Basye v. United States, 24170-24175.

• Decision Date: 23 November 1971
• Docket Number: No. 24170-24175.,24170-24175.
• Citation: 450 F.2d 109
• Parties: James A. BASYE and Evelyn E. Basye, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

450 F.2d 109 (1971)

James A. BASYE and Evelyn E. Basye, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.

No. 24170-24175.

United States Court of Appeals, Ninth Circuit.

September 16, 1971.

As Modified on Denial of Rehearing November 23, 1971.

Ernest J. Brown (argued), Lee A. Jackson, Meyer Rothwacks, Lester B. Snyder, Dept. of Justice, Johnnie M. Walters, Asst. Atty. Gen., Washington, D. C., James L. Browning, Jr., U. S. Atty., John M. Younquist, Asst. U. S. Atty., San Francisco, Cal., for defendant-appellant.

John Wells (argued), John F. Banker, of Stark, Simon & Sparrowe, Leonard Marcussen, Gen. Counsel, The Permanente Med. Group., Oakland, Cal., for plaintiffs-appellees.

McKnight Brunn, Donald B. Falconer, of Helzel, Leighton, Brunn & Falconer, Oakland, Cal., for amicus curiae.

Before MERRILL, DUNIWAY and HUFSTEDLER, Circuit Judges.

DUNIWAY, Circuit Judge:

Appellee taxpayers brought these consolidated actions in the District Court for the refund of income taxes paid for the taxable years 1960 through 1963. The District Court found in their favor, 295 F.Supp. 1289, and the government appeals. We affirm.

The case was submitted to the district court on the parties' agreed statement of facts. Taxpayers are physicians who, during each of the tax years involved, were general partners in the Permanente Medical Group (Permanente), a limited partnership organized in 1949 to practice medicine in California. The Articles of Partnership provide that "all earnings by any of the partners from the practice of medicine * * * shall belong to the partnership," and that each partner's "compensation shall be restricted to his distributive portion of the earnings of the partnership." Permanente reported its income by the accrual method in the information returns that it filed for the years involved in these cases; appellees reported their individual income by the cash method.

Before the tax years in question, Permanente contracted with Kaiser Foundation Health Plan, Inc. (Kaiser) to provide medical services to members of Kaiser in its Northern California region. Kaiser operates a pre-paid hospital and medical care program for its dues paying members. The contract between Permanente and Kaiser provides for exclusivity of service — Kaiser agrees not to contract with other physicians for medical services and Permanente agrees not to render such services to other direct service, prepayment plans. Under the contract Kaiser pays Permanente as compensation for the services of its physicians a monthly sum based on the size of Kaiser's membership. In addition the contract contemplates the creation of a retirement plan to which Kaiser would make additional payments. Such a plan was established to take effect July 1, 1959, by a trust agreement between Kaiser, Permanente and Bank of America National Trust and Savings Association, as trustee. This retirement plan is the focal point of the tax controversy.

The primary purpose of the retirement plan is to insure Kaiser a stable and reliable pool of physicians providing medical service to its members. The plan accomplishes this purpose by creating an incentive for physicians to devote their careers to Kaiser members, either by remaining with Permanente or by joining some other group of physicians contracting to serve Kaiser members. The plan operates in the following manner. Kaiser makes payments into the trust each month as partial compensation for the services of Permanente. Any physician with a minimum of two years service in Permanente, whether or not a partner, is eligible to participate in the plan. Each participant is assigned a certain number of "units" based on such factors as his salary, his past service with Permanente and his age at the time of his association with Permanente. The earnings of the trust fund (payments by Kaiser plus interest accrued on corpus) are tentatively credited to each participant's account in proportion to his assigned number of units.

When a participant retires, the total amount allocated to his account is used to purchase a retirement annuity contract. Until then, however, his account remains merely "tentative" because the amount allocated to it may change or his right to receive it at all may be defeated by the occurrence of one or more specified contingencies. First, if a participant in the plan leaves Permanente for reasons other than death or disability before either age 65 or the completion of fifteen years continuous service, and does not thereafter join another medical group serving Kaiser members, he forfeits all rights to the amount allocated to his tentative account. In the case of forfeiture, the amount forfeited is reallocated among the accounts of the remaining participants; none is ever repaid to Kaiser. Second, a participant will forfeit his right to the accrued benefits even after he has become eligible to receive them if he renders professional services for a competitor of Kaiser or if, while able to do so, he refuses to render consulting services to Kaiser or its affiliates. Third, if Permanente is dissolved or reorganized, and if at least 50% of the participants in the retirement plan reassociate with the reorganized Permanente or with another group serving Kaiser members, the trust fund remains intact and unretired participants who do not join the new group forfeit their accrued benefits. The forfeiture will not occur in two circumstances: (a) by mutual agreement Kaiser and Permanente could use the trust funds to support a new retirement plan which would preserve the accruals of all participants; (b) in the case of dissolution or reorganization without the 50% regrouping, the trust fund is to be liquidated and the proceeds distributed pro rata to all participants.

During the four tax years involved Kaiser paid into the trust fund a total amount in excess of $2 million. Net earnings on the corpus amounted to an additional $60 thousand. Permanente did not report these amounts in its partnership income returns, nor did the partners include them in their individual returns. The Commissioner of Internal Revenue determined that the omission of these sums resulted in an understatement of partnership income and in deficiencies in the income tax returns of each of the partners. In computing the deficiencies, the Commissioner calculated the total amount of trust earnings attributable to employees' accounts in the retirement plan, and allocated this sum among the partners according to their distributive shares of partnership income. The theory of this assessment, apparently, is that the payments into the plan by Kaiser in favor of employees of Permanente relieved the partnership of an expense that it might otherwise have undertaken and thus created additional income. With regard to each partner's own tentative account in the retirement plan, the Commissioner treated the "unit" allocations as a modification of the distribution provisions in the partnership agreement and assessed each partner for the annual increment attributable to his own account.¹

The taxpayers do not contend that the payments into the trust by Kaiser should never be taxed, but they do disagree with the Commissioner as to when the tax ought to be imposed and upon whom. Because of the substantial possibility of forfeiture of the right to receive the amounts allocated to the tentative accounts,² taxpayers argue, there is no current realization of income to the individual partners and taxation should be postponed until the right of receipt has become fixed. The government, on the other hand, prefers to tax now and to treat the amount on which the tax is paid as an addition to each partner's basis in his respective partnership share. Should a partner subsequently forfeit the amount in his tentative account, he would get a capital loss for that which was taxed earlier as ordinary income.³

This case thus presents the question whether the payments by Kaiser into the retirement trust were income realized by the taxpayers in the years in which the payments were made. We hold first that, viewing the taxpayers solely in their individual capacities as participants in the retirement plan, there is no current realization of taxable income. The amounts allocated to the tentative accounts are completely contingent and forfeitable; when payments are made to the trust, it is not possible to determine just who among the participants will ever receive the amount in his tentative account or by how much his account will have been augmented by forfeitures of other participants at the time of receipt. Taxpayers have not constructively received the amounts allocated to their tentative accounts, because they have never had a right to immediate receipt of the payments and they have exercised no control over their disposition. The payments were made solely to fund the trust. Had a participant elected not to join the plan, he could not have received his allocable share as current income in lieu of payments into the trust. Finally, because the tentative accounts cannot be transferred or assigned and are completely forfeitable, the payments into the trust confer no immediate economic benefit upon the participants. Cf. Commissioner of Internal Revenue v. LoBue, 1956, 351 U.S. 243, 249, 76 S.Ct. 800, 100 L.Ed. 1142.

For these reasons ...