*745 1. Employee participants in pension fund held taxable on amounts received in the taxable year in excess of their contributions to the fund.
2. Held, that the taxable amounts received by the employees from the fund in the taxable year, other than accretions attributable to the contributions of the employees, are earned income for purposes of computing the earned income credit.
*41 The Commissioner determined deficiencies in the income taxes of petitioners for the year 1938 in the following amounts:
| Petitioner | Docket No. | Deficiency |
| William J. R. Ginn | 105265 | $294.15 |
| Paul F. and Helen McB. Schucker | 105297 | 326.98 |
By amended answer, respondent requests that the deficiency in income tax of William J. R. Ginn be increased by the sum of $130.36. The primary issue before the Board is whether or not contributions to a pension fund by persons other than employer or employee are taxable to the employee member upon surrender of his pension for a single cash payment in the taxable year. An alternative issue concerns*746 the computation of the earned income credit on amounts received from the pension fund by petitioners.
FINDINGS OF FACT.
Petitioner in Docket No. 105265 is an individual and resides in Hartsdale, New York. Petitioners in Docket No. 105297 are husband *42 and wife and reside in Larchmont, New York. The husband, Paul F. Schucker, will hereinafter sometimes be referred to as Schucker. Petitioners' income tax returns for the taxable year were filed with the collector of internal revenue for the second district of New York.
Petitioners Ginn and Schucker, during 1938 and for many years prior thereto, were employed by the firm of Speyer & Co. (or predecessor firms of the same name), a banking partnership doing business in New York.
Under date of June 30, 1906, the following agreement was entered into by James Speyer, hereinafter sometimes referred to as Speyer.
* * * party of the first part, and Gordon Macdonald, Henry Ruhlender, Edgar Wachenheim, and Herman Z. Ambrosius as Managers of The Pension Fund of Speyer & Co., and their successors, of the same place, parties of the second part, and such Employees of Speyer & Co. and its successors as may subscribe hereto, *747 parties of the third part, WITNESSETH:
First. - The party of the first part hereby makes a voluntary gift to the party of the second part of Twenty-five Thousand Dollars ($25,000.00), expressly conditioned upon all the terms of the foregoing instrument made a part hereof, and designated THE CONSTITUTION AND GOVERNMENT OF THE PENSION FUND OF SPEYER & Co.
Second. - The parties of the third part each for himself as an employee of Speyer & Co. hereby agrees to pay to the parties of the second part as a gift the sums provided for in the foregoing instrument, made a part here0f, and designated The Constitution and Government of The Pension Fund of Speyer & Co., expressly conditioned upon all the terms of said instrument.
Third. - The parties of the second part for themselves and their successors accept the said donations aforesaid, expressly conditioned, however, upon all the terms of the foregoing instrument, made a part hereof, and designated The Constitution and Government of The Pension Fund of Speyer & Co.
"The Constitution and Government of The Pension Fund of Speyer & Co.", referred to in the agreement of June 30, 1906, and hereinafter known as the fund constitution, provided*748 for the creation of a pension fund:
(A) By the donation of Twenty-five Thousand (25,000) dollars on the part of Mr. James Speyer;
(B) By such other donations as from time to time may be made;
(C) By contributions of the employees of Speyer & Co. as hereinafter provided;
(D) By the income, rents, issues and profits derived from the investment of the foregoing as hereinafter provided.
Throughout the subsequent years the fund constitution was amended from time to time. As amended, it permitted employees to contribute to the fund and participate in its benefits, but did not require any employee to contribute. Those employees who elected to participate in the fund were required to contribute 2 percent of annual salary if such salary were below $3,000 and 3 percent if the salary were above $3,000 per annum, the contribution not to exceed $300 for any one year. The fund constitution provided that upon failure of a contributing employee to make any of the required payments the employee would *43 forfeit to the fund all payments previously made and be entitled to none of the benefits of the fund.
