The opinion of the court was delivered by: Richard Mills, District Judge:
L. Hand, The Spirit of Liberty: Papers & Addresses of
Learned Hand, 213 (I. Dilliard ed. 1960).
A tax case of first impression.
(1) Whether 26 U.S.C. § 404(a)(1)(A)(iii) required the
taxpayer/professional corporation to allocate between
current and past service costs the benefits accruing to
its sole shareholder in 1980 under a defined benefit
(2) Whether the actuarial assumptions the
taxpayer/professional corporation utilized in 1980 for the
defined benefit pension plan, principally the
pre-retirement 5% interest rate assumption, were
reasonable in the aggregate as required by
26 U.S.C. § 412(c)(3)?
The taxpayer, Jerome Mirza & Associates, Ltd., is a
professional corporation in the business of providing legal
services and is controlled by its sole shareholder, Jerome
Mirza. On December 31, 1980, the taxpayer adopted the "Jerome
Mirza & Associates, Ltd., Defined Benefit Pension Plan" with
an effective date of January 1, 1980.
Article I, § A of the Plan states that the taxpayer desired
to create a scheme of deferred compensation consistent with §
401 of the Internal Revenue Code, and all provisions should be
construed so as to comply with the tax code's requirements for
qualification. The plan provides, inter alia, that an employee
is eligible to participate after three years of service but may
accrue benefits only after completing a fourth year of service.
Eligible individuals then receive an accrued benefit equal to
30% of the participant's compensation for the first year of
participation on or after January 1, 1980, plus 5% of his or
her salary for each of the next three years, reduced by 37% of
social security benefits ratably earned over the initial four
years of plan participation. Each participant is entitled to
his or her accrued benefit upon reaching the retirement age of
55 and attaining 10 years of plan participation. The plan also
provides that the normal retirement benefit may not exceed the
lesser of $110,625 per year or 100% of the participant's total
annual income averaged over the high consecutive three years of
The plan covered two employees in 1980. Jerome Mirza had
been employed by the taxpayer for seven years and was 43 years
old. David Dorris had been employed for five years and was 33
years old. During 1980, Mr. Mirza's compensation totalled
$275,000. Mr. Dorris' income was $27,000 of which he elected
$9,760 to be considered for pension purposes. Based upon the
plan's provisions, the annual accrued benefit was calculated
as $80,927 and $1,215 for Mr. Mirza and Mr. Dorris
respectively. In other words, upon their retirement at the
plan retirement age of 55, Mr. Mirza and Mr. Dorris would
receive those respective sums each year even if no benefits
accrued in later years.
To fund enough money to pay the yearly benefits, the plan's
actuary, The Wyatt Company, then prepared an actuarial
valuation report for the plan using the unit credit cost
method. The actuarial assumption for the 1980 valuation
included an interest rate of 5% for the pre-retirement period.
This assumption was the actuary's estimate of the rate the
plan would earn on
its investments. Because of existing circumstances, mortality,
turnover and salary increase assumptions were unnecessary.
Employing the actuarial assumptions, the actuary determined
the present value of Mr. Mirza's accrued benefit to be
$619,925 and Mr. Dorris' to be $6,000. The total of $625,925
was reported as the normal cost for the year. The unfunded
past service liability was recorded as zero for the December
31, 1980, valuation.
The taxpayer's 1980 tax return reported a deduction of
$625,925 attributable to the pension plan. The amounts
contributed in the plan year and how they were invested are as
9/15/80 $100,000 6 month CD@11.65%
9/15/80 $200,000 36 month CD@12.4%
1/5/81 $100,000 6 month CD@15.5%
1/8/81 $100,000 6 month CD@15.5%
3/3/81 $100,000 6 month CD@15.75%
3/3/81 $18,007 6 ...