Kenneth L. Nordtvedt v. Commissioner

116 T.C. No. 13

• Court: United States Tax Court
• Decided: March 13, 2001
• Docket: 670-99
• Status: Unknown

Opinion

116 T.C. No. 13

UNITED STATES TAX COURT

KENNETH L. NORDTVEDT, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 670-99. Filed March 13, 2001.

P adjusted the basis in his retirement annuity by an inflation factor, to take account of inflation between the date of his contributions to the retirement plan and the annuity starting date, for purposes of calculating the amount of his pension annuity subject to Federal income tax. P further adjusted the basis in his retirement annuity to account for expected inflation over his actuarial life for purposes of calculating the amount of his pension annuity subject to Federal income tax.

Held: P may not adjust the basis in his retirement annuity to account for inflation for purposes of calculating the amount of his pension annuity subject to Federal income tax.

Kenneth L. Nordtvedt, pro se.

Virginia L. Hamilton, for respondent. - 2 -

OPINION

RUWE, Judge: Respondent determined a deficiency of $580 in

petitioner’s 1996 Federal income tax. The issues for decision

are: (1) Whether petitioner may adjust the basis in his

retirement annuity by an inflation factor, to take account of

inflation between the date of his contributions to the retirement

plan and the annuity starting date, thereby increasing his basis

from the amount of $36,734 to an adjusted basis of $57,972, for

purposes of calculating the amount of his pension annuity subject

to Federal income tax; and (2) whether petitioner may further

adjust the basis in his retirement annuity to take into account

expected inflation over his actuarial life for purposes of

calculating the amount of his pension annuity subject to Federal

income tax.

Background

The parties submitted this case fully stipulated pursuant to

Rule 122.1 The stipulation of facts and the attached exhibits

are incorporated herein by this reference. Petitioner resided in

Friday Harbor, Washington, at the time he filed his amended

petition.

Petitioner was employed by Montana State University from

1 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. - 3 -

September of 1965 until he retired in July of 1988. Montana

State University participates in the Montana Teachers Retirement

System of the State of Montana (MTRS), a qualified defined

benefit pension plan under section 401(a).

During his employment, petitioner made mandatory after-tax

contributions to the MTRS. From July of 1985 to July of 1988,

petitioner made after-tax contributions in accordance with

Montana State law allowing for additional contributions to build

up a retirement base. Petitioner’s contributions to the MTRS

were as follows:

Year Taxed Contribution

1965-66 $350 1966-67 350 1967-68 611 1968-69 639 1969-70 793 1970-71 822 1971-72 922 1972-73 887 1973-74 1,131 1974-75 1,122 1975-76 1,613 1976-77 1,592 1977-78 1,814 1978-79 1,102 1979-80 1,774 1980-81 529 1981-82 1,838 1982-83 1,012 1983-84 2,893 1984-85 7,042 1987-88 7,898 Total 36,734

Petitioner’s nominal basis in his pension plan is $36,734. Since

petitioner’s retirement in July of 1988, he has been receiving a - 4 -

gross pension payment of $26,313 annually.

The formula used by the MTRS to determine the taxable

portion of petitioner’s pension based on his after-tax

contributions (the formula) is in accordance with the rules

prescribed by the regulations promulgated under the Internal

Revenue Code. See sec. 1.72-4, Income Tax Regs. According to

the formula, the portion of petitioner’s pension income that is

subject to tax in 1996, based on the nominal value of his after-

tax contributions and the age of petitioner at his retirement in

1988, is $24,843.

Petitioner reported $22,979 as the amount of his pension

that was subject to tax in 1996. To arrive at this figure,

petitioner first adjusted the basis in his retirement annuity by

an inflation factor to take account of inflation between the date

of his contributions to the retirement plan and the annuity

starting date. According to his calculation, petitioner’s basis

as of his retirement in 1988 was $57,972 instead of the nominal

basis of $36,734. Petitioner then adjusted the basis in his

annuity as of the date of his retirement to account for expected

inflation over his actuarial life.

Discussion

Petitioner’s total pension income in 1996 was $26,313.

Pursuant to the applicable regulation, which allows for recovery

of petitioner’s basis in the pension, the taxable portion of - 5 -

petitioner’s 1996 pension was $24,843. See sec. 1.72-4, Income

Tax Regs. Petitioner agrees that the determination of the

taxable portion of $24,843 is in accordance with the regulations.

However, petitioner maintains that the taxable amount should be

reduced by $1,864 for 1996 in order to take into account the

effect of inflation on his contributions.

