Opinion
Docket Nos. 3322 3323.
1944-04-17
D. D. HUBBELL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.ELIAS F. WILDERMUTH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
S. U. Robinson, Esq., and J. I. Boulger, Esq., for the petitioners. W. W. Kerr, Esq., for the respondent.
A corporation purchased annual premium annuity contracts for petitioners, who were stockholders of the corporation and its principal officers. So-called employees' trust were created for petitioners, under which a trustee held the annuity contracts. The corporation had no pension plan or program for its employees generally and none of its employees other than petitioners have ever received pension or retirement benefits. Held, (1) the trusts were not within the purview of section 165 of te Internal Revenue Code in effect prior to the amendments made by the Revenue Act of 1942; (2) the premiums paid by the corporation on the annuity contracts were for petitioners' benefit and represented additional compensation to them and they are taxable thereon under the provisions of section 22(a) of the Internal Revenue Code. S. U. Robinson, Esq., and J. I. Boulger, Esq., for the petitioners. W. W. Kerr, Esq., for the respondent.
These consolidated proceedings involve deficiences in income tax for the year 1941 as follows:
+-------------------------------------+ ¦ ¦Docket¦ ¦ +-------------------+------+----------¦ ¦Petitioner ¦No. ¦Amount ¦ +-------------------+------+----------¦ ¦D. D. Hubbell ¦3322 ¦$10,606.03¦ +-------------------+------+----------¦ ¦Elias F. Wildermuth¦3323 ¦4,527.81 ¦ +-------------------------------------+
The only question presented is whether amounts paid under so-called employees' trusts by the White-Haines Optical Co. for premiums upon annuity contracts on the lives of the petitioners, who were officers of that company, constitute income to petitioners in the year in which the premiums were paid.
Petitioners are residents of Columbus, Ohio, and filed their returns for the taxable year with the collector for the eleventh district of Ohio.
FINDINGS OF FACT.
During the year 1936 the White-Haines Optical Co., hereinafter called the Optical Co., was contemplating the purchase of annuities for both petitioners. Since the Optical Co. had not reached a decision by October 1936, petitioner Hubbell, on October 2, 1936, made application to the Prudential Insurance Co. of America for an annuity policy on his own life, with payments of annuities to him commencing at his 70th birthday. The policy was to be issued for 40 premium units and the annual premium was to be $4,000. In his application petitioner named his daughter as the person entitled to recieve death benefits.
Hubbell was president, treasurer, and general manager of the Optical Co. and had been associated with that company since 1901. Petitioner Wildermuth was secretary and sales manager of the Optical Co. and had been employed by it since 1913. The only other officer of the Optical Co. was one Ballard, who was its vice president.
The Optical Co. was controlled by the Bausch & Lomb Optical Co., which owned 59 percent of the Optical Co.'s outstanding stock. Hubbell owned 8 percent and Wildermuth owned 2.3 percent. The Optical Co.'s board of directors consisted of Hubbell, Wildermuth, Ballard, one Haines, and two representatives of the Bausch & Lomb Optical Co.
On December 4, 1936, at a meeting of the Optical Co.'s board of directors, a resolution was passed which provided, inter alia, as follows:
WHEREAS, it is the desire of the Company to facilitate the retirement of certain of its executives and employees with compensation by providing suitable pension funds commensurate with the salaries of said executives and employees during the years preceding retirement, the years of service of such executives and employees being also considered in determining the amounts of such retirement pensions
And WHEREAS, Daniel D. Hubbell is now President, Treasurer and General Manager, and E.F. Wildermuth is now Secretary and Sales Manager of said company, and are two of the officers for whose retirement said company desires to provide pension funds, now therefore be it
‘RESOLVED, that the proper officers of said company be and they are hereby authorized and empowered to purchase from The Prudential Insurance Company of America Premium Refund Annuity Contracts calling for an annual purchase premium of $5,000.00 per annum for Daniel D. Hubbell, and an annual purchase premium of $3,000.00 per annum for E.F. Wildermuth; and the Treasurer is authorized and directed to pay to said Insurance Company such annual premiums; and ordered further that said Contracts of Insurance so procured from said Insurance Company be made payable to The Ohio National Bank of Columbus, Ohio as Trustee in accordance with the terms of a Trust Agreement to be entered into between the Corporation and said bank.‘
Pursuant to this resolution, the Optical Co. on January 2, 1937, took over the policy previously secured by Hubbell, increasing the policy to 50 premium units, with an annual premium of $5,000. The $4,000 previously paid by Hubbell to the Prudential Co. was returned to him by that company and the Optical Co. paid the Prudential Co. the new policy premium of $5,,00. On February 4, 1937, pursuant to the application of the Optical Co., an annuity policy was issued by the Prudential Insurance Co. of America, payable to Wildermuth as the annuitant. The policy provided for 30 premium units, with an annual premium of $3,000, and the annuity payments were to begin when Wildermuth reached the age of 70 years. Both policies contained the following provisions:
