70 T.C. 1001 (1978), 10703-75, Pulver Roofing Co., Inc. v. C.I.R.

Docket Nº:Docket 10703-75, 903-77.
Citation:70 T.C. 1001
Opinion Judge:TANNENWALD, Judge:
Attorney:Donald J. Aquilio, Henry H. Melchor, and George C. Shattuck, for the petitioner. Louis J. Zeller, Jr., for the respondent.
Judge Panel:CHABOT, J., concurring: SIMPSON, J., agrees with this concurring opinion. DRENNEN, J., dissenting: FAY, STERRETT, GOFFE, HALL, WILES, and WILBUR, JJ., agree with this dissenting opinion.WILBUR, J., dissenting:
Case Date:September 19, 1978
Court:United States Tax Court

Page 1001

70 T.C. 1001 (1978)




Docket Nos. 10703-75, 903-77.

United States Tax Court

September 19, 1978

In 1961, petitioner obtained a ruling from respondent that its profit-sharing plan, which did not cover its union employees, was a qualified plan under sec. 401(a), I.R.C.1954. Ostensibly unforeseen business conditions caused a decline in the number of nonunion employees covered by the plan who were not officers, shareholders, supervisors, or highly compensated. In his notices of deficiency, respondent retroactively determined that the plan was discriminatory and therefore not qualified during the taxable years involved. Held, during those years, petitioner's plan did not satisfy the coverage requirements of sec. 401(a)(3)(B), I.R.C.1954. Held, further, respondent's retroactive determination was not an abuse of discretion and, therefore, petitioner's contributions under the plan are not deductible.

Page 1002

Donald J. Aquilio, Henry H. Melchor, and George C. Shattuck, for the petitioner.

Louis J. Zeller, Jr., for the respondent.


Respondent determined the following deficiencies in petitioner's Federal income tax:

