The respondent determined a deficiency of $1,693.41 in the petitioners’ Federal income tax for 1967. The issue for decision is whether a lump-sum payment received by one of the petitioners under an early retirement plan should be taxed as a long-term capital gain. The answer depends upon whether, to qualify under section 401(a) of the Internal Revenue Code of 1954,1 a pension plan must be “funded” and whether the plan under which the petitioner received the lump-sum payment was funded.
ETNDINGS 03? 3?ACT
Some of the facts have been stipulated, and those facts are so found.
The petitioners, Thomas and Jeanne Trebotich, are husband and wife and maintained their residence in Oakland, Calif., at the time the petition was filed in this case. They filed their 1967 joint Federal income tax return with the district director of internal revenue, San Francisco, Calif. Mr. Trebotich will sometimes be referred to as the petitioner.
On or about June 30, 1967, the petitioner retired from his job as a longshoreman on the San Francisco docks. On that date, he was qualified to receive, and applied in writing for, a “vesting benefit” under a 1966 agreement negotiated by the International Longshoremen’s and Warehousemen’s Union (ILWU) and the Pacific Maritime Association (PMA). The PMA was an employers’ association with the primary function of negotiating and administering labor contracts with the Pacific coast maritime unions. Pursuant to this agreement, the' petitioner received two monthly payments of $270.84 less applicable payroll and withholding taxes. He then properly applied to have the remaining monthly payments to which he was entitled paid to him in one lump sum; and on or about August 25, 1967, he received a lump-sum payment of $12,291.66 less applicable payroll and withholding taxes.
In an effort to mechanize the operations and bring about greater efficiency in the west coast shipping industry, an agreement was entered into between the ILWU and the PMA on November 15, 1961. As a part of the agreement, it was provided that the employers would contribute to a mechanization fund. The agreement also provided for the establishment of three trusts — a vesting benefit trust, a welfare trust (which was to handle the payment of certain death and disability benefits), and a trust to distribute certain supplemental unemployment benefits. Funds were to be transferred from the mechanization fund to such trust as they were needed. The 1961 agreement expired on June 30, 1966, but in a 1966 agreement, the mechanization fund, the vesting benefit trust, and the welfare trust were all continued.
Under the 1966 agreement, the employers were to contribute approximately $38 million to the mechanization fund, at the rate of $7.4 million per year.2 The PMA was to collect such funds from the employers and had the power to compel defaulting employers to meet their obligations to the fund. While the PMA did not have the power to increase the rate of yearly contributions above $7.4 million per year, it was permitted to decrease the rate of contributions, if there were no immediate or projected needs for the funds. However, the total amount of contributions could be reduced if and only if the union engaged in unauthorized work stoppages or other actions inconsistent with the agreement.
The PMA was to administer the mechanization fund. As such, the PMA was to act as the agent of the employers and as a “conduit for transferring the whole, or portions, of the Mechanization Fund” to the vesting benefit trust. It was not to “act as a repository of Contributions by Employers to the Mechanization Fund beyond such time as may be reasonably necessary to perform accounting and banking transactions required for effectuation of the Plan * * During the time that the PMA was to hold the contributions, it was to act only as a collecting agent, and neither the trustees of the vesting trust, those of the welfare trust, the employees, nor the XLWU were to “have any right, title or interest, or any claim whatsoever, legal or equitable, in or to any portion of the Mechanization Fund,” except as provided in the agreement. Each employer’s interest in the fund was based upon the proportion of his contributions thereto, and the PMA was not to commingle the contributions with any other funds it held.
The PMA was to transfer funds from the mechanization fund to the vesting benefit trust as they were required for the immediate payment of the trust’s obligations or expenses. The trustees were required to submit to the PMA periodic reports concerning the monthly obligations of the trust, and the amount of funds to be transferred was based on these reports. Neither the PMA, the ILWU, nor any employer had any interest in the funds after they were transferred to the trust, and once funds were transferred to the trust, they were to be used immediately.
