Matz, Robert v. Household Int'l Tax ( 2004 )

In the
United States Court of Appeals
For the Seventh Circuit
____________
Nos. 03-4344, 03-4345
ROBERT J. MATZ, individually and on
behalf of all others similarly situated,
Plaintiff-Appellee, Cross-Appellant,
v.
HOUSEHOLD INTERNATIONAL TAX
REDUCTION INVESTMENT PLAN,
Defendant-Appellant, Cross-Appellee.
____________
Appeals from the United States District Court for
the Northern District of Illinois, Eastern Division.
No. 96 C 1095—Joan B. Gottschall, Judge.
____________
ARGUED SEPTEMBER 8, 2004—DECIDED NOVEMBER 5, 2004
____________
Before POSNER, RIPPLE, and WOOD, Circuit Judges.
POSNER, Circuit Judge. The district judge, in this suit by
participants in an ERISA pension plan, has asked us, and we
have agreed, to entertain an interlocutory appeal from a
ruling in which she answered in favor of the plaintiffs a
potentially controlling question of law that had arisen in the
course of the litigation. 28 U.S.C. § 1292(b). (The plaintiffs
2 Nos. 03-4344, 03-4345
have cross-appealed, but since they are defending rather
than attacking the judge’s ruling, the cross-appeal is im-
proper, Rose Acre Farms, Inc v. Madigan, 956 F.2d 670, 672
(7th Cir. 1992), and is hereby dismissed.) The question is the
correct approach to deciding whether an ERISA pension
plan—in this case a defined-contribution plan in which the
employer matched contributions that its employees made by
means of payroll deductions to individual retirement
accounts—has been partially terminated.
Provided that certain requirements are met, the interest
or other earnings in an individual retirement account are
not taxed as they accrue. John D. Colombo, “Paying for the
Sins of the Master: An Analysis of the Tax Effects of Pension
Plan Disqualification and a Proposal for Reform,” 34 Ariz.
L. Rev. 53, 56-58 (1992); see 26 U.S.C. §§ 402(a), 501(a).
Suppose the employer terminates the plan. Were it not for
the special rule on terminations that is the focus of this case,
an employee whose pension entitlement had not yet fully
vested would receive (i.e., would be deemed fully vested as
to), over and above the vested portion of the employer’s con-
tribution, only the contributions he had made to his retire-
ment account, plus the earnings on them. The portion of the
employer’s contributions that had not yet vested would
revert to the employer, compare 29 U.S.C. § 1053(a)(2) with
id. § 1053(a)(1), yielding it a tax benefit because the amount
by which its contributions had grown as a result of the pen-
sion plan’s investing them would have escaped being taxed.
But this is where the special rule clicks in: in the event of
termination the rights of all the participants in the terminated
plan vest in full, so that none of the money that the em-
ployer contributed is returned to it. 26 U.S.C. § 411(d)(3).
The purpose of the rule is to prevent plan terminations
motivated by the prospect of a tax windfall. Matz v. Household
International Tax Reduction Investment Plan, 227 F.3d 971, 975
Nos. 03-4344, 03-4345 3
(7th Cir. 2000), vacated on other grounds, 533 U.S. 925(2001) (per curiam); Bruch v. Firestone Tire & Rubber Co., 828
F.2d 134, 151 (3d Cir. 1987), reversed in part on other grounds,
489 U.S. 101 (1989); Vincent Amoroso et al., “A Policy Premise
Approach to Partial Terminations,” New York University Review
of Employees Benefits and Executive Compensation § 8.01[3],
pp. 8-9 (2002); E. Thomas Veal & Edward R. Mackiewicz,
Pension Plan Terminations 364-65 (2d ed. 1998). We are uncon-
vinced by an alternative rationale sometimes suggested for
the rule—to protect nonvested employees’ expectations
of receiving pension benefits. Tipton & Kalmbach, Inc. v.
Commissioner, 83 T.C. 154, 160-61 (1984); see also Matz v.
Household International Tax Reduction Investment Plan, supra,
227 F.3d at 975; Halliburton Co. v. Commissioner, 100 T.C. 216,
227-28 (1993). Until his pension benefits have vested, an
employee at will, lacking as he does any job tenure, has no
reasonable expectations of receiving benefits. The point of
vesting is to create such an expectation.
