Connecticut Mutual Life Insurance Company and Consolidated Subsidiaries v. Commissioner , 106 T.C. No. 27 ( 1996 )

106 T.C. No. 27UNITED STATES TAX COURT
CONNECTICUT MUTUAL LIFE INSURANCE COMPANY AND CONSOLIDATED
SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE,
Respondent
Docket No. 4291-94. Filed June 26, 1996.
P created a voluntary employees' beneficiary
association (VEBA) trust designed to fund P's future
holiday pay obligations to its employees. On or about
Dec. 27, 1985, P contributed $20 million to the VEBA.
This $20 million contribution significantly exceeded
the amount of P's average annual holiday pay
obligation, which was approximately $2 million. P
deducted the entire $20 million contribution as an
ordinary and necessary business expense on its 1985
Federal income tax return.
Held: P's $20 million contribution to the VEBA in
1985 provided P with substantial future benefits. P is
therefore not entitled to deduct its $20 million
contribution in 1985. INDOPCO, Inc. v. Commissioner,
503 U.S. 79 (1992), applied.
- 2 -
Matthew J. Zinn, J. Walker Johnson, and Tracy L. Rich,
for petitioner.
Jill A. Frisch and Randall P. Andreozzi, for respondent.
RUWE, Judge: Respondent determined a deficiency of
$7,372,712 in petitioner’s 1985 Federal income tax. The sole
issue for decision is whether petitioner is entitled to a 1985
deduction for its $20 million contribution to a voluntary
employees’ beneficiary association (VEBA) trust. In order to
prevail, petitioner must establish that the $20 million
contribution was an ordinary and necessary business expense under
section 162(a).1
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts is incorporated herein by this
reference. At the time its petition was filed, petitioner
maintained its principal office in Hartford, Connecticut.
During all relevant periods, petitioner was a mutual life
insurance corporation subject to tax under the provisions of
sections 801-818. Petitioner filed its Federal income tax
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable year in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
- 3 -
returns on a calendar year basis using the accrual method of
accounting.
During 1984, two of petitioner’s officers--Richard Bush2 and
Robert Chamberlain3--initiated discussions regarding VEBA's.
These discussions began with an analysis of the benefits of using
VEBA's to fund employee welfare benefits and eventually led to a
recommendation that a VEBA be created.
VEBA I
On December 28, 1984, petitioner established a VEBA trust
entitled the “Connecticut Mutual Life Insurance Company Voluntary
Employee Beneficiary Trust”. This VEBA trust (VEBA I) was
established to fund the cost of certain medical and group life
insurance benefits. Petitioner's $7,293,225 contribution to VEBA
I funded benefits for 1 year. Petitioner claimed a Federal
income tax deduction for the entire contribution on its 1984
income tax return.
VEBA II
Since its incorporation in 1846, petitioner has provided its
employees with annual fixed paid holidays. Petitioner has never
2
Mr. Bush had been an assistant counsel in petitioner’s
legal department since 1981. In April 1985, Mr. Bush became an
assistant vice president in the corporate tax department.
3
During 1984, Mr. Chamberlain served as an assistant vice
president in petitioner's human resources department.
- 4 -
failed to pay any employee for a fixed holiday when the employee
was entitled to holiday pay under petitioner’s employment
policies.
Petitioner believed that the use of a VEBA to fund its
holiday pay obligations would produce tax savings and allow
petitioner to provide employee benefits more efficiently. In
particular, petitioner anticipated that tax savings would result
from the income tax benefit to be gained from an up-front
deduction for the entire contribution to the VEBA, the reduction
of surplus tax,4 and the income tax saved because the VEBA’s
investment earnings would be tax exempt pursuant to section
501(c)(9).5 Assuming that petitioner was allowed a complete
4
Surplus tax is a term used in the life insurance industry
to refer to the reduction that sec. 809(a)(1) imposes on a life
insurance company's policyholder dividends deduction under sec.
808(c). The parties have stipulated that petitioner's use of
VEBA II to fund holiday pay benefits saved petitioner surplus tax
under sec. 809 in the following amounts:
Year Amount
1985 $117,318
1986 -0-
1987 594,394
1988 64,260
1989 -0-
1990 60,112
1991 -0-
1992 -0-
1993 -0-
5
Sec. 501(a) exempts from taxation VEBA's that provide for
the payment of life, sick, accident, or other benefits to
employees, or their dependents or designated beneficiaries,
(continued...)
