SCOTUS Reports

Tag: Death Benefit Exclusion

  • Estate of Stefanowski v. Commissioner, 63 T.C. 386 (1974): Tax Treatment of Lump-Sum Distributions from Terminated Profit-Sharing Plans

    Estate of Robert A. Stefanowski, Deceased, June Stefanowski, Surviving Spouse, and June Stefanowski, Petitioners v. Commissioner of Internal Revenue, Respondent, 63 T. C. 386 (1974)

    Lump-sum distributions from terminated profit-sharing plans do not qualify for capital gains treatment or death benefit exclusion if made on account of plan termination rather than the employee’s death.

    Summary

    In Estate of Stefanowski v. Commissioner, the U. S. Tax Court held that a lump-sum distribution from a terminated profit-sharing plan, received by the beneficiary of a deceased participant, was not eligible for capital gains treatment or a death benefit exclusion. The court reasoned that the distribution was made due to the plan’s termination, not the participant’s death, despite the beneficiary receiving the payment after the participant’s death. This ruling emphasizes that the origin of the right to receive a distribution, rather than the sequence of events, determines its tax treatment. The case highlights the importance of distinguishing between distributions made on account of plan termination versus those made due to an employee’s death or separation from service.

    Facts

    Robert A. Stefanowski was a participant in the Kroger Employees’ Savings and Profit Sharing Plan, a qualified profit-sharing trust. The plan was set to terminate as of January 2, 1971, and Stefanowski died on February 23, 1971. The plan’s assets were liquidated and distributed to participants or their beneficiaries on March 25, 1971. June Stefanowski, as the designated beneficiary, received a lump-sum distribution of $15,278. 49, which included appreciation in the plan’s assets from January 3, 1971, to the distribution date. She sought to treat part of the distribution as long-term capital gain and claimed a death benefit exclusion.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in the Stefanowskis’ 1971 federal income tax and denied the capital gains treatment and death benefit exclusion. June Stefanowski, acting pro se, petitioned the U. S. Tax Court for a redetermination of the deficiency. The Tax Court heard the case and issued its opinion on December 19, 1974.

    Issue(s)

    1. Whether the lump-sum distribution received by June Stefanowski qualifies for capital gains treatment under section 402(a)(2) of the Internal Revenue Code.
    2. Whether any amount of the distribution is excludable from gross income as an employee’s death benefit under section 101(b) of the Internal Revenue Code.

    Holding

    1. No, because the distribution was made on account of the termination of the plan, not on account of the employee’s death.
    2. No, because the distribution was not paid by reason of the employee’s death but due to the plan’s termination.

    Court’s Reasoning

    The court focused on the origin of the right to receive the distribution, citing United States v. Johnson and other cases. It determined that the right to receive the distribution arose from the plan’s termination, not Stefanowski’s death. The court noted that the plan’s assets were liquidated and the distribution amount included post-termination appreciation, which would not have occurred if the distribution were solely due to death. The court distinguished this case from Smith v. United States and Thomas E. Judkins, where distributions were linked to the employee’s separation from service. The court also emphasized that the identity of the distributee (the beneficiary) was determined by the participant’s death, but this did not affect the tax treatment of the distribution itself.

    Practical Implications

    This decision clarifies that distributions from terminated profit-sharing plans are not eligible for capital gains treatment or death benefit exclusion if the right to receive them originates from the plan’s termination rather than the employee’s death or separation from service. Practitioners should carefully analyze the source of a distribution’s entitlement when advising clients on its tax treatment. The ruling may impact how employers structure plan terminations and communicate with participants about the tax consequences of distributions. Subsequent legislative changes, such as the Tax Reform Act of 1969, have eliminated capital gains treatment for all such distributions, but this case remains relevant for understanding the principles governing pre-1969 distributions.

  • Hess v. Commissioner, 31 T.C. 165 (1958): Taxation of Lump-Sum Distributions from Qualified Pension Plans

    31 T.C. 165 (1958)

    Lump-sum distributions from qualified pension plans to beneficiaries are taxable as capital gains to the extent they exceed the employee’s contributions, while beneficiaries may exclude up to $5,000 as a death benefit. Also, beneficiaries are not entitled to a deduction for a portion of the estate tax on their father’s estate.