Death Benefit.— Immediately upon receipt of due proof of the death of the Annuitant before the first monthly instalment of any Annuity hereunder has become due, while this Policy is in force, and upon legal surrender of this Policy at the Home Office of the Company, the Company shall pay either the sum of all the premiums actually paid under this Policy which fell due prior to such death, less any existing indebtedness on account of this Policy, or the net Cash Surrender Value of this Policy at the time of such death, whichever is the greater; or, if a Life Annuity (A) as herein provided has not been elected and the Annuitant lives to receive one or more monthly instalments of Annuity hereunder, but dies before the one hundred and twenty monthly instalments certain have been paid the instalments certain remaining unpaid discounted at three and one-quarter per cent. per annum compound interest shall, upon receipt of due proof of the death of the Annuitant, be paid in one sum; such payment shall be made to THE OHIO NATIONAL BANK, OF COLUMBUS, OHIO, TRUSTEE UNDER TRUST AGREEMENT DATED DECEMBER 23, 1936.
If there is no Beneficiary living at the death of the Annuitant to receive the Death Benefit herein provided, such Death Benefit shall be paid to the executors, administrators or assigns of the Annuitant, unless otherwise provided in the Policy. The right to change the Beneficiary has . . . been reserved.
NON-FORFEITURE PROVISIONS
Paid-up Annuity.— If this Policy, after being in force on full year, shall lapse or become forfeited for non-payment of any premium on the date when due, as specified herein, and if it is not surrendered for its Cash Surrender Value, the Company will put in force in lieu of this Policy, without any action on the part of the Annuitant, a Paid-up Annuity Policy which shall provide for an Annuity payable in equal monthly instalments in the same manner as the Annuity under this Policy, commencing on the same date in the same year as provided for the first monthly instalment of the Annuity under this Policy and terminating with the last periodical instalment before the death of the Annuitant, except as hereinafter provided. The amount of each such monthly instalment under said Paid-up Annuity Policy shall bear the same proportion to the amount of the monthly instalment of the Annuity under this Policy as the net Cash Surrender Value of this Policy at the time of such lapse or forfeiture, increased by any dividends standing to the credit of the Policy, with interest at the rate of three and one-quarter per cent., compounded annually, to the due date of the first monthly instalment of the Annuity hereunder, bears to the tabular Cash Surrender Value of this Policy at the end of the last policy year preceding the commencement of annuity payments. * * *
Cash Surrender Value.— If this Policy is continued in force by the due payment of premiums for at least one year, the Annuitant, by written application and return of the Policy to the Home Office of the Company at any time but not after three months from the due date of any premium in default, may elect, subject to the consent of any irrevocable beneficiary, to surrender this Policy for its net Cash Surrender Value. * * *
PROVISIONS FOR ANNUITY PAYMENTS PRIOR TO MATURITY.
At any time prior to the due date of the first monthly instalment of Annuity provided on the first page hereof, if all due premiums have been paid, the Annuitant may, subject to the consent of any irrevocably designated Beneficiary, elect in writing to receive in lieu of all other benefits under this Policy:
(A) A Life Annuity, payable in equal monthly instalments in every year during the lifetime of the Annuitant, commencing on the date to which premiums instalment due before the death of the Annuitant, the amount of the monthly instalment payable to be determined upon the basis of the attained age of the Annuitant at the commencement of such monthly instalments in accordance with Table A below; or
(B) An Annuity payable in equal monthly instalments in every year during the lifetime of the Annuitant, commencing on the date to which premiums have been paid under this Policy and terminating with the last monthly instalment due before the death of the Annuitant, except that if the Annuitant dies before receiving one hundred and twenty monthly instalments certain, the discounted value of the unpaid instalments certain shall be paid accordance with the provision of this Policy headed ‘Death Benefit,‘ contained on the first page hereof, the amount of the monthly instalment payable to be determined upon the basis of the attained age of the Annuitant at the commencement of such monthly instalments in accordance with Table B below.
Both policies contained the following endorsements:
The White Haines Optical Company may not withdraw this policy or be the death beneficiary or be entitled to receive any refunder of premiums.
