OPINION
Sterrett, Judge:In a notice of deficiency dated October 6, 1978, respondent determined a deficiency in the income taxes paid by petitioners for their taxable years ended December 31, 1970 and 1971, in the amounts of $512.34 and $6,491.60, respectively. After concessions, the only remaining issue for our decision is whether that part of the net distribution, which was received from a profit-sharing trust not qualified or exempt under sections 401(a) and 501(a), I.R.C. 1954, that is attributable to contributions made to the trust in years when it was qualified, should be taxed as ordinary income or as long-term capital gain.
This case was submitted under Rule 122, Tax Court Rules of Practice and Procedure. Hence, all of the facts have been stipulated and are so found.
Curtis B. Woodson resided in Corpus Christi, Tex., at the time the petition was filed herein. Curtis B. Woodson and Fern R. Woodson (petitioners) were husband and wife until the death of Fern R. Woodson on November 3, 1971. Curtis B. Woodson was appointed independent executor of the Estate of Fern R. Woodson, deceased. Petitioners filed their joint Federal income tax return for 1971 with the Director, Internal Revenue Service Center, Austin, Tex.
Curtis B. Woodson and Edna Woodson, married in 1973, filed joint income tax returns for 1973 and 1974 with the Director, Internal Revenue Service Center, Austin, Tex. On or .about May 6, 1974, Curtis B. Woodson filed an application for tentative refund (Form 1045) claiming a refund of $33.01 for taxable year 1971 based on the carryback of unused investment credit in that amount from taxable year 1973.
On or about March 3, 1975, Curtis B. Woodson filed an application for tentative refund (Form 1045), claiming a refund of $41,388.96 for taxable year 1971 based on claimed operating loss carryback from 1974 to taxable year 1971. On or about May 22, 1974, and March 13, 1975, petitioners received refunds of their 1971 taxes in the amounts of $33.01 and $41,388.96, respectively, for a total tentative allowance of $41,421.97 for the 1971 taxable year.
In 1974, Curtis B. and Edna Woodson received a net lump-sum distribution from the profit-sharing trust of Gibson Products Co. of Corpus Christi, Inc., in the amount of $25,485.98 (total distribution of $30,052.81 less employees’ contributions of $4,566.83). This distribution represented their entire interest in the trust.
Gibson Products Co. of Corpus Christi, Inc. (hereinafter Gibson Products), a small business corporation, was incorporated in April 1961 and had a fiscal year ending March 31. Curtis B. Woodson was president of the corporation during all years relevant to this case. The corporation was liquidated as of December 27, 1974. As of that date, the shareholders were as follows:
Curtis B. Woodson . 226 shares
Estate of Fern R. Woodson, deceased . 283 shares
Curtis B. Woodson as custodian for David Woodson . 56 shares
David Woodson is petitioners’ son.
The corporation had a profit-sharing trust from 1966 until September 9, 1974, when the trust was terminated. Curtis B. Woodson and Edna Woodson were each members of the profit-sharing trust. The profit-sharing trust was qualified under section 401(a) from 1966 until April 1,1973, the effective date of the revocation of its exempt status by respondent. Petitioners do not contest the revocation of its exempt status. The revocation letter, dated July 30, 1975, from the Office of the District Director of Internal Revenue, Austin, Tex., to Gibson Products stated in part: “In view of the fact that benefits were forfeited on partial termination of the plan and funds were diverted to purposes other than for the exclusive benefit of the participants, our determination letters referred to above are hereby revoked, effective April 1,1973.”
Of the net distribution of $25,485.98 received by petitioners, $2,643.39 was attributable to contributions to the trust made during the period of time following the loss of its exempt status until its termination on September 9,1974.
In 1974, Curtis B. and Edna Woodson received a net lump-sum distribution from the Gibson Products Co. profit-sharing trust of $25,485.98, which represented their entire interest in the trust. The only issue before the Court is whether any part of the distribution was from a qualified trust. The tax stakes are clear. If the distribution is deemed from a qualified trust exempt from tax under sections 401(a) and 501(a), I.R.C. 1954, then section 402(a)(2)1 allows petitioners to characterize the income as long-term capital gain. That part of the distribution which is from a nonqualified trust is controlled by section 402(b)2 which treats it as ordinary income.
