Rich, Circuit Judge, Cowen, Senior Circuit Judge, and Kashiwa, Circuit Judge.
This case, on appeal from the United States Claims Court,*fn1 raises an issue of first impression for this court. We must decide whether the cost of an educational benefit plan for the children of employees is presently deductible by the employer under section 162 or deductible later under section 404 of the Internal Revenue Code. We hold that section 162 applies.
Appellant, Greensboro Pathology Associates, P.A., is a North Carolina professional corporation formed on July 1, 1970. It provides medical services in the field of pathology to the Moses H. Cone Memorial Hospital at Greensboro, North Carolina. Appellant is a cash basis taxpayer that operates for tax purposes on a fiscal year ending June 30. It is the successor to a four-physician partnership that was previously engaged in the same business. The four partners became appellant's original shareholders, officers and directors.
In May, 1973, one of the shareholders, Dr. McLendon, left his position with the appellant and accepted an appointment as a Professor of Pathology at the University of North Carolina. Subsequently, in late 1973, appellant's shareholders consulted with the corporation's counsel and business consultant about instituting a company-wide educational benefit plan. The shareholders were interested in instituting such a plan as a means of attracting and retaining employees of high quality. It was believed such a plan would help make appellant competitive with institutions of higher learning that provided such educational benefits for their employees. The shareholders were advised that in the late 1960's the Internal Revenue Service had issued private letter rulings to several taxpayer-employers who had adopted plans similar to those being considered by appellant. The rulings had indicated that such plans would be considered welfare benefit plans. As a welfare benefit plan, contributions would be presently deductible under section 162 of the Internal Revenue Code. Appellant, however, never applied for its own private letter ruling.
On June 24, 1974, appellant adopted the educational benefit plan at issue in this suit. At that time appellant's work force was composed of four shareholders, Drs. H. Z. Lund, C. M. Hassell, D. D. Leonard and R. M. Gay, and two other individuals, Dr. H. W. Baird and Mrs. Lara Wible. The educational plan adopted was designed by Mastrom, Inc., a North Carolina corporation that is unrelated to and completely independent of appellant. Mastrom served as the plan's administrator. A trust was established with the North Carolina National Bank for the receipt and maintenance of the monies necessary to fund the future benefits of the plan. Mastrom served as the trustee.
Under the plan, every employee was eligible for benefits amounting to $4,000 per year for up to four years for each child of his who was between the ages of 18 and 29 and pursuing a course of undergraduate or graduate study at an accredited college or university. Participation in the plan was available to all appellant's employees without restriction or qualification. Appellant bore the full cost of the plan. At the plan's inception, eleven children of employees were designated to receive benefits. Of those eleven, nine were those of shareholders, while two were not. At the time of the plan's adoption, the children of one of the shareholders, Dr. Lund, had already completed their education.
Under the educational benefit plan, the child of an employee is eligible to receive the benefits of the plan without regard to academic achievement or financial need. A child whose parent is presently employed by appellant is eligible under the plan. One whose parent has left the appellant's employ for retirement or for reasons of disability is also eligible. If a beneficiary's parent leaves the appellant's employ for any other reason, however, all benefits under the plan immediately cease. In that circumstance, funds remaining in the account of the departed employee's child would be applied to the reduction of appellant's future contributions under the plan.
The plan could be amended or terminated in the discretion of appellant's board of directors. No portion of the trust corpus, however, could ever revert to or inure to the benefit of appellant or its shareholders.
During the fiscal years ending June 30, 1974, June 30, 1975, and June 30, 1976, appellant made payments to the trustee of the plan's trust through the plan's administrator in the amounts of $15,000, $9,739 and $9,739 respectively. Appellant then deducted these amounts as ordinary and necessary business expenses under section 162 of the Internal Revenue Code in its returns for those years. The Internal Revenue Service disallowed these deductions and assessed deficiencies. Appellant subsequently paid the deficiencies, filed a claim for refund which was denied and filed this suit in a timely manner.
Trial Judge Willi held that the payments made by appellant under the educational benefit plan were not presently deductible. He found the plan was really a plan of deferred compensation and the deductibility of its expenses was governed by section 404 of the Internal Revenue Code and not section 162. He reasoned that the benefits received by the recipients of the plan were in the nature of compensation and therefore were to be considered deferred compensation.
Section 162 of the Internal Revenue Code of 1954, 26 U.S.C. § 162 (1970 and 1976) [all subsequent section references are to the Internal Revenue Code of 1954 as amended], allows deductions for ordinary and necessary business expenses. It provides in pertinent part:
SEC. 162. TRADE OR BUSINESS EXPENSES.
(a) In General. -- There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * * *.
Section 404(a), on the other hand, provides in pertinent part:
SEC. 404. DEDUCTION FOR CONTRIBUTIONS OF AN EMPLOYER TO AN EMPLOYEES' TRUST OR ANNUITY PLAN AND COMPENSATION UNDER A DEFERRED-PAYMENT PLAN.
(a) General Rule. -- If contributions are paid by an employer to or under a stock bonus, pension, profit-sharing, or annuity plan, or if compensation is paid or accrued on account of any employee under a plan deferring the receipt of such compensation, such contributions or compensation shall not be deductible under section 162 (relating to trade or business expenses) or section 212 (relating to expenses for the production of income); but, if they satisfy the conditions of either of such sections, they shall be deductible under this section, subject, however, to the following limitations as to the amounts deductible in any year:
(5) Other Plans. -- If the plan is not one included in paragraph (1), (2), or (3), in the taxable year in which an amount attributable to the contribution is includible in the gross income of employees participating in the plan, but, in the case of a plan in which more than one employee participates only if separate accounts are maintained for each employee.
The Government concedes that the payments made by appellant to the educational benefit plan were ordinary and necessary business expenses. It, however, contends these expenses were paid under a plan that deferred the payment of compensation. The Government therefore contends the deduction of these payments is governed by section 404 and not section 162.*fn2 Under section 404 the payments by the appellant to the trust would first be deductible in the year the payments were made to the beneficiary of the plan.
Treas. Reg. § 1.162-10, first promulgated in 1958 and still in effect today, is the only regulation promulgated that helps delineate the difference between those payments eligible for deduction under section 162 and ...