Opinion
Docket No. 50122.
1956-09-19
TIME OIL CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
A. R. Kehoe, Esq., for the petitioner. John H. Welch, Esq., and Wilford H. Payne, Esq., for the respondent.
A. R. Kehoe, Esq., for the petitioner. John H. Welch, Esq., and Wilford H. Payne, Esq., for the respondent.
Petitioner held not entitled to deduct contributions made to a profit-sharing trust during 1949 and 1950.
The respondent determined deficiencies in the income tax of petitioner as follows:
+--------------------+ ¦Year ¦Deficiency ¦ +------+-------------¦ ¦1949 ¦$63,105.48 ¦ +------+-------------¦ ¦1950 ¦50,046.05 ¦ +--------------------+
The sole issue presented for our decision is the correctness of the respondent's action in determining that petitioner is not entitled to deduct amounts contributed to an employees' profit-sharing trust during 1949 and 1950.
All other issues presented by the pleadings have been disposed of by stipulation.
FINDINGS OF FACT.
Petitioner is a corporation organized under the laws of the State of Washington with its principal place of business at Seattle, Washington.
Petitioner filed its income tax returns for 1949 and 1950 with the collector of internal revenue for the district of Washington at Tacoma, Washington. The returns were prepared on an accrual basis.
On May 14, 1945, petitioner executed an instrument designated as a stock bonus plan and profit-sharing trust, made effective as of November 25, 1944. The plan was submitted to the respondent, and on May 28, 1945, the respondent issued a letter advising petitioner that the plan met the requirements of section 165(a) of the Internal Revenue Code of 1939, that the income of the trust was exempt from Federal income taxation, and that contributions to the trust by the petitioner would be deductible under section 23(p) of the 1939 Code.
The plan provides for an administrative committee of 3 to be appointed by the company to administer the plan and requires the appointment of 3 trustees to hold and distribute the trust assets. Every employee of the company who has earned at least $250 during the company's fiscal year is eligible to participate in the plan. The company is required to make a contribution to the trust each year of an amount equal to 25 percent of its net income for each taxable year with the limitation that such contribution shall not exceed 15 percent of the aggregate compensation of all participating employees.
The amounts allocated to participants who hold more than 10 percent of the voting stock of the company are not to exceed 30 percent of the total contributions for all participants. The trustees are given power to invest the corpus in bonds, preferred stock, or such other securities as they in their sole discretion may select. The trustees are not restricted to investments in securities commonly known as legal investments for trust funds. The trustees are required, however, to invest at least 80 percent of the trust funds in first mortgage bonds of the company and 3 1/2 percent cumulative preferred stock of the company if such securities are available. The trustees are required to keep accurate and detailed records of the administration of the trust and such records are to be open for inspection at all reasonable times by any person designated in writing by the committee or the company. Within 60 days following the close of each company fiscal year (or such other time as may be agreed upon by the trustee and the company), the trustees are required to file with the company and committee a written statement disclosing all investments, receipts, disbursements, and other transactions consummated during the year.
The plan provides that the company's contributions should be either in cumulative preferred stock of the company or cash. The company's contribution is to be held in a suspense account by the trustees for allocation as of the end of the fiscal year of the company.
Each eligible employee is to have credited to his account at the end of each fiscal year the fractional portion of the entire suspense account which his total annual compensation bears to the total compensation of all eligible employees for that year. The plan provides for the vesting of 20 percent of the amount credited to a participating employee's account after 1 year of participation with an additional vesting of 20 percent per year for 5 years, so that after 5 full years of participation the employee is entitled to the full amount credited to his account. In the event of retirement at any time prior to the expiration of the 5-year period, each participating employee is entitled to the entire amount credited to his account as of the date of retirement. In the event of severance of employment, the participating employee's undistributed vested interest is to be paid to him over a period of 5 consecutive years in annual installments of 20 percent each year.
The plan provides for the distribution of the participating employee's interest upon completion of 10 years of participation under the plan. Such distribution is to be made in 10 equal annual installments. The plan provides for distribution in the event of death and provides for accelerated distributions in the event of the sickness or disability of a participant or a member of his immediate family. The trust instrument expressly states that it is the intention of petitioner that the trust and profit-sharing plan should qualify under section 165(a) of the 1939 Code, and provides that in the event the trust and plan are held by the Commissioner or other competent authority not to qualify under section 165(a) of the Code, the contributions made to the trust and held to be nondeductible shall be refunded to the petitioner, insofar as the trust fund is sufficient to permit such repayment. The company is entitled to amend or terminate the foregoing plan at any time but in the event of such termination no part of either the corpus or income of the trust is to revert to the company or is to be diverted to any use other than for the exclusive benefit of the participants, their beneficiaries, or estates.