Petitioners concede that the part of the distribution which represents contribution to the trust following the loss of its exempt status ($2,643.39) is a distribution from a nonqualified plan and is ordinary income. Petitioners, citing the Second Circuit's decision in Greenwald v. Commissioner, 366 F.2d 538 (2d Cir. 1966), revg. in part 44 T.C. 137 (1965), argue that, although the $2,643.39 should be taxed as ordinary income in 1974, the remaining $22,842.59 of the net distribution should be treated as a distribution from a qualified plan and therefore taxed as long-term capital gain.3
Eespondent argues that, since the plan and its related trusts were nonexempt in the year of distribution, this Court’s decisions in Greenwald v. Commissioner, supra, and Epstein v. Commissioner, 70 T.C. 439 (1978), require the distribution be taxed as ordinary income under section 402(b). In Greenwald v. Commissioner, we found that the profit-sharing plan in issue was not exempt at the time the distribution was made in 1959 and held that the entire distribution was taxable as ordinary income pursuant to section 402(b). On appeal, the Court of Appeals for the Second Circuit agreed that the plan was nonexempt, but reversed in part the decision of this Court and held that the distribution attributable to contributions made to the plan during the time it was qualified under section 401(a) was taxable as capital gain under section 402(a)(2).
The possibility of taxing the trust distribution partly as capital gain and partly as ordinary income was not argued in this Court by the parties in Greenwald. Only on appeal, and then only in supplemental briefs submitted at the behest of the Court of Appeals, was that result considered. In that sense, we face that issue for the first time.4
Who did what, is obviously a relevant question in determining whether a plan has lost its exempt status. It is not a relevant question, in consideration of the issue, whether a distribution must be taxed as all ordinary income or part ordinary income and part capital gain, since the distribution should be taxed the same whether the recipient is the one who caused the disqualification by some misfeasance or is an innocent lower-echelon employee.
Section 402(a) is entitled “Taxability of Beneficiary of Exempt Trust” and provides in paragraph (1) thereof that an amount actually distributed from an exempt trust shall be taxable to the distributee “in the year in which so distributed or made available, under section 72.” Paragraph (2) goes on to provide that any total or lump-sum distribution within 1 year, under circumstances satisfied herein, shall be treated as capital gain. Absent the foregoing provision, the recipient would be compelled to take the entire distribution, resulting from perhaps years’ accumulations, into income in 1 year, thereby distorting his tax liability viewed from the perspective of the years over which the income was in reality earned. This is so because the employer’s contributions were exempt from tax to the beneficiary at the time made, and hence, the beneficiary never earned a basis in his account which he could offset against a subsequent distribution.
Section 402(b), on the other hand, is entitled “Taxability of Beneficiary of Nonexempt Trust” and again provides that the amount distributed “shall be taxable to him in the year in which so distributed or made available, under section 72.” This subsection is the natural corollary to section 402(a), but it is written in the context of the normal situation where an individual is taxed on income made available to him. Thus, the employer’s contributions to a nonexempt trust are taxed currently to the “beneficiary.” The “beneficiary” is therefore building up a basis in his account which is available to him to offset against any lump-sum distribution, thereby eliminating any distortion of taxable income even viewed from the perspective of the years over which the money was paid in.
Subsections (a) and (b) are internally consistent, each dealing with a different set of circumstances. Each is premised on the concept that it is the act of distribution that triggers a tax. Yet, in characterizing the distribution, as ordinary income or capital gain, one must relate the distribution to the set of circumstances which caused its creation. Any other interpretation would be much too narrow and would aid in frustrating Congress’s avowed purpose to make it possible for taxpayers to prepare for their own retirement.5
At issue here is a lump-sum distribution which is the result largely of contributions to an exempt trust but is also attributable in a stipulated amount to contributions to a trust nonexempt at the time of distribution as a result of the retroactive revocation of the exemption. Respondent would have us characterize the entire distribution, without regard to the tax status of the trust at the time of the contributions that formed the basis for the distribution, in terms of the trust’s status at the later date. We do not consider it a happenstance that the trust was nonexempt at the time. We cannot conceive of respondent accepting, even in principle, the argument that the gain on any distribution from an exempt, but formerly nonexempt, trust is entitled to capital gain treatment.
