ALFRED E. GALLADE, PETITIONER v. COMMISSIONER Docket Nos. 791-94, 792-94. Filed May 28, 1996. C, P's wholly owned corporation, operated a pension plan in which P participated. Because of C's poor financial disposition, P executed a "waiver", to assign his fully vested, accrued benefits to C. Due to the waiver, P did not report any taxable distribution. R determined that P's waiver was an impermissible attempt to assign or alienate his benefits in violation of sec. 206(d)(1) of ERISA and sec. 401(a)(13), I.R.C. 1. Held, P received a taxable distribution. 2. Held, further, the distribution was received by P in 1986. 3. Held, further, R abused her discretion by failing to waive the penalty for substantial understatement of income tax. Kenneth M. Barish, James R. McDaniel, and Bruce L. Ashton, for petitioner. Paul B. Burns, for respondent. GERBER, Judge: Respondent alternatively determined a $540,716 income tax deficiency and a $135,179 addition to tax under section 66611 for the 1985 tax year, or a $537,808 income tax deficiency and a $107,562 addition to tax under section 6661 for the 1986 tax year. The issues remaining for our consideration are: (1) Whether petitioner's waiver of his pension plan benefits and use of them by his wholly owned corporation resulted in a taxable distribution to him; (2) if it is a taxable distribution, whether it is recognizable in 1985 or 1986; and (3) whether petitioner is liable for an addition to tax under section 6661. FINDINGS OF FACT2 Petitioner resided in Fontana, California, at the time of the trial of these consolidated cases. Petitioner was married to Adele M. Gallade (ex-wife) during the period under consideration, except for an interim period when they were divorced (January 20 through December 29, 1979). They separated in November 1985, and they were divorced a second time as of November 30, 1987. 1 Unless otherwise indicated, section references are to the Internal Revenue Code in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. 2 The stipulation of facts and the exhibits are incorporated herein by this reference. In 1943, petitioner received a bachelor of science degree in philosophy. After graduation, petitioner served in the U.S. Navy for approximately 5 years, after which he returned to the Los Angeles area to operate what he refers to as "small businesses". In the late 1940's, petitioner began working for Hughes Aircraft Co. (Hughes) until approximately 1950, when he started a tire distribution business. After working in this business, petitioner returned to Hughes. Subsequently, petitioner was hired by a chemical company as a general manager in Inglewood, California. After leaving the Inglewood chemical company, on January 2, 1970, petitioner incorporated his own chemical distribution business, Gallade Chemical, Inc. (GCI), of which he was the sole shareholder and officer. GCI maintained its principal place of business in Santa Ana, California. Petitioner was employed by GCI from its date of incorporation through the years in issue. On December 1, 1970, GCI adopted a pension plan known as the "Defined Benefit Pension Plan of Gallade Chemical, Inc." (the plan), which, at all relevant times, was qualified under section 401(a). The First American Trust Co. (First American) was the trustee of the plan. Petitioner participated in the plan from its inception through its termination, at which time his accrued benefit was fully vested.3 Section 9.05 of the plan, captioned "Nonreversion", prohibited the plan funds from being used for any purpose other than for the exclusive benefit of the participants or their beneficiaries, except that Upon termination of the Plan, any assets remaining in the Trust Fund because of an erroneous actuarial computation after the satisfaction of all fixed and contingent liabilities under the Plan shall revert to the Employer. Under the heading of "Nonassignability”, section 16.03(A) of the plan stated: None of the benefits, payments, proceeds or claims of any Participant shall be subject to any claim of any creditor of any Participant and, in particular, the same shall not be subject to attachment or garnishment or other 3 At the plan's termination, the present value of petitioner's accrued benefit was $1,057,830, and the plan's total available assets at that time were $1,498,682. The present value of the accrued benefits of all other plan participants was at that time $312,469. The parties agree that, if petitioner failed to report his distribution from the plan, the amount should be $1,057,830 rather than $1,082,000, the amount stated in the notices of deficiency. legal process by any creditor of any Participant, nor shall any Participant have any right to alienate, anticipate, commute, pledge, encumber or assign any of the benefits or payments or proceeds which he may expect to receive under this Plan (except as provided in this Plan for loans from the Trust). [Emphasis added.] On May 20, 1985, petitioner, his sons (who were also employees of GCI), petitioner's C.P.A. Henry Zdonek (Mr. Zdonek), and a vice president of Actuarial Consultants, Inc., Scott Salisbury (Mr. Salisbury), met to review the yearend 1984 valuation of the original plan and the profit-sharing plan (the profit-sharing plan) and to discuss the distribution owed to petitioner, as petitioner was near retirement age. The options reviewed by petitioner included his receiving a distribution from the plan as taxable income, rolling the benefits over into an individual retirement account (IRA), or rolling the benefits over into the profit-sharing plan. At this meeting, the individuals present did not discuss the possibility of petitioner's waiving his vested plan benefits. After the May 20, 1985, meeting, petitioner evaluated the financial needs of GCI. Amid GCr's decreasing customer base and financial losses, petitioner