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Benbow v. Commissioner of Internal Revenue

September 30, 1985

DONALD L. BENBOW, PATRICIA J. BENBOW, EARL R. LUECKEL, LOIS B. LUECKEL, WILLIAM H. STRONG, AND ELLA K. STRONG, PETITIONERS, DANIEL W. CASS, JR., BARBARA CASS, FREDERIC E. SAUNDERS, AND MARY ALICE SAUNDERS, PETITIONERS-APPELLEES, *FN1
v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT-APPELLANT



On Appeal from the Decision of the United States Tax Court As to Daniel W. Cass, et al., Petitioners-Appellees

Author: Fairchild

Before BAUER and WOOD, Circuit Judges, and FAIRCHILD, Senior Circuit Judge

FAIRCHILD, Senior Circuit Judge. Taxpayers Daniel W. Cass, Jr. and Frederic E. Saunders*fn2 were employees of Electric Cord Sets, Inc. In 1959 Electric Cord established a pension plan and related trust. In 1959, and again in 1963 upon the plan's amendment, the Commissioner of Internal Revenue (Commissioner) issued letters determining that the plan was "qualified" under § 401(a) of the Internal Revenue Code of 1954, 26 U.S.C. § 401(a), and the trust was therefore exempt from tax under § 501(a) of the Code, 26 U.S.C. § 501(a).

On July 18, 1978, Electric Cord terminated the plan effective for the plan year ending December 31, 1977. In 1978 the trustees distributed the plan's assets to the participants, including taxpayers Cass and Saunders. Cass and Saunders then "rolled over" their distributions to individual retirement accounts (IRAs) relying on the tax-free rollover provisions of § 402(a)(5) of the Code. There had been no employee contributions.

In 1979 the plan and the trust were examined by the Commissioner. Based on this examination it was determined that the plan discriminated among salaried employees. A preliminary letter proposing revocation of the plan's qualified status under § 401(a), and the trust's exempt status under § 501(a), was issued by the Commissioner in September, 1979. On February 15, 1980 the Commissioner revoked the plan's qualified status and the trust's exempt status retroactively, effective as of January 1, 1976. Thus, when employer contributions were made in 1976 and 1977 and when the terminating distributions were made in 1978, the plan was not a tax-qualified plan and the trust was not exempt.

On audit the Commissioner determined that since the plan was not qualified at the date of distribution, the distributions from the trust in 1978 should have been reported as ordinary income and were ineligible for taxfree rollover treatment under § 402(a)(5) of the Code. The Commissioner also determined that the full amounts that the taxpayers had transferred into IRA's constituted "excess contributions" and thus were subject to the 6% excise tax of § 4973(a) of the Code.*fn3

In the Tax Court taxpayers did not contest the Commissioner's determination that the plan was not qualified, nor the retroactive revocation of qualified status. They argued, however, that the tax treatment of the distributions should not be determined by the status of the plan at the time of distribution, but at the date of contributions to the trust. Thus, they argued that that portion of the distribution attributable to contributions made prior to January 1, 1976 should be entitled to the tax-free rollover treatment of § 402(a)(5).

The Tax Court agreed, holding that to the extent each 1978 distribution was attributable to pre-disqualification contributions, the amount thereof was to be treated as having been rolled over tax-free under § 402(a)(5), and not excess contribution to an IRA under § 4973. The remainder was treated as ordinary income under § 402(b). Benbow v. Commissioner, 82 T.C. 941 (1984). The Commissioner appeals.

But for the rollover claimed to be authorized by § 402(a)(5), and giving the disqualification retroactive effect, the distributions would be includible in taxpayers' gross incomes for 1978. Section 402(b).

Section 402(a)(5) provides in pertinent part:

(5) ROLLOVER AMOUNTS-

(A) GENERAL RULE.-if-

(i) the balance to the credit of an employee in a qualified trust is to be paid to him in a qualifying rollover distribution,

(ii) the employee transfers any portion of the property he receives in such distribution to an ...


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