To become a beneficiary of the vesting benefit trust, an employee had either to remove himself voluntarily or to be removed mandatorily from the longshoremen labor force. To be eligible for voluntary removal, a longshoreman must have had at least 25 years of service, be at least 62 years of age, and make a written application for benefits. If an employee retired and made a written application when he first became eligible for benefits, he received a 'total of $13,000 of benefits, but if he delayed retiring or filing his application, the total benefits that he would receive were reduced. The $13,000 in benefits could also be reduced if the amount of employers’ contributions was insufficient to pay all the benefits which 'had accrued. Benefits were to be payable monthly, but upon request by the employee, the trustees could, at any time, distribute an employee’s remaining benefits to him in a lump sum.
The 1966 agreement was amendable, except as to the provisions regarding the interests which the employers, the ILWTJ, the PMA, and the employees had in the funds once they were transferred to a trust. Except for the paying of benefits to persons who had qualified before July 1, 1971, and the distribution of any other moneys which had not been distributed by that time, the agreement was to run concurrently with the basic union contract and terminate July 1, 1971. Finally, the agreement was conditioned on the continued validity of a letter ruling under the 1961 agreement, which permitted the employers to take an income tax deduction for contributions when the PMA transferred the contributions to the trusts.
The petitioner reported the $12,833.34 received from the vesting benefit trust as a long-term capital gain. The respondent, in his notice of deficiency, treated the $12,833.34 as ordinary income on the basis that the vesting benefit trust did not meet the requirements of section 401.
OPINION"
Section 402(a) (2), as in effect for 1967, provided that if the total distributions payable to an employee from a trust meeting the requirements of section 401(a) were paid within 1 year by reason of the employee’s separation from service, such distributions were taxable as a long-term capital gain.3 Whether the petitioner is entitled to treat the payments which he received from the vesting benefit trust as a long-term capital gain depends upon whether that trust was a part of a plan which meets the requirements of section 401. The resolution of this issue necessitates the consideration of two basic questions: (1) Must a plan qualifying under section 401 be funded; and (2) do the provisions of the 1966 agreement providing for vesting benefits establish a funded plan? Before discussing these questions, the possibility that the 1966 agreement established a qualified profit-sharing plan will be examined.
At the trial, the petitioner took the position that the vesting benefit trust was part of either a pension plan or a profit-sharing plan. On brief, the petitioner made no reference to his position that the vesting benefit trust could qualify as a part of a profit-sharing plan; and in any event, it is clear that such position has no merit.
¡Section 1.401-1 (b) (1) (ii), Income Tax Regs., states that, for purposes of section 401, “A profit-sharing plan is a plan established and maintained by an employer to provide for the participation in his profits by his employees or their beneficiaries.” Although the 1966 agreement stated that the mechanization fund was established to enable employees to share in the savings that would result to employers from mechanization and modernization of longshore operations, the payments made by the employers into the fund were in no way geared to or dependent upon the existence of profits, but were in predetermined amounts. Such a plan is not a profit-sharing plan under the statute and Income Tax Regulations. Mississippi River Fuel Corporation v. Koehler, 266 F. 2d 190 (C.A. 8, 1959), affirming 29 T.C. 1248 (1958) and 164 F. Supp. 844 (D. Mo. 1958), certiorari denied 361 U.S. 827 (1959).
Having decided that the vesting benefit plan is not a profit-sharing plan, we now reach the more serious question of whether the plan is a pension plan which meets the requirements of section 401. A pension plan which does meet such requirements is referred to as a qualified plan.
In general, section 401 sets forth the requirements for the qualification of a trusteed pension, profit-sharing, or stock bonus plan. Such a plan must provide for the accumulation of employer or employee contributions for the purpose of distributing them to employees, must prohibit the diversion of any such contributions prior to the satisfaction of all obligations under the plan, and must not discriminate in favor of officers, shareholders, supervisors, or highly compensated employees. Employer contributions to a qualified plan are deductible, subject to certain limitations, irrespective of whether the employees’ rights to them are forfeitable, and the earnings of such a trust are nob taxable to the trust. An employee covered by such a plan is not taxable on the contributions made on his behalf until the benefits are distributed to him; and under some circumstances, a lump-sum distribution is taxable to him as a long-term capital gain. Section 403 provides similar tax treatment for annuity plans in which there is no trust, and section 401(f) extends similar tax treatment to certain plans in which the funds are held by a custodian, instead of a trust.