- 5 -
deduction in 1985, and that the VEBA was not liquidated until
1998, Mr. Bush estimated that the present value of petitioner's
tax savings on December 27, 1985, was $5,455,000.
On December 24, 1985, petitioner established the Connecticut
Mutual Life Insurance Company Holiday Pay Plan6 (holiday pay
plan), and on December 27, 1985, petitioner established the
Connecticut Mutual Life Insurance Company Employee Welfare
Benefit Trust (referred to herein as VEBA II or VEBA II trust).
Petitioner created the trust as a funding medium for its holiday
pay plan. On or about December 27, 1985, petitioner contributed
$20 million to the trust and deducted the entire contribution on
its 1985 Federal income tax return as an ordinary and necessary
business expense.
The holiday pay plan and the VEBA II trust essentially
provided for the following:
5
(...continued)
provided that no part of the net earnings of the employer inures
(other than through such payments) to the benefit of any private
shareholder or individual. Sec. 501(c)(9).
On May 13, 1986, petitioner transmitted to the Internal
Revenue Service a completed Form 1024 (Application for
Recognition of Exemption Under Section 501(a) or for
Determination Under Section 120) for the VEBA II trust. On Jan.
13, 1988, the IRS recognized the tax-exempt status of the VEBA II
trust, determining that it qualified as a voluntary employees'
beneficiary association pursuant to sec. 501(c)(9).
6
Petitioner amended the holiday pay plan on Dec. 31, 1985.
- 6 -
(1) Membership in the holiday pay plan consisted of
petitioner’s employees, with minor exceptions that are not
relevant to our decision.
(2) Members would receive holiday pay benefits for 8 fixed
holidays7 designated by petitioner for each plan year, commencing
with the Memorial Day holiday on May 26, 1986. However, if
petitioner altered the number of fixed holidays designated for a
particular plan year, the plan would only provide holiday pay
benefits for the number of holidays then so designated by
petitioner.
(3) The trustees of VEBA II were to hold, invest, and
distribute the trust fund in accordance with the terms in the
trust agreement. Petitioner was to make an initial contribution
to the trust in 1985, and such additional contributions in
subsequent plan years as petitioner deemed appropriate, to pay
for plan benefits and administrative expenses on a continuing
basis. In the event there was an excessive accumulation of fund
earnings in a particular plan year after payment of plan benefits
and administrative expenses for that plan year, and the
accumulation of fund earnings attributable to that plan year was
not used to pay plan benefits or administrative expenses in the
immediately succeeding plan year, then petitioner would direct
7
During 1985, petitioner provided 10 paid holidays to its
employees, of which 8 were fixed holidays on days specified by
petitioner and 2 were floating holidays on days chosen by the
individual employee.
- 7 -
the trustees to use these accumulated earnings to pay for other
types of permissible benefits under section 501(c)(9) within a
reasonable amount of time thereafter.
(4) It was not permissible for any part of the trust fund
to be diverted to purposes other than the benefit of the members
as provided under the plan or for payment of administrative
expenses of the trust fund.
(5) The trustees were to invest the assets of the trust
fund as a single fund, without distinction between principal and
income, in common stocks, preferred stocks, bonds, notes,
debentures, savings bank deposits, commercial paper, mutual
funds, and in such other property as the trustees deemed suitable
for the trust fund.
(6) Petitioner was entitled to amend or terminate the plan
and the trust agreement at any time. Under no circumstances,
however, could any assets of the fund revert to petitioner unless
the contribution was made due to mistake of fact and returned
within 1 year after such mistake became known.
(7) Upon termination of the plan, the trustees were to
apply all the remaining income and assets of the trust fund in a
uniform and nondiscriminatory manner toward the provision of plan
benefits or other life, sickness, accident, or similar benefits
permissible under section 501(c)(9).
The trust agreement named the following officers of
petitioner as trustees: Robert W. Rulevich, vice president;
- 8 -
Robert E. Casey, senior vice president, and Walter J. Gorski,
senior vice president and general counsel.