Docket No. TYE- Deficiency
10703-75 Oct. 31, 1970 $6,517.00
Oct. 31, 1971 7,547.00
903-77 Oct. 31, 1972 2,108.74
Sept. 30, 1973 2,067.29
The sole issue remaining for decision is whether petitioner is barred from deducting, under section 404(a)(3),[1] payments made to a profit-sharing trust on the ground that the plan discriminates in favor of employees in the prohibited group.[2] FINDINGS OF FACT Most of the facts have been stipulated and are found accordingly. The stipulation of facts and the exhibits attached thereto are incorporated herein by reference. Petitioner is a New York corporation which had its principal place of business at Utica, N.Y., at the time of the filing of the petitions herein. It filed its Federal income tax returns for the taxable years in question with the North Atlantic Service Center, Andover, Mass. At all times pertinent, petitioner was in the commercial, industrial, and residential roofing and siding business. Page 1003 During each of the taxable years involved, petitioner's president and sole stockholder was Owen J. Owens. Margaret Owens, his wife, was petitioner's secretary, and Richard Owens, their son, was its treasurer during each of these years. William Owens, another son, became petitioner's vice president during the fiscal year ending October 31, 1971, and continued to serve in that capacity through September 30, 1973. Petitioner adopted a profit-sharing plan effective November 1, 1958, and simultaneously created a trust to receive the contributions to be made pursuant to the plan. On January 27, 1961, petitioner adopted the first amendment to its profit-sharing plan. The plan, as amended, provided for: (1) Coverage for all employees except- (a) Participants in a labor union pension, profit-sharing, or welfare plan, established through collective bargaining, to which petitioner makes contributions, and (b) Employees who customarily work 20 or fewer hours per week or 5 or fewer months per calendar year; (2) Contributions to the trust of a percentage of " net income" of petitioner as defined in the plan, up to, but not exceeding, 15 percent of the aggregate compensation of all participants in the plan; (3) Full vesting upon retirement, disability, or death; (4) Vesting where employment is terminated for other reasons, according to the following schedule:
Vested interest
Years as member of plan (percent)
Less than 2 0
At least 2 and less than 3 15
At least 3 and less than 4 30
At least 4 and less than 5 45
At least 5 and less than 6 60
At least 6 and less than 7 80
7 or more 100
That portion of a participant's account not vested as of the time of termination is forfeited, deemed an additional contribution by petitioner, and allocated to the remaining participants in proportion to their compensation for the year of forfeiture. On November 3, 1959, petitioner requested the District Director to determine whether the profit-sharing plan satisfied Page 1004 the requirements of section 401(a). The tax information schedule attached to the request showed employee coverage for the fiscal year ending October 31, 1959, as follows:
Employees ineligible due to union membership 26
Employees ineligible due to minimum compensation3 41
Total ineligible employees 67
Eligible and covered 9
Total employees 76
Relevant data contained in the information schedule concerning the eligible and covered employees was as follows:
of stock Supervisory
Name Officer ownership duties Compensation
Owen Owens Yes 50 Yes $19,700.00
Margaret Owens No 0 Yes 3,380.00
Elizabeth Owens Yes 50 Yes 3,120.00
John Burnett No 0 No 4,698.55
Morris Park No 0 Yes 3,300.00
David Thomas No 0 No 4,845.60
Francis Alsante No 0 No 1,407.21
Adam Kozinski No 0 No 1,964.56
Robert Terry No 0 No 1,719.35
Respondent, on February 28, 1961, issued a letter stating that the trust was a qualified trust under section 401(a) and that it was exempt from income tax under section 501(a). This letter contained the following caveat: Attention, however, is invited to section 1.401-1(b)(3) of the 1954 Regulations which states in part: " The law is concerned not only with the form of a plan but also with its effects in operation." At the time the plan was adopted and during the early 1960's, the residential roofing business accounted for approximately one-half of petitioner's business. Subsequently, residential roofing accounted for a declining share of petitioner's operation, to the point that, during the taxable years involved herein, it represented less than 10 percent of the business. This decline Page 1005 was due, in large part, to the tendency of residential roofers theretofore employed by petitioner to go into business for themselves. Petitioner's employees who worked in the nonresidential portion of the business generally were not eligible to participate in the profit-sharing plan because of their participation in labor union pension plans. Residential roofers did not participate in such plans and were thus eligible to become members of petitioner's plan. The decline in petitioner's residential roofing business was accompanied by a decline in the number of roofers eligible to become members of the plan. The participants in petitioner's profit-sharing plan during the taxable years at issue and their compensation [4] were as follows: Eleanor Miller and Isabelle Hoffman were employed in clerical positions. Philip Schremmer and Nandor Sarus were roofers. Employees who participated in labor union pension plans were compensated as follows:
Number of employees
Oct. 31, Oct. 31, Oct. 31, Sept.30,
Compensation 1970 1971 1972 1973
Less than $1,000 19 17 14 16
$1,000 to $2,000 5 8 6 -
$2,000 to $5,000 3 6 3 6
$5,000 to $8,000 7 4 8 5
$8,000 to $10,000 4 6 5 2
$10,000 to $15,000 2 7 6 8
More than $15,000 1 1 1
Total[1] 40 49 43 38
Page 1006 Respondent determined in the notices of deficiency that the profit-sharing plan discriminated in favor of shareholders, officers, and highly compensated employees in violation of section 401(a)(3) and (4). OPINION Petitioner seeks to deduct amounts contributed to a profit-sharing trust. Such deductions are allowed under section 404(a)(3) if the trust is exempt under section 501(a), which requires that the trust be a " qualified trust" as defined in section 401(a).[5] Page 1007 Respondent contends that the profit-sharing plan failed to meet the coverage requirements of section 401(a)(3) because it discriminated in favor of the prohibited group, i.e., employees who are officers, shareholders, supervisors, or highly compensated. He also contends that the contributions and benefits under the profit-sharing plan discriminated in favor of the prohibited group within the meaning of section 401(a)(4). Petitioner asserts that the change in plan coverage, subsequent to respondent's determination in 1961 that the plan was qualified, was produced by " unforeseen and uncontrollable changes in business activities" and that the revocation of the prior ruling was " an arbitrary and abusive exercise" of respondent's authority. Alternatively, it argues that the plan coverage in 1972 was virtually identical to the coverage at the time the plan was approved and, at least for that year, respondent's determination cannot be sustained. Finally, it disputes respondent's contention for nonqualification by virtue of the application of section 401(a)(4). We address ourselves in the first instance to the question whether the petitioner's profit-sharing plan satisfies the coverage requirements of section 401(a)(3), an issue which is separate from that relating to the functioning of the plan in respect of contributions and benefits under section 401(a)(4). Babst Services, Inc. v. Commissioner, 67 T.C. 131, 136 (1976). It is apparent that the safe-harbor percentage test of section 401(a)(3)(A) has not been met. Accordingly, the issue before us as to coverage depends upon the applicability of section 401(a)(3)(B). Resolution of that...

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