*211 Decisions will be entered for the petitioners in Docket Nos. 40631 and 40633.
Decision will be entered under Rule 50 with respect to Docket No. 40632.
Held, that total distributions out of retirement fund paid in one taxable year to petitioners on account of their separation from the service of their employer upon sale of employer's business, are to be treated as long-term capital gain pursuant to Internal Revenue Code section 165 (b). Upon the facts of the instant case, the termination of the fund was not a controlling factor.
*294 The respondent determined deficiencies in income taxes of the petitioners for the calendar year 1948 as follows:
| Petitioner | Deficiency |
| Mary Miller | $ 157.10 |
| Joe Cristo | 125.00 |
| Clara Cortese | 41.00 |
The question is whether distributions made by*213 the trustee of an employees' retirement fund are taxable as ordinary income or as capital gain.
FINDINGS OF FACT.
The facts stipulated by the parties are found accordingly.
Petitioners Mary Miller and Joe Cristo are residents of Youngstown, Ohio. Petitioner Clara Cortese is a resident of Phoenix, Arizona. The Federal income tax return of each of the petitioners for the calendar year 1948 was filed on the cash basis with the collector of internal revenue for the eighteenth district of Ohio.
The Strouss-Hirshberg Company, hereinafter sometimes called the Corporation, was organized under the laws of the State of Ohio in July 1906 and operated a general department store business in Youngstown, Ohio, and New Castle, Pennsylvania.
On March 30, 1943, the Corporation, under a Trust Agreement entered into with the Dollar Savings & Trust Company as trustee, established the Strouss-Hirshberg Company Employees' Retirement Fund, hereinafter called the fund. The Trust Agreement was amended on August 25, 1944, October 30, 1944, May 7, 1948, and August 21, 1948.
Throughout its existence the fund, as controlled by the Trust Agreement, as amended from time to time, and as actually operated, constituted*214 a contributory profit sharing plan which satisfied the requirements of Internal Revenue Code section 165 (a). Each of the petitioners was a participant in the fund throughout its existence.
Article IV, section 1, of the Trust Agreement provided that the Corporation agreed "to pay into the trust fund on or before sixty (60) days after the close of each fiscal year hereafter" a certain portion of its net earnings in that fiscal year, as provided in the Trust Agreement, during the term of the agreement. This amount was not to exceed 15 per cent of the aggregate earnings in the year of the participating employers.
The Trust Agreement also contained the following pertinent provisions, as amended:
Article VII.
DISTRIBUTIONS
Section 1. Retirement.
* * * *
*295 (b) Distribution:
(1) If an employee's distributive share shall not exceed Five Hundred Dollars ($ 500), the full amount may be paid to him in cash upon date of retirement at the discretion of the Trustee.
(2) If his distributive share shall exceed Five Hundred Dollars ($ 500), then he may be paid Five Hundred Dollars ($ 500) in cash upon retirement, at the discretion of the Trustee, and the remainder shall be paid in equal *215 monthly payments on the following basis:
| Age at Time of Retirement or Termination of Service | Number of months |
| Prior to 55 Years | 210 Months |
| 55 to 60 Years | 180 Months |
| 60 to 65 Years | 150 Months |
| 65 to 70 Years | 120 Months |
| Over 70 Years | 100 Months |
* * * *
(c) Special Relief. If in the judgment of the Trustee there is some justifiable reason in the circumstances of the case for increasing the amount, and decreasing the number, of such monthly payments either to the employee or to the beneficiary, or to pay the entire amount in one lump sum, the Trustee has full and complete authority to make such change.
* * * *
Section 3. Resignation, Dismissal or Other Termination of Service. In the event of resignation, dismissal or termination of service, other than by retirement after the age of Fifty (50), or after completion of Twenty-five (25) years of service, death or permanent disability, the following provisions shall govern:
(a) If an employee's service with the Companies is terminated before he has been credited with any Companies' Service Contributions, he shall receive only the amount of his own deposits, if any.
(b) If after an employee has been credited*216 with Company Contributions for a period of one year or more, his service with the Companies is terminated, he shall receive full distribution benefits as provided in Section 1 of this Article, unless the service was terminated by discharge for misconduct or by voluntary resignation and was terminated prior to completion of Twenty-five (25) years service with the Companies or prior to the reaching of the age of Fifty (50) years.
