SCOTUS Reports

Tag: Employee Retirement Plans

  • Professional & Executive Leasing, Inc. v. Commissioner, 89 T.C. 225 (1987): Defining ‘Employee’ Status for Retirement Plan Qualification

    Professional & Executive Leasing, Inc. v. Commissioner of Internal Revenue, 89 T.C. 225 (1987)

    For retirement plans to qualify for tax-exempt status, they must be for the exclusive benefit of the employer’s employees, and the determination of ’employee’ status for leased workers hinges on common law principles of control, not merely contractual labels.

    Summary

    Professional & Executive Leasing, Inc. (PEL) sought a declaratory judgment that its pension and profit-sharing plans qualified under section 401 of the Internal Revenue Code. PEL leased professionals back to their former businesses, claiming they were PEL’s employees, thus eligible for PEL’s retirement plans. The Tax Court held that these leased professionals were not common law employees of PEL because PEL lacked sufficient control over their work. The court emphasized that the professionals, often owners of the recipient businesses, controlled their work details and that PEL primarily served a payroll and benefits administration function. Consequently, PEL’s retirement plans failed the ‘exclusive benefit’ rule, as they improperly benefited individuals not genuinely employed by PEL.

    Facts

    Professional & Executive Leasing, Inc. (PEL) was formed to lease management and professional personnel to businesses and practices.

    PEL entered into ‘Contracts of Employment’ (COE) with professionals (workers) and ‘Personnel Lease Contracts’ (PLC) with operating businesses/practices (recipients).

    Workers were often previously employed by and held ownership interests in the recipient businesses to which they were leased.

    Recipients provided equipment, tools, and office space for the workers.

    Workers controlled the details of their service performance, including assignment selection.

    PEL handled payroll, withholding taxes, and provided benefits and retirement plans for the workers.

    Recipients paid PEL setup fees, monthly service fees, and worker compensation.

    The IRS determined that the workers were not employees of PEL and thus PEL’s retirement plans did not qualify under section 401.

    Procedural History

    PEL submitted its pension and profit-sharing plans to the IRS for determination of qualified status.

    The IRS issued a final adverse determination letter, stating the plans did not meet section 401 requirements because the workers were not PEL’s employees.

    PEL petitioned the Tax Court for a declaratory judgment under section 7476, alleging the plans were qualified.

    The case was submitted to the Tax Court without trial based on the administrative record.

    Issue(s)

    1. Whether the workers leased by Professional & Executive Leasing, Inc. to recipient businesses are considered ’employees’ of Professional & Executive Leasing, Inc. for purposes of section 401(a) of the Internal Revenue Code.
    2. Whether Professional & Executive Leasing, Inc.’s pension and profit-sharing plans qualify under section 401(a) if the covered individuals are not considered its employees.

    Holding

    1. No, the workers are not common law employees of Professional & Executive Leasing, Inc. because PEL does not exercise sufficient control over the details of their work.
    2. No, because the plans cover individuals who are not employees of Professional & Executive Leasing, Inc., they fail to meet the ‘exclusive benefit’ rule of section 401(a)(2) and thus do not qualify under section 401(a).

    Court’s Reasoning

    The Tax Court applied common law principles to determine employer-employee status, referencing Treasury Regulations and the Restatement (Second) of Agency.

    The court emphasized the ‘right to control’ test: “Generally such relationship exists when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished.”

    The court considered several factors from *United States v. Silk*, including:

    1. Degree of control exercised by the purported employer.
    2. Investment in work facilities.
    3. Opportunity for profit or loss.
    4. Whether the work is part of the principal’s regular business.
    5. Right to discharge.
    6. Permanency of the relationship.
    7. The parties’ perceived relationship.

    Applying these factors, the court found:

    PEL exercised minimal control; workers controlled their work details and assignments.

    Recipients, not PEL, invested in work facilities.

    PEL’s profit was limited to setup and service fees, not the profits from the workers’ services.

    PEL’s right to discharge was deemed illusory, especially given workers’ ownership in recipient businesses.

    Despite contractual language, the economic reality was that PEL functioned as a payroll service, and the workers remained essentially self-employed or employed by the recipients.

    The court concluded the arrangement lacked objective economic substance and that the workers were not common law employees of PEL. Therefore, the retirement plans failed the exclusive benefit rule of section 401(a)(2).