To prevent evasion, the rule requiring immediate vesting
of all participants’ pension benefits applies to “partial” termi-
nations as well as to complete ones. The statute does not
define “partial termination,” however, although a Treasury
Regulation tells the IRS to base the determination on “all the
facts and circumstances of a particular case.” 26 C.F.R.
§ 1.1411(d)-2(b)(1). Despite the phrasing of the regulation,
and “despite their origin in tax law, disputes as to whether
a partial termination has occurred rarely involve the IRS,
which has been a party to only a small minority of the reported
cases and rulings.” Veal & Mackiewicz, supra, at 363. This
case is not one of the small minority. (Actually not such a
small minority, as the table later in this opinion reveals.)
The case law has assumed that the regulation is intended to
guide adjudicators as well as the IRS, and we shall indulge
the assumption.
4 Nos. 03-4344, 03-4345
So vague a regulation is no help to anyone. But some
years ago the IRS, in an amicus curiae brief filed in Weil v.
Retirement Plan Administrative Committee, 933 F.2d 106 (2d
Cir. 1991), suggested that, with an important qualification
that we’ll take up at the end of this opinion, a pension plan
should be deemed partially terminated if at least 20 percent
of the plan’s participants lose coverage. The IRS was putting
welcome flesh on a skeletal regulation, and the court in Weil
deferred to the IRS’s position on the basis of the Chevron prin-
ciple. 933 F.2d at 110. So did we the first time this protracted
litigation came before us. Matz v. Household International
Reduction Investment Plan, supra. The Supreme Court, however,
vacated our decision, 533 U.S. 925 (2001) (per curiam), in
light of the just-decided United States v. Mead Corp., 533 U.S.
218 (2001), where the Court had ruled that informal agency
actions are not to receive Chevron deference. A position
stated in an amicus curiae brief has seemed to us a good
example of what the Court had in mind. Keys v. Barnhart,
347 F.3d 990, 993-94 (7th Cir. 2003); see also Matz v. Household
International Tax Reduction Investment Plan, 265 F.3d 572, 574-
75 (7th Cir. 2001); Doe v. Mutual of Omaha Ins. Co., 179 F.3d
557, 563 (7th Cir. 1999); cf. In re New Times Securities Services,
Inc., 371 F.3d 68, 80-82 (2d Cir. 2004).
On remand from the Supreme Court, freed from the IRS
incubus we “adopt[ed] the rule that only non-vested parti-
cipants should be counted in determining whether partial
termination of a pension plan has occurred.” 265 F.3d at 576.
By “non-vested” we meant not fully vested. ERISA requires
that at least 20 percent of the employee’s benefits vest at the
end of the third year, another 20 percent at the end of the
fourth, and so on, so that by the end of seven years the
employee is fully vested. 29 U.S.C. § 1053(a)(2)(B). (The plan
can provide for more rapid vesting, § 1053(d), and this one
did; vesting was complete in five years rather than seven.)
The case went back down to the district court, where the
Nos. 03-4344, 03-4345 5
question arose whether we had meant that vested partici-
pants should be excluded only from the numerator or also
from the denominator in deciding how “partial” the
termination had been. The 20 percent figure in the IRS’s
amicus brief in Weil was the percentage of the plan’s parti-
cipants who were terminated, irrespective of how many either
of them or of the remaining participants were fully vested.
From a favorable reference in our first opinion, see 227
F.3d at 975-76, to In re Gulf Pension Litigation, 764 F. Supp.
1149 (S.D. Tex. 1991), affirmed under the name Borst v.
Chevron Corp., 36 F.3d 1308 (5th Cir. 1994), the district judge
inferred that we would exclude from both numerator and
denominator all fully vested participants, although we hadn’t
said that. So if the plan had 200 participants, 50 lost their
plan coverage, 10 of those were not fully vested, and the
total number of not fully vested participants was 20, the
relevant percentage would be not 25 percent (50 ÷ 200) but
50 percent (10 ÷ 20). The judge reasoned that since the effect
of termination, either from the participants’ standpoint or
from the tax standpoint, is limited to those who aren’t fully
vested, they are the only participants who should be con-
sidered in deciding whether a partial termination has
occurred. The plan agrees that only participants who were
not fully vested should be in the numerator, but it argues
that all the participants should be in the denominator,
which would change the percentage in our hypothetical
example from 50 percent to 5 percent (10 ÷ 200).
