Baetens v. Comm'r of Internal Revenue

• Decision Date: 26 January 1984
• Docket Number: Docket No. 21748–80.
• Citation: 82 T.C. 152,5 Employee Benefits Cas. 1804,82 T.C. No. 14
• Parties: THEODORE L. BAETENS AND JOYCE R. BAETENS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

5 Employee Benefits Cas. 1804

82 T.C. 152

82 T.C. No. 14

THEODORE L. BAETENS AND JOYCE R. BAETENS, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 21748–80.

United States Tax Court

Filed January 26, 1984.

In July 1977, petitioner-received a distribution from a profit-sharing trust of the total amount credited to his account. He rolled over the entire amount into an IRA. The distribution was attributable solely to employer contributions in years when the trust was exempt from tax under sec. 501(a), I.R.C. 1954. In 1979, respondent retroactively revoked the trust's exempt status effective March 31, 1974. Held, petitioner is entitled to roll over the distribution into an IRA under sec. 402(a)(5), I.R.C. 1954, because the distribution is attributable to contributions made in years the trust was exempt. Greenwald v. Commissioner, 366 F.2d 538 (2d Cir. 1966), revg. in part44 T.C. 137 (1965), and Woodson v. Commissioner, 73 T.C. 779 (1980), revd. 651 F.2d 1094 (5th Cir. 1981), followed. Held further, sec. 1.402(a)-1(a)(1)(ii), Income Tax Regs., is invalid to the extent it looks solely to the exempt or nonexempt status of the trust at the time of distribution. Herbert M. August, for the petitioners.

Kevin W. Cobb and Peter M. Ritteman, for the respondent.

OPINION

PARKER, Judge:

Respondent determined a deficiency in petitioners' 1977 Federal income tax in the amount of $7,239.16. The sole issue for decision is whether a 1977 distribution from a profit-sharing trust may be rolled over tax free into an individual retirement account pursuant to section 402(a)(5).¹

This case was submitted fully stipulated and the stipulated facts are so found. The stipulation and the exhibits attached thereto are incorporated herein by this reference.

Petitioners Theodore L. and Joyce R. Baetens resided in Grosse Pointe Woods, Michigan, at the time they filed their petition in this case. They timely filed a joint Federal income tax return for 1977 using the cash receipts and disbursements method of accounting. Joyce R. Baetens is a party to this case solely by virtue of having filed a joint return with her husband, Theodore L. Baetens (hereinafter petitioner).

Petitioner was an employee and shareholder of Stan's Trucking, Inc., a small business corporation. Effective April 1, 1966, Stan's Trucking, Inc., established a profit-sharing plan and related trust (hereinafter sometimes referred to collectively as “the plan”). On March 28, 1967, respondent issued a letter determining that the plan qualified under section 401(a) and the related trust was thus exempt from tax under section 501(a). Stan's Trucking, Inc., made contributions to the plan for petitioner's benefit from 1966 through the corporation's tax year ending March 31, 1973 but made no contributions to the plan after that date.

Petitioner's employer terminated the plan effective April 30, 1976. On May 31, 1977, the employer submitted to respondent an Application for Determination Upon Termination, Form 5310, requesting immediate approval of termination of the plan.

On July 1, 1977, petitioner received a distribution of $21,077 from the plan. The funds thus distributed were attributable solely to employer contributions and constituted the entire amount that was credited to petitioner's account. ^1A On July 31, 1977, petitioner rolled over the entire amount of the plan's distribution ($21,077) into an Individual Retirement Account (IRA) at the First Federal Savings of Detroit.

On November 9, 1977, respondent issued a proposed adverse determination letter regarding the qualified status of the plan.²

On March 28, 1979, respondent issued a final adverse determination letter that retroactively disqualified the plan effective for tax years ending March 31, 1974 and thereafter.³

The plan was a qualified plan under section 401(a) at the time all contributions for petitioner were made to the plan. The plan was not a qualified plan on July 1, 1977, when the $21,077 distribution was made to petitioner.

Petitioner did not report as income for 1977 any part of the $21,077 that was distributed to him in that year. Also during 1977, petitioner's IRA earned $759 in interest, and petitioner did not include this interest in income for that year. Respondent determined that the distribution from the profit-sharing plan did not qualify to be rolled over into an IRA under section 402(a)(5), but was includable in petitioner's income for 1977. Respondent also determined that petitioner's IRA was not qualified under section 408 and therefore the interest earned on that account in 1977 was not exempt from tax.