Although section 401 refers to the accumulation of funds in a trust, neither that section nor the regulations thereunder explicitly require that a qualified pension plan be funded. However, the Commissioner has issued revenue rulings requiring funding of a qualified plan. See, e.g., Rev. Rul. 71-91, 1971-1 C.B. 116; Rev. Rul. 69-421, 1969-2 C.B. 59, 62. The respondent seems to use the term “funded” to describe the accumulation of contributions in an entity beyond the employer’s control and prior to the payment of benefits. Such a definition is narrower than that used by some commentators who consider any plan which entails accumulation prior to the payment of benefits as funded, and who designate the funding to which the respondent refers as “advance funding.” See Rothman, Establishing & Administering Pension & Profit Sharing Plans & Trust Funds 105 (1967). But see Duncan & Chaice, “Relative Merits of Funded & Unfunded Plans” in Sellin, Taxation of Deferred Employee and Executive Compensation 258, 262 (1960). Regardless of whether they call it funding or advance funding, commentators seem uniformly to agree that it is required to have a qualified pension plan. See, e.g., Holzman, Guide to Pension and Profit Sharing Plans 6 (1969); Montgomery’s Federal Taxes 8-23 (39th ed. 1964); 2 Rabbin & Johnson, Federal Income, Gift and Estate Taxation, ch. 15.01, p. 1504; Rothman, supra at 107; Wood & Cemey, Tax Aspects of Deferred Compensation 234 (2d ed.); Duncan & Chaice, supra at 258, 262. In this opinion, the term funding will be used to mean the accumulation of funds in a person independent of the employer.
To be funded, a trust must have more than a res. A trust res is the trust property and nearly any property interest which is capable of being beneficially owned (Bogert, Law of Trusts and Trustees, sec. Ill (1965)), including a promise made under seal to contribute to a pension plan, can constitute a trust res. Rev. Rul. 55-640,1955-2 C.B. 231. Cf. Tallman Tool & Machine Corporation, 27 T.C. 372 (1956); 555, Inc., 15 T.C. 671 (1950), affirmed per curiam 192 F. 2d 575 (C.A. 8, 1951). For purposes of determining whether contributions are deductible, it has been held that a trust exists when, and only when, the trust has a res. West Virginia Steel Corporation, 34 T.C. 851 (1960); Tallman Tool & Machine Corporation, supra; Abingdon Potteries, Inc., 19 T.C. 23 (1952); Crow-Burlingame Co., 15 T.C. 738 (1950), affirmed per curiam 192 F. 2d 574 (C.A. 8, 1951) ; 555, Inc., supra. In those cases, the only issue was when was the trust established; no issue was raised as to whether the trust qualified under section 401. In the present case, there is little doubt that the rights of the trust under the 1966 agreement constituted a trust res and that a trust existed; the question is whether the trust is funded so that the plan qualified under section 401.
In the early 1900’s, there were three basic forms of pension plans. One involved the payment of benefits by the employer as they became due; tlie second, the establishment by the employer of a reserve account to accumulate funds for pensions; and the third, the accumulation of funds in a trust. Harbrecht, Pension Funds and Economic Power 7 (1959). Only the third type could be said to be funded, as the first involved no accumulations and the second, accumulations within the employer’s absolute control.
Prior to 1921, there were no specific provisions in the revenue laws dealing with employee trusts. Generally, if an employer made contributions to a pension fund which he held, the contributions were not deductible; but if he made them to a fund which he did not hold, they were deductible. See O.D. 110,1 C.B. 224 (1919); art. 136, Pegs. 33. The tax consequences to the employee were determined under the constructive-receipt doctrine (4A Mertens, Law of Federal Income Taxation, sec. 25B.02, p. 3 (1966)), and income earned by the trust was taxable under the rules applicable to trusts in general. Revenue Act of 1918, sec. 219,40 Stat. 1071-1972.
