T.C. Memo. 2018-92
UNITED STATES TAX COURT
VAL LANES RECREATION CENTER CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 24887-10R. Filed June 26, 2018.
James R. Monroe and Michael A. Gilmer, for petitioner.
Nicholas D. Doukas and David Conrad, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
PARIS, Judge: In this declaratory judgment proceeding under section
7476,1 petitioner challenges respondent’s September 29, 2010, final revocation
1 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect at all relevant times, and all Rule references are to the Tax Court’s Rules of Practice and Procedure. -2-
[*2] letter (FRL) retroactively revoking respondent’s prior favorable determination
letter (FDL) finding that petitioner’s employee stock ownership plan (ESOP) was
qualified under section 401(a) and that the ESOP’s related trust (ESOT) was
exempt from taxation under section 501(a) for the ESOT’s plan year ending March
31, 2001, and all subsequent plan years. The Court concludes that respondent
abused his discretion in revoking the FDL.2
FINDINGS OF FACT
The parties were unable to agree as to the completeness and accuracy of the
purported administrative record, and the Court held a hearing in this matter to
determine the contents of the administrative record. At the hearing the parties
submitted additional documents that they agreed were part of the administrative
record. After the hearing the parties submitted this case pursuant to Rule 122,
agreeing that the record also included witness testimony and additional exhibits
presented at the hearing. In an action for declaratory judgment involving the
revocation of a retirement plan determination, the Court is not limited to the
administrative record in making its decision. Rule 217(a); RSW Enters., Inc. v.
Commissioner, 143 T.C. 401, 407 (2014). Therefore, the Court incorporates the
2 This opinion is limited to the ESOP’s qualification. Respondent has raised several income tax issues, but the Court does not address matters here that are more appropriately addressed in a deficiency proceeding. -3-
[*3] stipulated record herein by this reference and makes additional findings on
the basis of the information presented during the hearing.3
Petitioner was incorporated in Iowa on August 21, 1990, for purposes of
operating a bowling alley in West Des Moines, Iowa. Petitioner was an S
corporation for Federal tax purposes from incorporation in 1990 to at least 2005.
Patrick Essy served as petitioner’s president, treasurer, and sole director. Rosalie
Essy, Mr. Essy’s wife, served as petitioner’s vice president and secretary.
Petitioner had no other officers. Before October 2000 Mr. Essy owned all 5,000
shares of petitioner.
Beginning in or around 2000 petitioner retained Stephen Thielking and the
accounting firm Oden and Thielking, C.P.A.s, P.C., to provide accounting
services. Mr. Thielking had been a licensed certified public accountant (CPA) in
3 On brief respondent incorrectly asserts that petitioner withdrew Exhibits 110-P through 120-P and 123-P through 127-P introduced during the hearing. Only Exhibits 110-P through 114-P were withdrawn. Respondent used the remaining exhibits during the hearing despite objecting to their admissibility. The Court reserved ruling on Exhibits 115-P through 120-P and 123-P through 127-P to allow the parties to brief their respective arguments to respondent’s objections to the admissibility of those exhibits. The Court now overrules respondent’s objections and rules that the exhibits are admitted as supplements to the administrative record. The Court reiterates that it may look beyond the administrative record in making its decision and may consider witness testimony made in reliance on the exhibits. See supra p. 2. -4-
[*4] Iowa since 1978 and had known Mr. and Mrs. Essy since the mid to late
1990s.4 Mr. Thielking’s firm prepared petitioner’s Form 1120S, U.S. Income Tax
Return for an S Corporation, each year beginning in or around 2000 through at
least 2005.
In addition to providing services to petitioner, Mr. Thielking also prepared
and filed the incorporation documents for Essy Management Corp. (Essy
Management). Essy Management was incorporated in Iowa on September 12,
2000, and was an S corporation for Federal tax purposes from 2000 to at least
March 2005. It was created to hold real estate and investments as well as to
provide management services. Mr. Essy was the president of Essy Management.
