Gordon J. and Bonnie L. Schoof v. Commissioner

110 T.C. No. 1UNITED STATES TAX COURT
GORDON J. AND BONNIE L. SCHOOF, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 4265-96, 6210-96, Filed January 12, 1998.
6394-96, 6617-96,
6761-96, 7632-96,
9362-96, 9490-96,
15341-96, 15342-96,
17606-96, 17607-96.
T, an individual, sought approval from the Internal
Revenue Service to become a trustee of an individual
retirement account (IRA) trust. During 1991,
distributions out of individual retirement plans were
made to Ps. Those distributions were then rolled over to
1
Cases of the following petitioners are consolidated
herewith: Lyman K. and Judith Kennedy, docket No. 6210-96; Melvin
L. and Gail H. Rush, docket No. 6394-96; Alice M. Johnson, docket
No. 6617-96; Robert J. and Bette Barraclough, docket No. 6761-96;
William N. and Joan E. Hughes, docket No. 7632-96; William W. and
Joan E. Agnew, docket No. 9362-96; Joe O. and Daurine M. Baker,
docket No. 9490-96; Joseph P. and Genice Spetz, docket No. 15341-
96; Robert C. and Mary D. Borman, docket No. 15342-96; Nurit
Haramgaal, docket No. 17606-96; and John S. Husmann and Elinor C.
MacKinnon, docket No. 17607-96.
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the IRA trusts of which T was to be the trustee.
Concurrently therewith each of the IRA trusts acquired a
unit(s) (or fraction thereof) in an investment in a bus
stop shelter program.
1. Held: T is not qualified to serve as a trustee
of an IRA trust under sec. 408(a)(2), I.R.C., and sec.
1.408-2(b)(2), Income Tax Regs.
2. Held, further, the distributions to Ps were
taxable in the year of distribution and were subject to
the 10-percent additional tax pursuant to sec. 72(t),
I.R.C.
3. Held, further, under Wood v. Commissioner, 93
T.C. 114 (1989), Ps did not substantially comply with the
rollover contribution requirements of sec. 408(d),
I.R.C., so as to exclude the distributions from income.
Stephen M. Goodman, for petitioners.
Lisa W. Kuo, for respondent.
JACOBS, Judge: Respondent determined deficiencies in
petitioners' 1991 Federal income tax as follows:
Docket
No. Petitioner(s) Deficiency
4265-96 Gordon J. and Bonnie L. Schoof $24,605
6210-96 Lyman K. and Judith Kennedy 4,112
6394-96 Melvin L. and Gail H. Rush 8,706
6617-96 Alice M. Johnson1 7,397
6761-96 Robert J. and Bette Barraclough 10,764
7632-96 William N. and Joan E. Hughes 128,225
9362-96 William W. and Joan E. Agnew 46,533
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9490-96 Joe O. and Daurine M. Baker 3,002
15341-96 Joseph P. and Genice Spetz 8,724
15342-96 Robert C. and Mary D. Borman 16,462
17606-96 Nurit Haramgaal 11,405
17607-96 John S. Husmann and Elinor C. MacKinnon 4,606
1
A notice of deficiency was issued to Alice M. Johnson and her
husband Duaine E. Johnson. Mr. Johnson died on Sept. 1, 1994. An
estate was not opened for him. Alice M. Johnson, as surviving
spouse, is the sole petitioner in docket No. 6617-96.
Each of these 12 consolidated cases involves the following
transactions: (a) A distribution from an individual retirement
plan, (b) an attempted tax-free rollover contribution of that
distribution to a newly established putative individual retirement
account trust, and (c) a purchase of a unit(s) (or fraction
thereof) in a bus stop shelter program. The issue for decision is
whether the rollover qualifies for tax-free treatment. Resolution
of this issue depends in part upon whether the trustee of the
putative individual retirement account trust is an eligible
trustee.
Unless otherwise indicated, all section references are to the
Internal Revenue Code in effect for the year in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The
stipulation of facts and attached exhibits are incorporated herein
by this reference.