Petitioner’s contention that he is entitled to adjust the

basis in his annuity pension to account for inflation is

incorrect. Section 61(a) provides that gross income includes all

income from whatever source derived, unless otherwise

specifically excluded. Section 61(a)(9) provides that gross

income includes income from annuities. The Supreme Court has

reasoned that Congress “intended ‘to use the full measure of its

taxing power’” when it created the income tax. Commissioner v.

Kowalski, 434 U.S. 77, 82 (1977) (quoting Helvering v. Clifford,

309 U.S. 331, 334 (1940)). The Court explained that Congress

intended “‘to tax all gains except those specifically exempted.’”

Id. at 82-83 (quoting Commissioner v. Glenshaw Glass Co., 348

U.S. 426, 429-430 (1955)). There is no statutory or regulatory

provision permitting petitioner to exempt gain which may be

attributable solely to inflation by adjusting the basis in his

annuity pension to account for such inflation.2

2 We note that when Congress intends for inflation to be taken into account, it does so by providing for it by statute. (continued...) - 6 -

The pension plan administered by the MTRS is a qualified

defined benefit pension plan as provided for in section 401(a).

The taxation of the distributee of such a plan is governed by

section 402(a). Section 402(a) provides that the amounts

distributed under a section 401(a) plan shall be taxable to the

distributee under section 72.

Section 72 provides in general that amounts received under

an annuity contract are includable in gross income except to the

extent that such amounts are considered to be a reduction or

return of consideration paid. Specifically, section 72(a)

provides that unless otherwise provided, gross income includes

any amount received as an annuity under an annuity contract.

Section 72(b), however, provides that a portion of the annuity

will be excluded from gross income. In particular, gross income

does not include that part of any amount received as an annuity

under an annuity contract which bears the same ratio to such

amount as the investment in the contract (as of the annuity

starting date) bears to the expected return under the contract

(as of such date). See sec. 72(b); sec. 1.72-4, Income Tax Regs.

This ratio is referred to as the “exclusion ratio.” Sec. 72(b);

sec. 1.72-4, Income Tax Regs. Section 72(c), as relevant here,

defines the investment in the contract to be the aggregate amount

2 (...continued) See, e.g., secs. 1(f), 151(d)(4); Bartley v. Commissioner, T.C. Memo. 1998-322 n.10. - 7 -

of premiums or other consideration paid for the contract (or in

the instant case, petitioner’s after-tax basis). The “expected

return” amount is determined by multiplying, at the commencement

of the annuity, the total of the annuity payments to be received

annually by a multiple based on the annuitant’s age and, for

contributions prior to 1986, on the annuitant’s sex. Sec. 1.72-

5(a)(1), Income Tax Regs.

The application of the “exclusion ratio” to each annuity

payment determines the amount excluded from the gross income of

the annuitant and, thus, not subject to Federal income tax. This

excluded amount represents that part of the annuity payment which

accounts for the return of the annuitant’s investment in the

annuity.

In the relevant statutes governing the determination of the

taxable amount of a pension plan annuity, there is no provision

for, or mention of, any adjustment to an annuitant’s basis or

investment in his annuity to take account of inflation from the

date the annuitant first began to contribute to the annuity to

the annuity starting date. Nor is there any provision permitting

an adjustment to take account of inflation via a discount factor

from the date of the commencement of the annuity until the

nontaxable basis has been fully repaid to the annuitant.

When a statute is clear on its face, we require clear

unequivocal evidence of legislative purpose before construing a - 8 -

statute to override the plain meaning of the words used therein.

See Hirasuna v. Commissioner, 89 T.C. 1216, 1224 (1987);

Huntsberry v. Commissioner, 83 T.C. 742, 747-748 (1984). The

legislative history of the statutes relevant to this case

contains no evidence that Congress intended that there be any

adjustment to account for inflation.

As with the statutes, the regulations also contain no

mention of inflation adjustments. The regulations under section

72 are interpretative regulations. Such regulations must be

upheld “unless unreasonable and plainly inconsistent with the

revenue statutes”. Commissioner v. South Tex. Lumber Co., 333

U.S. 496, 501 (1948). The regulations under section 72 are not

unreasonable and are not plainly inconsistent with the statute

with respect to the issue presented in the instant case.

