Kute v. United States ( 1999 )

Opinions of the United
1999 Decisions States Court of Appeals
for the Third Circuit
9-22-1999
Kute v. United States
Precedential or Non-Precedential:
Docket 99-3195
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Filed September 22, 1999
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 99-3195
WILLIAM T. KUTE and FRANCIS M. KUTE,
Appellants
v.
UNITED STATES OF AMERICA
On Appeal from the United States District Court
for the Middle District of Pennsylvania
(D.C. Civ. No. 98-00299)
District Judge: Honorable Sylvia H. Rambo
Submitted pursuant to Third Circuit Rule 34.1(a)
September 17, 1999
BEFORE: GREENBERG, SCIRICA, and RENDELL,
Circuit Judges
(Filed: September 22, 1999)
Gary M. Lightman
Eric C. Stoltenberg
Lightman & Welby
2705 North Front Street
P.O. Box 911
Harrisburg, PA 17108
Attorneys for Appellants
David M. Barasch
United States Attorney
Loretta C. Argrett
Assistant Attorney General
Teresa E. McLaughlin
Annette M. Wietecha
Donald B. Tobin
Attorneys Tax Division
United States Department of Justice
Tax Division
P.O. Box 502
Washington, DC 20044
Attorneys for Appellee
OPINION OF THE COURT
GREENBERG, Circuit Judge.
I. INTRODUCTION
This matter is before this court on appeal from an order
entered on January 15, 1999, on the parties' cross motions
for summary judgment in the district court in this tax
refund case. The district court entered the order in
accordance with its accompanying memorandum opinion.
The district court had jurisdiction under I.R.C.S 7422(a)
and 28 U.S.C. S 1346(a)(1). We have jurisdiction under 28
U.S.C. S 1291. We exercise plenary review on this appeal,
which involves only legal conclusions. See ACM Partnership
v. Comissioner, 157 F.3d 231, 245 (3d Cir. 1998), cert.
denied, 119 S.Ct. 1251 (1999).
The case arises out of the interplay between state and
federal law and involves the application of the ten percent
tax imposed by I.R.C. S 72(t) on a taxpayer on a nonperiodic
distribution constituting an early withdrawal from a
qualified I.R.C. S 401(a) retirement plan. The germane facts
are not in dispute.1 In 1974, the Commonwealth of
_________________________________________________________________
1. While William T. Kute and Francis M. Kute, his wife, are the taxpayers
and all income tax returns and proceedings involved here have been
2
Pennsylvania enacted the State Employees' Retirement
Code (Retirement Code), 71 Pa. Cons. Stat. Ann.SS 5101-
5956 (West 1990), which continued the earlier established
State Employees' Retirement System (Retirement System)
and the State Employees' Retirement Fund (Fund). See id.SS 5102, 5932. A Board of Directors (Retirement Board)
administers the Retirement System and the Fund. See id.SS 5901-5931. The Retirement Board has the authority to
adopt and promulgate rules and regulations for the uniform
administration of the system. See id. S 5902(h).
In April 1987, the Fraternal Order of Police (FOP), Kute's
bargaining agent, initiated collective bargaining procedures
with the Commonwealth to obtain a successor agreement to
its contract effective for 1986 through 1988. Inasmuch as
the negotiations reached an impasse, the FOP invoked the
binding arbitration provisions of 43 Pa. Cons. Stat. Ann.
S 217.4(a) (West 1992). On February 17, 1988, the
arbitration panel awarded a change in pension benefits to
Pennsylvania state troopers with at least 20 years of service
who retire on or after July 1, 1989, eliminating any
requirement that a trooper attain a specific age before
retiring. The award further provided that in lieu of the
standard single life annuity provided under 71 Pa. Cons.
Stat. Ann. S 5702(a)(1), a trooper retiring after at least 20
years of service was entitled to receive an annuity of 50%
of his highest yearly salary and that a trooper retiring after
at least 25 years of service was entitled to receive an
annuity of 75% of his highest yearly salary. The award also
provided that if a court invalidated the pension benefit
increase it would be replaced by a $1,000 pay increase with
appropriate adjustments to reflect rank differential
provisions. The parties refer to the award as the DiLauro
Award in recognition of the chairperson of the arbitration
panel.