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At the time the petitions were filed, the following
petitioners resided in California: Gordon J. and Bonnie L. Schoof;
Lyman K. and Judith Kennedy; Alice M. Johnson; William N. and Joan
E. Hughes; Joseph P. and Genice Spetz; Robert C. and Mary D.
Borman; Nurit Haramgaal; and John S. Husmann and Elinor C.
MacKinnon. Melvin L. and Gail H. Rush resided in Colorado; Robert
J. and Bette Barraclough resided in Texas; William W. and Joan E.
Agnew resided in Massachusetts; and Joe O. and Daurine M. Baker
resided in Nebraska.
Bus Stop Shelter Investments
In 1984, Jean Claude LeRoyer founded Metro Display
Advertising, Inc. (MDA), doing business as Bustop Shelters of
California, Inc.2 MDA manufactured, installed, and sold shelters
which were situated at bus stops to protect riders from inclement
weather while they waited for their bus. The shelters were
constructed of aluminum and safety tempered glass or lexan; the
shelters' components were modular in design to make replacement
inexpensive and fast. The shelters were mounted in concrete and
lit at night. Each shelter contained space behind the glass or
lexan to place advertisements, and MDA generated revenue by leasing
the advertising display space on the shelters.
2
Metro Display Advertising, Inc., filed for bankruptcy
in 1992.
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Between 1984 and 1992, MDA offered investments in bus stop
shelters (hereinafter referred to as the bus stop shelter
program).3 Each bus stop shelter was referred to as a bus stop
shelter unit. Through the bus stop shelter program, investors
entered into a purchase agreement with MDA pursuant to which the
investor acquired a bus stop shelter unit for $10,000. Upon the
purchase of the bus stop shelter unit, the investor had the option
to either lease the bus stop shelter to MDA or independently
operate and maintain the shelter.
If the investor chose to lease the bus stop shelter to MDA,
the investor was required to enter into two agreements: An
equipment lease agreement and a maintenance agreement. Pursuant to
the terms of these agreements, MDA agreed to: (1) Pay the investor
$200 per month (less $30 per month for maintenance costs); (2)
maintain, operate, and assemble the shelter; and (3) maintain
insurance for the shelter.
Upon the expiration of the agreements, MDA agreed (pursuant to
a buyback agreement) that it would repurchase the bus stop shelter
from the investor for $10,000 or its fair market value, whichever
was higher.
3
By using the term "shelter" we do not mean to suggest
or decide that the investments herein were "tax shelters" as that
term is understood.
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FAC Individual Retirement Account
Donald L. Thomson was one of several individuals who actively
sold bus stop shelter units as part of MDA's bus stop shelter
program. Mr. Thomson was a financial planner and accountant who
did business as Financial & Accounting Consultants, Inc. (FAC).
Despite its name, FAC was a sole proprietorship and not a
corporation.
During the late 1980's, Mr. Thomson sought approval from the
Internal Revenue Service (IRS) to become a trustee of an individual
retirement account (IRA) trust that ultimately would make an
investment in MDA's bus stop shelter program (the FAC IRA).
Mr. Thomson prepared a FAC IRA disclosure statement which was
delivered to all prospective investors in the FAC IRA. The
disclosure statement stated:
The Trust is established with the intent that it qualify
as an "Individual Retirement Account" under Section
408(a) of the Code, and the provisions hereof shall be
construed in accordance with such intent. * * *
The Trust was last approved as an acceptable form of
prototype trust under Section 408(a) of the Internal
Revenue Code by the National Office of the Internal
Revenue Service (IRS) in Opinion Letter Serial No.
B111447b dated March 27, 1987.
Upon opening the FAC IRA, the investor executed an IRA adoption
agreement. The adoption agreement authorized FAC to invest the IRA
contributions in MDA's bus stop shelter program and to open a
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custodial account at the El Dorado Bank in Newport Beach,
California, to collect the rental income generated from the lease
agreements entered into with MDA.