The net amounts contributed by petitioner to the trust, the form of payment, and the dates of payment from May 14, 1945, through December 31, 1950, are as follows:
+------------------------------------------------------+ ¦Date of payment¦Promissory¦Cash ¦For year ¦ +---------------+----------+-------------+-------------¦ ¦ ¦note ¦ ¦ended ¦ +---------------+----------+-------------+-------------¦ ¦Sept. 17, 1945 ¦ ¦$33,859.84 ¦Nov. 30, 1944¦ +---------------+----------+-------------+-------------¦ ¦ ¦ ¦ ¦Nov. 30, 1945¦ +---------------+----------+-------------+-------------¦ ¦Sept. 5, 1947 ¦ ¦1,485.57 ¦Nov. 30, 1946¦ +---------------+----------+-------------+-------------¦ ¦May 1948 ¦$30,466.86¦ ¦Nov. 30, 1947¦ +---------------+----------+-------------+-------------¦ ¦Feb. 28, 1949 ¦66,342.82 ¦ ¦Dec. 31, 1948¦ +---------------+----------+-------------+-------------¦ ¦Apr. 20, 1949 ¦ ¦1 30,466.86¦ ¦ +---------------+----------+-------------+-------------¦ ¦Feb. 15, 1950 ¦84,568.49 ¦ ¦Dec. 31, 1949¦ +---------------+----------+-------------+-------------¦ ¦Apr. 17, 1950 ¦25,067.96 ¦ ¦Dec. 31, 1949¦ +---------------+----------+-------------+-------------¦ ¦Aug. 8, 1950 ¦ ¦2 66,342.82¦ ¦ +---------------+----------+-------------+-------------¦ ¦Aug. 8, 1950 ¦ ¦3 21,926.45¦ ¦ +------------------------------------------------------+
The amounts equal to 25 percent of the net income of petitioner and 15 percent of the total compensation of all its eligible employees for the fiscal year ended November 30, 1947, and the calendar years 1948 through 1950 were as follows:
+----------------------------------------------+ ¦ ¦ ¦15 per cent of ¦ +--------+--------------+----------------------¦ ¦ ¦25 per cent of¦aggregate compensation¦ +--------+--------------+----------------------¦ ¦Year ¦net income ¦of eligible employees ¦ +--------+--------------+----------------------¦ ¦1947 ¦$30,466.86 ¦$34,475.51 ¦ +--------+--------------+----------------------¦ ¦1948 ¦66,342.82 ¦42.347.54 ¦ +--------+--------------+----------------------¦ ¦1949 ¦109,636.45 ¦51.562.31 ¦ +--------+--------------+----------------------¦ ¦1950 1 ¦1 100,000.00¦60,000.00 ¦ +--------+--------------+----------------------¦ ¦ ¦ ¦ ¦ +----------------------------------------------+ approximately.
and therefore that amounts contributed by petitioner to the trust during 1949 and 1950 were not deductible under section 23(p) of the 1939 Code.
Petitioner initially contributed $62,148.13 to the trust for the fiscal year ended November 30, 1944. Thereafter, it was determined that the 15 percent limitation prescribed by the trust instrument restricted the contribution for the fiscal year 1944 to only $33,859.84. The balance, or, 28,288.29, was refunded to the petitioner. Of the $33,859.84 contributed for 1944, 80 percent, or $27,090, was invested in 3 1/2 percent cumulative preferred stock of the company.
Inasmuch as the petitioner experienced an operating loss during the fiscal year ended November 30, 1945, no contribution was made to the trust for that year.
As indicated above, petitioner made no cash contributions to the profit-sharing trust for the years ended November 30, 1947, and December 31, 1948, but, instead, gave its negotiable promissory note, payable on demand, to the trustees in the amount of $30,466.86 by way of contribution to the trust for 1947, and its note in the amount of $66,342.82 as payment of its contribution for 1948. On April 20, 1949, the company paid the trustees $30,466.86 in cash, discharging the note for that amount issued in 1948.
On February 15, 1950, petitioner issued to the trust its demand note in the amount of $84,568.49 and on April 17, 1950, it gave the trust its note in the amount of $25,067.96, making a total amount of $109,636.45 intended as a contribution to the trust for 1949.