The Commonwealth judicially challenged the DiLauro
Award on the ground that 71 Pa. Cons. Stat. Ann.S 5955
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joint, as a matter of convenience we refer to William T. Kute as the sole
taxpayer. We note that the complaint recites that Kute's wife's name is
"Frances." Nevertheless, we refer to her as "Francis" in accordance with
the caption used in the district court pleadings in this case.
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barred collective bargaining over pension benefits. The
Supreme Court of Pennsylvania, however, upheld the
award. See Commonwealth of Pennsylvania v. State
Conference of State Police Lodges of the Fraternal Order of
Police, 575 A.2d 94, 97 (Pa. 1990) ("Fraternal Order of
Police"). In particular, the court held that the Retirement
Code "prohibits only collective bargaining agreements from
determining pension rights" but "does not prohibit
bargaining over pension benefits [nor] pension benefits from
being affected by arbitration awards." Id. at 96-97. The
court further concluded that the award was "a mandate to
the legislature to enact whatever legislation [was] necessary
to implement or fund the arbitration award." Id. at 97.
In response to Fraternal Order of Police, the Retirement
Board voted to implement the DiLauro Award as follows:
The awarded benefits of 50% of the highest year's
salary after 20 years of service or 75% of the highest
year's salary after 25 years of service shall be inserted
into the Retirement Code structure in lieu of the
standard single life annuity for purposes of calculating
a withdrawal or superannuation annuity under Section
5702(a)(1).
The resolution further provided that "[a]ll other [Retirement]
Code benefits remain in full force and effect and all optional
benefit payment plans . . . remain in effect."
The legislature then amended section 5955, effective
August 5, 1991, to provide in relevant part:
Regardless of any other provision of law, pension rights
of State employees shall be determined solely by this
part or any amendment thereto, and no collective
bargaining agreement nor any arbitration award
between the Commonwealth and its employees or their
collective bargaining representatives shall be construed
to change any of the provisions herein, to require the
[Retirement Board] to administer pension or retirement
benefits not set forth in this part, or otherwise require
action by any other government body pertaining to
pension or retirement benefits or rights of State
employees. Notwithstanding the foregoing, any pension
or retirement benefits or rights previously so established
4
by or as a result of an arbitration award shall remain
in effect after the expiration of the current collective
bargaining agreement between the State employees so
affected and the Commonwealth.
71 Pa. Cons. Stat. Ann. S 5955 (West Supp. 1999)
(emphasis added). In 1992, after nearly 30 years of service
as a state trooper, Kute retired at the age of 51 years, and
became eligible to receive retirement benefits.
Kute elected an alternative annuity option (Option 4)
under 71 Pa. Cons. Stat. Ann. S 5705(a)(4)(iii), which was
the actuarial equivalent of the maximum single life annuity
provided by section 5702. Under Option 4, a portion of the
retirement benefit (not in excess of the total accumulated
deductions standing to the member's credit) may be paid as
a lump sum, and the balance of the present value of the
maximum single life annuity is paid as an annuity.
Consequently, Kute received a monthly retirement benefit of
$3,132.42 and a one-time payment of $49,607.13, as well
as post-termination interest of $385.20. The $49,607.13
payment was composed of nontaxable member
contributions of $13,593.94, taxable member contributions
of $19,079.34, and interest on the contributions of
$16,933.90. The ten percent tax on a portion of the
payment of $49,607.13 is at issue here.
On his 1992 federal income tax return Kute reported and
paid the ten percent additional tax in the amount of $3,700
under I.R.C. S 72(t), attributable to the distribution of
$36,998 in taxable member contributions and interest.
Kute then filed an administrative claim for refund of the
additional tax. The IRS disallowed the claim, and Kute then
brought this timely suit for refund.2
The parties thereafter submitted a stipulation of
uncontested material facts and exhibits and served and
filed cross-motions for summary judgment. The exhibits
_________________________________________________________________
2. In its brief, the government points out that the sum of the taxable
member contributions of $19,079.34 and interest of $16,933.90 was only
$36,013.24. We also note that there seem to be some other de minimus
numerical discrepancies in the numbers involved. No further mention of
these problems appears in the briefs and thus we do not deal with them.
5
included a declaration of Dale Everhart, Assistant Executive
Director of the Retirement System, setting forth that the
IRS has treated the Retirement System as a qualified plan
under I.R.C. S 401(a) since at least 1982 and that because
the IRS has treated the Retirement System as a qualified
plan, the Retirement System had not requested a
determination letter from the IRS regarding its status as a
qualified plan. Kute does not contest this point on this
appeal.
