Parker-Hannifin v. C.I.R.
| Decision Date | 23 March 1998 |
| Docket Number | No. 96-2580,PARKER-HANNIFIN,96-2580 |
| Citation | 139 F.3d 1090 |
| Parties | -1115, 98-1 USTC P 50,278, 21 Employee Benefits Cas. 2973, Pens. Plan Guide (CCH) P 23941Z CORPORATION, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. |
| Court | U.S. Court of Appeals — Sixth Circuit |
Stephen F. Gladstone (briefed), William R. Stewart (argued and briefed), Thompson, Hine & Flory, Cleveland, OH, for Petitioner-Appellant.
Gary R. Allen, Acting Chief, Kenneth L. Greene (briefed), Annette Wietecha (argued and briefed), U.S. Department of Justice, Appellate Section Tax Division, Washington, DC, for Respondent-Appellee.
Before: NELSON, SUHRHEINRICH, and GILMAN, Circuit Judges.
Parker-Hannifin Corporation (Parker) appeals from the judgment of the United States Tax Court disallowing a substantial portion of the income tax deduction it claimed for its $42 million contribution to a welfare benefit fund on June 30, 1987. We AFFIRM IN PART AND REVERSE IN PART.
The facts are set forth in greater detail in the Tax Court's opinion at T.C. Memo.1996-337, 1996 WL 412009. Parker is an accrual basis taxpayer which files its Federal income tax returns on a June 30 fiscal year. Parker and its subsidiaries are engaged in, among other things, the design, manufacture, and marketing of components and systems for builders and users of durable goods, including products controlling motion, flow, and pressure. As of June 30, 1987, Parker had 28,708 employees, of whom approximately 1,854 (6.46%) were represented by unions.
On June 30, 1987, Parker established the Parker-Hannifin Employees Welfare Benefit Trust (hereinafter the "VEBA Trust") with Ameritrust Company National Association (Ameritrust) as trustee. The VEBA Trust uses the cash method of accounting and has a fiscal year ending June 30. The parties have stipulated that the VEBA Trust qualifies as a welfare benefit fund under 26 U.S.C. § 419(e). 1
Parker designed the VEBA Trust to serve as the funding medium for certain employee welfare benefit plans. The Trust Agreement Creating the Parker-Hannifin Corporation Voluntary Employees' Beneficiary Association (hereinafter the "Trust Agreement") stated that the purpose of the VEBA Trust was to provide "health care, disability, life, and other welfare benefits under the Plans to Members, Dependents, and Beneficiaries, other than post-retirement health care and life benefits for 'key employees,' as that term is defined in Section 416(i) of the Code." According to the Trust Agreement, Parker intended:
to make contributions, on a sound actuarial basis, to the Trustee, on or before the last day of the Corporation's fiscal year, in such amounts as determined to be necessary to provide benefits required under the Plans. The Corporation's determination of such contributions shall be final and conclusive upon all persons....
Contributions to the VEBA Trust, once made, were irrevocable. The Trust Agreement also provided that "[n]otwithstanding any provision of this Agreement to the contrary, in no event shall the Corporation be required to continue to fund benefits under any Plan through the Trust."
On June 30, 1987, Parker contributed $42 million (hereinafter the "1987 contribution") to the VEBA Trust. Effective July 1, 1987, the maximum Federal income tax rate for corporations decreased from 46% to 34%. Parker's 1987 contribution to the VEBA Trust consisted of the following amounts:
Incurred but unpaid medical,
dental, & short-term
disability benefits $9,022,227
Administration fees 479,089
Long-term disability benefits 2,500,000
Union medical benefits 3,210,991 2
Post-retirement benefits
a) Retirees 10,779,650
b) Active employees 16,133,508
-----------------
Total $42,125,465 3
The VEBA Trust funded the Parker-Hannifin Group Insurance Plan and the Long-Term Disability Plan for Salaried Employees of Parker-Hannifin Corporation. Director of taxation, Joseph B. Dorn, was primarily responsible for the implementation and funding of the VEBA Trust. 4
Parker reflected $33.6 million of the 1987 contribution on its balance sheet as a "prepaid expense" under the category of current assets and the remaining $8.4 million as an "other asset." With respect to the provision of health care and life insurance benefits, Parker's 1987 annual report stated:
In addition to providing pension benefits, the Company provides certain health care and life insurance benefits for retired employees. Substantially all of the Company's employees may become eligible for those benefits if they become eligible for retirement while working for the Company. The cost of retiree health care and life insurance benefits is recognized as expense as claims are paid....