Mr. Thomson executed a Form 56 (Notice Concerning Fiduciary
Relationship) with respect to each investor in the FAC IRA. Both
Mr. Thomson and each investor in the FAC IRA executed a Form 5305-A
(Individual Retirement Custodial Account) assigning the IRA
contributions to the custodial account.
Petitioners' Investments in the FAC IRA
All petitioners in this case caused distributions to be made
out of existing qualified IRA's (and in one instance an existing
qualified IRA and a pension plan4) for the purpose of rolling over
the distribution into the FAC IRA. The distributions and
contributions into the FAC IRA were as follows:
Distribution
from IRA/ Contribution
Petitioner Pension Plan Date to FAC IRA Date
1
Gordon J. Schoof $62,151.00 0 2/05/91 $65,000.00 02/07/91
3,579.77 02/07/91
Bonnie L. Schoof 7,397.69 08/16/91 20,000.00 09/04/91
10,709.06 08/26/91
Lyman K. Kennedy 5,000.00 04/18/91 5,000.00 04/24/91
Judith Kennedy 5,000.00 04/18/91 5,000.00 04/24/91
4
Only petitioner Nurit Haramgaal caused a distribution
to be made from a pension plan.
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2
Melvin L. Rush 81,059.51 02/14/91 20,000.00 02/14/91
Alice M. Johnson3 25,969.82 1,4
1991 25,000.00 11/19/91
Robert J.
4
Barraclough 10,000.00 1991 10,000.00 06/25/91
4
Bette Barraclough 10,000.00 1991 10,000.00 06/25/91
William N. Hughes 306,860.10 02/14/91 305,000.00 02/14/91
5 1
William W. Agnew 202,500.00 07/31/91 200,000.00 08/01/91
1
Joe O. Baker 10,000.00 08/23/91 10,000.00 08/23/91
1
Daurine M. Baker 10,000.00 08/23/91 10,000.00 08/23/91
Joseph P. Spetz 14,166.54 07/23/91 20,000.00 07/23/91
3,500.74 07/23/91
Robert C. Borman6 46,412.00 03/06/91 45,000.00 02/27/91
Nurit Haramgall 19,223.50 01/31/91 30,000.00 05/02/91
9,852.17 04/11/91
John S. Husmann 5,284.90 01/04/91 5,000.00 01/07/91
Elinor C.
MacKinnon 4,191.02 03/11/91 5,000.00 04/06/91
1
Petitioners were age 59-1/2 or older at the time of the
distributions.
2
The balance of the distribution was rolled over into an
unrelated individual retirement account.
3
The distribution and contribution were made by petitioner's
husband.
4
The exact dates of distribution in 1991 are unknown.
5
Petitioners William W. and Joan E. Agnew reported $2,500 of
the distribution as taxable in 1991.
6
There is no explanation in the record as to why petitioner's
distribution occurred after the date of the rollover contribution
to the FAC IRA.
All petitioners made their contributions to the FAC IRA by
writing checks made payable to "Bustop Shelters Co. of California,
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Inc.", or some variation of that name. None of the investors made
their checks payable to the FAC IRA or Mr. Thomson as trustee. All
petitioners, other than Joe O. and Daurine M. Baker, contributed to
the FAC IRA by writing checks drawn on their personal checking
accounts. Petitioners Joe O. and Daurine M. Baker caused the
trustee of their existing IRA's to issue cashier's checks.
After investing in the FAC IRA, all petitioners executed
purchase, lease, maintenance, and buyback agreements with MDA and
executed an IRA adoption agreement with FAC. Mr. Thomson executed
a Form 56 with respect to each petitioner. Mr. Thomson and each
petitioner executed a Form 5305-A.
The rents generated by the bus stop shelter units were
deposited into the El Dorado Bank custodial accounts. The bus stop
shelter units were held in the FAC IRA trust.
None of petitioners reported the distributions from their
IRA's (and in the case of Nurit Haramgaal, she did not report the
distribution from her IRA and pension plan) as a taxable event on
their 1991 Federal income tax returns.
In the respective notices of deficiency to petitioners,
respondent determined that the IRA and pension plan distributions
were taxable events on the predicate that petitioners did not
properly roll over the distributions into qualified IRA's.
