Snap-Drape, Inc. v. Comm'r of Internal Revenue

• Citation: 105 T.C. No. 2,105 T.C. 16,19 Employee Benefits Cas. 1592
• Decision Date: 13 July 1995
• Docket Number: No. 2174–93.
• Parties: SNAP-DRAPE, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: United States Tax Court

105 T.C. 16

105 T.C. No. 2

19 Employee Benefits Cas. 1592

SNAP-DRAPE, INC., Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 2174–93.

United States Tax Court.

July 13, 1995.

OPINION

WRIGHT

Respondent determined a deficiency in petitioner's Federal. income tax for taxable year 1990 in the amount of $239,463.

After concessions by the parties, the issues for our consideration are as follows:

(1) Whether dividends paid to an employee stock ownership plan, deductible under section 404(k) ¹ are deductible under section 56(g)(4)(C)(i) in computing the adjusted current earnings of a corporation for purposes of determining alternative minimum tax, and thus, whether section 1.56(g)–1(d)(3)(iii)(E), Income Tax Regs., is valid,. We hold that the section 404(k) dividends are not deductible under section 56(g)(4)(C)(i) and that the regulation is valid.

(2) Whether respondent abused her discretion by providing retroactive application of section 1.56(g)-l(d)(3)(iii)(E), Income Tax Regs. We hold that she did not.

Some of the facts have been stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein. At the time the petition was filed, petitioner's principal place of business was Carrollton, Texas.

Petitioner is a corporation organized and existing under the laws of Texas. Petitioner was formed during the 1970's and prior to February 22, 1990, was owned 100 percent by Raymond R. Belknap (Belknap) and Gerald E. Guebert (Guebert), equally. As of February 22, 1990, there were 1,240,000 shares of common stock issued and outstanding; Belknap and Guebert each-owned 620,000 shares. Petitioner's principal business is the manufacturing and marketing of table skirting for buffet tables, banquet tables, conference tables, and the like. Petitioner is also in the textile business converting fabric into table skirting. Belknap and Guebert invented a clip which is used to attach the table skirting to the tables.

On February 1, 1990, petitioner established the Snap–Drape, Inc. Employee Stock Ownership Plan and Trust (the ESOP). Felton Norris, Darrin Garlish, and John Phillips were designated as the trustees. On January 22, 1991, respondent issued a favorable determination letter to the ESOP for qualification under sections 401(a) and 501.

Prior to February 1990, Belknap and Guebert decided to retire and sell their respective interests in petitioner. On February 22, 1990, the ESOP entered into an agreement with Belknap and Guebert. The agreement provided that the ESOP would purchase 1,000,000 shares of common stock in petitioner (approximately 80 percent of its common stock issued and outstanding) from Belknap and Guebert. To facilitate the transaction the ESOP borrowed $5,000,000 from First City, Texas–Dallas (the Bank), and executed a note payable to the Bank in the face amount of the same. The loan was guaranteed by petitioner. In addition, the note provided for mandatory prepayments of principal based upon a formula related to petitioner's available cash flow. Also on February 22, 1990, the ESOP distributed the proceeds of the loan by issuing a total of four checks, two each to both Belknap and Guebert, totaling $5,000,000 in exchange for 1,000,000 shares of petitioner's stock. Belknap and Guebert each received $2,500,000 in exchange for 500,000 shares of stock in petitioner.

During taxable year 1990, petitioner made contributions to the ESOP in the amount of $240,732 and claimed a deduction for the entire amount under section 404(a). Petitioner also paid to the ESOP a cash dividend with respect to its common stock in the amount of $1,440,000. The ESOP transferred the entire amount of the dividend to the Bank as payment of interest and principal under the note.

On its 1990 Federal income tax return, petitioner claimed a deduction with respect to the cash dividend paid to the ESOP in the amount of $1,440,000 under section 404(k) (section 404(k) deduction or section 404(k) dividend). Attached to petitioner's return, among other items, is Form 4626, Alternative Minimum Tax—Corporations. Petitioner did not include the section 404(k) deduction in the computation of its adjusted current earnings (ACE or ACE adjustment) for purposes of determining its alternative minimum tax (AMT), and as a result, concluded that it was not liable for AMT. Respondent determined that by failing to include the section 404(k) dividends in its ACE adjustment, petitioner did not properly compute its AMT and therefore is liable for AMT in the amount of $210,613.