    Practical Implications

    This case clarifies that labeling workers as ‘leased employees’ does not automatically qualify them as employees of the leasing organization for retirement plan purposes.

    It reinforces the importance of the common law ‘control test’ in determining employer-employee relationships in tax law, particularly concerning employee benefits.

    Businesses cannot merely interpose a leasing company to provide retirement benefits to owners and key personnel while circumventing employee benefit rules for other staff.

    Subsequent cases and IRS guidance continue to apply common law factors to scrutinize worker classification in leasing arrangements, especially in professional service contexts, ensuring that retirement plans genuinely benefit the employees of the sponsoring employer.

  • Strouss-Hirshberg Co. v. Commissioner, 13 T.C. 306 (1949): Taxation of Lump-Sum Distributions from Employee Retirement Plans Following a Business Reorganization

    Strouss-Hirshberg Co. v. Commissioner, 13 T.C. 306 (1949)

    A lump-sum distribution from an employee retirement plan, following a corporate reorganization, is taxable as a capital gain if the distribution is made within one taxable year and on account of the employee’s separation from the service of the former employer.

    Summary

    The case concerns the tax treatment of lump-sum distributions from an employee retirement fund following a corporate reorganization. Employees of Strouss-Hirshberg Company, participating in a qualified retirement plan, received distributions from the plan after the company’s assets were transferred to the May Company, and the original company was dissolved. The Tax Court had to determine whether these distributions were taxable as ordinary income or capital gains. The court held that the distributions were eligible for capital gains treatment because they were paid within one taxable year and were considered to be on account of the employees’ separation from the service of their former employer, even though they continued working for the acquiring company.

    Facts

    Strouss-Hirshberg Company (the “Corporation”) had an employee profit-sharing plan. The Corporation entered into a reorganization agreement with the May Company, transferring its assets and business to May Company and dissolving. Employees of the Corporation continued in the same jobs, but now as employees of the May Company. The Corporation decided to terminate its employee retirement fund after the reorganization. The plan’s trustee liquidated the fund and distributed the assets to the employees in a lump sum. The IRS contended that the distributions were taxable as ordinary income, while the employees argued for capital gains treatment.

    Procedural History

    The case came before the U.S. Tax Court to determine the proper tax treatment of the lump-sum distributions received by the employees. The IRS argued that the distributions were taxable as ordinary income, whereas the petitioners contended that the distributions should be treated as capital gains.

    Issue(s)

    1. Whether the distributions received by the employees were “on account of the employee’s separation from the service” of their employer, Strouss-Hirshberg Company.

    Holding

    1. Yes, because the Tax Court found that, despite the employees continuing to perform the same jobs after the reorganization, the distributions were considered to be “on account of” their separation from the service of their former employer.

    Court’s Reasoning

    The court analyzed the language of Section 165(b) of the Internal Revenue Code, which addresses the taxability of distributions from employee trusts. The key question was whether the distributions were made “on account of the employee’s separation from the service.” The court reasoned that the employees had, in fact, separated from the service of the Corporation, even if they continued working in the same jobs for the May Company. The Corporation was dissolved, and their employment relationship with the Corporation ended on a specific date. The fact that the employees received distributions within one taxable year was also important for capital gains treatment. The court distinguished this case from prior case law, noting that in the prior case, the distributions were not made in one taxable year and that the employee did not receive the same benefits upon termination of employment as they did upon termination of the plan. The court also emphasized that, while the employees could have been paid upon termination of the fund or termination of their employment, the distributions in question were made on account of the termination of their employment with the former employer.

    Practical Implications

    This case is significant for its clarification of the “separation from service” requirement under Section 165(b). It shows that a change of employers due to a corporate reorganization can trigger a “separation from service” even if the employee continues to perform the same job for the acquiring company. Lawyers advising clients in similar situations must carefully analyze the specific facts, including the formal separation from the original employer, the timing of distributions, and the terms of the retirement plan, to determine the appropriate tax treatment. This case supports the principle that the substance of the transaction, rather than just the form, will determine the tax consequences. The case underscores the importance of ensuring lump-sum distributions are made within a single taxable year to qualify for capital gains treatment. Later cases citing this one focus on whether an employee has sufficiently separated from service to trigger capital gains treatment of the distribution from a retirement plan.