On August 8, 1950, petitioner paid the trustees under the profit-sharing trust the sum of $175,979.27 in cash, of which $66,342.82 was in payment of the note given the trustees during 1949 and the balance, or $109,636.45, was intended as payment of the 2 notes issued during 1950. The trustees of the profit-sharing trust on August 8, 1950, issued a check in the amount of $87,710 (approximately 80 percent of the value of the 2 notes totaling $109,636.45) to the petitioner for the purchase of 8,771 shares of 3 1/2 percent cumulative preferred stock of the company. The petitioner advised the trustees that the aforementioned stock was not available and the $87,710 stock purchase payment was retained by petitioner. The net payment acquired by the trust in the amount of $21,926.45 was endorsed on the note in the amount of $84,568.49 issued by petitioner on February 15, 1950.
On April 21, 1949, $25,560, or approximately 80 percent of petitioner's contribution in the amount of $30,466.86, was invested in 2,556 shares of 3 1/2 percent cumulative preferred stock of the petitioner. Approximately 80 percent of the company's contribution in the amount of $66,342.82, or $53,080, was invested in 5,308 shares of 3 1/2 percent cumulative preferred stock of petitioner.
The original trustees included R. D. Abendroth, president of petitioner, and E. A. Peyser, petitioner's counsel. John Parker Holden, vice president and assistant secretary of petitioner, has served as a trustee since August 1945. The president trustees are Abendroth, Holden, and C. E. Miller, chairman of petitioner's board of directors.
During the course of the administration of the profit-sharing trust, no accounting work was done within the first 2 years, after which time the accounting firm of Ernst & Ernst was engaged to bring the records up to date. Since its employment by the trustees, the firm of Ernst & Ernst has maintained the ledger account showing the interests of the beneficiaries, and has been in complete control of all bookkeeping. The trustees maintained no accounts of their own. The accounting firm of Ernst & Ernst prepared a list of terminated employees and the amount of each such employee's interest in the trust fund. In the letter to the trustees dated November 18, 1950, the firm of Ernst & Ernst informed the trustees of the existence of several hundred accounts of terminated employees totaling over $7,500, part of which had become fully payable on December 31, 1949, and the remainder of which would become payable on December 31, 1950. The terminated employees were not paid the respective amounts thus determined to be due and payable under the terms of the trust instrument.
The trustees were not aware of the amount due the terminated employees until they were so advised by Ernst & Ernst on November 21, 1950, upon completion of an audit of the trust records. Distributions to terminate employees were not begun until June 16, 1955, approximately 60 days prior to the hearing herein. Petitioner on that date commenced distribution of its preferred stock in payment of the interests of the employees in the profit-sharing trust. At no time was cash distributed to the employees of petitioner.
The trust funds were invested exclusively in the stock of petitioner. Apart from petitioner's contributions to the trust, the trust income resulted solely from dividends on petitioner's stock. Dividends earned on the aforementioned stock for 1945, 1946, and 1947 were paid to the trust on April 12, 1948. The dividend earned during 1948 was paid on April 28, 1949.
Petitioner claimed deductions for contributions to the profit-sharing trust in the amounts of $30,466.86 and $66,342.82 in its income tax returns for the years 1947 and 1948, respectively. The intended contribution, in each instance, was represented by a promissory note. Fifteen percent of the total compensation of all eligible employees of petitioner for 1948 is $42,347.54. Respondent proposed the assessment of a deficiency in petitioner's income tax for 1947 and 1948, based in part on the disallowance of the foregoing deductions.
Petitioner executed a waiver of restrictions on assessment and collection of deficiency in tax (Form 870) and paid the deficiency assessed for each of the foregoing years.
Petitioner claimed a deduction in its income tax return for 1949 in the amount of $109,636.45, representing the total face amount of 2 demand notes contributed to the employees' trust for that year. The foregoing amount is equal to 25 percent of petitioner's net income for 1949. Fifteen percent of the total compensation of all eligible employees of petitioner for 1949 is $51,562.31.
Petitioner deducted $88,269.27 on its return for 1950 for payments made to the trust during that year. Fifteen percent of the total compensation of all eligible employees of petitioner for 1950 is approximately $60,000.
On April 2, 1951, respondent notified petitioner by letter of the revocation of the ruling letter issued May 28, 1945, and advised petitioner that its employees' profit-sharing plan did not meet the requirements of section 165(a) of the 1939 Code because the plan had not been operated for the exclusive benefit of its employees.
OPINION.
WITHEY, Judge:
Respondent has determined that the trust and profit-sharing plan of petitioner were neither formed nor operated for the exclusive benefit of its employees within the meaning of section 165(a) of the 1939 Code,