Appeal from the United States District Court for the Central District of Illinois, Springfield Division. No. 86-3182, Richard Mills, Judge.
Coffey, Flaum, and Ripple, Circuit Judges.
Jerome Mirza & Associates appeals from a district court decision dismissing its claim for a refund of federal income taxes under 28 U.S.C. § 1346(a)(1). For the reasons discussed below, we affirm.
The taxpayer Jerome Mirza & Associates is a professional corporation engaged in the business of providing legal services. In 1980, the taxpayer established a pension plan to provide pension benefits for two of its employees, Jerome Mirza and David Dorris. Under the terms of the plan, which was designed to conform to the requirements of §§ 401 and 501 of the Internal Revenue Code, each participant accrued a benefit equal to 30% of his compensation for 1980 plus 5% of his compensation for each of the next three years of participation, reduced by the amount necessary to fund social security benefits. This accrued benefit was payable in annual installments on the date the participant reached 55 years of age and completed ten years of participation in the plan.*fn1 In 1980, Jerome Mirza was 43 years of age and earned $275,000 while Dorris was 33 years of age and earned $27,000. Consequently, under the terms of the plan, Mirza accrued a benefit of $80,927 payable annually for life at age 55 while Dorris accrued an annual benefit of $1,215. At the time that the plan was adopted, Mirza, who was the corporation's sole shareholder, had been employed by the taxpayer for seven years and Dorris had been employed by the taxpayer for five years.
In order to determine the amount of contributions necessary to adequately fund the benefits accrued under the plan, the taxpayer hired enrolled actuary Joseph Beres. Beres chose the unit credit cost method, an accepted actuarial technique, in making his assumptions and determined that a 5% annual return on investment was an appropriate assumption. Employing this figure, Beres calculated the present value of the future benefits under the plan as $625,925. Beres informed the taxpayer that this sum represented the "normal cost" of the plan and was immediately deductible under 26 U.S.C. § 404(a)(1)(A)(iii).
The taxpayer followed Beres' advice and deducted the entire amount from its federal income taxes for 1980. This deduction created a loss for 1980 which the taxpayer carried back for several years and ultimately resulted in a refund of $235,731. The Commissioner, however, audited the taxpayer's 1980 return and substantially reduced the allowable deduction. Initially, the Commissioner determined that the actuary's 5% interest rate assumption was not reasonable within the meaning of 26 U.S.C. § 412(c)(3) in view of the abnormally high interest rates prevalent in 1980 and substituted its own figure of 8%. Accordingly, the Commissioner reduced the single sum present value of the accrued benefits under the plan from $625,925 to $442,010. In addition, the Commissioner apportioned this amount between the cost attributable to service in 1980 (which he deemed to be the normal cost of the plan) and that attributable to the participant's past service (which under § 404(a)(1)(A)(iii) had to be amortized over a ten year period). This allocation reduced the taxpayer's deduction in 1980 to $115,953.71 which in turn increased the taxpayer's tax liability by $227,415. The taxpayer paid this amount plus interest of $193,950 and sued for a refund under 26 U.S.C. § 1346(a)(1).
The district court conducted a hearing on the question of the reasonableness of the actuary's assumptions, concluded that Beres' 5% interest assumption was not reasonable based on the experience and characteristics of the taxpayer's plan, and upheld the Commissioner's calculation of the present value of the benefits provided by the plan as $442,010. In addition, the district court, on cross motions for summary judgment, determined that under 404(a)(1)(A)(iii) this figure had to be allocated between the cost of benefits attributable to service in 1980 and the cost of benefits attributable to service in prior years. Accordingly, the district court upheld the Commissioner's determinations in all respects. The taxpayer appeals from this decision.
The initial question on appeal is whether the district court correctly concluded that the actuary's 5% interest rate assumption was not reasonable. The issue of the reasonableness of an actuary's assumptions under § 412 is a question of fact and the district court's decision will not be reversed unless clearly erroneous. See Board of Trustees, Michigan United Food and Commercial Workers Unions v. Eberhard Foods, Inc., 831 F.2d 1258 (6th Cir. 1987). Under the clearly erroneous standard, an appellate court will not disturb a district court's finding unless it is left with the firm conviction that a mistake has been committed. Shore v. Dandurand, 875 F.2d 656 slip op. at 8 n.9 (7th Cir. 1989).
In our view, the district court's findings were not clearly erroneous. At trial, there was conflicting expert testimony on the question of reasonableness. Plaintiffs' witnesses concluded that because the plan's principal beneficiary who was 43 years of age at the time the plan was instituted intended to retire at age 55, the relevant time period for making the actuarial assumptions was twelve years and testified that pension plans earned approximately 5% on their investments in the twelve-year period 1968-1980. In addition, these witnesses testified that actuaries, fearing personal liability if the plan ultimately proves to be inadequately funded, are generally very conservative in making their assumptions.
Not surprisingly, the government's witnesses took a different view of the reasonableness of the actuary's assumptions. The government's witnesses noted that under § 412(c)(3), the reasonableness of an actuary's assumptions must be evaluated in light of the plan's experience and reasonable expectations and testified that an interest rate assumption of 5% was simply not reasonable when these factors were taken into account. In particular the government's witnesses testified that at the time the valuation was made, interest rates on certificates of deposit ranged between 11.65% and 15.75% and were approximately 12% for long-term (i.e., 10 and 20 year) certificates. In addition, the government's witnesses noted that at the time Beres made his calculations the plan had already invested $300,000 in short-term certificates of deposit and contended that this information should have alerted the actuary to the type of investment the plan preferred i.e., conservative investments. Finally, the government's witnesses emphasized that under the terms of the plan most of the accrued benefits were to be funded within four years of the actuary's valuation. Given these facts, the government's witnesses testified that an interest rate assumption of 7-10% would have been reasonable.
As noted above, we will not reverse the district court's decision unless we are left with the firm conviction that an error has been committed. On the facts of this case we are unable to reach this conclusion. In view of the structure of the funding of the plan and its history of investments there is abundant evidence in the record supporting the government's position that an 8% rate of interest was appropriate. Conversely, there was ample evidence adduced at trial indicating that the actuary's 5% interest rate assumption was not reasonable given the peculiarities of the taxpayer's plan. In particular, the actuary's reliance on the long-term returns on investments by large-scale pension plans was unsound given the fact that the taxpayer's plan was very small and would be fully funded over a very short period. Moreover, by relying on information which included substantial investments in the stock ...