Mr. Thielking’s firm prepared the corporate tax returns and corporate minutes for
Essy Management between 2000 and 2006.5
On September 12, 2000, upon Mr. Thielking’s recommendation, petitioner’s
board of directors adopted the ESOP and the ESOT with a plan year ending March
31. Mr. Thielking prepared the plan and trust documents with the board’s
4 Mr. Thielking passed away in December 2016, after the hearing in this matter but before this opinion was filed. 5 Beginning some time after 2005 Mr. Thielking’s firm served as the registered agent for both petitioner and Essy Management because Mr. and Mrs. Essy moved out of Iowa. -5-
[*5] expectation of submitting the documents to the Internal Revenue Service
(IRS) for a favorable determination regarding the ESOP’s qualified status. Mr.
Essy was the ESOP’s administrator; Mrs. Essy was the ESOT’s trustee.
Additionally, the board of directors adopted a resolution reserving the right to
amend the ESOP retroactively to its effective date (September 12, 2000) if
necessary to receive a favorable determination from the IRS.
After forming the ESOP and the ESOT, Mr. Essy transferred all 5,000
outstanding shares of petitioner’s stock to the ESOT in exchange for the ESOT’s
assumption of a non-interest-bearing account payable of $5,000 to Mr. Essy
($1/share). The ESOT also received 10 shares of Essy Management’s stock in
exchange for the ESOT’s assumption of a non-interest-bearing account payable of
$10 to Essy Management ($1/share).6
Petitioner retained Mr. Thielking to prepare and submit a Form 5300,
Application for Determination for Employee Benefit Plan, for a favorable
determination from respondent regarding the ESOP’s qualification under section
401(a). Mr. Essy signed Form 5300 and dated it September 12, 2000. On May 5,
6 The payables were recorded on the ESOT’s books but remained unpaid. The ESOT’s Schedule I, Financial Information -- Small Plan, attached to its Form 5500, Annual Return/Report of Employee Benefit Plan, listed “$5,010” in liabilities each year. -6-
[*6] 2001, apparently in response to respondent’s review of petitioner’s
application, petitioner submitted an amended and restated ESOP plan document
reflecting the intent to have the document executed upon receipt of the FDL. The
amended plan document included language to comply with section 414(u)
requiring qualified plans to contain certain language with respect to participants
with qualified military service.
On June 11, 2001, petitioner submitted several additional amendments
reflecting the intent to have them executed upon receipt of the FDL. On June 21,
2001, respondent issued the FDL to petitioner with respect to the ESOP,
conditioned upon petitioner’s timely adoption of the amendments attached to the
May 5 and June 11, 2001, letters.7 Petitioner adopted the amendments and restated
plan document shortly after receiving the FDL.8
For each plan year, petitioner retained Mr. Thielking to prepare and file
Form 5500 detailing the ESOT’s assets as well as petitioner’s contributions to the
ESOT. Because the ESOT was the sole shareholder of both petitioner and Essy
Management, all net income from both S corporations flowed through to the
7 Rev. Proc. 2001-55, 2001-2 C.B. 552, generally extended the deadline for amending plans pursuant to the sec. 414(u) amendments until February 28, 2002. 8 See infra pp. 24-25 for further explanation regarding this finding. -7-
[*7] ESOT in accordance with the S corporation regime in effect at the time. The
ESOT’s net assets as of the end of the initial plan year ending March 31, 2001,
consisted of petitioner’s stock, Essy Management’s stock, income from petitioner
and Essy Management, and employer contributions.9
A portion of the 5,000 shares of petitioner’s stock and all 10 shares of Essy
Management’s stock were allocated to Mr. Essy’s account some time during the
initial plan year.10 The remaining shares of petitioner’s stock were allocated to the
three other employees deemed to be eligible plan participants during the initial
9 The Court bases its finding on the ESOT’s Form 5500 for the plan year ending March 31, 2001; the ESOT’s Schedule K-1, Shareholder’s Share of Income, Credits, Deductions, etc., for petitioner for the period from October 1, 2000, to March 31, 2001; the ESOT’s Schedule K-1 for Essy Management; petitioner’s Form 1120S for the short period from October 1, 2000, to March 31, 2001; and Essy Management’s Form 1120S for the period from September 12, 2000, to March 31, 2001. The record does not contain stock appraisals for the initial plan year ending March 31, 2001. The stock valuation as of that date is based on the participant account balances for the plan year ending March 31, 2002, which list both the “Current” and “Accumulative” amounts for the “Change in Value of Trust Assets” allocated to each participant’s account. The Court calculated the total value of petitioner’s stock and the total value of Essy Management’s stock as of March 31, 2001, by subtracting the current amount from the accumulative amount for each plan participant. 10 Respondent determined in his April 17, 2008, Form 886-A, Explanation of Items, that on the basis of the participant account statements for the plan year ending March 31, 2002, all 10 shares of Essy Management’s stock and between 75% and 80% of the shares of petitioner’s stock were allocated to Mr. Essy’s account some time during the initial plan year ending March 31, 2001. Upon review of the record the Court agrees. -8-
[*8] plan year.11 Mr. Essy’s wages were $41,557 and $40,000 in 2000 and 2001,
respectively. Petitioner contributed $1,626.92 to Mr. Essy’s account for the plan
year ending March 31, 2001, and $500 for the plan year ending March 31, 2004.
