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Estate of Jack A. Benjamin v. Commissioner of Internal Revenue

decided: June 8, 1972.


Swygert, Chief Judge, Hastings, Senior Circuit Judge, and Kiley, Circuit Judge. Swygert, Chief Judge (dissenting).

Author: Kiley

KILEY, Circuit Judge.

The Tax Court decided, 54 T.C. 953 (1970), that a lump payment to the taxpayer,*fn1 secondary beneficiary under an employees' pension fund annuity contract, is entitled to capital gains treatment. The Commissioner has appealed. We affirm.

Alice U. Benjamin's husband, Jack A. Benjamin, before his death was employed*fn2 by Uhlmann Grain Company. During Benjamin's employment Uhlmann established a pension plan trust, qualified under 26 U.S.C. § 401(a), for the exclusive benefit of its employees or their beneficiaries. The plan from its inception was funded by purchases of individual annuity contracts for each employee, with premiums paid by contributions of both Uhlmann and the employees. The contract for Benjamin was purchased from Mutual Benefit Life Insurance Company of Newark, New Jersey, on or about November 1, 1945.

In October, 1957, Uhlmann terminated the pension trust plan. The annuity contract, representing Benjamin's entire interest of $28,664.76 in the trust, was assigned to him by the Trustee. On November 1, 1960, Mutual, by virtue of a retention agreement, began the monthly payments to Benjamin of the proceeds of the contract. After receiving four payments, and while still employed by Uhlmann, Benjamin died on February 27, 1961. Taxpayer surrendered the contract during 1961 and received the lump sum payment of $30,606.88*fn3 which is the subject of this litigation.

Taxpayer in her 1961 income tax returns excluded $5,000.00 from gross income under 26 U.S.C. § 101(b) (2) (B) (i) and reported the balance of $25,312.19 as a capital gains distribution from the Uhlmann pension trust.*fn4 The Commissioner made a deficiency assessment of $9,838.13 against taxpayer for the year 1961. Her petition for redetermination before us followed.

In the Tax Court taxpayer originally proceeded on the theory that under 26 U.S.C. § 402(a) (2)*fn5 the 1961 lump sum payment was entitled to capital gains treatment. At the Tax Court's invitation taxpayer claimed alternatively that 26 U.S.C. § 403(a) (2)*fn6 applied to the same effect in her favor. The Tax Court held that § 402(a) (2) did not apply but granted relief under § 403(a) (2). The Tax Court's theory was that although the trusteed plan terminated in 1957, the assignment of the trust annuity contracts to Benjamin and others converted the trusteed plan into a qualified non-trusteed plan so as to entitle taxpayer to capital gains treatment of the 1961 lump sum payment from the qualified non-trusteed annuity plan by virtue of § 403(a) (2).

The Commissioner contends that the Tax Court erred in deciding that there was a conversion from the trusteed to a non-trusteed plan effected by the 1957 assignment of the annuity contract to Benjamin. He claims that under the general rule of either § 402(a) (1) or § 403(a) (1) the lump sum payment is taxable as ordinary income*fn7 because after the 1957 termination there was no annuity pension plan in existence. No case has been cited or found which decides the precise question presented by the Commissioner's contention.

Prior to 1942 Congress made no provision in 26 U.S.C. § 165 (1952 ed.), the 1939 predecessor of § 402(a) (2), for capital gains treatment of payments from employee pension trusts. Section 162(d) of the Revenue Act of 1942 amended § 165 and introduced capital gains treatment to a distributee's net lump sum payments from employees' trusts on account of the employee's "separation from the service." In the 1954 Code, § 165(b) was rewritten as § 402(a) (2) covering trusteed employee pension plans.*fn8 In 1954 § 403(a) (2) was also adopted, extending capital gains treatment to non-trusteed employee pension plans. The congressional purpose was to correct inequities resulting from capital gains treatment accorded to lump sum distributions from trusteed plans because of separation from service while not granting similar treatment to lump sum distributions from non-trusteed or insurance plans.*fn9

The general rule is that amounts received by an employee under an annuity are taxable as ordinary income. § 403(a) (1). An exception to the general rule is provided in § 403(a) (2) which allows capital gains treatment of lump sum payments under a plan which meets the requirements of § 404(a) (2).*fn10 And the taxpayer had the burden of proving that the 1961 lump sum payment comes within the exception. The elements to be proven are (a) that after the 1957 termination of the trusteed pension plan a qualified annuity plan under § 403(a) (2) existed; (b) that the plan was a written program communicated to the employees as required by Treas. Reg. § 1.401-1(a) (2) (1961); and (c) that the annuity plan was established and maintained by Uhlmann as required under Treas. Reg. § 1.401-1(b) (1) (i).

The relevant requirements of § 404(a) (2) are that the plan meet the requirements of § 401(a)(3), (4), (5), and (6). The latter requirements deal in (3) with the minimum employee coverage and minimum span of employment of the annuity plan needed for qualification, in (4) with the need of non-discrimination in favor of officers, etc., in (5) with what classifications are not discriminatory, and in (6) with what in one respect satisfies the time span requirement of § 401(a) (3).*fn11

The exception to the general rule in § 403(a) (2) (A) provides that: If

(i) an annuity contract is purchased by an employer for an employee under a plan described in paragraph (1);

(ii) such plan requires that refunds of contributions with respect to annuity contracts purchased under such plan be used to reduce subsequent ...

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