The Revenue Act of 1921 provided that the income of “A trust created by an employer as a part of a stock bonus or profit-sharing plan * * * to which contributions are made by such employer, or employees, or both, for the purpose of distributing to such employees the earnings and principal of the fund accumulated” was not taxable until distributed to the employee. Revenue Act of 1921, sec. 219(f), 42 Stat. 247. In 1926, such provision was expanded specifically to include pension trusts, and the basic language of the present section 401 (a) (1) came into being. Revenue Act of 1926, sec. 219 (f), 44 Stat. 33.
The 1921 and 1926 Acts contain no provision dealing explicitly with the deductibility of contributions to a pension trust, but under the general provision dealing with the deductibility of business expenses, the regulations limited employer deductions to the amount of contributions made to plans under which the employer himself did not hold the funds. Sec. 214(a), art. 109, Regs. 65, 69. The Board of Tax Appeals, in applying a standard like that of the regulations, denied an employer a deduction where the employer simply set aside funds in a reserve account, but allowed a deduction where the employer made contributions to a trust. Merrill Trust Co., 21 B.T.A. 1409 (1931); Lemuel Scarbrough, 17 B.T.A. 317 (1929).
In 1928, employer contributions to a qualified pension trust were, by statute, made presently deductible, if for present services, and deductible over a 10-year period if for past services. Revenue Act of 1928, sec. 23 (q), 45 Stat. 802. The deduction for past services was added by the Senate Finance Committee. The committee noted that employer contributions to funds held by the employer were not deductible (see Merrill Trust Co., supra at 1410) and desired to allow a deduction, to be spread over a 10-year period, for such funds if they were transferred to a qualified pension trust. S. Rept. No. 960, to accompany H.K. 1 (Pub L. No. 562), 70th Cong., 1st Sess., p. 21-22 (1928). The importance of the Senate report is that it explicitly recognized that there were various forms of pension plans, did not suggest any change in the treatment in pension funds held by the employers, but did indicate that the favorable tax treatment was intended to apply only when the pension funds were not held by the employer. See Caxton Printers, Ltd., 27 B.T.A. 1110 (1933).
The subsequent legislative history of the tax treatment of pension trusts involved provisions designed to assure that the funds set aside for such purposes would actually benefit employees generally. In 1938, the favorable tax treatment was limited to trusts under which it was impossible for the corpus or income of the trust to be used by the employer before all liabilities to the employees under the trust were met. Revenue Act of 1938, sec. 165 (a), 52 Stat. 518. This provision had the purpose of assuring the employee that he would not be deprived of expected benefits by the diversion of the accumulated funds from the trust. H. Kept. No. 1860, to accompany H.R. 9682 (Pub- L. No. 554), 75th Cong., 3d Sess., p. 46 (1938). In 1942, the pension trust provisions were revised extensively. The nondiscrimination requirements were established to deny qualification to a plan which “either cover[ed] only a small percentage of the employees or else favor[ed] the higher paid or stock-holding employees * * H. Kept. No. 2333,77th Cong., 2d Sess. (1942), 1942-2 C.B. 413. The earlier provisions referred to a trust which accumulates principal and income, but in 1942, the language was changed so as to refer to a trust which accumulates corpus and income. There was no discussion of this change in the legislative history, thus suggesting that the draftsmen considered that the substitution of corpus for principal had no significance and that for this purpose the two words had similar meanings. In addition, most of the tax advantages of a qualified pension trust were made available to a nontrusteed plan under which annuity contracts were purchased for employees, if the plan met the requirements of section 401. Finally, the provision for long-term capital gains treatment of a lump-sum distribution from a qualified pension trust was enacted. The reason given for such provision was to relieve taxpayers who received such a lump-sum distribution from the added tax burden resulting from the taxation in a single year of income accumulated over a number of years.