(c) If such employee is discharged for misconduct or voluntarily resigns before either having attained the age of Fifty (50) years or having completed Twenty-five (25) years' service, the Trustee shall pay him, (1) his own deposits plus earnings thereon, and (2) the percentage of his Company Contributions plus earnings thereon shown on the following schedule applicable to his years of service with the Companies:
* * * *
Article IX.
MISCELLANEOUS
* * * *
Section 2. Termination. The Companies, by action of their Boards of Directors, shall have the right at any time to give written notice in the manner specified in the preceding section, to the Trustee and to all employees who are then participating in the Trust Fund, that after the calendar year in which notice*217 is given it will discontinue its contributions to the Trust Fund. In the event such right shall be exercised, the Companies may make contributions for the year, or *296 any part thereof, in which the notice is given and the Trustee shall receive payments made by employees up to and including the date specified in said notice. Thereafter neither the employees nor the Companies shall make further deposits or contributions. After such notice is given, the Trustee shall proceed to liquidate the Trust Assets in an orderly manner. After such termination the Trustee shall administer the investment of the Trust Estate and its distribution, (a) to the employees who have retired, or are eligible for retirement, or who have been discharged or voluntarily resigned, in accordance with all of the provisions of this agreement; and (b) to all other employees who were participating in the Trust Fund at the time such deposits and contributions were discontinued, in accordance with the provisions of Section 1 of Article VII, as if such employees had become eligible for retirement at such time.
On March 4, 1948, the Corporation entered into an agreement, entitled "Agreement and Plan of Reorganization," *218 with The May Department Stores Company, a corporation organized and existing under the laws of the State of New York, hereinafter called the May Company. At a special meeting of the stockholders of the Corporation held on March 29, 1948, the stockholders formally approved the Agreement and Plan of Reorganization of March 4, 1948, and further, elected to dissolve the Corporation in compliance with the provisions of that agreement.
In a letter to the shareholders of the Corporation, dated March 4, 1948, accompanying the notice of the shareholders' meeting of March 29, 1948, the president of the Corporation, among other things, stated (regarding the agreement of March 4, 1948):
No change in the management, policies, or personnel of the Strouss-Hirshberg Company stores is contemplated; all of the May Company stores are locally managed in order to remain an integral part of the communities which they serve.
On May 10, 1948, which was the closing day under the agreement, the Corporation transferred all its assets and business to the May Company in exchange solely for 147,983 shares of common stock of the May Company which shares were thereafter distributed to the shareholders of the Corporation*219 in cancellation of their 185,000 outstanding shares in the Corporation. The May Company by agreement assumed all liabilities and obligations of the Corporation outstanding on the closing day. On May 13, 1948, the Corporation was legally dissolved.
The stores which prior to May 10, 1948, were operated by the Corporation were, on and after that date, operated by the May Company under the same name as theretofore. Prior to May 10, 1948, the petitioners were employees of the Corporation; thereafter they were employees of the May Company in the same jobs.
At the March 29, 1948, meeting of the stockholders of the Corporation there was adopted a resolution authorizing the board of directors and the proper officers of the Corporation to take such action with respect to the fund (by way of amendment or termination thereof or *297 otherwise) as might be necessary or appropriate in order that the fund, after the consummation of the March 4, 1948, agreement, might be continued independently, terminated, integrated with the retirement plan of the May Company, or otherwise provided for.
At a meeting of the board of directors of the Corporation held on May 7, 1948, the chairman explained*220 discussions had with officials of the May Company and suggested that action be taken to terminate the fund. Resolutions were adopted which resulted in notices being given by the Corporation on May 10, 1948, to the trustee and to the employee-participants of the fund that, pursuant to the provisions of the Trust Agreement, as amended on May 7, 1948, the Corporation was discontinuing its contributions to the fund, save for a final contribution in respect of the period February 1, 1948, through May 13, 1948. Resolutions were also adopted which authorized and resulted in the officers of the Corporation opening a new bank account with its bank and depositing in said account, called "The Strouss-Hirshberg Company Liquidation Account," the sum of $ 125,000 to cover the estimated amount payable to the fund as the Corporation's final contribution thereto and to cover the estimated dissolution expenses of the Corporation. Thereafter, pursuant to the provisions of the Trust Agreement, as amended, the trustee proceeded to liquidate and distribute the trust assets.