Elias F. Wildermuth (or Daniel D. Hubbell) may not withdraw any cash surrender value while in the employ of The White House Optical Company. Henry S. Ballard is the attorney to consult if legal counsel is advisable.
Pursuant to the resolution of December 4, 1936, two separate trust agreements were executed on December 23, 1936, by and between the Optical Co. as settlor and the Ohio National Bank of Columbus as trustee, in which the petitioners were the respective beneficiaries. The agreements were executed in behalf of the Optical Co. by Hubbell as president, and Wildermuth as secretary. The agreements, which were identical except for the name of the beneficiary and the amount of annual premium, recited that the Optical Co. desired to provide a pension fund for each beneficiary and to that end had purchased an annuity contract for each beneficiary maturing when the beneficiary reached the age of 70 years. Under the agreements, the Optical Co. transferred all right, title, and interest in the annuity contracts to the trustee. The trustee agreed to hold the contracts and use its best efforts to collect all sums payable thereunder. The trustee was not required to present a claim to the insurance company until notified in writing by the Optical Co. or the trust beneficiary and was not required to take legal steps to collect any claims until indemnified. If the contracts matured during the lives of the beneficiaries, the trustee was to receive the monthly payments from the insurance company and remit such amounts, less its commission, to the beneficiaries within five days of receipt of such payments. In the event of the death of a beneficiary, the trustee was to remit any payments under the contracts to such persons as the beneficiary shall have designated in his lifetime. The trustee was not required to pay any premiums to keep the contracts in force and it was particularly charged not to permit the beneficiaries to withdraw any of the cash value of the contracts while such beneficiary was employed by the Optical Co. It was further provided that the Optical Co. was not to be a beneficiary of any payment under the contracts nor was it entitled to receive any payments by way of a refunder of premiums. If the company should discontinue the payment of premiums, the annuity contracts were to be held in the reduced proportions provided therein and the trusts were to continue to operate in the same manner as if the Optical Co. had continued such premium payments.
On December 13, 1938, the board of directors of the Optical Co. passed a resolution authorizing the treasurer to discontinue payments on the annuity contracts for the benefit of petitioners and in lieu thereof a bonus was paid to Hubbell of $2,500, and to Wildermuth of $1,500. On December 18, 1939, the Optical Co. passed a resolution authorizing payment of a bonus to Hubbell in the amount of $5,000 and to Wildermuth in the amount of $3,000. During each of the years 1938 and 1939, the Optical Co. did not pay the premiums specified in the two annuity contracts. During the years 1936 to 1941, inclusive, Hubbell received an annual salary of $20,000 exclusive of bonuses, and Wildermuth received an annual salary of $12,000, exclusive of bonuses.
On December 5, 1940, the board of directors of the Optical Co. passed a resolution to the effect that the annuity contracts should be reinstated and the current payments paid. It was decided that the insurance company be asked to make a loan upon the annuity contracts in the aggregate amount sufficient to pay the lapsed premiums thereon. The insurance company refused to make the loans as desired by the Optical Co. and thereafter, during the year 1941, the Optical Co. paid the insurance company the back premiums and the current premiums in the aggregate sum of approximately $25,000.
On August 14, 1941, a supplemental trust agreement was entered into between the Optical Co. and the Ohio National Bank of Columbus, as trustee in connection with the Hubbell trust. The agreement recited that by reason of an error on the part of the insurance broker the application for the Hubbell annuity contract was filed on a personal rather than a corporate application form, and that as a result of the error the annuity contract appeared to have been owned by Hubbell prior to its assignment to the trustee, when in fact the Optical Co. owned the contract prior to the assignment. The agreement further recited that to correct the error Hubbell, on July 8, 1941, assigned the contract to the Optical Co., which in turn, on the same date, assigned the contract to the Ohio National Bank of Columbus, as trustee. The agreement provided that the trustee should hold the annuity contract under the terms of the trust agreement of December 23, 1936. On December 10, 1941, the board of directors of the Optical Co. passed a resolution that it was never the intention of the Optical Co. to allow the annuity contracts to lapse, but that the real intent was merely to defer the payment of premiums on the contracts until the company was in a better cash position.