The regulations promulgated under section 72 are of long

standing, originally adopted on November 14, 1956, by T.D. 6211,

1956-2 C.B. 29. While there have been numerous amendments to the

regulations, none have affected the issue at bar. With respect

to the longevity of these regulations, the Supreme Court has

stated that long-standing rules should not be overruled except

for weighty reasons. See Commissioner v. Sternberger’s Estate,

348 U.S. 187, 199 (1955). As discussed below, there are no such

weighty reasons in the instant case.

While there are no cases directly on point dealing with - 9 -

pension plans or annuities,3 the issue decided in Hellermann v.

Commissioner, 77 T.C. 1361 (1981), involved the same principles.

In Hellermann v. Commissioner, supra, the taxpayers argued that

gain that was realized from the sale of property should be

adjusted to take into account the inflation that occurred during

the ownership of the property. We disagreed.

First, we relied upon “the well-established doctrine that

Congress has the power and authority to establish the dollar as a

unit of legal value with respect to the determination of taxable

income, independent of any value the dollar might also have as a

commodity.” Id. at 1364. For this proposition, we relied upon

3 This Court has consistently denied taxpayers deductions for losses due to inflation and has repeatedly rejected the argument that inflation is a proper ground for failing to report income. See Sibla v. Commissioner, 68 T.C. 422, 430-431 (1977), affd. 611 F.2d 1260 (9th Cir. 1980); Gajewski v. Commissioner, 67 T.C. 181, 195 (1976), affd. without published opinion 578 F.2d 1383 (8th Cir. 1978); Bartley v. Commissioner, T.C. Memo. 1998-322; Ruben v. Commissioner, T.C. Memo. 1987-277; Downing v. Commissioner, T.C. Memo. 1983-97; Warren v. Commissioner, T.C. Memo. 1982-696; Notter v. Commissioner, T.C. Memo. 1982-96; Cunninghman v. Commissioner, T.C. Memo. 1981-365; Milkowski v. Commissioner, T.C. Memo. 1981-225; Crossland v. Commissioner, T.C. Memo. 1976- 59. Other courts have reached the same conclusions when faced with similar situations. See Stelly v. Commissioner, 804 F.2d 868, 870 (5th Cir. 1986) (“The * * * [taxpayers’] contention that they are entitled to an inflation adjustment to their interest income is plainly incorrect.”); Birkenstock v. Commissioner, 646 F.2d 1185, 1186 (7th Cir. 1981) (“The market price of gold in terms of dollars is * * * irrelevant to the determination of * * * taxable income”), affg. T.C. Memo. 1979-201; Bates v. United States, 108 F.2d 407, 408 (7th Cir. 1939) (attaching no “significance to the statutory gold content of the dollar as a factor in the determination of gain from the sale of capital assets”); Daugherty v. United States, 1 Cl. Ct. 216, 218 (1983) (taxpayer not entitled to “inflation factor” deduction). - 10 -

cases upholding Congress’ right to provide for a currency having

a uniform legal value that did not necessarily correspond to the

market value of gold bullion which backed the currency. See

Perry v. United States, 294 U.S. 330 (1935); Nortz v. United

States, 294 U.S. 317 (1935); Norman v. Baltimore & Ohio R.R. Co.,

294 U.S. 240 (1935); Legal Tender Cases, 79 U.S. (12 Wall.) 457

(1870).

As a second ground for rejecting the taxpayers’ position in

Hellermann v. Commissioner, supra, we relied upon the doctrine of

common interpretation; i.e., defining income on the basis of the

understanding of a lay person, not an economist. See id. at

1366. Under this doctrine, the taxpayers’ gain must be measured

on the basis of the nominal gain on the sale of property, not on

the basis of a gain reduced by an inflation factor, or the real

gain in an economic sense. See id. “[N]either the Constitution

nor tax laws ‘embody perfect economic theory.’” Id. (quoting

Weiss v. Weiner, 279 U.S. 333, 335 (1929)).

In Hellermann v. Commissioner, supra, the taxpayers were

arguing that the Government’s failure to take inflation into

account to determine gain or loss resulted in the taxation of

return of capital. This is the essence of petitioner’s argument

in the instant case. However, as previously stated, the

applicable statutes and regulations do not provide that

petitioner may take inflation into account. See secs. 72, 401, - 11 -

and 402; Hellermann v. Commissioner, supra at 1363; secs. 1.72,

1.401, and 1.402, Income Tax Regs. Accordingly, we hold that

petitioner may not adjust the basis in his retirement annuity to

account for inflation for purposes of calculating the amount of

his pension annuity subject to Federal income tax.

Decision will be entered for

respondent.