The fund constitution further provided that an employee member reaching*749 the age of 60, having served in the employ of Speyer & Co. for 25 years, might retire from service and be entitled to receive from the fund an annual payment for life equal to 2 percent of the average amount of his yearly salary for the 10 years preceding his retirement multiplied by the number of years of service in the company after the employee became 21 years of age.
The administration of the fund was vested in a board of managers consisting if two partners of Speyer & Co. and two employees elected by employees participating in the fund. The managers were given broad powers of administration over the fund. In the event of the managers reaching an impasse in voting on any question, the deciding vote was to be cast by the senior member of the firm of Speyer & Co. who was not a manager of the fund.
Partners of Speyer & Co. were not entitled to participate in the benefits of the fund, which were confined to qualifying employees of the firm. Neither the firm nor its members was required to make contributions to the fund. During the existence of the fund, Speyer & Co. contributed an aggregate of $63,241.52 to the fund.
The fund constitution provided that the fund might be*750 dissolved by the managers with the consent of Speyer & Co. upon return to Speyer and other nonparticipating contributors, or their legal representatives, the amounts contributed plus 4 percent interest, and to participating employees, the amounts contributed plus 4 percent interest. In the event that upon dissolution there were insufficient funds to repay the contributors, the fund was to be distributed pro rata between the nonparticipating contributors, or their legal representatives, and the employees, according to their respective payments.
Including the original payment of $25,000 made to the fund by James Speyer in 1906, the following amounts were paid into the fund in years prior to 1938 by Speyer and other partners in the firm, as "donations":
| Speyer | $61,099.34 |
| Henry Ruhlender | 11,000.00 |
| Richard Schuster | 5,000.00 |
| Ferdinand Hermann | 4,000.00 |
| H. Winterfelt | $4,000.00 |
| Jesse Hirschman | 202.50 |
| Total | 85,301.84 |
In 1910 Mrs. George Speyer left a bequest of $11,415 to the fund.
In 1921 Mrs. James Speyer bequeathed the sum of $1,000 to the fund.
Several employees of Speyer & Co. died and failed to withdraw their contributions from the fund. Such undrawn*751 amounts aggregated $3,906.75.
It became apparent in 1934 and 1935 that the fund was not actuarially sound. At that time it was also evident that the firm of Speyer & Co. *44 would not continue long in business. The managers of the fund consulted with representatives of insurance companies concerning the matter of investing the assets of the fund in annuity policies for the members of the fund. Legal counsel were consulted as to the steps to be taken in converting the fund's assets into annuities. Counsel advised that if the fund were dissolved the persons who had contributed amounts to the fund might be entitled to recover the amounts contributed. Consequently, upon advice of counsel, the managers of the fund undertook to obtain waivers from participating contributors to the fund, releasing the managers of the fund from any obligation to refund the amounts of the contributions. Releases were obtained from most of the living contributors and also from Speyer & Co. Some releases were not sought, due to the absence of the contributors or their representatives from the country. The managers of the fund also received a waiver from Speyer as executor of his wife's estate. *752 At the time the waivers were requested Speyer was the only contributor who still remained a member of the firm of Speyer & Co.
After prolonged negotiation between the managers of the fund and the Equitable Life Assurance Society, a plan was suggested whereby the assets of the fund might be used to purchase annuities for all the members of the fund under a group contract. The proposed arrangement contemplated coverage of members who were already under pension from the fund, as well as members who had not yet received benefits. The plan provided for payment of annuities to pensioners and those members thereafter attaining the age of 60 in an amount equal to 1.4 percent of the annuitant's last yearly salary multiplied by his years of service. These payments would be in lieu of the payments provided for in the fund constitution. The plan further provided that each annuity contract would have a cash surrender value equivalent to 95 percent of the premium paid for the contract if surrendered prior to June 1, 1943, and 100 percent if surrendered on or after that date.