Respondent also determined that each petitioner was liable for a
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10-percent additional tax pursuant to section 72(t) for early
distributions from qualified retirements plans.5
OPINION
Generally, distributions from qualified retirement plans are
includable in the distributee's income in the year of distribution
as provided in section 72. Secs. 402(a)(1), 408(d)(1). An
exception exists if the distribution proceeds are rolled over into
an eligible retirement plan or an IRA within 60 days of the
distribution. Secs. 402(a)(5), 408(d)(3).
In the consolidated cases before us, respondent contends that
petitioners' distribution proceeds were not rolled over into a
qualified IRA because the purported trustee of the FAC IRA, Mr.
Thomson, was not eligible to serve in that capacity. Respondent
also asserts that petitioners did not acquire their interests in
MDA's bus stop shelter program through an IRA but rather in their
5
Respondent concedes on brief that petitioners Gordon J.
Schoof, Alice M. Johnson, William W. Agnew, and Daurine M. Baker
are not liable for the 10-percent additional tax pursuant to sec.
72(t) for the distributions made to them during 1991 because they
were age 59-1/2 or older at the time of the distributions. See
sec. 72(t)(2)(A)(i). Because petitioner Joe O. Baker was also
age 59-1/2 or older at the time of his distribution, we hold that
he is not liable for the sec. 72(t) additional tax.
In the notice of deficiency, there was no determination that
petitioners Robert C. and Mary D. Borman were liable for the sec.
72(t) additional tax, but on brief, respondent made such an
assertion. See sec. 6214(c).
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own names.6 We need not, and do not, address this latter issue
because we hold that the failure of Mr. Thomson to qualify as a
trustee requires all of petitioners' distributions to be included
in their income for 1991.
The term "individual retirement account" is defined in section
408(a) as:
a trust created or organized in the United States for the
exclusive benefit of an individual or his beneficiaries,
but only if the written governing instrument creating the
trust meets the following requirements:
* * * * * * *
(2) The trustee is a bank (as defined in
subsection (n)) or such other person who
demonstrates to the satisfaction of the
Secretary that the manner in which such other
person will administer the trust will be
consistent with the requirements of this
section.
See also Orzechowski v. Commissioner, 69 T.C. 750, 754-755 (1978),
affd. 592 F.2d 677 (2d Cir. 1979).
6
Respondent also asserts that petitioners Alice M.
Johnson, Robert J. Barraclough, Bette Barraclough, and Nurit
Haramgaal failed to rollover their distributions into the FAC IRA
within 60 days. Because we hold that the rollovers do not
qualify for tax-free treatment, we need not address this issue.
Nonetheless, we are mindful that Mrs. Johnson and the
Barracloughs did not establish the date of their IRA
distributions, and that Ms. Haramgaal's May 2, 1991, contribution
was more than 60 days from her Jan. 31, 1991, pension plan
distribution.
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Obviously neither Mr. Thomson nor FAC was a bank; thus, we are
concerned only with whether Mr. Thomson may be deemed "such other
person" who could serve as a trustee for an IRA trust.
The regulations set forth extensive requirements in order for
a person to qualify as a nonbank trustee for an IRA trust. In this
respect, the prospective trustee must apply in writing to the
Commissioner and prove that the requirements provided in the
regulations are satisfied. Sec. 1.408-2(b)(2), Income Tax Regs.
The applicant must demonstrate: (1) Its ability to act within the
accepted rules of fiduciary conduct; (2) its experience and
competence with respect to accounting for the interests of a large
number of individuals (including calculating and allocating income
earned and paying out distributions to payees); (3) its experience
and competence with respect to other activities normally associated
with the handling of retirement funds; (4) the existence of
procedures for administering fiduciary powers and for the proper
auditing and investing of the funds; and (5) other evidence of the
applicant's ability to act as a trustee for an IRA. Secs. 1.401-
12(n), 1.408-2(b)(2)(ii), Income Tax Regs.7
7
Sec. 1.408-2(b), Income Tax Regs., provides that the
qualification of nonbank trustees is governed by the regulations
under sec. 401(d)(1). Par. (n) of sec. 1.401-12, Income Tax
Regs., which applies to nonbank trustees of pension and profit
sharing plans, was redesignated as par. (e) of sec. 1.408-2,
(continued...)