Petitioner made no contributions during the plan years ending March 31, 2002 and
2003. Mr. Essy’s account balance as of the end of each year included his share of
the ESOT’s income/loss, his share of the change in value of the ESOT’s assets,
employer contributions (if any), and his share of expenses (if any). Allocations to
Mr. Essy’s account were $138,523.94, $255,939.14, and $167,060.85 in the plan
years ending in 2001, 2002, and 2004, respectively, and a loss of $155,268.58 in
the plan year ending in 2003.
In addition to preparing Form 5500, Mr. Thielking performed and submitted
appraisals valuing petitioner’s stock and Essy Management’s stock as of the end of
the plan year. Each appraisal included the following declaration:12
The undersigned holds himself out to be an appraiser.
11 The FRL did not challenge the allocations of income to the other plan participants’ accounts. 12 Although the record does not contain signed copies of the appraisals, Mr. Thielking credibly testified that it was his practice to submit Form 5500 and the original, signed appraisal to the Department of Labor in accordance with yearly reporting requirements, see Employee Retirement Income Security Act of 1974, Pub. L. No. 93-406, sec. 104, 88 Stat. at 847, information that was conveyed to the IRS examiner. -9-
[*9] The undersigned is a certified public accountant who is familiar with the assets being appraised.
The undersigned is not a party to any transaction related to this appraisal.
The undersigned understands that a false or fraudulent overstatement of the value of the property being appraised may subject the appraiser to a civil penalty under Internal Revenue Code section 6701 for aiding and abetting an understatement of tax liability, and consequently, the appraiser may have appraisals disregarded pursuant to 31 U.S.C. 330(c).
The fee charged for this appraisal is not based upon a percentage of the appraisal value of the property.
Appraisals prepared by the appraiser are not being disregarded pursuant to 31 U.S.C. 330(c) on the date the appraisal summary is signed.
On May 12, 2005, respondent notified petitioner that the ESOP was selected
for examination for the plan year ending March 31, 2003. Petitioner retained Mr.
Thielking to represent it throughout the examination. On February 8, 2007, during
examination of the ESOP, respondent requested executed copies of the plan
amendments attached to the May 5 and June 11, 2001, letters. On March 7 and
again on April 17, 2007, respondent sent petitioner a Form 886-A identifying five
issues constituting possible grounds for revocation of the ESOP’s qualified status,
including that petitioner made excess contributions to the ESOT, failed to use an
independent appraiser, and failed to timely amend the ESOP for required - 10 -
[*10] language. On April 17, 2008, respondent sent petitioner another Form 886-
A proposing to disqualify the ESOP because of excess contributions and/or failure
to use an independent appraiser but not failure to timely amend the ESOP for
required language.
On May 28, 2008, on petitioner’s behalf Mr. Thielking submitted a protest
to the proposed disqualification. The protest listed Mr. Thielking’s qualifications
including his educational background in accounting, his CPA licensure, his
membership in professional organizations, his experience teaching courses on
ESOPs and appraisals of closely held corporations, his experience performing
appraisals, and his firm’s advertisement to the public as an appraiser of businesses
and estates. The protest also included a copy of a Des Moines Yellow Pages
listing in which Mr. Thielking’s firm identified “Business & Estate Appraisals”
among its available services.