Petitioner argues that section 3–.56(g)–1(d)(3)(iii)(E), Income Tax Regs., is an improper interpretation of section 56(g)(4)(C)(i), and thus it is invalid. Alternatively, petitioner argues that if we find that the regulation is valid, respondent abused her discretion by providing retroactive application. Respondent argues otherwise. We agree with respondent.

Expert Reports

As a preliminary matter, petitioner offered two expert witness reports for consideration by the Court. The reports conclude that section 404(k) dividends are deductible for purposes of computing earnings and profits and are therefore deductible for purposes of computing the ACE adjustment. The reports also state that had respondent never issued section 1.56(g)-l(d)(3)(iii)(E), Income Tax Regs., the section 404(k) deduction would not be disallowed in computing the ACE adjustment. Each expert further opined that prior to the issuance of the regulation, it was not reasonably foreseeable that respondent would disallow a section 404(k) deduction for purposes of computing the ACE adjustment.

Prior to trial, respondent filed a Motion in Limine objecting to the testimony of the expert witness reports that petitioner offered into evidence. Respondent seeks the exclusion of the expert reports on the following grounds: (1) The reports address only questions of law and not fact; (2) the testimony offered by each witness constitutes only advocacy of the underlying legal question; and (3) the probative value of the reports is substantially outweighed by considerations of undue delay, waste of time, and needless presentation of cumulative evidence. Petitioner argues that even if we find that the reports contain improper conclusions of law as to whether section 1.56(g)–1(d)(3)(iii)(E), Income Tax Regs., is valid, the reports should be accepted for purposes of considering whether respondent abused her discretion. Specifically, petitioner contends that the expert reports are helpful in determining whether it relied on settled law sufficient to preclude retroactive application of the regulation.

We agree with respondent that the reports contain improper conclusions as to issues of law and not fact, as well as statements of mere advocacy, which violate our holding in Laureys v. Commissioner, 92 T.C. 101 (1989). Although Laureys addressed expert testimony with respect to valuation issues, we believe that the principles stated therein are applicable to the instant case. Specifically, the experts in t.he instant case have become advocates for the position argued by petitioner. Id. at. 129. After careful consideration of petitioner's expert reports, we find them to be of no assistance in making our findings of fact and deciding the issues in the instant case. Consequently, respondent's objections are sustained, and the reports will not be received in evidence.

Validity of Regulation

Treasury regulations are not to be rejected unless they are unreasonable and plainly inconsistent with the revenue statutes. Rotenberry v. Commissioner, 847 F.2d 229 (5th Cir.1988); Western Waste Indus. & Subs. v. Commissioner, 104 T.C. 472 (1995). The initial phase of an analysis considering the validity of a Treasury regulation generally requires the determination of whether the regulation in question is a legislative regulation or an interpretive regulation. Treasury regulations issued pursuant to a specific grant of congressional authority are entitled to an especially high degree of deference. Anderson, Clayton & Co. v. United States, 562 F.2d 972, 976 (5th Cir.1977); Phillips Petroleum v. Commissioner, 97 T.C. 30, 34 (1991). The regulation at issue in the instant case was issued pursuant to the Omnibus Budget Reconciliation Act of 1989, Pub. L. 101–239, sec. 7611(g)(3), 103 Stat. 2106, 2373. Section 7611(g)(3) of the Act provides:

Regulations on Earnings and Profits Rules.—Not later than March 15, 1991, the Secretary of the Treasury or his delegate shall prescribe initial regulations providing guidance as to which. items * * * of deduction are disallowed under section 56(g)(4)(C) * * *

We therefore conclude that section 1.56(g)–1(d)(3)(iii)(E), Income Tax Regs., is a legislative regulation, issued pursuant to a specific grant of authority and is entitled to an elevated degree of deference.

Where the Commissioner acts under specific authority, our primary inquiry is whether the interpretation or method is within the delegation of authority. Rowan Cos. v. United States, 452 U.S. 247, 253 (1981). The purpose for the enactment of the AMT regime is as follows:

the minimum tax should serve one overriding objective: to ensure that no taxpayer with substantial economic income can avoid significant tax liability by using exclusions, deductions, and credits. Although these provisions may provide incentives for worthy goals, they become counterproductive when taxpayers are allowed to use them to avoid virtually all tax liability. The ability of * * * highly profitable corporations to pay little or no tax undermines respect for the entire tax system * * *. In addition, * * *, the committee believes that it. is inherently unfair for * * * highly profitable corporations to pay little or no tax due to their ability to utilize various tax preferences.

In particular, both the perception and the reality of fairness have been harmed by instances in which major companies have paid no taxes in years when they...