Which approach is right? And what difference does it
make in this case, where, as a result of a series of reorgan-
izations of subsidiaries of Household, a total of 2,396 of
the 11,955 participants in Household’s plan ceased to be
participants? We can and shortly will select what we believe
to be the correct approach. But because of unresolved issues
in the district court (remember that the case is here on
6 Nos. 03-4344, 03-4345
interlocutory appeal), we can’t use the approach to generate
a definite percentage in this case.
One of the unresolved issues is whether the terminations
should be treated as a single termination. They were closely
related in time (all occurred between the end of August 1994
and the end of June 1996) and appear to have had the same
motive, unlike the two partial terminations in Administrative
Committee of Sea Ray Employees’ Stock Ownership & Profit
Sharing Plan v. Robinson, 164 F.3d 981, 987-88 (6th Cir. 1999),
which had unrelated causes. See Matz v. Household International
Tax Reduction Investment Plan, supra, 227 F.3d at 976-77
and 265 F.3d at 576; Weil v. Retirement Plan Administrative
Committee, 750 F.2d 10, 13 (2d Cir. 1984). But there is no
actual finding by the district court.
Likewise unresolved are whether the figure for participants
whose coverage is canceled includes any of the employees
who Household asserts left voluntarily (the plaintiffs claim on
the contrary that those employees were constructively dis-
charged) and therefore shouldn’t count in determining
whether a partial termination has occurred, Sage v. Automation,
Inc. Pension Plan & Trust, 845 F.2d 885, 891-92 (10th Cir. 1988);
whether only participants who were employed by the reorg-
anized entities, as opposed to Household itself, should be
counted; and how to treat participants who became fully
vested during or at the end, rather than at the beginning, of
the reorganizations. By our calculations (the district court
can redo them if we’ve made a mistake), the percentage re-
duction in coverage under the IRS’s approach ranges from
15.4 percent, if all three issues are resolved in the plan’s
favor, to 35.8 percent if all three issues are resolved in favor
of the plaintiffs. The corresponding percentages under the
district court’s (and the plaintiffs’) approach are 13.5 percent
and 79.8 percent, and under the plan’s approach they are 7.2
percent and 16.4 percent. We do not know what further
Nos. 03-4344, 03-4345 7
adjustments would be necessary if the terminations were
treated separately rather than as one.
Although our decision in the last appeal of this case ges-
tured toward the Gulf Pension approach (not fully vested
over not fully vested, the district court’s and the plaintiffs’
preferred approach), it did not adopt that approach expli-
citly. This has opened the way for the plan to argue as we
noted that while the numerator should be limited to the not
fully vested, the denominator should not be. It is true that
if only a very small percentage of plan participants lose
benefits, the policy of the statute is not strongly engaged. But
that does not justify the plan’s approach, which has bizarre
consequences. For suppose, in a variant of our hypothetical
case, that the plan was terminated as to all but 10 of the 200
participants and of those 10, five were not fully vested. On
the plan’s view, this would be only a 2.5 percent termination
(5/200), and hence not a partial termination on anyone’s
view. But how can a reduction in the coverage of a plan
from 200 to 10 employees—a reduction of 95 percent—not
be considered even a partial termination? To say it is not
would do extreme violence to the language of the statute.
But so does the district court’s approach. Suppose that only
one of the 200 participants is nonvested, and now the plan
is modified so that he loses coverage. Is this a partial termi-
nation? Under the district court’s approach, absolutely— the
termination percentage is 100 percent.
Where both approaches go astray is in confusing the pur-
pose of a statute with its terms, a common error. Brogan v.
United States, 522 U.S. 398, 402-04 (1998); Board of Governors
of Federal Reserve System v. Dimension Financial Corp., 474 U.S.
361, 373-75 (1986); Wood v. Thompson, 246 F.3d 1026, 1035
(7th Cir. 2001); United States v. Medico Industries, Inc., 784
F.2d 840, 844 (7th Cir. 1986). (A further stumble was to as-
sume that the 20 percent figure, which the IRS adopted with
8 Nos. 03-4344, 03-4345
reference to all participants, fully vested and not, could have
any application when all participants are replaced, in either
numerator or denominator or both, with not fully vested
participants. Such an alteration would change the premises
of the IRS’s choice of the 20 percent benchmark.) The
purpose of section 411(d)(3) of the Internal Revenue Code is to
prevent an employer from obtaining a tax windfall at the
expense of the not fully vested participants in his plan. But
the statute does not provide that plan alterations which
result in a tax windfall at the expense of such participants
shall be deemed terminations and precipitate full vesting. It
provides that terminations precipitate full vesting, and to
prevent evasion adds that terminations include partial ter-
minations.