On February 4, 1942, the Optical Co. decided to discontinue the annual payments on the annuity contracts, and the annuity contract on the life of Wildermuth was converted into a paid-up annuity policy providing for an annuity of $2,122.44, payable in equal monthly installments of $176.87, beginning February 4, 1957. This policy contains an endorsement as follows:
PROVISIONS AS TO OWNERSHIP 9of THE POLICY
All legal incidents of ownership in the Policy, including all rights, benefits and advantages which the printed provisions thereof purport to confer on the Annuitant, except the right of the Annuitant to receive any Annuity payments becoming due during his or her lifetime, shall, anything in the Policy to the contrary notwithstanding but subject to any limitation herein set forth, belong to THE WHITE-HAINES OPTICAL CO., OF COLUMBUS, OHIO, ITS SUCCESSORS OR ASSIGNS.
Without limiting the generality of such incidents of ownership, such incidents shall include the right.
(a) to change the Beneficiary from time to time; and
(b) to elect that Annuity payments shall begin prior to the due date of the first monthly instalment of the Annuity provided on the first page of the Policy;
but the incorporation of this rider in the Policy shall not affect the right to receive any payment after the death of the Annuitant, unless the right to change the Beneficiary is exercised. Any exercise of the right to change the Beneficiary shall be by written request to the Company at its Home Office, and shall become effective when a provision to that effect has been endorsed upon the policy by the Company.
On February 7, 1942, the annuity contract on the life of Hubbell was converted into a paid-up annuity policy providing for an annuity of $3,419.40, payable $284.95 monthly, beginning October 7, 1953.
During the taxable year, the Optical Co. had approximately 350 employees. The Optical Co., to the date of the hearing in this proceeding, has never established employees' trusts for any of its employees other than petitioners, nor has it had any plan or progress for the formation of such employees' trusts.
OPINION.
HARRON, Judge:
The issue in these proceedings is whether amounts paid under so-called employees' trusts by the Optical Co. during the taxable year for premiums upon annuity contracts on the lives of petitioners constitute taxable income to petitioners under section 22(a) of the Internal Revenue Code.
That section has been amended by the Revenue Act of 1942, but the amendment has no retroactive effect upon the taxable year in these proceedings.
SEC. 165. EMPLOYEES' TRUSTS. (Prior to amendment by sec. 162 of the Revenue Act of 1942.)A trust forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of some or all of his employees—(1) if contributions are made to the trust by such employer, or employees, or both, for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accumulated by the trust in accordance with such plan, and(2) If under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees under the trust, for any part of the corpus or income to be (within the taxable year of thereafter) used for, or diverted to, purposes other than for the exclusive benefit of his employees,shall not be taxable under section 161, but the amount actually distributed or made available to any distributee shall be taxable to him in the year in which so distributed or made available to the extent that it exceeds the amounts paid in by him. Such distributees shall for the purpose of the normal tax be allowed as credits against net income such part of the amount so distributed or made available as represents the items of interest specified in section 25(a).
Petitioners contend that the two trusts created by the Optical Co. comply with the literal requirements of section 165, since they were for the exclusive benefit of ‘sone or all‘ of the Optical Co.'s employees. They argue that the word ‘some‘ represents an indefinite number which should be interpreted as meaning ‘two or more.‘ They maintain that this interpretation is in accord with the legislative intent as shown by the fact that the 1942 amendment requires the inclusion of a minimum percentage of employees in order that a trust might qualify as tax exempt under section 165. In support of their contention, they cite and rely upon Raymond J. Moore, 45 B.T.A. 1073, and Phillips H. Lord, 1 T.C. 286.
Respondent contends that the trusts for petitioners are not employees' trusts within the meaning and intent of section 165 and that the premiums paid on the annuity policies by the Optical Co. represent additional compensation to petitioners and taxable income to them under section 22(a).
The legislative history of section 165 has been discussed in Oscar A. Olstad, 32 B.T.A. 670. Its undoubted purpose was to encourage employers to share profits with their employees and to provide a measure of security for their employees by means of pensions when the earning power of the employee has decreased or ended. W. F. Parker, 38 B.T.A. 989. To encourage this laudable purpose it was provided that if a trust qualified under section 165 the employer was allowed a deduction on its income tax return to provide for the payment of reasonable pensions to its employees, and the employees were allowed to defer the payment of tax on the amounts contributed by the employer for their benefit until they received payments under the pension plan. Because of these benefits to both employer and employee, in determining whether a trust qualifies as tax exempt under section 165 it is necessary to scrutinize the details of the plan, its method of operation, and the circumstances under which the plan is actually carried out. The pension plan must be bona fide, for the exclusive benefit of the employee, and with the intent on the part of the employer to provide retirement benefits to its employees. A so-called pension plan, however, may be merely a device to pay employees additional compensation, with the tax on such compensation deferred until a later date. This is particularly so where the plan only provides retirement benefits for a few key executives or officers.