We refuse to take an all-or-nothing approach. We have found no congressional mandate requiring such an approach. Absent such a mandate, we refuse to adopt a rule of law that would cause such inequities. The fact of the matter is that the largest portion of the amount at issue had its formation in contributions to an exempt trust, and it is no distortion to hold that therefore the stipulated portion of the distribution was made with respect to an exempt trust. The loss of an exemption should not convert existing qualified assets in an exempt trust to nonqualified assets in a nonexempt trust. To hold otherwise would create a rule of law that would penalize the innocent employee who had no say in the management of the trust and retroactively change the ground rules that he could fairly have anticipated would govern the taxability of payments to him.
The subsections are in agreement that the act of distribution is the event triggering a tax. Admittedly, Congress did not explicitly take care of the situation where a distribution is from a trust which had occupied both an exempt and nonexempt status at differing times. We believe that the subsections can be “harmonized” by holding that the tax character of the distribution, as distinguished from the timing of the imposition of the tax, is determined by the status of the trust at the time the contribution is made to it by the employer.
The second sentence of section 402(b) implies that Congress intended to prevent contributions, which were made to a nonexempt trust, from acquiring the benefits of an exempt trust at the time of distribution. Therefore, even if the nonexempt trust became a qualified trust in some later taxable year, the amount contributed in the earlier years would be taxable under section 402(b) as section 72 income in the year of distribution, an obviously appropriate result. However, and conversely, amounts contributed to a qualified trust should be treated as distributions from a qualified plan at the time of distribution.
Our conclusion that, once actually contributed, assets should retain their qualified nature is supported by the longstanding treatment of excess contributions to qualified plans. Since 1961, the regulations under section 404 have provided that excess contributions made to a profit-sharing plan, for example, in or for a taxable year for which the trust is exempt, are deductible in a following tax year of the trust under the provisions of section 404(a)(3)(A) — even if the trust is not exempt in those later year(s), or even if the trust had terminated. Sec. 1.404(a)-9(a), (b), and (e), Income Tax Regs. See also sec. 1.404(a)-3(a), - 4(d), -6(b), and -13(a), Income Tax Regs. Royer’s, Inc. v. United States, 265 F.2d 615 (3d Cir. 1959).
This approach is also analogous to that taken by the Commissioner in requalification of profit-sharing plans. Rev. Rul. 73-79, 1973-1 C.B. 194, discussed a profit-sharing plan that had been established prior to loss of its exemption. In the year following disqualification, the employer amended the plan to correct the defect. The Service ruled that the plan regained its exempt status as a result of the amendment. The ruling makes clear that nonqualified assets of the trust could remain in the trust after requalification. However, those assets would presumably be treated as employee contributions.6 Therefore, the accounting thereof must be separate from the qualified assets.
Respondent’s approach, it would appear, is to segregate the qualified from nonqualified assets in the area of requalification. However, respondent would have us bunch together all the assets of a distribution from a plan which subsequently became disqualified. This position may be inconsistent. While we reserve any decision with respect to the treatment of trust assets following a requalification, we hold that the assets in a distribution from a previously qualified plan should be separated. That part of the net distribution attributable to contributions to the trust, made prior to its disqualification, should be treated as a distribution from a qualified trust exempt from tax under section 501(a).
The retroactive revocation of the plan in the instant case was effective on April 1, 1973. Thus, the $22,842.59 attributable to contributions to the trust prior to that date should be treated as a distribution from a qualified trust and be entitled to capital gains treatment under section 402(a)(2).7 The remaining part of the net distribution should be treated as a distribution from a nonexempt trust and taxed according to section 402(b).