The natural way to decide whether a partial termination
has occurred is to see how close it is to a complete termina-
tion. On the one hand, clearly an employer shouldn’t be able
to get away with ejecting 99 percent of the plan’s partici-
pants. On the other hand, no one is arguing that an em-
ployer should be forbidden to alter his plan in the slightest
degree without forfeiting tax benefits. Such a rule would go
far toward erasing the distinction between fully vested and
not fully vested employees. For every time the plan was
altered to remove even a small handful of not fully vested
participants, there would be a case for treating the alteration
as a partial termination, requiring immediate full vesting of
all not yet fully vested participants.
So where to draw the line? The IRS, which is not famous
for encouraging tax windfalls, draws it at 20 percent. As we
look back upon the course of this litigation, now in its ninth
year and its third interlocutory appeal to this court, we find
ourselves drawn back to the IRS’s position. Not because it
is entitled to Chevron deference—we adhere to our holding
Nos. 03-4344, 03-4345 9
that it is not—but because, having toyed with the alterna-
tives, we think it is the best available and we respect the
IRS’s experience in formulating tax rules.
But what about that Treasury Regulation we quoted earlier,
which tells the IRS and presumably us as well to base the
determination of whether a partial termination has occurred
on “all the facts and circumstances of a particular case”?
This language has given rise to judicial formulations like the
following that are distressingly vague: “The regulation’s
plain language clearly directs us to consider all the facts and
circumstances, of which the percentage of excluded plan
participants is but one, albeit generally the most persuasive
one. Of course, in a particular case the percentage may be so
high or so low as to be determinative standing alone, but as
a general matter we must look beyond the mere percentages
unless and until Congress or the Treasury Department
provides otherwise.” Kreis v. Charles O. Townley, M.D. &
Associates, P.C., 833 F.2d 74, 79-80 (6th Cir. 1987) (citations
omitted); see also Administrative Committee of Sea Ray
Employees’ Stock Ownership & Profit Sharing Plan v. Robinson,
supra, 164 F.3d at 987; Freeman v. Central States, Southeast &
Southwest Areas Pension Fund, 32 F.3d 90, 92 n. 5 (4th Cir.
1994); cf. Gluck v. Unisys Corp., 960 F.2d 1168, 1183 (3d Cir.
1992).
We acknowledge that even the 20 percent rule proposed
in the IRS’s amicus brief in Weil was not intended to be hard
and fast despite its appearance of mathematical exactitude.
See Brief for the United States as Amicus Curiae in Weil
v. Retirement Plan Administrative Committee, pp. 7-8; Veal &
Mackiewicz, supra, at 368-69; Halliburton Co. v. Commissioner,
supra, 100 T.C. at 237; Internal Revenue Manual § 7.12.1.2.7,
http://www.irs.gov/irm/index.html. And yet the follow-
ing table (adapted from Veal & Mackiewicz, supra, at 367),
which summarizes the cases (treating cases involving dis-
10 Nos. 03-4344, 03-4345
tinct plans as multiple cases) and rulings on partial termina-
tion, reveals the surprising robustness of the 20 percent
benchmark:
PARTIAL TERMINATION CASES AND RULINGS
Case or Ruling Total Number Percentage Partial
Partici- Who Lost Who Lost Termina-
pants Coverage Coverage tion?
Revenue Ruling 69–24, 224 220 98.2 Yes
1969 Cumulative Bulletin
110
Collignon v. Reporting Ser- 6 5 83.3 Yes
vices Co., 796 F. Supp.