The Operation and Administration of VEBA II
Petitioner’s employee population during the period 1985
through 1994 was as follows:
Year Employee Population
1985 2,069
1986 2,165
1987 2,244
1988 2,118
1989 2,160
1990 2,082
1991 2,150
1992 2,076
1993 2,177
1994 1,765
The number of petitioner’s employees eligible to receive benefits
and whose holiday pay was funded pursuant to the holiday pay plan
during 1986 and subsequent years was as follows:
Year Employees
1986 2,106
1987 2,186
1988 2,012
1989 1,876
1990 1,728
1991 1,746
1992 1,664
1993 1,813
1994 1,645
- 9 -
The assets in VEBA II consisted of cash, State and municipal
securities, and shares of a regulated investment company. These
assets were held in custodial accounts. The amounts of
investment earnings produced by the principal in the VEBA II
trust were as follows:
Year Dividends and Interest
1986 $1,642,171
1987 1,643,649
1988 1,649,955
1989 1,650,062
1990 1,641,441
1991 1,637,590
1992 1,633,604
1993 (per Form 990) 1,605,327
(per Form 5500) 1,591,961
1994 1,536,469
Petitioner paid holiday pay directly to its employees who
were covered by VEBA II. The amounts of holiday pay benefits for
fixed holidays paid to employees covered by the holiday pay plan
were as follows:
Year Holiday Pay Plan Benefits Paid
1986 $1,523,997
1987 1,896,719
1988 1,800,515
1989 2,041,601
1990 2,101,084
1991 2,150,267
1992 2,209,211
1993 2,287,228
1994 1,768,692
- 10 -
The investment earnings of the VEBA II trust were
distributed from the trust to petitioner to reimburse petitioner
for the amounts of holiday pay it paid to employees. No portion
of the $20 million principal in the VEBA II trust has been
distributed. After 1986, the investment earnings from VEBA II
were insufficient to reimburse petitioner completely for its
holiday pay obligations. During the years 1987 through 1994, the
difference between petitioner's fixed holiday pay obligations
covered by VEBA II and the investment earnings from VEBA II was
supplied from the following sources:
Petitioner’s Holiday
Payments for which it Transfers from
Year Received no Reimbursement VEBA I or III
1987 $214,948
1988 150,845
1989 391,426
1990 $459,140
1991 547,128
1992 550,869 2,100
1993 626,750
1994 161,275
On petitioner's annual statement filed with the State of
Connecticut Insurance Department for 1985, petitioner treated the
$20 million contribution to VEBA II as an expense and charged the
contribution directly to its capital and surplus account. In
1992, petitioner sought and received approval from the State
Insurance Department to report the $20 million principal in VEBA
- 11 -
II as an asset. Thereafter, petitioner reported the VEBA II
trust as an admitted asset on its annual statements. The change
in petitioner's annual statement reporting resulted from its
desire to change to an accounting practice similar to that
adopted in the Statement of Financial Accounting Standards No.
87.
VEBA III
Subsequent to the establishment of the holiday pay plan and
the VEBA II trust, petitioner established a third VEBA trust
(VEBA III) in order to fund its wellness program and health
services plans. Petitioner contributed $10 million to VEBA III
in 1986 but claimed no Federal income tax deduction in the year
of contribution.8 In 1991 and 1992, petitioner liquidated VEBA
III because of expense problems and capital and surplus
management considerations. Petitioner used the funds from VEBA
III to pay employee benefits other than those provided under the
wellness and health services plans.9 Over $1 million, for
instance, was used to fund vacation pay for petitioner's
employees. By using the assets of VEBA III to pay employee
benefit expenses, petitioner's expenses for the year were
reduced, and petitioner was able to maintain surplus growth.
8
See infra p. 22.
9
Petitioner did not terminate these plans; they remained
intact but were unfunded.
- 12 -
OPINION
The issue for decision is whether petitioner is entitled to
a section 162(a) deduction for its $20 million contribution to
the voluntary employees' beneficiary association (VEBA II) trust
established to provide holiday pay to its employees.
Section 162(a) allows a deduction for all ordinary and
necessary business expenses paid or incurred during the taxable
year. With respect to deductions for employee benefits, section
1.162-10(a), Income Tax Regs., provides as follows:
Amounts paid or accrued within the taxable year for
dismissal wages, unemployment benefits, guaranteed
annual wages, vacations, or a sickness, accident,
hospitalization, medical expense, recreational,
welfare, or similar benefit plan, are deductible under
section 162(a) if they are ordinary and necessary
expenses of the trade or business. * * * [Emphasis
added.]
