Wood v. C.I.R.

• Decision Date: 31 January 1992
• Docket Number: No. 91-1717,91-1717
• Citation: 955 F.2d 908
• Parties: -649, 60 USLW 2523, 92-1 USTC P 50,073, 14 Employee Benefits Cas. 2401 Dallas C. WOOD, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 908

955 F.2d 908

69 A.F.T.R.2d 92-649, 60 USLW 2523,

92-1 USTC P 50,073,

14 Employee Benefits Cas. 2401

Dallas C. WOOD, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

No. 91-1717.

United States Court of Appeals, Fourth Circuit.

Argued Oct. 1, 1991.

Decided Jan. 31, 1992.

Kenneth L. Greene, Tax Div., U.S. Dept. of Justice, Washington, D.C., argued (Shirley D. Peterson, Asst. Atty. Gen., Gary R. Allen, Steven W. Parks, Tax Div., U.S. Dept. of Justice, on brief), for respondent-appellant.

Robert Gerald Nath, Odin, Feldman & Pittleman, P.C., Fairfax, Va., argued, for petitioner-appellee.

Before WIDENER and NIEMEYER, Circuit Judges, and MERHIGE, Senior District Judge for the Eastern District of Virginia, sitting by designation.

OPINION

NIEMEYER, Circuit Judge:

Section 4975 of the Internal Revenue Code imposes an excise tax on any "disqualified person" who participates in a "prohibited transaction" with a qualified defined benefit plan created under ERISA. We are presented with the question of whether the assignment of third-party promissory notes by a disqualified person to a plan in discharge of a funding obligation is a prohibited transaction. The Tax Court determined that it was not. The Commissioner of Internal Revenue appeals, viewing the transaction as a "sale or exchange" of property that is prohibited by 26 U.S.C. § 4975(c)(1)(A) (1988). We agree and therefore reverse.

I

During the years in issue, Dallas Wood was a self-employed real estate broker in Fairfax County, Virginia. As permitted by ERISA, Wood adopted the Dallas C. Wood Defined Benefit Plan ("the plan"), effective January 1, 1984. While Wood is the plan's sole participant and serves as plan administrator and trustee, he relied on an actuary to establish, fund, and operate the plan. The plan, which is subject to the ERISA minimum funding requirements of 26 U.S.C. § 412, permits the receipt of non-cash contributions in satisfaction of its funding requirements. As calculated by the actuary, applying an "aggregate level cost method," the cost of funding the plan for the year which ended December 31, 1984 was $114,000.

In order to meet this funding obligation, Wood contributed three promissory notes with face values totalling $114,000. One note in the face amount of $60,000 made payable to Wood was received by him in 1983 when he sold his principal residence. The remaining two notes, in the face amounts of $39,000 and $15,000, were executed by purchasers in real estate transactions in which Wood acted as a broker. He purchased these notes at a discount for $32,000 and $11,250, respectively. The notes were transferred to the plan "without recourse" in 1984 and 1985, and by 1986 they all were paid in full.

On his 1984 Federal income tax return, Wood claimed a deduction of $114,000, representing the combined face amount of the notes he contributed to the plan, although the total fair market value of the notes at the time they were transferred to the plan was only $94,430. Wood did not report any gain as a result of this transfer. The parties have now stipulated, however, that the contribution of the notes was a recognition event for income tax purposes and have agreed that Wood was, and is, required to report as capital gains the difference between the face value of the notes and his basis in the notes.

In 1988 the IRS issued a notice of deficiency, having determined that Wood was liable for excise taxes under 26 U.S.C. § 4975(a) in the amount of $3,000 for 1984, $5,700 for 1985, and $5,700 for 1986, representing five percent of the third-party notes contributed as of each of those years. The IRS also imposed penalties for failure to pay the taxes timely.

Wood challenged the determinations of the IRS by filing a petition with the Tax Court for redetermination of the deficiency. The Tax Court agreed with Wood and held that Wood's contribution of third-party promissory notes to the plan was not a prohibited transaction within the meaning of § 4975(c) and that therefore he was not liable for excise taxes. It reasoned that there is nothing in the Code which precludes the contribution of non-cash property to fund a pension trust. As the Tax Court stated:

In summary, we conclude that nothing in ERISA changes prior law permitting transfers of property to a pension trust. We believe that, if such a change had been intended, Congress would have said so directly rather than by the imposition of a tax under section 4975.