Kute argued in the district court that I.R.C. S 72(t) did
not apply to his lump sum one-time distribution. In this
regard, he contended that the section applies only to
distributions from "qualified plans" under I.R.C. S 401(a), so
that in his view the tax was not applicable as his
distribution came from the DiLauro Award rather than from
the Retirement System. The government argued that the
payment fell within I.R.C. S 72(t) as it was from a qualified
plan and resulted from Kute's election of an alternative
annuity option provided in the Retirement Code.
The district court granted the government's motion for
summary judgment, holding that I.R.C. S 72(t) applied to
the distribution. The court rejected Kute's assertion that
the arbitration award created a benefit distinct from the
Commonwealth's qualified pension plan. The district court
held that the DiLauro Award was integrated into the
Commonwealth's qualified pension plan. It pointed out that
the Pennsylvania Supreme Court had determined that the
arbitration board had the authority to issue an award
affecting police retirement benefits and that the award was
"a mandate to the legislature to enact whatever legislation
[was] necessary to implement or fund the arbitration
award." The district court further noted that the legislature
had recognized the award when it amended section 5955 of
the Retirement Code prospectively to prohibit arbitration
awards from amending the Retirement Code by including
language stating that "any pension or retirement benefits or
rights previously so established by or as a result of an
arbitration award shall remain in effect after the expiration
of the current collective bargaining agreement between the
State employees so affected and the Commonwealth." 71
Pa. Cons. Stat. Ann. S 5955.
6
The district court concluded that, in upholding the
DiLauro Award, "the Pennsylvania Supreme Court
determined that pension benefits under the Retirement
Code could be modified by an arbitration award governing
the contract between the Commonwealth and the state
police." The court further observed that "[p]ursuant to the
terms of the [Retirement] Board resolution, the increased
pension benefits were ``inserted' into the Retirement Code."
The court also noted that Kute's lump sum payment was
made pursuant to an option provided under the Retirement
Code. See 71 Pa. Cons. Stat. Ann. S 5705(a)(4)(iii).
The court rejected Kute's argument that his retirement
payments must be allocated between amounts received
under the arbitration award and amounts received under
the Retirement Code, as it concluded that Pennsylvania
State Troopers Ass'n v. Pennsylvania State Employees'
Retirement Board, 677 A.2d 1329, 1330 (Pa. Commw. Ct.
1996), alloc. denied, 689 A.2d 237 (Pa. 1997), prohibited
such a result. The court determined that, under that
decision, the arbitration award and formulas replaced the
other benefits to state troopers under the Retirement Code
and were not separate from benefits payable under the Code.3
II. DISCUSSION
On this appeal, Kute summarizes his argument as
follows. While he recognizes that the Retirement System is
treated as a qualified retirement plan under I.R.C. S 401(a),
he contends that his lump sum pension benefit was not
attributable to that system, but rather was derived from the
DiLauro Award, which eliminated any age requirement for
pension eligibility and provided that a trooper with 20 years
of service was eligible for a pension benefit in an amount
equal to 50% of his highest year's salary, and that a
trooper, such as Kute, retiring with 25 years of service was
eligible for an annuity equal to 75% of his highest year's
_________________________________________________________________
3. The district court also rejected Kute's assertion that the payments at
issue did not flow from a qualified plan because their source was the
State Police benefit account established by 71 Pa. Cons. Stat. Ann.
S 5936, rather than the Retirement Fund itself. Kute does not challenge
this holding on this appeal.
7
salary. The award further provided that should the pension
increase be judicially overturned, it would be replaced by
an across-the-board pay increase of $1,000. This award4
affected Kute's annual pension amount, the timing of when
that amount is due, and the timing and amount of the
return of his contributions. As such, the pension benefits
were derived from the DiLauro Award rather than from the
Retirement System. The Retirement Code makes no
reference to the pension benefit under which he retired.
While those benefits were inserted into the Retirement
Code's structure for ease of administration, the award as
opposed to the Retirement Code established them.
Moreover, the legislature never amended the Retirement
Code to add the benefits. Thus, the district court, in Kute's
view, erred in determining that the lump sum amount was
taxable under I.R.C. S 72(t).
As we have indicated, we are concerned here with a
qualified pension plan under I.R.C. S 401(a). Under I.R.C.