    Summary

    The United States Tax Court addressed the tax treatment of lump-sum distributions from qualified pension plans made to the children of a deceased employee. The court held that these distributions were taxable as capital gains to the beneficiaries under I.R.C. § 165(b) because they represented distributions of previously untaxed income. The court further addressed the application of I.R.C. § 22(b)(1)(B), which allows an exclusion for death benefits. The court ruled that the beneficiaries were entitled to the exclusion provided for in I.R.C. § 22(b)(1)(B). Finally, the court held that beneficiaries were not entitled to a deduction for estate tax attributable to the distributions, as it held that such distributions were not items of gross income in respect of a decedent.

    Facts

    Eli L. Garber, the father of the petitioners, was an employee and president of two corporations, Penn Dairies, Inc. (Penn) and Garber Ice Cream Company (Garber), both of which had established qualified pension plans. After Eli L. Garber’s death in 1951, the pension trusts made lump-sum cash distributions to his children, the petitioners in this case, as designated beneficiaries. The distributions were made in accordance with the pension plans and Eli L. Garber’s beneficiary designations.

    Procedural History

    The Commissioner of Internal Revenue determined deficiencies in the income tax of the petitioners, claiming that the distributions should have been included in gross income as gain from the sale or exchange of a capital asset. The petitioners challenged this determination in the U.S. Tax Court, disputing both the characterization of the distributions as income and the applicability of certain exclusions and deductions. The Tax Court consolidated the cases.

    Issue(s)

    1. Whether the lump-sum cash distributions made to the petitioners were taxable as gain from the sale or exchange of a capital asset under I.R.C. § 165(b).

    2. Whether the petitioners are entitled to exclude portions of the distributions from gross income under I.R.C. § 22(b)(1)(B) as a death benefit.

    3. Whether the petitioners are entitled to a deduction for estate tax under I.R.C. § 126(c).

    Holding

    1. Yes, because the distributions constituted distributions of income and were taxable under I.R.C. § 165(b).

    2. Yes, because the beneficiaries were entitled to the death benefit exclusion provided for under I.R.C. § 22(b)(1)(B).

    3. No, because the distributions were not items of gross income in respect of a decedent, as required for the deduction under I.R.C. § 126(c).

    Court’s Reasoning

    The court determined that the distributions from the pension trusts represented income, not corpus, and were thus taxable under I.R.C. § 165(b). The court found that the contributions made by the corporations to the pension trusts constituted compensation to the employees. The court distinguished the present case from the historical trust situation where property is transferred in trust with directions that the income be distributed to one person for a stated period and the corpus be distributed to another, finding that the pension plans involved here were intended to be for the exclusive benefit of employees and were not to be used for purposes other than compensating employees.

    Regarding the I.R.C. § 22(b)(1)(B) exclusion for death benefits, the court held that the petitioners were entitled to exclude a portion of the distribution, up to the $5,000 limit specified. The court rejected the Commissioner’s argument that because the decedent possessed a nonforfeitable right to the amounts while living, the exclusion did not apply. The court concluded that since Congress expressly limited the section to $5,000, it would have intended to include other limitations if such was desired.

    Finally, the court held that the petitioners were not entitled to a deduction under I.R.C. § 126(c). This was based on its finding that the distributions were not considered “items of gross income in respect of a decedent” since they were of income which had been received by the pension trusts and which were exempt from taxation. The court reasoned that I.R.C. § 126(c) applies only when an amount is included in gross income under I.R.C. § 126(a).

    There was a dissent on issues two and three.

    Practical Implications

    This case is significant for attorneys and tax professionals dealing with the tax treatment of distributions from qualified pension plans. It clarifies how lump-sum distributions are taxed, as gain from the sale or exchange of a capital asset, while also affirming the availability of the death benefit exclusion under I.R.C. § 22(b)(1)(B) for distributions from employer-provided plans, up to the statutory limit. The case illustrates the importance of distinguishing between distributions of income and distributions of corpus and its impact on tax liabilities.

    Attorneys should consider:

    • Properly characterizing distributions from qualified retirement plans.
    • Advising beneficiaries on the potential exclusion of death benefits.
    • Understanding the conditions under which the estate tax deduction may or may not apply.

    The case underscores the importance of careful planning and understanding the interplay between various tax code provisions when dealing with retirement plan distributions and the death of an employee.