Parker never notified any of the labor unions which represented its employees of the existence of the VEBA Trust, Parker's contribution to the VEBA Trust, or the existence of any reserves of the VEBA Trust. 5 Nor did Parker notify any of its employees or retirees except for those employees who were involved in the implementation of the VEBA Trust. Parker never disclosed the existence of the VEBA Trust or any reserves of the VEBA Trust on any of the summary plan descriptions which Parker provided to its employees to notify them of its pension and retirement plans.
In addition, Parker made no specific disclosure to its shareholders or the public that it had prefunded the VEBA Trust. For example, in its annual reports for 1987, 1988, and 1989, Parker disclosed the prefunding of certain future employee benefits under the heading "Other." The explanation of "Other," as provided in Parker's 1987 Annual Report, was as follows:
Other increases in assets included an increase in "Prepaid expenses" and "Investment in joint ventures and other assets" as a result of prefunding certain future employee benefits. "Excess cost of investments" increased primarily as a result of the acquisition of United Aircraft Products, Inc.
In a July 2, 1987, letter to the vice president of Ameritrust, W.C. Young, Parker's treasurer, stated:
Disbursements from this Trust will take the form of wire transfers to the Provident Insurance Company on Wednesday of each week and will run between $500,000 and $1,000,000 per transfer. Based on such a schedule it is anticipated that the $42,000,000 deposited in the Trust will be paid out within 12 to 18 months. ...
Similarly, in its "Tax Matters" document for June 1987, Parker stated: "It is estimated that the initial contribution to the VEBA and the earnings thereon will be depleted in approximately 14-18 months, primarily through the payment of health care benefits for active employees."
Beginning in September 1987, Parker deposited into the VEBA Trust amounts it had withheld from its employees for their share of the cost of providing the covered benefits. The VEBA Trust used its assets, which consisted solely of the 1987 contribution, employee contributions, and interest income, to pay the current cost of providing benefits to Parker's employees and retirees as the benefits came due during fiscal 1988 and the first 2 months of fiscal 1989. Beginning in August 1988, the VEBA Trust used its assets, consisting solely of amounts that were currently contributed and currently deducted by Parker along with employee contributions, to pay the current cost of providing benefits to Parker's employees and retirees as those benefits became due.
In August 1988, Parker filed a Form 1024 (i.e., an application for exemption from federal income tax) for the VEBA. Included with the application was unaudited financial statement information for Parker's 1988 fiscal year. This information indicated that $42,450,649.30 of benefits had been paid from the VEBA Trust as of June 30, 1988. On November 29, 1988, Parker received a determination letter from the Internal Revenue Service, which stated that the application for recognition of exemption under 26 U.S.C. § 501(c)(9) had been approved. The determination letter expressed no opinion as to whether Parker's contribution to the VEBA Trust was deductible.
The following table reflects the deposits, earnings, withdrawals, and ending balances of the VEBA Trust for fiscal years 1987, 1988, 1989, and 1990:
Fiscal Years
1987 1988 1989 1990
Employer
contributions $42,000,000.00 "0" $40,737,374.59 $50,783,404.03
Employee
contributions "0" $1,555,626.86 1,841,554.51 2,505,995.35
Interest
earned 773.98 1,749,030.80 78,641.10 "0"
Benefits
paid "0" 39,153,640.83 48,808,587.03 53,289,359.38
Ending
balance 42,000,773.98 6,151,016.83 "0" "0"
C.
On its Form 1120 (U.S. Corporation Income Tax Return) for 1987, Parker deducted its entire $42 million contribution to the VEBA Trust. The Commissioner of Internal Revenue (Commissioner) allowed Parker partial deductions in the amount of $9,022,227 for incurred but unpaid medical, dental, and short-term disability benefits and $353,624 for administrative expenses. The Commissioner subsequently conceded a deduction for additional administrative expenses in the amount of $125,465. Parker then petitioned the United States Tax Court, which sustained the Commissioner's disallowance of the remainder of the deduction Parker had claimed for its 1987 contribution ($32,498,684). Parker now appeals from the judgment of the Tax Court. See 26 U.S.C. § 7482(a)(1).
Enacted as part of the Deficit Reduction Act of 1984 (DEFRA), Pub.L. 98-369, 98 Stat. 854-860, 26 U.S.C. §§ 419 and 419A limit deductions for contributions made by a taxpayer to an employee welfare benefit fund. 6 Under prior law, taxpayers generally...
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