On September 29, 2010, following the examination, respondent issued the
FRL to petitioner retroactively revoking the FDL and determining that the ESOP
did not meet the requirements of section 401(a) for the plan year ending March 31,
2001, and all subsequent plan years and that the ESOT was therefore not exempt - 11 -
[*11] under section 501(a).13 Respondent identified the following three grounds
as bases for the FRL: (1) annual additions in excess of the dollar limit in section
415(c)(1)(A) were allocated to Mr. Essy’s account during the plan years ending in
2001, 2002, and 2004; (2) the ESOP failed to use an independent appraiser as
required by section 401(a)(28)(C) to perform annual valuations of the employer
securities the ESOT held; and/or (3) petitioner failed to timely amend the ESOP to
include mandatory provisions set forth in section 414(u) as required by section
401(a).14 Petitioner timely filed a petition for declaratory judgment.
OPINION
Section 7476(a) authorizes this Court to render a declaratory judgment,
subject to the limitations listed in section 7476(b). Neither party disputes that
13 The FRL incorrectly stated the ESOP did not meet the requirements of sec. 401(a) “for plan years ending September 12, 2000”. However, the determination regarding the ESOP’s qualification was for the plan year ending March 31, 2001, and all subsequent plan years. 14 Forms 886-A sent to petitioner on March 7 and April 17, 2007, did not contain any facts, law, or analysis with respect to petitioner’s alleged failure to timely amend the ESOP with the required sec. 414(u) language, instead listing broadly as an issue “Should the plan be disqualified for failure to timely amend for required plan language?”. Form 886-A sent to petitioner on April 17, 2008, did not list failure to timely amend as an issue. It was not until the FRL that respondent listed failure to timely amend the plan and specified the absence of the sec. 414(u) language as a ground for revocation. - 12 -
[*12] those limitations have been met, and the Court is satisfied it has jurisdiction
over the petition. See Efco Tool Co. v. Commissioner, 81 T.C. 976 (1983).
Petitioner bears the burden of proving that respondent abused his discretion
in determining that the ESOP was not qualified under section 401(a). To do so,
petitioner must persuade the Court that respondent’s determination was
unreasonable, arbitrary, or capricious. See Buzzetta Constr. Corp. v.
Commissioner, 92 T.C. 641, 648 (1989). Petitioner has met its burden.
An ESOP is a retirement plan designed to invest primarily in qualified
employer securities placed in a related trust. For the trust to receive favorable tax
treatment under section 501(a), the ESOP must be considered a “qualified plan” by
meeting the requirements set forth in section 401(a). For a plan to be qualified
“both its terms and its operations must meet the statutory requirements.” Buzzetta
Constr. Corp. v. Commissioner, 92 T.C. at 646. Before 1998 ESOPs were not
eligible S corporation shareholders.
Effective January 1, 1998, Congress amended section 1361(c) to allow
ESOPs and other tax-exempt organizations to be eligible S corporation
shareholders. Small Business Job Protection Act of 1996 (SBJPA), Pub. L. No.
104-188, sec. 1316(a), 110 Stat. at 1785-1786. Also effective January 1, 1998,
Congress amended section 512 so that an ESOP’s pro rata share of S corporation - 13 -
[*13] earnings did not constitute “unrelated business taxable income”. See
Taxpayer Relief Act of 1997, Pub. L. No. 105-34, sec. 1523, 111 Stat. at 1070-
1071. These provisions created a framework under which an ESOP could own all
outstanding shares of an S corporation, deferring tax on the S corporation’s
income at both the entity level and the shareholder level. That structure remained
unchanged for the next three years.
In 2001 Congress amended section 409(p) to prohibit allocations of S
corporation stock held by an ESOT to certain persons deemed to own at least 50%
of the number of shares of stock in the S corporation. See Economic Growth and
Tax Relief Reconciliation Act of 2001 (EGTRRA), Pub. L. No. 107-16, sec. 656,
115 Stat. at 131-135. Any such prohibited allocation would result in an excise tax
to the ESOP and income recognition to the persons deemed to own at least 50% of
the shares of stock in the S corporation. In amending section 409(p), Congress
recognized that “the income of an S corporation allocable to an ESOP * * * [was]
not subject to current taxation.” H.R. Conf. Rept. No. 107-84, at 274 (2001),
2001-3 C.B. 123, 397. The change generally applied to plan years beginning after
2004 for an ESOP that existed before March 14, 2001. EGTRRA sec. 656(d); see
also Austin v. Commissioner, T.C. Memo. 2017-69, at *32-*33 (addressing the
framework for certain ESOT-owned S corporations that existed between 1998 and - 14 -
[*14] 2005). Petitioner and Essy Management were S corporations, and their
ESOP and ESOT existed before March 14, 2001.