This case involves the tax treatment to be accorded to a distribution from a trust which was part of a formerly qualified employees' plan that was disqualified at the time the distribution was made to the employee. Here the employees' plan was qualified under section 401(a) and the trust was exempt from tax under section 501(a) during the years the employer made the contributions to the trust but the plan had become disqualified and the trust nonexempt by the time the distribution was made to petitioner. There is a split in the circuits as to whether we must look to the status of the employees' trust at the time of contribution or at the time of distribution, with the Second Circuit saying the time of contribution (Greenwald v. Commissioner, 366 F.2d 538 (2d Cir. 1966), affg. in part, revg. in part 44 T.C. 137 (1965)), and the Fifth Circuit saying the time of distribution (Woodson v. Commissioner, 651 F.2d 1094 (5th Cir. 1981), revg. 73 T.C. 779 (1980)). We must decide whether we will adhere to our position in Woodson, in which we followed the opinion of the Second Circuit in Greenwald, or whether we will overrule our Woodson opinion and follow the Fifth Circuit's reversal of our opinion in that case. For the reasons given below, we will continue to follow the position of the Second Circuit in Greenwald and our Court-reviewed opinion in the Woodson case.⁴

Beginning in 1966, the profit-sharing plan established by petitioner's employer was qualified under section 401(a) and its related trust was exempt from tax under section 501(a). The profit-sharing plan's qualified status (and therefore the trust's exemption from tax) was retroactively revoked effective as of March 31, 1974. Petitioner has not challenged the revocation of the plan's qualified status. However, all of the contributions to the plan for petitioner's benefit were made by his employer in years during which the plan was qualified and the trust exempt, i.e., from 1966 through the employer's tax year ending March 31, 1973.

In 1977 petitioner received a distribution of $21,077, representing his entire interest or balance in the trust. The specific legal issue in this case is whether that distribution, which petitioner received in a year when the plan was not qualified and the trust was not exempt under sections 401(a) and 501(a), can be rolled over tax free into an Individual Retirement Account (IRA) pursuant to section 402(a)(5).⁵ That depends upon satisfying a number of statutory requirements, namely, that the balance in a “qualified trust” be paid to the employee in a “qualifying rollover distribution” and that the employee timely transfer the funds into an “eligible retirement plan.” Petitioner has clearly met the requirements of section 402(a)(5) in respect to making a timely transfer of the distribution into an eligible retirement plan. Section 402(a) (5)(A)(ii), (B), and (C). The question is whether or not the distribution was a “qualifying rollover distribution” from a “qualified trust.” Section 402(a)(5)(A)(i), (D)(i), and (D)(iii).

Respondent asserts that the distribution does not qualify to be rolled over tax free into an IRA because it was made at a time when the trust was not exempt from tax under section 501(a) because its related plan was no longer qualified under section 401(a). Respondent has determined that the entire distribution is taxable as ordinary income to petitioner in 1977 under section 402(b).⁶ Petitioner argues that since all contributions to the plan were made when the plan and trust were qualified and exempt under sections 401(a) and 501(a), the distribution attributable to those contributions can be rolled over into an IRA without immediate tax consequences.

Petitioner's argument rests upon four court opinions: Greenwald v. Commissioner, supra; Woodson v. Commissioner, 73 T.C. 779 (1980), revd. 651 F.2d 1094 (5th Cir. 1981); Hesse v. United States, an unreported case (E.D. Mo. 1980, 47 AFTR 2d 81–1024, 81–1 USTC par. 9153); and Pitt v. United States, an unreported case (M.D. Fla. 1975, 35 AFTR 2d 75–1492, 75–1 USTC par. 9472). Of these cases, only Hesse v. United States, supra, specifically involved a rollover into an IRA under section 402(a)(5). The other cases petitioner relies upon involved the eligibility of any portion of the distributions for favorable treatment under section 402(a)(2).

Both parties assume and we agree that sections 402(a)(2) and 402(a)(5) are analogous and contain identical statutory requirements in regard to the status of the trust. Section 402(a) (2) is prefaced by the language: “In the case of an employee trust described in section 401(a), which is exempt from tax under section 501(a) . . . .”⁷ Section 402(a)(5), as it read before the 1978 amendments, contained this same preface; in the current version made retroactively applicable to the year before the Court, the required qualified trust is still defined as “an employees' trust described in section 401(a) which is exempt from tax under section 501(a).” Section 402(a)(5)(D)(iii); see footnote 5. Thus, for purposes of determining whether the distribution to petitioner is immediately taxable or whether it may be rolled over tax free into an IRA, we believe that case law under section 402(a)(2) is applicable. Under both sections 402(a)(2) and 402(a)(5), respondent has taken the position that a...