Immediately prior to May 10, 1948, there were 22 persons on the board of directors of the May Company and 9 persons on the board*221 of directors of the Strouss-Hirshberg Company, and no person who was a member of the May Company's board of directors was a member of the board of directors of the Strouss-Hirshberg Company. Some time after May 10, 1948, but prior to January 31, 1949, the May Company increased the membership of its board of directors to 23 and elected to the vacancy thus created one of the persons who had formerly been a member of the board of directors of the Strouss-Hirshberg Company. In that period, no other changes were made in the personnel comprising the board of directors of the May Company.
Immediately prior to May 10, 1948, none of the officers of the Strouss-Hirshberg Company was an officer of the May Company. Some time after May 10, 1948, but prior to January 31, 1949, the president and vice president of the Strouss-Hirshberg Company on May 10, 1948, were appointed as two of the 24 vice presidents of the May Company, and the secretary and treasurer of the Strouss-Hirshberg Company on May 10, 1948, were appointed as two of the 9 assistant secretaries of the May Company.
The following schedule states the amounts received in cash by the petitioners upon the distribution by the trustee on*222 the dates indicated (in each instance the total amount received constitutes the total and *298 only distributions payable from the fund with respect to each petitioner); the amount which each petitioner contributed to the fund; and the amount which represents the sum of the contributions by the Corporation in respect of each petitioner and his or her respective share of the earnings of the fund:
| Mary Miller | Joe Cristo | Clara Cortese | |
| Date received | Nov. 16, 1948 | Nov. 10, 1948 | Nov. 10, 1948 |
| Total cash distribution | $ 2,210.31 | $ 1,630.54 | $ 720.33 |
| Petitioner contributions | 356.00 | 328.00 | 192.00 |
| Corporation contributions -- | |||
| plus earnings of fund | $ 1,854.31 | $ 1,302.54 | $ 528.33 |
We further find as a fact that the distributions to petitioners from the Strouss-Hirshberg Company Employees' Retirement Fund were paid to them respectively within a single taxable year as to each petitioner, and on account of the separation of each petitioner from the service of that company.
OPINION.
The question in this proceeding is whether cash distributions made to petitioners in 1948 in total liquidation of an "exempt" employees' retirement fund are taxable as ordinary income or *223 capital gain to the extent that the distributions included amounts not contributed to the fund by each petitioner.
Petitioners contend that the distributions were paid on account of their separations from the service of their employer and that the amounts are taxable as capital gains pursuant to the provisions of section 165 (b) of the Internal Revenue Code. 1
*224 Respondent contends that the distributions were not paid on account of such separations from the service of their employer and that the amounts are taxable as if they were annuity payments under section 22 (b) (2) (B) of the Internal Revenue Code, 2 as incorporated into section 165 (b).
*225 *299 Petitioners were employees of the Strouss-Hirshberg Company, a department store, and participants in the company's profit sharing plan which was at all times exempt under the provisions of section 165 (a) of the Internal Revenue Code. The Corporation was obliged by the plan to pay into a trust fund, after the close of each fiscal year during the term of the plan, a certain portion of its net earnings for that year.
Pursuant to an agreement and plan of reorganization dated March 4, 1948, between the Corporation and the May Company, on the closing day under the plan, May 10, 1948, the Corporation transferred its assets and business, subject to the assumption of all outstanding liabilities, to the May Company in exchange for shares of the common stock of the May Company, which shares were distributed to the shareholders of the Corporation in cancellation of their outstanding shares. On May 13, 1948, the Corporation was dissolved as required by the agreement and plan.
The department store after May 10, 1948, was operated by the May Company under the same name as theretofore, and petitioners continued performing the same jobs as employees of the May Company as they had performed*226 prior to that date. The intention of the parties to the reorganization was not to disrupt or change the management, policies, or personnel of the department store.