S 402(a)(1) (now I.R.C. S 402(a)), an amount distributed is
taxable to the distributee in the year in which it is
distributed under I.R.C. S 72. I.R.C. S 72(a) provides that in
general gross income includes any amount received as an
annuity, but I.R.C. S 72(b) excludes amounts attributable to
the taxpayer's investment in the contract. While a plan can
seek an advance determination from the IRS that it is
qualified under I.R.C. S 401(a), it is not required to do so.
See Cornell-Young Co. v. United States, 469 F.2d 1318,
1320 (5th Cir. 1972). In this case, as we have indicated, the
Commonwealth has not sought a determination that the
plan is qualified but no one has challenged that it has that
status. While we need not set forth in detail the additional
tax implications of a plan being qualified, we do point out
that a qualified plan gives employees the benefit of deferring
taxes until when they receive distributions from the plan.
There are, however, limitations on the tax advantages of
an I.R.C. S 401(a) plan intended to discourage early
withdrawals. In particular, as effective in 1992, and as
_________________________________________________________________
4. In his brief Kute indicates that the "pension benefit" had these
consequences, br. at 10, but we believe he is referring to the DiLauro
Award.
8
germane here, I.R.C. S 72(t)(1) provided that the tax on any
amount includable in gross income received from a
qualified plan shall be increased by an amount equal to ten
percent of that amount, except for distributions made on or
after the date on which the employee attains age 59. There
is, however, a restriction on the imposition of the additional
tax, as the tax does not apply to part of a series of
substantially equal periodic payments (not less frequently
than annually) made for the life or life expectancy of the
employee. See I.R.C. S 72(t)(2)(A)(iv). Kute, of course, began
receiving the monthly payment long before he reached 59
years of age, but by reason of I.R.C. 72(t)(2)(A)(iv), his
monthly payments have not been subject to the additional
tax.
The lump sum payment, however, is another matter. As
we have stated, Kute concedes that the plan is qualified.
Moreover, he does not contend that an exception to the
requirement for the additional tax is applicable. Instead, he
contends that the distribution, rather than being from a
qualified plan, was attributable to the DiLauro award so
that I.R.C. S 72(t) was simply not applicable to it.
The district court rejected that argument and so do we as
it does not conform to the realities of the situation. See,
e.g., Geftman v. Commissioner, 154 F.3d 61, 68 (3d Cir.
1998). In Fraternal Order of Police the Supreme Court of
Pennsylvania held that the pension benefits due to state
troopers could be modified by an arbitration award. See
575 A.2d at 96-97. Then the Retirement Board, pursuant to
its authority to adopt rules and regulations, 71 Pa. Cons.
Stat. Ann. S 5902(h), passed a resolution on September 26,
1990, to implement the award. The resolution provided that
the increased benefits would be "inserted into the
Retirement Code structure," and that "[a]ll other Code
benefits remain in full force and effect and [that] all
optional benefit payment plans . . . remain in effect."
Moreover, the Retirement Board's resolution expressly
inserted the DiLauro Award "into the Retirement Code
structure."
There can be no doubt that the Retirement Board had the
authority to implement the changes it did without further
legislative action as the Commonwealth Court in
9
Pennsylvania State Troopers Ass'n upheld the Retirement
Board's action. See 677 A.2d at 1332. Furthermore, the
legislature, which apparently was dissatisfied with the
DiLauro Award, amended 71 Pa. Cons. Stat. Ann. S 5955 to
provide, but only prospectively, that the Retirement Code
alone would be the source of state employees' pension
rights. But at the same time it effectively ratified the
DiLauro Award because amended section 5955 provides
that "[n]otwithstanding the foregoing, any pension or
retirement benefits or rights previously so established by or
as a result of an arbitration award shall remain in effect
after the expiration of the current collective bargaining
agreement between the State employees so affected and the
Commonwealth."
Kute himself demonstrated by his actions that he
received the lump sum payment from a qualified plan as he
elected to obtain the benefit pursuant to Option 4 of the
Retirement Code, which provides that an employee may
receive a portion of his benefit in that form. Nothing in the
DiLauro Award even mentions such an option, as the award
dealt only with periodic payments. Overall, we are satisfied
that the district court clearly reached the correct result.
III. CONCLUSION
For the foregoing reasons the order for summary
judgment entered January 15, 1999, will be affirmed.
A True Copy:
Teste:
Clerk of the United States Court of Appeals
for the Third Circuit
10