Gen. Signal Corp. v. Comm'r of Internal Revenue

• Decision Date: 30 September 1994
• Docket Number: No. 20064–92.,20064–92.
• Citation: 103 T.C. 216,18 Employee Benefits Cas. 1932,103 T.C. No. 14
• Parties: GENERAL SIGNAL CORPORATION AND SUBSIDIARIES, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Tax Court

103 T.C. 216

103 T.C. No. 14

18 Employee Benefits Cas. 1932

GENERAL SIGNAL CORPORATION AND SUBSIDIARIES, Petitioner,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 20064–92.

United States Tax Court.

Aug. 22, 1994.As Amended Sept. 30, 1994.

Russell E. Greenblatt, Rex A. Guest, and David K. Schmitt, Chicago, IL, for petitioner.

Victoria Wilson Fernandez, Randall P. Andreozzi, New York City, Andrew W. Stumpff, and Michael Roach, Washington, DC, for respondent.

In December 1985, P established a Voluntary Employees Benefit Association (VEBA) Trust which qualified for exemption under sec. 501(c)(9), I.R.C. During the years in issue, P contributed amounts to the VEBA Trust to provide medical and certain other benefits to its employees. Such amounts were primarily used to satisfy benefits claims in the year following the year of contribution. Although the VEBA Trust was authorized to provide postretirement medical and life insurance benefits, in addition to current medical benefits, no reserves were established or funded for the purpose of paying postretirement benefits.

1. Held: Petitioner may not use the safe harbor limitation of sec. 419A(c)(5)(B)(ii), I.R.C., in computing an addition to its account limit for incurred but unpaid medical claims with respect to its 1986 or 1987 taxable years.

2. Held, further, petitioner may not use estimates of incurred but unpaid claims made by insurance administrators as of mid-year 1987 in computing an addition to its account limit for incurred but unpaid medical claims with respect to its 1986 or 1987 taxable years.

3. Held, further, petitioner's incurred but unpaid claims for medical benefits for its 1986 and 1987 taxable years determined based upon stipulated percentages of direct qualified costs. See sec. 419A(c)(1) and (c)(5), I.R.C.

4. Held, further, because P's contributions to the VEBA Trust did not result in the creation of a reserve funded as necessary to provide postretirement medical and life insurance benefits to its employees, P is not entitled to include any amount in its account limit pursuant to sec. 419A(c)(2), I.R.C., with respect to its 1986 and 1987 taxable years.

NIMS, Judge:

Respondent determined deficiencies in Federal income tax with respect to petitioner's 1986 and 1987 taxable years in the amounts of $15,388,891 and $6,787,120, respectively.

Unless otherwise indicated, all section references are to sections of the Internal Revenue Code in effect for the years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.

Following concessions by the parties, the sole issue to be decided in this opinion is whether and to what extent, if any, contributions made by petitioner to a welfare benefit trust during 1986 and 1987 are deductible pursuant to sections 419 and 419A. By Order, an issue relating to petitioner's entitlement to a net operating loss deduction for its taxable year ended December 31, 1987, has been severed and will be decided subsequently.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts and the attached exhibits are incorporated herein by this reference.

Petitioner is a New York corporation having its principal place of business at Stamford, Connecticut. It is an accrual basis taxpayer and files its Federal income tax returns on a calendar year basis.

Petitioner produces instrumentation and controls and related systems and equipment for semiconductor production, telecommunications transmission, test and measurement, industrial automation, management of electrical energy, and transportation. Petitioner is the common parent of an affiliated group of corporations filing consolidated Federal corporation income tax returns. Petitioner had approximately 40 domestic subsidiaries and 49 foreign subsidiaries during its 1986 and 1987 taxable years. Petitioner's common stock is publicly traded on the New York Stock Exchange.

Events Preceding Formation of the Voluntary Employees' Beneficiary Association (VEBA)

Robert M. Dolgin formed Dolgin & Associates in 1984 as a tax and benefits consulting business. Beginning in July 1985, Dolgin & Associates attempted to interest petitioner's tax department in a recommendation aimed at creating a significant tax deferral and, if an expected decrease in corporate tax rates occurred, permanent tax savings.