Plan Contributions
Section 415(c)(1) limits the annual addition to a participant’s account to the
lesser of (1) $30,000 (adjusted annually for inflation) or (2) 25% of the
participant’s compensation.15 “Annual addition” includes employer contributions,
employee contributions, and forfeitures. Sec. 415(c)(2). Section 401(a)(16)
provides that a “trust shall not constitute a qualified trust under this section if the
plan of which such trust is a part provides for benefits or contributions which
exceed the limitations of section 415.”
In the FRL respondent determined that the ESOP failed to meet the
requirements of section 401(a)(16) for the plan years ending in 2001, 2002, and
2004. Respondent determined that the amounts allocated to Mr. Essy’s account
during those plan years should be recharacterized as annual additions under
section 1.415-6(b)(2), Income Tax Regs. Section 1.415-6(b)(2), Income Tax
Regs., provides:
15 This was the limit during the ESOP’s first two plan years. For plan years beginning after December 31, 2001, the limit was the lesser of (1) $40,000 or (2) 100% of the participant’s compensation. - 15 -
[*15] [T]he term “annual additions” includes employer contributions which are made under the plan. Furthermore, the Commissioner may in an appropriate case, considering all of the facts and circumstances treat transactions between the plan and the employer or certain allocations to participants’ accounts as giving rise to annual additions.
In the FRL respondent stated that the allocations should be recharacterized
because the “dividend amounts paid on employer stock held by the trust” were
treated as income instead of being treated as contributions, and “the effect of this
financing was to transfer” petitioner’s earnings and Essy Management’s earnings
to the ESOT primarily for Mr. Essy’s benefit.
Petitioner has established that both it and Essy Management were S
corporations (and had been since incorporation). Petitioner has shown that there
were no distributions from it or Essy Management to the ESOT. The Court finds
that contrary to respondent’s position in the FRL, neither petitioner nor Essy
Management paid “dividends” on its stock because both were S corporations from
incorporation through at least 2005. Additionally, the Court finds that the ESOT’s
earnings were not the result of a financing arrangement and did not constitute a
transfer of funds. Rather, income and losses properly flowed through from
petitioner and Essy Management to the ESOT, the sole shareholder of both - 16 -
[*16] corporations.16 Without any facts or circumstances to justify the application
of section 1.415-6(b)(2), Income Tax Regs., the Court concludes that respondent
acted arbitrarily by recharacterizing allocations to Mr. Essy’s account as plan
contributions in the plan years ending in 2001, 2002, and 2004.
In the FRL respondent also addressed the initial allocation of Essy
Management stock to Mr. Essy but did not make clear the relationship between the
initial stock allocation and respondent’s determination of excess contributions. In
his answering brief respondent clarifies that the initial transfer of stock to the
ESOT without consideration constituted a plan contribution equal to the value of
the stock under section 1.415-6(b)(4), Income Tax Regs.17 Respondent argues that
the large increase in Mr. Essy’s account balance during the initial short plan year
from September 12, 2000, to March 31, 2001, demonstrates that the stock must
have been worth more than the purported value of $5,010 at the time of its
16 The Court reiterates that a unique framework existed for a short period during which an ESOT-owned S corporation could defer income tax at both the entity and shareholder levels without triggering additional tax consequences to persons in a position similar to Mr. Essy’s. See supra pp. 12-14. The ESOP’s plan years ending in 2001, 2002, and 2004 fell within that period. 17 On brief respondent mentions that the initial transfer of stock was also a prohibited transaction. The Court does not address any income tax or excise tax consequences for purposes of this declaratory judgment proceeding. - 17 -
[*17] contribution to the ESOT; therefore, respondent argues, the initial
contribution of stock exceeded the contribution limit during the initial short plan
year.
Petitioner contends that the ESOT purchased the stock through an account
payable from the ESOT to Mr. Essy. Petitioner further argues that even if the
stock transfer was without consideration, the total stock was valued at $5,010
($1/share) at the time of its contribution to the ESOT. Because the 10 shares of
Essy Management stock and a portion of petitioner’s stock were allocated to Mr.
