
to be considered a trust for purposes of section 401(a).

Rev. Rul. 89-52, 1989-1 C.B. 110 (citation omitted). In the trust at issue in the Ruling,

the trust was not qualified as an employee trust because the elements of a trust

relationship were not present. See id. (“[P]articipants [in the trust at issue] have the right

to acquire, hold and dispose of an amount attributable to their account balances in the

plan.”). If anything, the Ruling supports the proposition that a “qualified trust” must be a

“trust” and also meet certain other requirements.4

Taxpayers’ final argument against treating the ESOP trust as a “trust” under § 267

is a puzzling one. It relies on 29 U.S.C. § 1132(d), which states that “[a]n employee

benefit plan may sue or be sued [under ERISA] as an entity” and that “[a]ny money

judgment under [ERISA] against an employee benefit plan shall be enforceable only

against the plan as an entity and shall not be enforceable against any other person unless

4
The sentence in the Ruling relied on by Taxpayers cites to Tavannes Watch Co. v.
Commissioner, 176 F.2d 211, 215 (2d Cir. 1949). In that case the court held that an
entity was a trust that satisfied the requirements for an employer profit-sharing plan even
though it was not formally a trust. We do not think that this opinion helps Taxpayers
either. The court was dealing with a transitional provision for employee-benefit plans
that predated a new statute and did not comply with the new requirements. The court
ruled that the entity should be treated as qualifying during the transition period because
its essential nature was that of a trust. See id. at 214–16. No such special circumstances
are present here.

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liability against such person is established in his individual capacity under [ERISA].”

They conclude from this language that “it is the plan which is the legal entity, and not

the trust which is a part of that plan.” Aplt. Br. at 11. Are they suggesting that the

ESOP trust is a nonentity? The essential facts for application of § 267 are that the assets

of the plan are held in a trust and the participants in the plan are beneficiaries of the

trust. Taxpayers do not explain the relevance of statutory provisions concerning who

can sue whom. And anyway they admit that trustees of an ESOP trust can be sued,

although they assert, without citing authority, that in that event the trustees “are sued as

agents of the plan, not of the trust.” Id.

In addition to arguing that the ESOP trust is not a “trust” within the meaning of

§ 267, Taxpayers raise several objections to applying that section to an ESOP trust on the

ground that this would conflict with other provisions of the IRC. First they claim that

§ 267 cannot apply because it is within Subchapter B (of chapter 1 of subtitle A of the

IRC), which covers “Computation of Taxable Income,” whereas ESOPs are formed and

governed by the provisions in Subchapter D, which addresses “Deferred Compensation.”

But they do not point to any requirement in Subchapter D that conflicts with § 267, and

we perceive no conflict. What is before us to resolve is the taxation of the shareholders

of a Subchapter S corporation, who are subject to Subchapter B. The constructive

ownership rules of § 267(c) explicitly apply to transactions with corporations,

partnerships, estates, and trusts, see 26 U.S.C. § 267(c), all of which are also subject to

provisions in other subchapters of the IRC. See 26 U.S.C. §§ 301 et seq. (Subchapter C-

Corporate Distributions and Adjustments); §§ 641 et seq. (Subchapter J-Estates, Trusts,

17
Beneficiaries, and Decedents); §§ 701 et seq. (Subchapter K-Partners and Partnerships).

There is no reason to treat a Subchapter D trust differently.

Taxpayers similarly argue that applying the attribution rules in § 267 to trusts like

an ESOP trust would be absurd because ESOP participants would be taxed on their share

of ESOP income, as would beneficiaries of charitable trusts and the like. But § 267 does

not impose taxes on any person or entity that would not otherwise be taxed. It simply

says, roughly speaking, that deductions taken by those who are taxed may have to be

delayed—in particular, an accrual-basis taxpayer cannot deduct an accrued expense

payable to a related person (not necessarily a taxpayer) in a tax year before the tax year in

which the related person receives the payment. The tax liability of the related person is

not affected. Taxpayers’ various references to the nontaxation of ESOPs are therefore

beside the point. Of course, if a particular provision of Subchapter D explicitly overrides

§ 267 (as Taxpayers contend is true of 26 U.S.C. § 404(a), although we note that the

Commissioner disputes the contention), then the Subchapter D provision may well

prevail. But Taxpayers do not suggest that any provision of Subchapter D addresses their

situation.