During the period of negotiations between the managers of the fund and the Equitable Life Assurance Society, the*753 worth of the assets in the fund shrank so that the assets were not of sufficient value to purchase the annuities contemplated by the plan. As of June 1, 1938, the assets of the fund had an aggregate value of $405,930.76. The assets consisted of the following:
| Contributions of employee participants | $58,045.03 |
| Contributions by Speyer & Co | 63,241.52 |
| Interest, dividends and profits accrued on investments | 183,020.62 |
| Contributions prior to 1938 by partners individually, including Speyer | 85,301.84 |
| Bequests (Mrs. James Speyer, Mrs. George Speyer) | 12,415.00 |
| Contributions of employees who died and failed to withdraw contributions | 3,906.75 |
| Total | 405,930.76 |
*45 In order to carry out the plan of purchasing annuities for the members of the fund, an additional sum of $61,534.96 was required. Speyer made individual gifts to members of the fund aggregating that amount. The following letter accompanying Speyer's gift to Ginn is typical of the letters written by Speyer to each member to whom he made a gift in 1938:
As you are aware, the Managers of the Pension Fund of Speyer & Co., with the unanimous consent of the members and pensioners and for their benefit, *754 have arranged for the purchase of group annuity insurance. As the Fund is insufficient to purchase in your case, and some others, the amount of annuity contemplated, it gives me pleasure to enclose herewith my check for
$1,259.26
as a gift to you, to enable the purchase of the full annuity as arranged.
Ginn received from Speyer the amount of $1,259.26 referred to in the above quoted letter and paid that sum into the fund. Other members receiving such gifts from Speyer in 1938 also paid the amounts received into the fund. Schucker did not receive any gift from Speyer in 1938. Speyer paid a gift tax on those gifts made by him in 1938 to members of the fund where the gifts were in excess of $5,000.
The members of the fund held a meeting on May 13, 1938, at which all of the members were present, and agreed that the proposed plan of purchasing annuities for the members be adopted. The managers thereupon purchased annuity contracts for the members of the fund, paying the Equitable Life Assurance Society an aggregate premium of $467,465.72. The premium payment was made with the assets of the fund totaling $405,930.76, together with the gifts from Speyer in 1938 in the*755 sum of $61,534.96.
During the period of his employment by Speyer & Co. Ginn contributed a total of $2,040.89 and Schucker contributed an aggregate of $2,023.10 to the fund.
The managers of the fund allocated the following to the purchase of Ginn's annuity:
| Ginn's contributions | $2,040.89 |
| Speyer & Co. contributions and accrued income | 8,366.05 |
| "Gifts from others" (including Ginn's share of undrawn amounts left in the fund by deceased employees) | 3,295.31 |
| 1938 gift from Speyer | 1,259.26 |
| Total | 14,961.51 |
In 1938 Ginn surrendered his annuity contract, for which the managers had paid a premium of $14,961.51, for the sum of $14,213.43. In his Federal income tax return for 1938 Ginn included in gross income the sum of $7,617.97 representing the difference between the cash surrender value of the annuity and the sum of his contributions and his share of contributions of others to the fund. In computing *46 his earned income credit Ginn did not treat any part of the sum received in surrender of the annuity as earned income.
The managers of the fund allocated the following to the purchase of Schucker's annuity:
| Schucker's contributions | $2,023.10 |
| Speyer & Co. contributions and accrued income | 7,606.56 |
| "Gifts from others" (including Schucker's share of undrawn amounts left in the fund by deceased employees) | 2,779.80 |
| Total | 12,409.46 |
*756 In 1938 Schucker surrendered his annuity contract, for which the managers of the fund had paid a premium of $12,409.46, for the sum of $11,788.99. In their joint Federal income tax return for 1938, Paul F. and Helen McB. Schucker included in gross income the sum of $6,986.09 representing the difference between the cash surrender value of the policy and the sum of Schucker's contributions and his share of the contributions of others to the fund. In computing their earned income credit they did not treat any part of the sum received in surrender of the annuity as earned income.
