Tax Court: Exempt Org Not Subject to Excise Tax on Plan Reversion

March 1, 2012

Summary

In Research Corporation v. Commissioner, the Tax Court ruled that a private operating foundation was not subject to an excise tax on the portion of a terminating qualified plan that reverted to the foundation.

Extended Summary

The foundation obtained a private letter ruling, apparently PLR 200131034, stating that the reversion would not constitute unrelated business taxable income under Section 512(a)(1). Initially, the foundation also sought a ruling that the reversion would not be subject to excise tax under Section 4980, but it withdrew this request.

Instead, the foundation terminated the plan, distributed 25% of the $5.9 million potential gross reversion amount to a replacement plan, and transferred back to the foundation the remaining $4.4 million as a reversion. It then filed a Form 5330, reporting and paying excise tax on only a small fraction of the reversion amount. The foundation calculated the reversion amount based on the ratio of unrelated business taxable income it had reported in the roughly ninety years of its existence, over the total income it had received over the past fourteen years.

The IRS asserted a deficiency in the excise tax, asserting that the entire $4.4 million reversion was subject to the tax. Although the deficiency notice was issued more than six years after the foundation had filed the return, the foundation failed to assert the statute of limitations as a defense. On the other hand, the Tax Court did not treat the filing of the return and the payment of an excise tax as a concession on the part of the foundation that any tax at all was owed.

The question before the court was one of statutory construction. Section 4980(d) imposes an excise tax of 20% on the reversion of the assets of a qualified plan to the sponsoring employer. If the employer does not first establish a qualified replacement plan and transfer at least 25% of the potential gross reversion amount into the replacement plan, the tax is increased to 50%. In the present case, there was no dispute that the foundation had met this requirement.

The argument centered on the foundation's contention that it was not subject to the excise tax at all, because the plan it had terminated was not a "qualified plan" for purposes of the excise tax. The phrase "qualified plan" is defined at Section 4980(c)(1)(A) as a plan "other than a plan maintained by an employer [who] has, at all times, been exempt from tax under subtitle A" of the Code.

The foundation contended the reference to "subtitle A" was meant to refer only to income taxes. The Commissioner argued the tax on unrelated business income is imposed by Section 511, which is also a part of subtitle A. The Commissioner also argued the foundation had been subject to, and thus not "exempt from," UBTI during three years in the early 1950s, and again in two more recent years on income from unrelated debt-financed property.

The foundation cited Section 501(b), which provides that an organization exempted under Section 501(a) "shall be considered an organization exempt from income taxes for the purpose of any law which refers to organizations exempt from income taxes," notwithstanding that it may be subject to taxes on unrelated business income. The Commissioner argued this language referred only to the question whether the organization's exempt status might be revoked.

The Tax Court accepted the foundation's position, noting at least two instances in which the Commissioner's argument would lead to anomalies:

Section 6672(a), which excepts from penalties for failure to report and remit taxes "any unpaid, volunteer member of any board or trustees or directors of an organization exempt from tax under subtitle A"; and
Section 457, which provides that compensation deferred under an eligible plan is not includible in the employee's gross income until it is paid out, defining "eligible employer" to include not only local governments, but also "any other organization exempt from tax under this subtitle."

In each of these instances, the court observed, the obvious intent of the statute would be frustrated if the reference to subtitle A were construed to require that the organization never have any UBTI.

CPC Commentary

This appears to be the correct result, though the Tax Court did have to go behind the literal meaning of the statutory language and delve rather deeply into legislative intent to reach it.

Although we may be speculating, it appears during the PLR process the Foundation felt the reversion was not taxable, but the Service disagreed. So the Foundation obtained as many favorable rulings as it could in PLR 200131034, and filed as it deemed appropriate. The Service, for its part, tracked the transaction and asserted a deficiency.

Frequently, during the PLR process, these type of negotiations take place, and the Service often takes a hard line, assuming the taxpayer will not want to incur the cost and expense to litigate. Presumably, there was enough money in this particular case to encourage the taxpayer to go forward!