This appeal followed.

II

The Employee Retirement Income Security Act of 1974 (ERISA) was enacted in response to the enormous growth and development of private pension systems, and reflects the congressional concern that certain safeguards be imposed to provide adequate retirement security for plan participants and their beneficiaries. See Pub.L. No. 93-406, 88 Stat. 829, 832-33 (1974). It is a comprehensive remedial scheme designed to protect the pensions and benefits of employees by addressing not only the "malfeasance and maladministration in the plans, or the consequences of lack of adequate vesting, but also ... the broad spectrum of questions such as adequacy of [plan] funding" to pay promised benefits. H.R.Rep. No. 533, 93d Cong., 1st Sess. 910 (1974), reprinted in 1974 U.S.Code Cong. & Admin.News 4639, 4647-4648.

As part of Title II of ERISA, which is administered by the Internal Revenue Service, Congress enacted a prohibited transactions rule to prevent persons with a close relationship to a plan from using that relationship to the detriment of plan beneficiaries. Section 4975 of the Internal Revenue Code imposes two levels of excise tax on "any disqualified person who participates in [a] prohibited transaction." 26 U.S.C. § 4975(a), (b). It expressly prohibits the direct or indirect:

(A) sale or exchange, or leasing of any property between a plan and a disqualified person;

(B) lending of money or other extension of credit between a plan and a disqualified person;

(C) furnishing of goods, services, or facilities between a plan and a disqualified person;

(D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan (E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or

(F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.

26 U.S.C. § 4975(c). There is no dispute in this case that Wood is a disqualified person. See 26 U.S.C. § 4975(e)(2). The primary point of contention is whether Wood's contribution of third-party promissory notes to the plan is a sale or exchange of property, and thus a prohibited transaction within the meaning of § 4975(c).

The Commissioner contends that the taxpayer's contribution of third-party promissory notes in satisfaction of the statutory funding obligation is a sale or exchange within the meaning of § 4975(c). He argues that the term "sale or exchange" should be given the same meaning as it is given throughout the Tax Code, including the common notion that a transfer of property in satisfaction of indebtedness constitutes a "sale or exchange" of property. See, e.g., Rogers v. Commissioner, 103 F.2d 790, 792-93 (9th Cir.), cert. denied, 308 U.S. 580, 60 S.Ct. 98, 84 L.Ed. 486 (1939). Furthermore, the Commissioner argues that transferring property to the plan in satisfaction of an obligation to fund the plan is no different from satisfying the obligation with cash and then causing the plan to use the cash to purchase the property. The Commissioner observes that this interpretation is consistent with the legislative history and the interpretation given to 29 U.S.C. § 1106, a parallel provision in the portion of ERISA administered by the Department of Labor.

Wood acknowledges that § 4975 prohibits sales and exchanges between him and the plan in some circumstances. He readily agrees that if he had funded the plan with cash and then caused the plan to use the cash to purchase the third-party promissory notes from himself, the transaction would be prohibited by § 4975(c). He contends, however, that the prohibition applies only to the operation and management of a defined benefit plan, and does not pertain to contributions of property to fund the plan. He argues that under the structure of the Tax Code, §§ 4971, 4972, 4973 and 4979 address "the contribution phase" of a plan, imposing taxes for insufficient or improper contributions. Sections 4974 and 4975 (involved here) regulate the "operational phase," imposing taxes on improper management or improper transactions during the course of operations. And finally, he notes that §§ 4976 through 4980B, with the exception of § 4979, govern the "distribution phase" of a plan. In further support of his structural argument that § 4975 does not apply to contributions, Wood points out that § 4975 nowhere uses the word "contribution." If Congress intended the section to apply to non-cash contributions, he asserts, it would have said so as it did in sections specifically applicable to the contribution phase.

Alternatively Wood argues that his contribution of third-party promissory notes did not constitute a sale or exchange because § 4975(f)(3) limits the definition of "sale or exchange" to transfers of encumbered property. He observes that the Commissioner's interpretation would prohibit funding any plan with stocks, bonds, or any readily salable assets, regardless of their safety, a result that Wood suggests is irrational. Finally, Wood contends that § 4975 must be interpreted in a manner consistent with 26 U.S.C. § 404, which permits him to claim income tax deductions for non-cash contributions to his employee benefit plan.

It was clearly the intent of Congress to prohibit categorically disqualified persons...