Upon due consideration of all the facts of these proceedings, it is our opinion that these trusts do not qualify as tax exempt trusts under section 165. The Optical Co. had approximately 350 employees in the taxable year. Since its inception, it has never had a written program or definite plan under which its employees generally might secure retirement or pension benefits. It has never provided these benefits to any of its employees other than the petitioners, who were stockholders of the company and its principal officers. Petitioners were the only officer-stockholders of the Optical Co.
We do not believe that it was ever the legislative intent to allow trusts such as these to qualify as tax-exempt under section 165. In our opinion, the creation of the trusts and the purchase of the annuity contracts by the Optical Co. was a device to provide additional compensation to petitioners, with the tax on such compensation deferred, rather than a plan to provide for their future security. If this were not the case, it is difficult to understand why the Optical Co. deferred payments of premiums under the annuity policies in subsequent years at a time when they were paying cash bonuses to petitioners.
Were it not for the creation of the trusts in these proceedings, the factual situation here would be similar to that in Renton K. Brodie, 1 T.C. 275. In that case payments were made by an employer for premiums on annuity contracts on the lives of certain of its employees. The Court there held that the payment of premiums represented additional compensation to the employees, taxable to them under section 22(a). In the Brodie case, supra, the employees received vested property rights which were more restricted than those of petitioners in these proceedings. There, the annuity contracts could not have been assigned and they had no cash surrender value. Here, the trusts are silent as to the assignability of the annuity contracts and there is no provision in the trust agreements which prevents petitioners from receiving the cash surrender value of the policies after leaving the employ of the Optical Co.
Does, then, the creation of these trusts bring the proceedings within section 165 and make the rule of the Brodie case inapplicable? We think not. Under the trust agreements, the duties of the trustee were purely ministerial. The trustee agreed to hold the policies until they matured as claims. In that event, it agreed, upon written notice by the Optical Co. or the beneficiaries, to present the claims to the insurance company and to use its best efforts in collecting them. However, it was not required to take any legal proceedings for collection of the claims until it was indemnified. In the event of receipt of monthly payments under the policies it agreed to remit those payments, less commissions, to the beneficiaries within five days of such receipt, or in the event of the death of the beneficiaries it agreed to remit death benefits to such persons as the beneficiaries shall have designated in their lifetimes. The only real duty placed upon the trustee was to prevent a trust beneficiary from withdrawing the cash surrender value of the policy while such beneficiary was employed by the Optical Co., but this provision was mere surplusage, since the policies themselves contained the same provision, as well as the further provision that the Optical Co. was not to be a beneficiary in any way under the policies. Under the circumstances, the trustee was merely a conduit for the payment of claims from the insurance company to the trust beneficiaries. The trustee did not have the usual duties of a trustee, such as the management or investment of a fund. It was not required to pay any of the premiums on the policies or to see that the policies were kept in force. Although the record is not clear, the inference to be drawn is that the trustee did not even pay the premiums on the policies, but the Optical Co. We think that the trusts were a mere formality, and their only purpose was an attempt to bring the annuity contracts within the provisions of section 165 and under this factual situation would be to countenance and encourage a subterfuge.
The Moore case, supra, and the Lord case supra, upon which petitioners rely, are entirely distinguishable. In the Moore case, the corporation formally adopted a pension plan for its officers and employees under which certain payments were to be made annually to a trustee and administered by the trustee. Ten of the corporation's employees were selected for participation in the benefits of the plan. The number of persons employed by the company is not shown, but only four of the employees selected for participation in the plan were either officers or directors of the company. In the Lord case, a pension trust was established for the benefit of all of the company's permanent employees and the term of the trust were meticulously observed. In both of those cases there were definite written programs for the benefit of a substantial number of employees. They are entirely distinguishable from the trusts in these proceedings, where the only beneficiaries under the plan were the two officer-stockholders of the Optical Co. It may also be pointed out that, since the only beneficiaries were stockholders as well as officers, there is a strong inference that the trusts were established not merely because they were employees, but also because of their stock interest in the Optical Co. In that event, the trusts would not be ‘for the exclusive benefit of * * *employees‘”””’ as such.
Under the circumstances it is held that the trusts created by the Optical Co. are not within the purview of section 165 and that the amounts paid by the company during the taxable year for premiums on the annuity contracts represent taxable income to petitioners under section 22(a).
Decision will be entered for respondent.