Even though Congress has never said explicitly that a qualified plan must be funded, it has referred to the accumulation of principal, or corpus, in a trust, and it is clear that all of the provisions relating to qualified plans were enacted on the assumption that funds would be accumulated in a trust or by some person other than the employer for the subsequent payment of the benefits to the employees. The statutory provisions relating to qualified plans establish special and favorable tax treatment for the participants in such plans. As stated by a Presidential committee, “The purpose of tax concessions granted by the Federal Government to qualified pension plans is to encourage the growth of sound plans which supplement the public retirement security system.” The President’s Committee on Corporate Pension Funds and Other Private Retirement and Welfare Programs, Public Policy and Private Employee Retirement Plans 50-51 (1965). The interests of the employees are furthered by having an employer set aside, while the employees are working, the funds to be distributed to them when they retire. In that manner, the employees’ retirement funds are protected from the misfortunes that may occur to the employer. The diversion of funds accumulated for the retirement of employees is specifically prohibited. We cannot assume that Congress would have extended the favorable tax treatment to plans in which funds were not accumulated in an independent trust or similar manner for the benefit of employees. Thus, we think that it is fair to conclude from the legislative history that Congress expected qualified plans to be funded.
At least two courts have approved of qualified plans in which the funds were accumulated by an independent person, even though a formal trust was not created. In Tavannes Watch Co. v. Commissioner, 176 F. 2d 211, 215 (C.A. 2, 1949), a separate corporation was formed to hold the funds accumulated under the plan, and the court held that such a corporation should be considered a trust for purposes of section 401. In South Penn Oil Co., 17 T.C. 27 (1951), the employer made contributions to a life insurance company which did not segregate such contributions, but which agreed to purchase annuities for the employees as they retired. This arrangement was held to be a trust for purposes of section 401. These cases demonstrate that, although a formal trust may not be required, a plan will be qualified when funds are accumulated in the hands of a person independent of the employer.
Tn the light of the legislative history and the court decisions, we conclude that a qualified plan must be funded. Having reached such conclusion, we now come to the question of whether the vesting benefit plan was so funded.
Under the 1966 agreement, the vesting benefit trust acquired only such funds as were immediately necessary to meet its obligations, including the payment of benefits to employees and the payment of its administrative expenses. Under the agreement, it is not altogether clear as to the precise period that the trust would hold funds, but it is clear that it would not hold any substantial funds for any significant period of time. For all practical purposes, the vesting benefit trust was merely a conduit, receiving the funds from the PMA and paying them over to the employees. It did not have the typical duties of a fiduciary of receiving the employer contributions when made and of holding and investing such funds until distributed to employees; rather, it was more like an agent, acting merely as a conduit, that received money with one hand from the PMA and distributed it to the employees with its other hand. Such an arrangement does not constitute funding of a trust as contemplated under section 401.
Nor is it clear that the PMA was to accumulate funds under the plan. At one place, the 1966 agreement provided for the PMA to collect funds from the employers at predetermined annual rates. However, the agreement elsewhere provided that the PMA was not to act as a repository but was merely to collect the necessary funds from the employers. The PMA was given the power to reduce the scheduled contributions when it found that they were unnecessary to meet the obligations of the trust under the agreement. Thus, it appears that although the contributions were to be made at scheduled annual rates, the PMA. could, and should, reduce them to a rate sufficient to pay the benefits as they became due to employees. If in fact the agreement operated in that manner, then funds were not accumulated by the PMA in a substantial amount for any significant period of time.