Essy’s account, his total stock allocation was worth no more than $5,010. Even
when combined with the $1,626.92 plan contribution made to Mr. Essy’s account,
the total did not exceed the plan limitation for 2001.
Petitioner has demonstrated that Mr. Essy’s account balance increased from
September 12, 2000, to March 31, 2001, because of petitioner’s income earned
during the initial plan year, Essy Management’s income earned during the initial
plan year, and an increase in the value of petitioner’s stock allocated to Mr. Essy’s
account.18 Therefore, the increase in Mr. Essy’s account balance does not show
18 The Court reviewed the ESOT’s Form 5500 for the initial plan year; participant account balances for the plan year ending March 31, 2002; petitioner’s Form 1120S for the short period from October 1, 2000, to March 31, 2001; and Essy Management’s Form 1120S for the period from September 12, 2000, to (continued...) - 18 -
[*18] that there was a misvaluation of stock at the time of its contribution to the
ESOT or at the time of its allocation during the initial plan year. The Court does
not decide for purposes of this proceeding whether the initial stock transfer was
without consideration and thus constituted a plan contribution under section
1.415-6(b)(4), Income Tax Regs. Even if the transfer did constitute a contribution,
the total contribution did not exceed the contribution limit for the initial plan
year.19
18 (...continued) March 31, 2001. On the basis of those documents, the Court finds that Mr. Essy’s account balance as of March 31, 2001, consisted of an employer contribution to his account, Essy Management’s income, a portion of petitioner’s income, and a portion of the increase in the value of petitioner’s stock. The remainder of the increase in petitioner’s stock value and petitioner’s income was allocated to the other plan participants. The total of the participant account balances as of the end of the initial plan year matches the ESOT’s net assets as reported on its Form 5500 for the initial plan year. 19 Under sec. 415(c), the contribution limit for the initial plan year was the lesser of $30,000 or 25% of the participant’s compensation. For purposes of computing the sec. 415 limitation, “compensation” includes Mr. Essy’s wages between April 1, 2000, and March 31, 2001 (defined as the plan year and limitation year in the ESOP’s plan document). Mr. Essy received $41,557 and $40,000 in wages in the 2000 and 2001 calendar years, respectively. There is no information regarding the amount Mr. Essy specifically earned during the 12- month limitation year from April 1, 2000, to March 31, 2001, but it is reasonable to assume that it was somewhere between $40,000 and $41,557. Additionally, neither party argues that Mr. Essy’s compensation for purposes of computing the sec. 415(c) limitation was less than $40,000 during the initial plan year. Using $40,000 as Mr. Essy’s compensation, the sec. 415(c) limitation was $10,000. - 19 -
[*19] Respondent’s position is that the excess contribution in the initial plan year
is a continuing failure in future years. See Martin Fireproofing Profit-Sharing
Plan & Tr. v. Commissioner, 92 T.C. 1173, 1184-1189 (1989). Because the Court
does not find that the stock value exceeded the contribution limit, the Court finds
respondent’s argument regarding the effect on subsequent plan years to fail in this
case. The Court finds that respondent abused his discretion by retroactively
revoking the FDL on the basis of excess contributions to the ESOT.
Independent Appraiser
For an ESOP to be considered a qualified plan, section 401(a)(28)(C)
requires that an independent appraiser perform all valuations of employer
securities that are not readily tradable on an established securities market. Section
401(a)(28)(C) defines “independent appraiser” as any appraiser meeting
requirements similar to the requirements of the regulations prescribed under
section 170(a)(1) regarding “qualified appraisers”. Those regulations specify
several requirements for a “qualified appraiser” including that the individual
provide a declaration on the appraisal summary that the individual holds himself
or herself out to the public as an appraiser or performs appraisals regularly and is
qualified to make appraisals of the type of property being valued based on his or - 20 -
[*20] her background, experience, education, and membership, if any, in
professional organizations. Sec. 1.170A-13(c)(3)(ii)(F), (c)(5), Income Tax Regs.
The regulations exclude the following persons from being “qualified
appraisers” with respect to the property being appraised: (1) the donor of the
property, (2) a party to the transaction in which the donor acquired the property,
(3) the donee of the property, (4) any person employed by the donor or the donee,
(5) any person considered a related party (within the meaning of section 267(b))
with respect to anyone described above, and (6) an appraiser regularly used by the
donor, donee, or an employee of the donor or donee who does not perform a
majority of his or her appraisals made during the taxable year for other persons.