In order to qualify for deduction under section 162(a), five
requirements must be satisfied. The item must: (1) Be paid or
incurred during the taxable year; (2) be for carrying on a trade
or business; (3) be an expense; (4) be a "necessary" expense; and
(5) be an "ordinary" expense. Commissioner v. Lincoln Sav. &
Loan Association, 403 U.S. 345, 352 (1971). A capital
expenditure, in contrast, is not an "ordinary" expenditure within
the meaning of section 162(a) and is therefore not currently
deductible. Id. at 353; see sec. 263(a). Deductions from gross
- 13 -
income are a matter of legislative grace, and taxpayers bear the
burden of demonstrating that they are entitled to the deductions
they claim. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S.
79, 84 (1992).
The principal effect of characterizing a payment as either a
business expense or a capital expenditure concerns the timing of
the taxpayer's cost recovery. A business expense is currently
deductible, while a capital expenditure is normally amortized and
depreciated over the life of the relevant asset, or, if no
specific asset or useful life can be ascertained, is deductible
upon dissolution of the enterprise. INDOPCO, Inc. v.
Commissioner, supra at 83-84.
The Supreme Court's decision in INDOPCO, Inc. v.
Commissioner, supra, serves as the starting point for any
discussion on the distinction between ordinary and necessary
business expenses and capital expenditures. The Court emphasized
at the outset "that the 'decisive distinctions' between current
expenses and capital expenditures 'are those of degree and not of
kind'". Id. at 86 (quoting Welch v. Helvering, 290 U.S. 111, 114
(1933)). As a result, "the cases sometimes appear difficult to
harmonize." Id. The Court then rejected the argument that the
creation or enhancement of a separate and distinct asset is a
prerequisite to capitalization, explaining that "the creation of
a separate and distinct asset well may be a sufficient, but not a
necessary, condition to classification as a capital expenditure."
- 14 -
Id. at 87. The Supreme Court went on to hold that capitalization
is also required when the expenditure provides the taxpayer with
significant benefits beyond the year in which the expenditure is
incurred. Id. at 87-89. The Court cautioned, however, that "the
mere presence of an incidental future benefit--'some future
aspect'--may not warrant capitalization". Id. at 87. Applying
these principles to the case at hand, we must inquire into the
duration and extent of any benefits that petitioner received as a
result of its $20 million contribution to the VEBA II trust in
1985. See Black Hills Corp. v. Commissioner, 73 F.3d 799, 806
(8th Cir. 1996), affg. 102 T.C. 505 (1994); A.E. Staley
Manufacturing Co. v. Commissioner, 105 T.C. 166, 194 (1995).
Petitioner has provided its employees with fixed paid
holidays for the past 150 years. This holiday pay was a quid pro
quo for the employees' services. Petitioner's employees were
paid for a designated holiday only if they were employed by
petitioner on the working days immediately preceding and
following the holiday.
Through its contribution to the VEBA II trust, petitioner
effectively prefunded a substantial portion of its anticipated
holiday pay obligations for many years to come. Petitioner's own
expert witness, Stanley B. Rossman, opined that petitioner's $20
million contribution in 1985 was sufficient to pay holiday pay
benefits for 8 to 10 years. Mr. Rossman assumed that both income
and principal from VEBA II would be used to fund the full amount
- 15 -
of petitioner's annual holiday pay obligations. We believe this
is a very conservative estimate considering the fact that average
annual holiday pay covered by the plan for the years 1986 through
1994 was approximately $2 million. At that rate, the $20 million
fund would last for 10 years even if it generated no investment
income. In fact, investment earnings from VEBA II have covered
over 80 percent of petitioner's holiday pay obligations between
1986 and 1994.10
Petitioner, nevertheless, argues that its contribution
should be deductible because it is the employees, rather than
petitioner, who benefited from the creation of the VEBA and that
any future benefit to petitioner was merely incidental. In
support of its position, petitioner relies on two prior decisions
of this Court in which we permitted employers to deduct VEBA
contributions pursuant to section 162(a).