1136 (C.D. Ill. 1992)
Revenue Ruling 73–284, 15 12 80.0 Yes
1973–2 Cumulative Bulle-
tin 139
Revenue Ruling 72–439, 170 120 70.6 Yes
1972–2 Cumulative Bulle-
tin 223
Peter M. Boruta M.D., P.C. 3 2 66.7 Yes
v. Commissioner, 55
T.C.M. 670 (1988)
Revenue Ruling 81–27, 165 95 57.6 Yes
1981–1 Cumulative Bulle-
tin 228 (superseding Rev-
enue Ruling 72–510,
1972–2 Cumulative Bulle-
tin 223)
Tipton & Kalmbach, Inc. v. 43 22 51.2 Yes
Commissioner, supra (1972
plan year)
In re Gulf Pension Litiga- 14,233 6,427 45.2 Yes
tion, supra
In re Gulf Pension Litiga- 24,599 8,534 34.7 Yes
tion, supra (alternative
calculation)
Weil v. Retirement Plan 386 132 34.2 Yes
Administrative Committee,
1988 U.S. Dist. Lexis 5802,
at *5 (S.D.N.Y. June 15,
1988)
Tipton & Kalmbach, Inc. v. 65 22 33.8 Yes
Commissioner, supra (1971
plan year)
Nos. 03-4344, 03-4345 11
Administrative Committee 3,111 867 27.9 No
of Sea Ray Employees’
Stock Ownership & Profit
Sharing Plan v. Robinson,
1996 U.S. Dist. Lexis
22772, at *93 (E.D. Tenn.
Oct. 30, 1996) (1991 plan
year)
Halliburton Co. v. Commis- 19,598 3,891 19.9 No
sioner, supra
Administrative Committee 4,084 651 15.9 No
of the Sea Ray Employees’
Stock Ownership & Profit
Sharing Plan v. Robinson,
supra (1990 plan year)
Morales v. Pan American 835 128 15.3 No
Life Ins. Co., 718 F. Supp.
1297, 1303 (E.D. La. 1989),
affirmed on other
grounds, 914 F.2d 83 (5th
Cir. 1990)
Kreis v. Townley, supra 20 3 15.0 No
Babb v. Olney Paint Co., 109 16 14.7 No
764 F.2d 240 (4th Cir.
1985)
Kreis v. Townley, supra 22 3 13.6 No
(second plan)
Wishner v. St. Luke’s Hos- 1,529 57 3.7 No
pital Center, 550 F. Supp.
1016 (S.D.N.Y. 1982)
Ehm v. Phillips Petroleum 16,444 415 2.5 No
Co., 583 F. Supp. 1113 (D.
Kan. 1984)
Bruch v. Firestone Tire & 10,500 228 2.2 No
Rubber Co., 640 F. Supp.
519, 530 (E.D. Pa. 1986)
In 20 of the 21 cases and rulings, if 20 percent or more of the
participants lose coverage, there is a finding of a partial
termination, and if fewer than 20 percent do, a partial
termination is not found. The exception is the Sea Ray case,
where a 27.9 percent loss of coverage was held not to be a
partial termination because the loss was the consequence
purely of economic conditions; the employer was not mo-
tivated by any desire to obtain a tax benefit or reallocate
pension benefits to favored participants in the pension plan.
12 Nos. 03-4344, 03-4345
In an effort to make the law as certain as possible without
opening up gaping loopholes, we shall generalize from the
cases and the rulings a rebuttable presumption that a 20
percent or greater reduction in plan participants is a partial
termination and that a smaller reduction is not. How rebut-
table? One can imagine cases in which a somewhat smaller
reduction in the percentage of plan participants would be
tax-driven and might on that account be thought a “partial”
termination, and other cases, like Sea Ray, in which the
reduction is perhaps not so far above 20 percent that further
inquiry is inappropriate. We assume in other words that
there is a band around 20 percent in which consideration of
tax motives or consequences can be used to rebut the
presumption created by that percentage. A generous band
would run from 10 percent to 40 percent. Below 10 percent,
the reduction in coverage should be conclusively presumed
not to be a partial termination; above 40 percent, it should
be conclusively presumed to be a partial termination.
We have considered whether we should invite the IRS to
submit an amicus curiae brief advising us of its current view
of the proper approach to determining partial termination.
We have decided not to do so because of the great age of the
case. Obviously should the IRS decide on its own to revisit
the issue, we would give its views significant weight and
therefore the rule we have just formulated for deciding such
cases as this should be considered tentative.
The range of possible reduction-of-coverage percentages
in the present case—15.4 percent to 35.8 percent (treating
the series of terminations as a single event—if on remand
the district court rejects that treatment this will affect the
range, perhaps decisively)—lies within the band, and so a
remand will be necessary in which the district court will
have to consider additional “facts and circumstances.” But
given that the statutory purpose is to prevent tax windfalls,
Nos. 03-4344, 03-4345 13
it seems to us that the only relevant facts and circumstances
should be the tax motives and tax consequences involved in
the reduction in plan coverage.
VACATED AND REMANDED.
A true Copy:
Teste:
_____________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-02-C-0072—11-5-04