When the stockholders of the Corporation approved the plan of reorganization on March 29, 1948, they adopted a resolution to the effect that action be taken with respect to the employees' retirement fund to the end that the fund, after consummation of the plan of reorganization, might be continued independently, terminated, integrated with the retirement plan of the May Company, or otherwise provided for. After discussions with officials of the May Company, the Corporation's board of directors, in a meeting on May 7, 1948, adopted a resolution to the effect that action be taken to terminate the fund. Thereafter, pursuant to the provisions of the trust agreement (as amended on May 7, 1948, relative to termination), (1) the Corporation gave notice to the trustee and the employees on May 10, 1948, that the Corporation was discontinuing its contributions to the fund after a final contribution for the period ending May 13, 1948; and (2) the trustee proceeded to liquidate and distribute the trust assets. Accordingly, petitioners*227 in November 1948 received cash distributions in full of all their interests in the fund. We are asked to decide whether these cash distributions were made "on account of the employee's separation from *300 the service" so as to qualify for long-term capital gain treatment under section 165 (b) of the Internal Revenue Code.
Petitioners had certain rights under the provisions of the Trust Agreement upon termination of their services with the Strouss-Hirshberg Company. Article VII, section 3, of the Trust Agreement of the Employees' Retirement Fund states that in the event of termination of service, except under circumstances not applicable to the cases at hand, an employee shall receive full distribution benefits as provided in the case of retirement. The retirement provisions, article VII, section 1, permit the employee to be paid up to $ 500 in cash, at the discretion of the trustee, and the remainder of his distributive share in equal monthly payments ranging from 100 to 210 months, depending upon the age of the employee. This section, however, also provides as follows:
(c) Special Relief. If in the judgment of the Trustee there is some justifiable reason in the circumstances*228 of the case for increasing the amount, and decreasing the number, of such monthly payments either to the employee or to the beneficiary, or to pay the entire amount in one lump sum, the Trustee has full and complete authority to make such change. [Italics added.]
Thus, as we interpret the provisions of the Trust Agreement, upon termination of their services petitioners would have become eligible, at the discretion of the trustee, to receive their full distribution benefits as follows: Either (1) a sum not exceeding $ 500 in cash, plus certain monthly payments thereafter, or (2) in one lump sum.
The Trust Agreement provides for precisely the same distribution benefits for petitioners upon termination of the plan as it does for termination of service. Article IX, section 2, as amended on May 7, 1948, provides for termination of the plan and states that, after the company gives notice that its contributions to the trust fund will be discontinued, the trustee shall administer the distribution of the trust estate,
(a) to the employees who have retired, or are eligible for retirement, or who have been discharged or voluntarily resigned, in accordance with all of the provisions*229 of this agreement; and (b) to all other employees who were participating in the Trust Fund at the time such deposits and contributions were discontinued, in accordance with the provisions of Section 1 of Article VII, as if such employees had become eligible for retirement at such time.
If petitioners had been "discharged" prior to the termination of the plan under clause (a) of the above termination provision, their distribution rights ("in accordance with all the provisions of this agreement") would be determined by article VII, section 1, explained above, as in the case of retirement, since such discharge was not for misconduct (see article VII, section 3 (b)). The same rights would result if petitioners had been "participating in the Trust Fund" at the time of termination of the fund under clause (b) of the above termination provision.
*301 We, therefore, conclude that petitioners were eligible to receive the same distribution amounts in 1948 whether such distributions were made under the provisions of the agreement relating to termination of the plan or those relating to termination of service. Despite this conclusion that the payments could have been made for*230 termination of either the plan or the petitioners' service, we must still decide whether or not the distributions were, in fact, made "on account of the employee's separation from the service" as the statute provides.
The phrase "separation from the service" means separation from the service of "his employer," Edward Joseph Glinske, Jr., 17 T. C. 562, 565. On May 10, 1948, petitioners became the employees of the May Company and were not paid for their services thereafter by the Strouss-Hirshberg Company. We have no difficulty in finding that petitioners, on that day, had severed connections with their former employer and that there had been a "separation from the service" of that employer. Furthermore, on that day they became eligible to receive distribution of their shares under the terms of the Trust Agreement because of their termination of service with the Corporation. The actions to dissolve the Corporation and to terminate the fund in no way affected petitioners' rights at that time to receive their distributive shares of the fund.