In Moser v. Commissioner, T.C. Memo. 1989-142, affd. on
other grounds 914 F.2d 1040 (8th Cir. 1990), we held that a
corporation was entitled to a deduction pursuant to section
162(a) for a $200,000 contribution to a VEBA created to provide
members with death benefits, sick and accident benefits, and
10
Petitioner has avoided using any of the original principal
to pay its holiday pay obligations. Since 1987, the annual
investment earnings from the VEBA II trust have been insufficient
to cover the total annual cost of petitioner's holiday pay
obligations. To make up the difference, petitioner has either
transferred funds from VEBA I or VEBA III or funded the
difference itself.
- 16 -
severance pay benefits. Since the benefits provided by the VEBA
were commensurate with the salaries and ages of its members, we
rejected the Commissioner's initial argument that the VEBA was
actually nothing more than a private investment fund created for
the benefit of petitioner's president, Berkley B. Strothman, and
his wife.
In addition, we determined that the Strothmans did not
possess "total unfettered control" over the VEBA's assets,
despite the fact that the Strothmans, via their controlling
interest in the employer-corporation, could effect amendments or
termination of the VEBA. We explained:
"We realize the [employer] could at any time
terminate or alter the plan although the monies of the
trust could never revert to or inure to the
[employer's] benefit. This minimal retention of
control is not sufficient to make the benefits of the
plan in any way illusory. Employers need to retain
rights to alter or terminate plans to meet the changing
needs of the employees and employer. This flexibility
may be required with numerous types of plans including
the medical, vacation and other welfare benefit plans
specified by regulation." * * * [Moser v.
Commissioner, T.C. Memo. 1989-142 (quoting Greensboro
Pathology Associates, P.A. v. United States, 698 F.2d
1196, 1203 n.6 (Fed. Cir. 1982)).]
A critical inquiry, therefore, was whether the funds in the plan
could ever revert to the employer, and this question was
"integrally related" to any analysis of whether the plan was
truly a "welfare or other similar benefit plan" to which
contributions are deductible by employers as ordinary and
- 17 -
necessary business expenses pursuant to section 162(a). Our
review of the plan documents in question indicated that the
reversion of any assets from the VEBA was clearly prohibited.
Finally, in Moser v. Commissioner, supra, we disagreed with
the Commissioner's argument that the corporation's contribution
was excessive, and, therefore, the corporation should not be
allowed a deduction for the full amount. The corporation's
$200,000 contribution was based on calculations made by a
financial consultant to ascertain the full amount of all
potential severance benefits and the life insurance and medical
insurance premiums that were necessary to fund death, disability,
and accident benefits for 1 year. We found that the
corporation's original $200,000 contribution had "provided for
full funding of the severance benefits and generated income
sufficient to fund the annual costs of providing VEBA benefits -
no more, no less." Moser v. Commissioner, supra.
In Schneider v. Commissioner, T.C. Memo. 1992-24, we held
that a personal service corporation was entitled to deduct
contributions made to three employee welfare benefit plans
established to provide death, disability, and termination
benefits to employees and educational benefits to the children of
eligible employees. The Commissioner argued that the
contributions at issue were capital expenditures because they
created a benefit for the taxpayer that lasted substantially
beyond the taxable year in which the contributions were made.
- 18 -
At the outset, this Court explained that "We have
traditionally analyzed the deductibility of an employer's
contributions to a welfare benefit plan by taking into
consideration, among other things, both the degree of control
which an employer retains over the plan and the degree to which
the employees, as opposed to the employer, are benefited."
Schneider v. Commissioner, supra; see also Weil Clothing Co. v.
Commissioner, 13 T.C. 873, 879-880 (1949). Regarding the first
consideration, we stated that in the context of an employee
benefit plan, an employer does not necessarily retain too much
control when it retains the right to terminate or alter the plan,
so long as the funds in the plan may never revert to or inure to
the benefit of the employer. Schneider v. Commissioner, supra.
Similarly, concerning the second consideration, we stated that
the employer's contributions must directly benefit its employees
rather than the employer.11 With respect to taxpayer
contributions that produce future benefits for the taxpayer, we
stated:
if an expenditure results in a substantial benefit to
the taxpayer, as distinguished from an incidental
benefit, which can be expected to produce returns to
11
See Anesthesia Serv. Medical Group, Inc. v. Commissioner,
85 T.C. 1031, 1044-1045 (1985), affd. 825 F.2d 241 (9th Cir.
1987) (holding that a trust established to provide protection
against the malpractice claims of the employer's physician-
employees was concerned primarily with the interests of the
employer, which was jointly and severally liable for the
negligence of its employees).