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These stringent requirements derive from the concern by
Congress with regard to the trustee's ability to manage and invest
retirement funds and the trustee's accountability for its actions.
H. Rept. 93-779, at 132 (1974), 1974-3 C.B. 244, 375. One of
Congress' apparent concerns with respect to the trustee's
accountability was the continuity of the trustee beyond the death
or change of the trustee's owner. The applicable House report
stated: "It is anticipated that the Secretary probably will not
allow individuals to act as trustees for individual retirement
accounts." Id. Consequently, section 1.401-12(n)(3)(i), Income
Tax Regs., provides:
The applicant must assure the uninterrupted performance
of its fiduciary duties notwithstanding the death or
change of its owners. Thus, for example, there must be
sufficient diversity in the ownership of the applicant to
ensure that the death or change of its owners will not
interrupt the conduct of its business. Therefore, the
applicant cannot be an individual.
Mr. Thomson operated his business affairs as a sole proprietor
through FAC. As an individual, he was not eligible to serve as a
trustee for an IRA trust.
Nonetheless, Mr. Thomson testified that he submitted a written
application to the IRS in May 1986 and received approval by letter
7
(...continued)
Income Tax Regs., effective Dec. 20, 1995. T.D. 8635, 1996-1
C.B. 52.
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from the IRS office in Washington, D.C., dated March 27, 1987, to
act as a trustee for the FAC IRA trust. This is the same date
reported by Mr. Thomson in FAC's IRA disclosure statement (given to
all prospective investors) in which he claims the IRA trust format
was approved by the IRS.
Respondent produced a letter from his Washington, D.C., office
with the same serial No. (B111447b) and date (March 27, 1987) as
that reported by Mr. Thomson in his disclosure statement. The
letter is addressed to "MFS Financial Service Inc" (MFS) of Boston,
Massachusetts, and states in part:
In our opinion, the amendment to the form of the
prototype trust, custodial account or annuity contract
identified above does not adversely affect its
acceptability under section 408 of the Internal Revenue
Code.
Each individual who adopts this approved plan will be
considered to have a retirement savings program that
satisfies the requirements of Code section 408, provided
they follow the terms of the program and do not engage in
certain transactions specified in Code section 408(e).
Please provide a copy of this letter to each person
affected.
The Commissioner's letter, despite Mr. Thomson's belief to the
contrary, does not indicate that he was approved by the
Commissioner to serve as a trustee for the FAC IRA. The letter
refers to an amendment to the form of a trust, see Rev. Proc. 87-
50, 1987-2 C.B. 647, 648, not to the approval of a trustee to serve
in that capacity. Moreover, the letter was addressed to MFS of
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Boston, Massachusetts, and not to Mr. Thomson or FAC, which is
located in Newport Beach, California. (Mr. Thomson did not
establish any relationship between MFS and himself or FAC.)
Consequently, we hold that Mr. Thomson was not eligible to serve as
a trustee to the FAC IRA trust.
We next consider the consequences of the distributions out of
individual retirement plans to petitioners and the subsequent
rollover of those distributions to a purported IRA trust with an
unqualified trustee. Respondent asserts that the disqualification
of Mr. Thomson requires such distributions to be included in
petitioners' income. Petitioners assert that so long as they
substantially complied with the statutory rollover contribution
requirements, they are entitled to exclude the distributions from
income. We agree with respondent.
In Fazi v. Commissioner, 102 T.C. 695 (1994), we addressed the
issue of whether the failure to adopt a formal written plan for the
establishment of an employer retirement plan was fatal to the
qualification of the plan, thus causing the distributions from that
plan to be includable in income. (Section 1.401-1(a)(2), Income
Tax Regs., requires a definite written program and arrangement
which is communicated to the employees. See also Employee
Retirement Income Security Act of 1974, Pub. L. 93-406, sec.