Officials of the Corporation, anticipating the result of selling the business, conferred with officials of the *231 May Company before deciding upon a proper course of action with respect to the retirement fund. Thereafter it was decided to terminate the fund. Because the Corporation was about to lose all of its employees and was obliged to dissolve immediately, this was a reasonable and logical decision. The trustee's exercise of its judgment and authority to pay the distributive shares to petitioners in one lump sum under these circumstances, as provided in the Trust Agreement, is also reasonable and logical. The situation is therefore one where petitioners' rights to receive distributions of their shares of the fund arose "on account of" their separation from the service of their employer, but the actual equivalent distribution of those shares was made in the course of terminating the fund.
We believe that the requisite causal connection between (1) the total distributions payable, which were paid within one taxable year, and (2) petitioners' termination of service with the Strouss-Hirshberg Company, is established by the facts in this case. We therefore hold that the distribution to each petitioner in 1949 was paid "on account of the employee's separation from the service," and that*232 the amount of such distribution to the extent exceeding the amounts contributed by each petitioner is taxable as a long-term capital gain.
Respondent contends that we are required to reach a contrary conclusion because of our holding in Edward Joseph Glinske, Jr., supra. *302 That case involved a situation where petitioner's employer sold all of its assets and "discontinued business." Petitioner continued in the employ of the purchaser. Three weeks later, the "new management" exercised its right under the trust agreement to discontinue the plan in its entirety. Petitioner received his distributive share in two payments, one in 1946 and one in 1948. We held in that case that the payment received in 1946 was taxable as ordinary income to the petitioner.
The circumstances in the Glinske case differ from the case at hand in several material respects:
(1) The distributions to that petitioner were not paid in "one taxable year of the distributee" as required by the capital gain portion of section 165(b) of the Internal Revenue Code. This fact alone made the distributions to that petitioner taxable as annuities and not as capital gain, regardless*233 of the reason for the distributions.
(2) Under the terms of the pension trust agreement, petitioner Glinske was not entitled to receive the same benefits upon termination of employment as he was upon termination of the plan. Upon termination of employment in 1946, petitioner, who was then 39 years old, would not have been entitled to receive his annuity contracts, or the proceeds thereof, until the anniversary date of the plan nearest his forty-fifth birthday. Upon termination of the plan, however, the trustee was required to "set over to the employees" the annuities, or the proceeds thereof, at that time. It was under the latter provision that distribution was made to that petitioner in 1946.
(3) The fact that petitioner's employment with the seller company was severed was immaterial to the Glinske case, not only because the distributions were not made within one taxable year, but also because the distributions were not made "on account of the employee's separation from the service" of that employer. The facts found by the Court indicated that the purchaser assumed the plan and retained it for a short period of time thereafter. It was while petitioner*234 was in its employ that purchaser terminated the plan which resulted in the distributions. There was no separation from the service of purchaser and it was purchaser, not seller, who terminated the plan. In the instant case, the May Company did not assume the Trust Agreement.
On the basis of the facts in the instant cases, we hold that the distributions to petitioners were paid "on account of" their separation from the service of the Strouss-Hirshberg Company.
Decisions will be entered for the petitioners in Docket Nos. 40631 and 40633.
Decision will be entered under Rule 50 with respect to Docket No. 40632.
Footnotes
1. SEC. 165. EMPLOYEES' TRUSTS.
(b) Taxability of Beneficiary. -- 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 22 (b) (2)↩ as if it were an annuity the consideration for which is the amount contributed by the employee, except that if the total distributions payable with respect to any employee are paid to the distributee within one taxable year of the distributee on account of the employee's separation from the service, the amount of such distribution to the extent exceeding the amounts contributed by the employee, shall be considered a gain from the sale or exchange of a capital asset held for more than 6 months.
2. SEC. 22. GROSS INCOME.
(b) Exclusions from Gross Income. -- The following items shall not be included in gross income and shall be exempt from taxation under this chapter:
* * * *
(2) Annuities, etc. --
* * * *
(B) Employees' Annuities. -- If an annuity contract is purchased by an employer for an employee under a plan with respect to which the employer's contribution is deductible under section 23 (p) (1) (B), or if an annuity contract is purchased for an employee by an employer exempt under section 101 (6), the employee shall include in his income the amounts received under such contract for the year received except that if the employee paid any of the consideration for the annuity, the annuity shall be included in his income as provided in subparagraph (A) of this paragraph, the consideration for such annuity being considered the amount contributed by the employee. * * *↩