- 19 -
the taxpayer for a period of time in the future, then
the expenditure is deemed capital and cannot be
currently deducted. See National Starch & Chemical
Corp. v. Commissioner, 918 F.2d 426 (3d Cir. 1990),
affg. 93 T.C. 67 (1989), cert. granted INDOPCO, Inc. v.
Commissioner, 500 U.S. ___, 59 U.S.L.W. 3769 (May 13,
1991). [Schneider v. Commissioner, supra.]
Applying these principles to the facts in Schneider v.
Commissioner, supra, we determined that the taxpayer was entitled
to a deduction pursuant to section 162(a). First, we found that
the assets contributed by the employer were held in trust to
provide the benefits discussed above, and none of the employee
benefit plans allowed for the reversion of assets to the employer
in the event the plan was amended or terminated.
Second, we found that the employer's contributions to these
plans directly benefited its employees and that any future
benefit that the employer would derive from its contributions was
based solely on the expectation that its employees were more
likely to remain loyal and perform to the best of their abilities
if their economic needs were satisfied. In our view, such a
benefit was only an incidental or indirect benefit, and therefore
not controlling. See Weil v. Commissioner, supra at 879-880;
Elgin Natl. Watch Co. v. Commissioner, 17 B.T.A. 339, 358 (1929),
affd. 66 F.2d 344 (7th Cir. 1933).
We also rejected the Commissioner's argument that the
taxpayer's contributions were essentially prepaid expenses, which
were required to be capitalized. We found that the annual
- 20 -
contributions were computed by an independent actuary who
determined the amounts necessary to fund the plans for 1 year.
We concluded that "the evidence in this case supports
petitioner's contention that its contribution to each plan for a
particular year relates only to the year in which the payment was
made." Schneider v. Commissioner, supra.
In our view, Moser v. Commissioner, T.C. Memo. 1989-142, and
Schneider v. Commissioner, supra, are distinguishable from the
case at hand. The critical distinctions involve the particular
nature of the benefits funded as well as their permanence and
extent. See INDOPCO, Inc. v. Commissioner, 503 U.S. at 87; A.E.
Staley Manufacturing Co. v. Commissioner, 105 T.C. at 194-195.
The benefit plans at issue in Moser v. Commissioner, supra,
and Schneider v. Commissioner, supra, funded death, disability,
and severance benefits for the employees and, in Schneider,
educational benefits for the employees' children. The most
significant benefits payable under the plans involved in Moser
and Schneider were payable to employees upon the occurrence of an
event, which would terminate their services for the employer.
Employer contributions to these plans tended to boost employee
morale, but we found that the employer's only benefit was its
expectation that its employees were more likely to remain loyal
and perform to the best of their abilities. Schneider v.
Commissioner, T.C. Memo. 1992-24. As a result, we found that
these benefits provided the employer with only incidental or
- 21 -
indirect future benefits, which do not require capitalization.
See INDOPCO, Inc. v. Commissioner, supra at 87.
In contrast, VEBA II was the funding medium for petitioner's
future holiday pay obligations. These future obligations were
contingent upon the future performance of services by
petitioner's employees. Holiday pay is closely akin to salary,
the most basic obligation any employer undertakes. The $20
million contribution to VEBA II provided funds to reimburse
petitioner for holiday pay obligations that it expected to incur
for many years into the future.
The employees in Moser v. Commissioner, supra, and Schneider
v. Commissioner, supra, generally had a vested right to the
severance, disability, or death benefits at the time the employer
made the contribution. The occurrence of a qualifying event,
such as the death, disability, or termination of an employee,
entitled the employee to benefits regardless of the fact that the
employee would no longer be providing services to the employer.
In contrast, the creation of the VEBA II trust to fund holiday
pay benefits did not provide petitioner's employees with a vested
right to future holiday pay. Petitioner could reduce its holiday
pay benefits or even liquidate the VEBA II trust without
incurring any liability to its employees for future holiday
pay.12 The right to holiday pay did not vest unless and until an
12
On Jan. 1, 1995, petitioner adopted a new "paid time away
(continued...)