Another of Taxpayers’ statutory arguments relies on 26 U.S.C. § 318, which, in

our view, actually supports the Commissioner. Titled “Constructive ownership of stock,”

§ 318 sets forth attribution rules for transactions by Subchapter C Corporations for such

purposes as determining whether a transaction is treated as a dividend or a sale of stock.

See Bittker & Eustice, Fed. Income Taxation of Corp. and S’holders, ¶¶ 9.02–9.05, Mar.

2019; S. Rep. 83-1622, at 45, 252-53 (1954) reprinted in 1954; U.S.C.C.A.N 4621, 4676,

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4890–92. Taxpayers point to § 318(a)(2)(B)(i), which excludes employee-benefit trusts

from the § 318 constructive-ownership rules. It states: “Stock owned, directly or

indirectly, by or for a trust (other than an employees’ trust described in section 401(a)

which is exempt from tax under section 501(a)) shall be considered as owned by its

beneficiaries in proportion to the actuarial interest of such beneficiaries in such trust.”

(Emphasis added.) In particular, stock owned by an ESOP trust would not be considered

as owned by its “beneficiaries” (presumably including the participants). Applying that

exception to the present case, Taxpayers contend that the Corporation stock owned by its

ESOP should not be considered to be owned by the Corporation employees who

participate in the plan.

The argument may look persuasive, but there is a fatal flaw. The language

introducing this provision is crucial. The relevant language of § 318 is:

(a) General rule. – For purposes of those provisions of this subchapter to which
the rules contained in this subsection are expressly made applicable
...
(2) Attribution from partnerships, estates, trusts, and corporations. –
...
(B) From trusts. –
(i) Stock owned, directly or indirectly by or for a trust (other than an
employees’ trust described in section 401(a) which is exempt from
tax under section 501(a)) shall be considered as owned by its
beneficiaries in proportion to the actuarial interest of such
beneficiaries in such trust.

26 U.S.C. § 318(a)(2)(B)(i) (emphasis added). Consequently, this provision cannot

exclude ESOP trusts from the meaning of trust in § 267 for two independently sufficient

reasons: (1) § 267 is not in the same subchapter as § 318 (which is in Subchapter C), and

(2) § 267 does not even mention § 318, much less make it “expressly . . . applicable.”

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Indeed, rather than supporting Taxpayers’ argument, § 318 undermines it because the

section implicitly assumes that an “employees’ trust described in section 401(a)” would

be considered a “trust” governed by that section if it were not expressly excluded. Thus,

the failure to explicitly exclude employee trusts in § 267 strongly indicates that such

trusts are included.

Taxpayers cite to Boise Cascade Corp. v. United States, 329 F.3d 751, 755 (9th

Cir. 2003), where § 318 was applied. But their reliance on that decision is misplaced.

The court applied § 318 to 26 U.S.C. § 302, entitled “Distributions in redemption of

stock.” Section 302, however, satisfies the conditions for application of § 318. It appears

in Subchapter C and it explicitly states that “section 318(a) shall apply in determining the

ownership of stock for purposes of this section.” 26 U.S.C. § 302(c)(1); see also

26 U.S.C. 318(b) (cross referencing § 302 as a provision to which § 318(a) applies).

Finally, Taxpayers, rather than analyzing the language of § 267, simply argue that

it is inconsistent with some other provisions of the IRC and that if it were intended to

apply to Subchapter S corporation ESOPs, it would have said so explicitly. We are not

persuaded. Applying § 267 to the circumstances here does not contradict any other

provision of the IRC, and the language of § 267 quite clearly applies in this context.

III. CONCLUSION

We AFFIRM the decision of the Tax Court except that we REMAND for

recalculation of the correct amounts of the deficiencies.

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