Respondent’s position would entitle certain participants in the plan to capital gain treatment while others received ordinary income treatment based solely on the date they terminated employment. Further, the “bunching effect” of respondent’s approach would result in assets being taxed which otherwise would not be subject to tax because of their previous qualified status. As the Second Circuit said in Greenwald v. Commissioner, supra, such a “harsh” and inequitable result is neither required by statute nor expressed in the legislative history. Based upon the foregoing discussion we have, upon reflection, concluded that despite the factual differences between the instant case and Epstein v. Commissioner, supra, our rationale herein requires the determination that the decision in Epstein was erroneous, and hence, we will no longer follow it.
Decision will be entered under Rule 155.
Reviewed by the Court.
SEC. 402. TAXABILITY OF BENEFICIARY OF EMPLOYEES’ TRUST.
(a) Taxability of Beneficiary of Exempt Trust.—
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(2) Capital gains treatment for portion of lump sum distribution. — In the case of an employee trust described in section 401(a), which is exempt from tax under section 501(a), so much of the total taxable amount (as defined in subparagraph (D) of subsection (e)(4)) of a lump sum distribution as is equal to the product of such total taxable amount multiplied by a fraction—
(A) the numerator of which is the number of calendar years of active participation by the employee in such plan before January 1,1974, and
(B) the denominator of which is the number of calendar years of active participation by the employee in such plan,
shall be treated as gain from the sale or exchange of a capital asset held for more than 6 months. For purposes of computing the fraction described in this paragraph and the fraction under subsection (e)(4)(E), the Secretary or his delegate may prescribe regulations under which plan years may be used in lieu of calendar years. For purposes of this paragraph, in the case of an individual who is an employee without regard to section 401(c)(1), determination of whether or not any distribution is a lump sum distribution shall be made without regard to the requirement that an election be made under subsection (e)(4)(B), but no distribution to any taxpayer other than an individual, estate, or trust may be treated as a lump sum distribution under this paragraph.
SEC. 402. TAXABILITY OF BENEFICIARY OF EMPLOYEES’ TRUST.
(b) Taxability of Beneficiary of Nonexempt Trust. — Contributions to an employees’ trust made by an employer during a taxable year of the employer which ends within or with a taxable year of the trust for which the trust is not exempt from tax under section 501(a) shall be included in the gross income of the employee in accordance with section 83 (relating to property transferred in connection with performance of services), except that the value of the employee’s interest in the trust shall be substituted for the fair market value of the property for purposes of applying such section. The amount actually distributed or made available to any distributee by any such trust shall be taxable to him in the year in which so distributed or made available, under section 72 (relating to annuities), except that distributions of income of such trust before the annuity starting date (as defined in section 72(c)(4)) shall be included in the gross income of the employee without regard to section 72(e)(1) (relating to amount not received as annuities). A beneficiary of any such trust shall not be considered the owner of any portion of such trust under subpart E of part I of subchapter J (relating to grantors and others treated as substantial owners).
Pitt v. Commissioner, an unreported case (M.D. Fla. 1975, 35 AFTR 2d 75-1492, 75-1 USTC par. 9472), also involved this same issue. In that case, the District Court, without elaboration, expressly followed the Second Circuit’s rationale in Greenwald v. Commissioner, 366 F.2d 538 (1966).
In Epstein v. Commissioner, 70 T.C. 439, 444 (1978), we stated the question of law but resolved the matter on the facts.
We are put in mind of Judge Learned Hand’s statement in Helvering v. Gregory, “as the articulation of a statute increases, the room for interpretation must contract; but the meaning of a sentence may be more than that of the separate words, as a melody is more than the notes, and no degree of particularity can ever obviate recourse to the setting in which all appear, and which all collectively create.” (69 F.2d 810, 811 (2d Cir. 1934).)
See S. Simmons, “Dangers of Disqualification of Qualified Plans,” 33 N.Y.U. Inst. on Fed. Tax. 507, 540 (1975).
Petitioners were “active” participants in a qualified plan up to Apr. 1, 1973. Therefore, in the instant case, the denominator in the apportionment fraction of 402(a)(2) is the same as the numerator.