- 22 -
employee was employed by petitioner on the working days
immediately preceding and following the holiday. Thus, the
prefunding of petitioner's future holiday pay obligations was
inextricably linked to acquiring the future benefits that
petitioner would reap from its employees' services in subsequent
years.
In Moser v. Commissioner, supra, the contribution was an
amount that provided for full funding of the vested severance
benefits. This funding also generated income sufficient to pay
relatively small annual insurance premiums for other VEBA
benefits. In Schneider v. Commissioner, supra, the taxpayer's
contribution to each plan for a particular year related only to
the year in which the payment was made. Petitioner's
contribution, on the other hand, did not fund benefits that were
already vested and was not calculated to fund benefits for a
specific period. Petitioner established VEBA II to prefund its
holiday pay obligations for many years, and the future benefits
from this prefunding were far from incidental. Between 1986 and
1994, petitioner's annual holiday pay expenses covered by the
plan ranged from approximately $1.5 million to $2.2 million.
Petitioner's original $20 million contribution produced
investment earnings sufficient to cover over 80 percent of these
12
(...continued)
from work policy". As a result, only 6 holidays are now covered
under the holiday pay plan and funded through the VEBA II trust.
- 23 -
expenses. It is clear that petitioner's $20 million contribution
to VEBA II for the purpose of funding its future holiday pay
obligations resulted in a substantial future benefit.
Contributions that provide taxpayers with substantial, as opposed
to merely incidental, future benefits must be capitalized.
INDOPCO, Inc. v. Commissioner, supra at 87.
Nevertheless, petitioner contends that deductions of this
sort must necessarily be allowed for taxable years prior to 1986.
Petitioner argues that Congress enacted sections 419 and 419A,
applicable to years after 1985, to prohibit the type of deduction
at issue here. Sections 419 and 419A generally restrict
deductions for contributions made to welfare benefit funds to the
year that benefits are actually paid out to employees. See
Schneider v. Commissioner, supra. Petitioner points to a
discussion at the end of our opinion in Schneider v.
Commissioner, supra, where we rejected the Commissioner's
argument that the taxpayer's contributions were not deductible
until paid out by the plans as benefits. We remarked that "the
statute [section 162] was amended by the enactment of sections
419 and 419A to bring about that result in the case of
contributions made after 1985", Schneider v. Commissioner, supra,
and we quoted from the House report, which explained that the
enactments resulted from Congress' belief "'that the current
rules under which employers may take deductions for plan
contributions far in advance of when the benefits are paid allows
- 24 -
excessive tax-free accumulation of funds.'" Schneider v.
Commissioner, supra (quoting H. Rept. 98-432 (Pt. 2), at 1275
(1984)). We also referred to the conference report accompanying
the enactment of sections 419 and 419A, which stated that "'An
employer's contribution to a fund that is a part of a welfare
benefit plan may be deductible in the year it is made rather than
at the time the benefit is provided.'" Schneider v.
Commissioner, supra (quoting H. Conf. Rept. 98-861, at 1154
(1984), 1984-3 C.B. (Vol. 2) 408).
The discussion of sections 419 and 419A in Schneider v.
Commissioner, supra, is not inconsistent with our holding in the
instant case. Under the law applicable to pre-1986 years, there
simply was no requirement that deductions for contributions to
VEBA's be delayed until benefits were actually paid to the
employees. Sections 419 and 419A imposed this requirement for
contributions made after 1985. However, as we recognized in
Schneider, there had always been a requirement that an
expenditure be capitalized if the expenditure provided the
taxpayer with substantial future benefits. In Schneider v.
Commissioner, supra, we found that the expenditures in issue had
not provided the taxpayer with substantial future benefits. In
the instant case, we have found that petitioner's contribution to
VEBA II did result in substantial future benefits. Our decision
today, therefore, is consistent with Schneider v. Commissioner,
supra, and the state of the law in 1985. As the Supreme Court
- 25 -
explained in INDOPCO, Inc. v. Commissioner, 503 U.S. at 86-87, it
was not articulating any new legal standard in holding that
capitalization is required when expenditures provide the taxpayer
with significant future benefits.
Petitioner has failed to prove that its $20 million
contribution to VEBA II in 1985 constitutes an ordinary and
necessary business expense pursuant to section 162(a). Rule
142(a); INDOPCO, Inc. v. Commissioner, supra at 84. Respondent's
determination is, therefore, sustained.
Decision will be entered
for respondent.