Sec. 1.170A-13(c)(5)(iv), Income Tax Regs.
In the FRL respondent concluded that Mr. Thielking was not an
independent appraiser because he performed numerous services for the ESOP and
ESOT each year, “including preparation of the Form 5500; participant account
statements and other recordkeeping functions” in addition to receiving a regular
income from petitioner. Respondent also noted that Mr. Thielking did not
advertise his services as an appraiser of securities and did not sign the appraisals.
Although the record does not contain signed copies of the appraisals, Mr.
Thielking credibly testified that it was his practice to submit the original, signed - 21 -
[*21] appraisals to the Department of Labor, information that was conveyed to the
IRS examiner. The Court may look beyond the administrative record in this
matter, see supra p. 2, and finds that Mr. Thielking did sign the appraisals.
In the FRL respondent challenged Mr. Thielking’s qualifications because he
did not hold himself out to the public as an appraiser of securities. Respondent
specifically referenced his listing in the Des Moines telephone directory, which
only advertised Mr. Thielking as a CPA. However, the record also contains a Des
Moines Yellow Pages listing in which Mr. Thielking’s firm identified “Business &
Estate Appraisals” as one of its available services. Additionally, there is no
requirement in the regulation for an advertisement to the public. Rather, the
regulation requires that the individual hold himself out to the public as an
appraiser or perform appraisals regularly. Sec. 1.170A-13(c)(5)(i)(A), Income Tax
Regs. In the May 28, 2008, protest to respondent’s proposed revocation of the
FDL, petitioner explained Mr. Theilking’s background and education. Petitioner
also specified that Mr. Thielking taught courses on the appraisal of closely held
corporations and performed “literally thousands of appraisals of all sorts.” During
the hearing petitioner introduced evidence that Mr. Thielking annually performed
approximately 40 appraisals of ESOT-owned closely held business stock. The - 22 -
[*22] Court finds that Mr. Thielking did have the appropriate background,
education, and experience to value petitioner’s stock and Essy Management’s
stock.
Respondent determined in the FRL that Mr. Thielking could not be
considered “independent of either the ESOP sponsor or the administration of the
ESOP” because he performed various services for the ESOP throughout the year.
The regulations regarding “qualified appraisers” specifically exclude those who
were donors or donees of the property (or their employees), parties to the
transaction in which the donor acquired the property, related parties within the
meaning of section 267(b), or an appraiser who is regularly used by any person
listed above who does not perform a majority of his or her appraisals made during
his or her taxable year for other persons. Sec. 1.170A-13(c)(5)(iv), Income Tax
Regs. Respondent appears to argue in favor of a broader reading of the
regulations, citing Mr. Thielking’s services as a CPA and overall involvement
with the ESOP as evidence as to his lack of independence. Respondent asks the
Court to find dispositive in this case this Court’s conclusion in Churchill, Ltd.
Emp. Stock Ownership Plan & Tr. v. Commissioner (Churchill), T.C. Memo.
2012-300, at *24, that Mr. Thielking was not an “independent appraiser” because
the Court stated that “on the basis of the administrative record, it appears that - 23 -
[*23] Thielking was not independent as he was the author and preparer of most of
the trust records and returns.”
In Churchill, at *21-*24, the Court first found that the administrative record
contained insufficient evidence as to Mr. Thielking’s background, education, and
experience in valuing the type of business at issue in the case even before stating
that Mr. Thielking was not independent. The Court in Churchill, therefore, did not
analyze section 1.170A-13(c)(iv), Income Tax Regs., excluding certain persons as
“qualified appraisers”, nor did it ultimately rely on its statement regarding Mr.
Thielking’s involvement in the plan and trust.
Here, the Court reviews the additional exhibits and testimony petitioner
introduced in this case and finds that Mr. Thielking was qualified to value
petitioner’s stock and Essy Management’s stock. Therefore, the Court must
consider whether section 1.170A-13(c)(iv), Income Tax Regs., excludes persons
beyond those specifically listed and finds that it does not. Section 401(a)(28)(C)
provides that the term “independent appraiser” is similar to the requirements of the
regulations for section 170(a)(1), which in turn define “qualified appraiser”.