Even if substantial funds were accumulated by the PMA, such fact does not constitute the fundings contemplated by section 401. Clearly, if the employers merely accumulated the funds in reserve accounts established and controlled by them, the arrangement would not constitute the funding of a qualified plan. Reginald H. Parsons, 15 T.C. 93 (1950); Caxton Printers, Ltd., supra; Merrill Trust Co., supra; Spring Canyon Coal Co., 13 B.T.A. 189 (1928), affd. 43 F. 2d 78 (C.A. 10, 1930), certiorari denied 284 U.S. 654 (1931). The 1966 agreement provided expressly that the PMA was to act as the agent of the employers and that the vesting benefit trust was to have no legal or equitable rights to the funds held by the PMA, except as provided in the agreement. The agreement did confer certain contract rights upon the trust, and it may be that under California law certain duties were imposed upon the PMA with respect to the handling of the funds; nevertheless, the contract rights of the trust and the duties thus imposed upon the PMA did not impress a trust upon the funds. Despite those rights and duties, the PMA held the funds as the agent of the employers, not as a fiduciary. The agreement did not give the PMA the power to invest the funds it collected, nor was there any provision for it to pay interest on any funds which it might hold. For their own reasons, the employers arranged to have their agent, the PMA, hold the funds until they were needed by the vesting benefit trust. The effect of the arrangement was as if the employers merely set aside the funds in a reserve account which they maintained. We cannot ignore the explicit provisions of the agreement; we must conclude that in effect the funds were still held by the employers, that the funds were not transferred to the vesting benefit trust to be held by it for any substantial period of time, and that the plan was not funded as contemplated by section 401.
It has been argued that the agreement imposed upon the employers the obligation to pay $38 million to the mechanization fund and that such obligation constituted the funding of the plan. However, there are several difficulties with that argument. First, it should be remembered that the amount to be contributed by the employers was subject to reduction in the event of unauthorized work stoppages or certain other actions. Secondly, and most significantly, no substantial funds were apparently to be accumulated by the PMA or by the vesting benefit trust. In effect, the employers were merely obligated to contribute to the trusts such amounts as they needed, up to $38 million ; if the benefits distributed by the two trusts did not use up the entire $38 million, the excess was to be distributed as agreed upon by the PMA and the ILWU. The only difference between such an arrangement and a pay-as-you-go retirement plan was that the money passed through the ’hands of two intervening parties, the PMA and the trust. Thus, the agreement did not provide for any funds to be accumulated, in any substantial amount or for any significant period of time in the hands of a trust or similar person.
The petitioner argues that since the employers are allowed to deduct their contributions to the vesting benefit trust, the employees should be allowed capital gain treatment when they receive a lump-sum distribution from that trust. However, there are situations in which an employer may deduct his contributions to a pension plan even though it does not qualify under section 401. See sec. 404(a) (5). Yet, distributions from a nonqualified trust are never entitled to long-term capital gain treatment. See sec. 402(b). Thus, there is no necessary correlation between the deductibility of the employer contributions and the availability of long-term capital gain treatment for the employee.
Also unconvincing is the petitioner’s argument that we will invalidate or undermine the 1966 agreement if we do not hold that he is entitled to long-term capital gain treatment. Congress has seen fit to relieve employees who receive a lump-sum distribution from a qualified trust in a single year from the tax burden that would otherwise be imposed upon such distribution; our responsibility is to determine whether this petitioner qualifies for that tax relief, and based upon an interpretation of the statute and the legislative history, we have con-eluded that he does not come within the class of taxpayers for whom such relief was designed. Moreover, we doubt that our holding in this case will significantly undermine the agreement between the ILWXJ and the PMA.
By the averaging provisions contained in section 1301 et seq., Congress has provided some tax relief for taxpayers who receive unusually large amounts of income in a single taxable year. From the evidence in this case, we cannot determine whether the additional income received by the petitioner as a result of the distributions under the vesting benefit trust qualify him for relief under such provisions. If such provisions are applicable, they should be applied in a Rule 50 computation.
In addition to the lack of funding of the vesting benefit trust, the respondent made several other arguments against the qualifications of the trust, but in view of our conclusion with respect to the funding issue, it is unnecessary for us to consider his other arguments.
Reviewed by the Court.
Decision will be entered under Rule 50.
Drennen, /., dissents.All statutory references are to the Internal Revenue Code of 1954, unless otherwise indicated.
In addition to the $7.4 million per year, $1.2 million was to be contributed by the employers over a 3-year period to pay benefits which had vested under the 196.1 agreement. The existence of this $1.2 million is not of importance in this case and mention is made of it only to explain how the $38 million figure was determined.
Sec. 402(a) was amended by sec. 515(a) (1) of the Tax Reform Act of 1969 (83 Stat. 643-644) to limit the long-term capital gain treatment of qualified trust distributions.