In December of 1985, Dolgin & Associates presented its “Proposal To General Signal Corporation For VEBA Contributions” (the “1985 Proposal”). The 1985 Proposal recommended that petitioner form a Voluntary Employees' Beneficiary Association (VEBA) for the purpose of funding employee benefits “in a unique manner which will result in a significant tax reduction in the current year.” The 1985 Proposal stated, in part, as follows:

We recommend that General Signal contribute an amount to a VEBA to create a reserve at the Company's year-end for benefit payments to be made next year. An employer can deduct a contribution to a VEBA prior to January 1, 1986 if the contribution is reasonable in amount. The contribution can cover current year claims for benefits as well as a reserve for benefits to be incurred in the succeeding year. We also recommend that the Company adopt a trust year-end preceding the Company's year-end so that the Company might obtain a deferral which will be permanent as long as the VEBA is prefunded in future years. * * *

The Tax Reform Act of 1984 eliminates the reserve for benefits to be incurred in succeeding years for contributions made after December 31, 1985 for taxable years ending after this date. These provisions of the Act do not apply for the year ending December 31, 1985. * * * Most of the tax savings from the contribution can be derived immediately by reducing the Company's estimated tax payment for the quarter in which the plan is implemented.

Income tax deferrals could be particularly beneficial if federal income tax rates are lowered as presently proposed. * * *

The 1985 Proposal included a discussion of the rules applicable to funding VEBAs prior to and after the effective date of sections 419 and 419A, as enacted by the Deficit Reduction Act of 1984, Pub.L. 98–369, 98 Stat. 494, 854. The 1985 Proposal also discussed the unrelated business income tax provisions contained in section 512(a)(3) as applicable to VEBAs under the Deficit Reduction Act of 1984.

The 1985 Proposal suggested that, under general tax principles, the deduction of advanced funding in 1985 would be allowed if the funding did not create a benefit with a useful life of more than one year. The 1985 Proposal advised that in years after 1985, funds equal to the amounts expended by the trust created in connection with the VEBA (see infra p. 6) during its taxable year could be contributed on a deductible basis at petitioner's yearend pursuant to section 419.

The 1985 Proposal recommended adopting a trust taxable year ending November 30 so that the trust could be prefunded in December i.e., the last month of petitioner's taxable year and the first month of the trust's taxable year. This method of funding was believed by Dolgin & Associates to allow prefunding of benefits while avoiding application of the unrelated business income tax at the trust's yearend.

In advance of the presentation of the 1985 Proposal, petitioner had agreed to pay Dolgin & Associates a contingent fee if the proposal was successfully utilized by petitioner. Petitioner paid fees to Dolgin & Associates for 1985, 1986, and 1987 with respect to the VEBA arrangement.

Formation of the VEBA

On December 20, 1985, petitioner's Corporate Pension Board (the “Pension Board”) received a recommendation that it establish a VEBA and that it “contribute $30,000,000 to the VEBA to create a reserve at year-end for the health and short term disability payments to be paid next year.” The recommendation also provided that

The trust should have a year-end preceding the Corporation's year-end so that the Corporation may obtain a deferral which will be permanent as long as the VEBA is prefunded in future years. Therefore, we will use November 30th as the year-end for the trust.

On the same day, pursuant to the above recommendation, the Pension Board resolved to establish the General Signal Corporation Employees Welfare Benefit Trust (the “VEBA Trust”) as the funding medium for certain employee welfare benefit plans. The Pension Board also resolved to contribute $30 million to the VEBA Trust by December 31, 1985.

The VEBA Trust Agreement, in accordance with the resolution of the Pension Board, provided that (1) The Pension Board would be the named Plan Manager, or fiduciary, (2) The Chase Manhattan Bank, N.A., would be appointed as the Trustee and Investment Manager, and (3) a trust account would be established at The Chase Manhattan Bank, N.A. The VEBA Trust Agreement provided that its purpose was to provide participants with welfare benefits of a type specified in section 501(c)(9) and that the trust fund was to be exclusively used to provide benefits to participants, their dependents, and designated beneficiaries, and for reasonable administration expenses.

The VEBA Trust Agreement provided that petitioner would “establish and carry out a funding policy consistent with the purpose of the Plan and the requirements of applicable law” and that, pursuant to such funding policy, petitioner would “contribute to the Trust such amount or amounts, if any, as the Company may determine.” The Trust Agreement directed the trustee

To make payments from the Trust Fund to such persons, in such manner, at such times and in such amounts as the Plan Manager shall direct without inquiring as to whether a payee is entitled to the payment or as to whether a payment is proper, to the extent such payment is made in good faith without actual notice or knowledge of the impropriety of such payment. * * *

The VEBA Trust Agreement provided that all assets of the trust were to be administered as a commingled fund and that...