Section 1.170A-13(c)(iv), Income Tax Regs., excludes certain persons from being
appraisers because of their inherent lack of independence. Petitioner has
established that Mr. Thielking was not disqualified under any of the exclusions. - 24 -
[*24] The Court finds that petitioner has proven that the ESOP met the
“independent appraiser” requirements. Therefore, the Court finds that respondent
abused his discretion for purposes of this declaratory judgment proceeding by
revoking the FDL on the basis of petitioner’s failure to use an independent
appraiser.
Plan Amendment
The FRL listed among the bases for revocation of the FDL petitioner’s
failure to amend the ESOP in accordance with the language required under section
414(u). In 1996 Congress amended section 414(u) to require qualified plans to
include language regarding special rules for employees with “qualified military
service.” SBJPA sec. 1703(n), 110 Stat. at 1886. The requirements were effective
for all plan years beginning after December 12, 1994. Id.
The record in this case contains an unsigned copy of a restated plan
document that includes the requisite section 414(u) language, additional proposed
amendments to the ESOP, and correspondence between Mr. Thielking and
respondent during the FDL application process. The FDL was conditioned upon
petitioner’s adoption of the proposed plan document and amendments.
During the hearing, Mr. Thielking credibly testified that, to the best of his
knowledge, the restated plan amendments were signed shortly after receipt of the - 25 -
[*25] FDL and that petitioner retained the originals. Mr. Essy credibly testified
that “every document * * * [Mr. Thielking] sent me I signed.” Upon reviewing
the amendments and restated plan document, he reiterated that he would have
signed them if Mr. Thielking had sent them. Mr. Essy further explained that in
either 2007 or 2008 weather damage caused the roof of petitioner’s facility to fail,
resulting in extensive water damage to the facility, including to documents related
to petitioner and Essy Management.20
The Court may look beyond the administrative record to determine the facts
in this matter. See supra p. 2. Given the existence of the previously approved
restated plan document and amendments and the credible explanation as to the
absence of executed copies in the record, the Court finds that petitioner has
established that it adopted the amendments soon after June 21, 2001, upon
receiving the FDL. The Court finds significant the fact that respondent did not list
failure to amend the plan with respect to the section 414(u) language as a proposed
ground for revocation in the April 17, 2008, Form 886-A, suggesting that there
20 Additionally, a witness for respondent testified that in September 2012 several Department of Labor and IRS agents seized documents and computers from Mr. Thielking’s home, home office, and business office pursuant to a search warrant. Mr. Thielking credibly testified that he was uncertain whether the purported administrative record contained all documents related to petitioner, Essy Management, and the ESOP and ESOT because he was unable to access all of his records after the computers were returned. - 26 -
[*26] was evidence provided during the examination process as to the adoption of
the requisite language. The absence of failure to timely amend as a ground for
revocation in the April 17, 2008, Form 886-A also precluded petitioner from
addressing the section 414(u) language during the appeal stage before receiving
the FRL.
Respondent asks the Court to consider the Hollen and Churchill cases in
which this Court held that plans were not qualified because they did not contain
the section 414(u) language, but there are significant differences between the fact
patterns of those cases and this case. In Hollen v. Commissioner, T.C. Memo.
2011-2, 2011 Tax Ct. Memo LEXIS 13, *7-*8, the plan adopted amendments
before the expiration of the remedial period, but the amendment was not effective
for all required years. In Churchill, at *10-*11, the plan adopted the required
amendments but only for the plan years going forward. Because the amendments
were not effective for all required years, the plan did not qualify under section
401(a).
Here, because of the resolution allowing petitioner’s board of directors to
amend the ESOP retroactively to its effective date and the fact that the proposed
amendments were previously approved during the FDL process, the only issue for
consideration is whether the amendments to the ESOP were adopted. Respondent - 27 -
[*27] does not question the sufficiency of the section 414(u) language contained in
the restated plan document but instead argues that the document was never
adopted. Because the Court finds the restated plan document and amendments
were adopted shortly after petitioner received the FDL, the Court finds that
respondent abused his discretion for purposes of this declaratory judgment
proceeding by determining that the plan had not been timely amended for required
language under section 414(u).
The Court has considered all of the arguments made by the parties, and to
the extent they are not addressed herein, they are considered unnecessary, moot,
irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
for petitioner.