102(a)(1), 88 Stat. 829, 841.) We held in Fazi that the regulatory
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requirement of a written plan that is communicated to employees
would have no meaning if the employer did not prepare a written
plan to which it (the employer) was contractually bound. Fazi v.
Commissioner, supra at 704. "An unexecuted and unadopted plan
would be of no comfort to employees who might have to rely upon the
terms of a plan for their future security." Id.
IRA trusts were created by Congress to provide retirement
savings opportunities to employees whose employers did not provide
qualified retirement plans. H. Rept. 93-779, supra at 124-125,
1974-3 C.B. at 367-368. The same concern as to employer retirement
plans, namely the beneficiary's future security, is at the heart of
the IRA trust arrangement. Consequently, a trustee who has the
capacity to administer the trust in a manner that is consistent
with the purpose of a retirement account is critical to the
qualification of an IRA trust. An individual, per se, does not
have such capacity because of the lack of continuity in case of his
or her death. As a result, the lack of a qualified trustee is
fatal to the existence of a qualified IRA trust under section
408(a).
The substantial compliance doctrine, which petitioners request
we apply to their situation, is not applicable to the situation
herein. In Wood v. Commissioner, 93 T.C. 114 (1989), a taxpayer
sought to roll over the proceeds from a profit-sharing plan into an
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IRA. The taxpayer properly executed the transaction within the
required 60-day period, but the trustee mistakenly recorded a part
of the proceeds as having been transferred to a non-tax-deferred
account. We therein found that the taxpayer did everything
reasonably expected to comply with the statutory rollover
contribution requirements, including meeting with his IRA trustee,
instructing the trustee to open an IRA, executing the documents to
open the IRA, and transferring the distribution to the trustee for
deposit in the IRA. Moreover, the trustee assured the taxpayer
that the rollover transaction would be carried out. We held in
Wood that the trustee's bookkeeping error did not preclude rollover
treatment because the taxpayer had substantially complied with the
statutory requirements.
The facts herein are distinguishable from those in Wood v.
Commissioner, supra. The present case involves the failure of a
fundamental element of the statutory requirements for an IRA
rollover contribution, namely the qualification of the IRA trustee;
whereas Wood v. Commissioner, supra, involved procedural defects in
the execution of the rollover.
Where the requirements of a statute relate to the
substance or essence of the statute, they must be rigidly
observed. On the other hand, if the requirements are
procedural or directory in that they do not go to the
essence of the thing to be done, but rather are given
with a view to the orderly conduct of business, they may
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be fulfilled by substantial compliance. [Citations
omitted.]
Rodoni v. Commissioner, 105 T.C. 29, 38-39 (1995); see also Taylor
v. Commissioner, 67 T.C. 1071, 1077-1078 (1977).
The present case is more like Rodoni v. Commissioner, supra,
wherein we held to be fatal the failure to rollover distributions
from a profit sharing plan to an IRA for the same person from whose
plan the distributions were made. That type of error related to
the essence of the statute in that case.
Here, petitioners did not substantially comply with the
requirements of rolling over their distributions into an IRA under
section 408(a). Although we are sympathetic to petitioners'
plight, we hold the distributions out of qualified IRA's to
petitioners (in the case of petitioner Nurit Haramgaal, the
distributions out of her qualified IRA and pension plan) are
includable in petitioners' 1991 income.
Section 72(t) imposes a 10-percent additional tax on premature
distributions from retirement plans. Exceptions exist as provided
under section 72(t)(2), including distributions made on or after
the date the recipient reaches the age of 59-1/2. Sec.
72(t)(2)(A)(i). Petitioners, other than Gordon J. Schoof, William
W. Agnew, Alice M. Johnson, Joe O. Baker, and Daurine M. Baker, are
liable for the 10-percent additional tax because the record does
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not show that they came within any of the exceptions to the tax
under section 72(t)(2).
To reflect the foregoing and the concessions of the parties,
Decisions will be entered
under Rule 155.