thought that expansion was necessary. Therefore, petitioner decided that it would be best for GCI if petitioner waived his benefits under the plan and had the funds paid to GCI to provide the necessary working capital. Between the meeting on May 20, 1985, and July 12, 1985, Mr. Zdonek called Mr. Salisbury and asked Mr. Salisbury to research the question of whether petitioner was permitted to waive his plan benefits. On July 12, 1985, Mr. Salisbury prepared a memorandum to GCr's pension file which memorialized a telephone conversation between Mr. Salisbury and Juanita Nappier (Ms. Nappier), a supervisor with the Pension Benefit Guaranty Corp. (PBGC). Mr. Salisbury stated that Ms. Nappier believed that it would be fine for petitioner to waive his benefits under the plan due to GCI's business conditions, so long as the rank and file employees received their benefits. Mr. Salisbury forwarded a copy of the memorandum to petitioner and Mr. Zdonek. On August 5, 1985, Mr. Salisbury sent a letter to Mr. Zdonek, a copy of which petitioner received. The letter confirmed that GCI desired to: (1) Terminate the plan; (2) pay all participants their then-accrued benefits, except for petitioner, whose benefit would "revert" to GCI; (3) create a new plan, to which the employees of GCI would transfer their plan benefits; and (4) have a waiver of benefits prepared for petitioner. Mr. Salisbury commented on the plan benefits with respect to Mrs. Gallade, stating that he believed: 66 temporary IRS regulations under the Retirement Equity Act of 1984, published in the Federal Register on July 19, 1985, indicate that, “. . any plan that has a termination date prior to September 17, 1985 and distributes all remaining assets as soon as administratively feasible after the termination date, is not subject to the new survivor annuity requirements [of sections 401(a)(11) and 417]." [See sec. 1.401(a)-11T, Q&A-10, Temporary Income Tax Regs., 50 Fed. Reg. 29373 (July 19, 1985).] On September 4, 1985, GCI adopted a resolution terminating the plan. The resolution stated that [petitioner] hereby waives all his rights and benefits under *** [the plan] and that all such rights and benefits will revert to the Employer-Corporation upon termination of [the] plan. The termination, which was signed by petitioner, was effective September 16, 1985. In anticipation of the plan's termination, on or about September 6, 1985, GCI filed an Internal Revenue Service Form 5310, Application for Determination Upon Termination; Notice of Merger, Consolidation or Transfer of Plan Assets or Liabilities; Notice of Intent to Terminate, with the PBGC. See sec. 2616.3, PBGC Regs. With the Form 5310, GCI sought a favorable determination letter from respondent, and it applied for a notice of sufficiency from the PBGC upon the plan's termination. On or about December 30, 1985, GCI opened an interestbearing account at Republic Bank (the Republic Bank account). Petitioner and J. Ray Haynes (Mr. Haynes) of First American were the designated signatories on the Republic Bank account, and all withdrawals or disbursements required both individuals to sign. On the same day, First American deposited $771,000 of funds from the plan into the Republic Bank account.4 4 Approximately $400,000 of petitioner's balance in the plan went towards paying suppliers, which we find was distributed to petitioner in 1986. The remainder, $771,000, was deposited into the Republic Bank account, which petitioner claims was to be used at some point for GCI's expansion into the Inland Empire. The record is unclear whether such a property was ever purchased. On January 8, 1986, the PBGC issued a notice of sufficiency to GCI in accordance with GCI's first application. On or about January 15, 1986, the funds were withdrawn, including accrued interest (total of $772,996.44). GCI filed a second Form 5310 on or about March 5, 1986, to notify respondent and the PBGC of GCI's plans to transfer the remaining assets from the plan to the GCI profit-sharing plan. On July 17, 1986, First American had transferred all those assets from the plan trust, payable to all plan participants except for petitioner, to the profit-sharing plan trust. First American then arranged for the remaining assets, to which petitioner was entitled, to be transferred from the plan trust to GCI on August 18 and September 23, 1986. During the summer of 1986, respondent assigned GCI's application for a determination to an employee plans specialist. During the period July 1986 through January 1987, the specialist and GCI's representatives corresponded concerning the application. On or about March 31, 1987, the matter was submitted internally within respondent's office for technical advice regarding the plan's termination. On June 9, 1988, respondent's national office issued a technical advice memorandum, stating its position. On or about July 27, 1988, GCI withdrew its application for a determination letter. Thereafter, this issue was addressed in the examination of petitioner which led to this controversy. A closing conference was held on October 23, 1991, and it was attended by petitioner, respondent's agent, the agent's supervisor, and Mr. Zdonek. At this meeting, respondent's agent discussed the substantive issues and the reasons he believed that a section 6661 penalty for substantial understatement should apply. Mr. Zdonek told respondent's agent that he believed this penalty should not apply. Evidentiary Objections OPINION We first consider the evidentiary objections to certain stipulated facts. Respondent objected to the admission of certain facts concerning a settlement meeting between the parties at which petitioner's counsel asked to have the section 6661 penalty waived. Petitioner seeks to introduce this fact solely to show that he asked respondent to waive the section |