The Commissioners, in his notices of deficiency sent to the respective petitioners' included in gross income all amounts received by petitioners over and above the amounts contributed to the fund by petitioners, except that in the case of petitioner Ginn the Commissioner did not include any portion of the gift made by Speyer to Ginn in 1938. By amended answer the Commissioner has asserted an additional deficiency in the proceeding of William J. R. Ginn on the ground that Speyer's 1938 donation to Ginn was in the nature of compensation rather than a gift. The Commissioner has allowed earned income credits*757 to petitioners on those amounts they received on surrender of their annunities which, in his notices of deficiency, he added to their gross incomes.
OPINION.
ARUNDELL: Petitioners contend that portion of the amounts they received upon surrender of the annuities, which represents contributions made by persons other than Speyer & Co., is not taxable income since such contributions were gifts or bequests. Respondent argues that the contributions of the partners, including the 1938 contribution by Speyer were not gifts, but compensation for past or future services of the employee participants in the fund. He urges that, in any event, the fund was a pension trust within the meaning of section 165 of the Revenue Act of 1938, 1 and that that *47 section required that the excess of the amounts received over the amounts contributed by petitioners be taxed to petitioners in the year of distribution.
*758 The parties seem agreed that the fund was a pension trust within the meaning of section 165. They differ, however, in their interpretation of the effect of that section here. The literal words of the statute require that an employee participant in a pension trust fund be taxed on the amounts distributed or made available to the employee in the taxable year to the extent that the distribution exceeds the amounts previously contributed by the employee. Respondent maintains that the statute must be construed literally and that such an interpretation requires that petitioners be taxed on all amounts received by them from the fund in excess of their contributions.
The predecessor of section 165 was section 219(f) of the Revenue Act of 1921, which applied only to trusts created by an employer as a part of a stock bonus or profit-sharing plan and provided that the amount actually distributed or made available to any distributee should be taxed to him in the year distributed or made available to the extent it exceeds the amount paid in by him. Congress, in the Revenue Act of 1926, amended section 219(f) to include a trust created by an employer as a part of a pension plan for employees. *759 In the Revenue Act of 1928 the substance of section 219(f) of the previous act were set forth in section 165, except that its provisions were changed to carry out Congress' intent not to tax appreciation in value of stock purchased by the trustee of a stock bonus or profit-sharing trust and distributed to the employee. Thus, the section provided that "the amount contributed to such fund by the employer and all earnings of such fund shall be taxed to the distributee in the year in which distributed or made available to him." In 1932, Congress, observing that the quoted provisions of section 165 of the Revenue Act of 1928 caused a participating employee to be taxed on contributions of the employer and all earnings of the fund even though invested in stock which had greatly depreciated in value, again changed the provisions of section 165. Section 165 of the Revenue Act of 1932 thus provides, as did section 219(f) of the Revenue Act of 1926, for the taxation to the distributee, in the year in which distributed or made available to him, of a stock bonus, profit-sharing, or pension trust of all amounts in *48 excess of the distributee's contributions. So far as is material here, *760 section 165 of the 1938 Act, which is applicable here, is substantially like section 219(f) of the Revenue Act of 1926 and section 165 of the Revenue Act of 1932.
Petitioners argue, however, that the tax should not be imposed according to the plain language of section 165, which would require that the difference between what petitioners received and what they contributed to the fund should be taxed to them. They contend that their aliquot amounts of the contributions by Speyer and other partners, individually, the bequests from the two estates, and the amounts undrawn by deceased employees were gifts to the fund and that this gift characteristic follows through to the receipt of pensions by individual members of the fund. But this does not follow even if it be assumed that the contributions in question were in the nature of gifts to the fund. The contributions were, in any event, made with the clear understanding that they would be distributed under the terms of the constitution of the pension trust.
The benefits of the pension fund were not available without consideration being furnished on the part of the employee. In order to benefit he had to comply with the conditions*761 prescribed by the fund's "Constitution and Government." These conditions were that the employee not only make contributions to the fund based upon salary, but also that he perform services for the firm of Speyer & Co. for no less than a specified number of years. The participating employees, by complying with the conditions of the fund, earned the right to pensions. Thus, whatever the status of the amounts contributed to the fund, the amounts received by the participants were in the nature of compensation to the extent that they exceeded employee's contributions. See Cora B. Beatty, Executrix, 7B.T.A. 726.
There can be no distinction made between the original contribution of $25,000 by Speyer, the contributions of the other partners, individually, the amounts left in the fund by deceased employees, and the amounts left to the fund by bequest. Upon receipt by the fund those amounts formed part of the principal of the fund which, together with accretions, was to be used to pay the pensions of qualifying employees. To the extent that those amounts plus the fund's accretions exceeded the contributions of the employees, petitioners received income in the taxable year when they*762 surrendered the annuities purchased for them. The result urged by petitioners would engender untold administrative difficulty. While it is not difficult in the present case to trace the contributions to their pro rata receipt by the pensioners, it would be practically impossible to do this in the case of a large pension trust, the existence of which might continue *49 after the year in which a tax is asserted against one of its pensioners. It seems clear that in the normal case of a pension trust the participants should be taxed on all amounts received by them in excess of their own contributions.
A different treatment must be accorded the contribution by Speyer in 1938. Respondent, by affirmative allegation in his answer, seeks to tax to petitioner Ginn the $1,259.26 received by him from Speyer. Consequently, the burden is on respondent to show that Ginn is taxable on this additional amount. We are of the opinion that he has not sustained the burden. Speyer made the gift directly to Ginn of the amount necessary to make up the difference between the amount of the fund available for the purchase of Ginn's annuity and the premium required for such purchase. Speyer, *763 in his letter accompanying the check for $1,259.26, informed Ginn that the amount was a gift to him "to enable the purchase of the full annuity * * *." Here the amount was paid to Ginn, who turned it in to the fund. Thus, it was really part of Ginn's own contribution to the fund, which is specifically tax-free under the provisions of section 165. This was a true gift and was both donated and received as a gift. It was not so qualified with conditions and requirements of the fund as to cause it to be treated as compensation. Accordingly, we deny respondent's request to increase the deficiency of petitioner Ginn.
Petitioners contend, in the alternative, that they should be allowed earned income credits on the amounts received on surrender of the annuities which might be held to be in the nature of compensation. Respondent has advanced no argument against this proposition. Moreover, his rulings indicate his complete accord. See I.T. 2370, C.B. VI-2, p. 28; Mim. 3283, C.B. IV-1, p. 14. We note that respondent, in his notices of deficiency, allowed petitioners earned income credits based on the entire amounts by which he increased their net incomes. We need not concern ourselves, *764 therefore, with this treatment. The question we have to determine is whether or not the earned income credit is allowable on the contributions made by the partnership as such and the earnings of the fund, which sums were originally returned by petitioners without claiming the earned income credit thereon. Respondent's own rulings would seem to require that the earned income credit be applied as to these sums, except that the earnings and accretions attributable to petitioners' own contributions should be treated as ordinary income. I.T. 2370, supra. The deficiency should be computed in this manner.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 165. EMPLOYEES' TRUSTS.
(a) EXEMPTION FROM TAX. - A trust forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of some or all of his employees -
(1) if contributions are made to the trust by such employer, or employees, or both, for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accordance with such plan, * * *
* * * shall not be taxable under section 161, but the amount actually distributed or made available to any distributee shall be taxable to him in the year in which so distributed or made available to the extent that it exceeds the amounts paid in by him. Such distributees shall for the purpose of the normal tax be allowed as credits against net income such part of the amount so distributed or made available as represents the items of interest specified in section 25(a). ↩