To take a leaf from Stephen Sondheim’s and Leonard Bernstein’s song “When You’re a Jet” from the 1957 hit musical “West Side Story”. In this case, a 501(c)(3) exemption doesn’t disappear, even though the corporation did pay unrelated business income tax (UBIT) in three years of its hundred-year life, and unrelated debt-financed income tax (UDFIT) in two other years, when the corporation gets an employer reversion from a qualified retirement plan. That would ordinarily trigger a Section 4980(a) 20% excise tax.
But Research Corporation dodges the proverbial bullet in the eponymous case, Research Corporation, 138 T.C. 7, filed 2/29/12, a leap year bonus from Judge Haines. It’s a case of first impression.
Briefly, Research was a 501(c)(3) from the day 501(c)(3) first showed up in IRC 1954. Research was incorporated in 1912, and was exempt when the income tax was first inflicted in 1916. Research did have some UBIT to pay back in the 1950s, and some UDFIT in the early years of the current millennium.
Research had a defined benefit retirement plan for its employees from 1961 until 2003, which from inception through amendment always got favorable letters from IRS. In 2002, Research terminated the plan, setting up a $5.8 million reversion, but rolled 25% of that into a new plan, having gotten a favorable PLR that the reversion would not constitute UBTI to Research under Section 512(a)(1) (but interestingly, Research withdrew the part of its ruling request relating to Section 4980 treatment).
Research filed Form 5330 with respect to the reversion for 2003, but only paid the ratio that its lifetime UBIT and UDFIT bore to its entire income for three years, around $14K. IRS issued a SNOD for the whole enchilada, around $4.4 million, in 2010, claiming that by filing the Form 5330 and paying the $14K, Research conceded its liability for the Section 4980 excise tax.
Judge Haines blows off the concession argument in a footnote: “We do not view either the submission of Form 5330 or the statement as a concession. We note that all concessions are subject to the Court’s discretionary review and may be rejected in the interests of justice. If the submission of the Form 5330 and the statement contained therein can be viewed as a concession, we reject it. Petitioner has maintained throughout this proceeding in its petition and its briefs that it is not subject to excise tax.” 138 T.C. 7, at p. 6, footnote 2 (Citation omitted).
IRS conceded that Research never made any contributions to any of its employee plans to offset either UBIT or UDFIT whenever it owed any, so no tax benefit inured to Research from any contributions.
Also of interest, Research never raised SOL, even though the SNOD was issued more than six years after the filing of the Form 5330, so Judge Haines deemed the argument waived. Possibly Research didn’t raise SOL because it also sought a refund of the $14K in the case (but it loses on that one on Section 6512(b)(3) grounds…too many years gone by since filed and paid, so no Tax Court jurisdiction to award a refund).
The whole case goes off on Section 4980(c)(1)(a). The excise tax applies to a “qualified plan”. IRS claims Research’s plan was qualified; Research says no. The magic language: “The term ‘qualified plan’ means any plan meeting the requirements of section 401(a) or 403(a), other than a plan maintained by an employer if such employer has, at all times, been exempt from tax under subtitle A. Sec. 4980(c)(1)(A).” 138 T.C. 7, at pp. 8-9. (Emphasis by the Court.)
But Research wasn’t “at all times” exempt, says IRS. They paid UBIT three times, and UDFIT twice, since 1954. Those are both Subtitle A taxes, so Research wasn’t exempt at all times.
Judge Haines buries that argument with Section 501(b), as to the plain meaning of which he finds that, notwithstanding the UBIT and UDFIT, which Section 501(b) states does not disqualify a 501(c)(3) like Research, Research never lost its 501(c)(3) exemption.
IRS says it’s not seeking disqualification of Research as a tax-exempt, but to collect an excise tax, not an income tax. More magic language from Judge Haines: “Respondent [IRS] would like us to ignore the plain language of section 501(b), which provides that a section 501(c)(3) organization shall be subject to tax to the extent it has UBTI but, notwithstanding any unrelated business income tax paid, the organization ‘shall be considered an organization exempt from income taxes for the purpose of any law which refers to organizations exempt from income taxes’.” 138 T.C. 7, at p. 12. (Emphasis by the Court.)
Any law means any law. And the issue isn’t whether Research or any 501(c)(3) ever paid any tax. It’s whether Research was exempt under Subtitle A, because that’s what the plain language says.
IRS wants Tax Court to look at legislative history. Not necessary, says Judge Haines, because no ambiguity. But he’ll humor IRS. Here’s IRS’ last hope: “‘The agreement provides that the excise tax does not apply to a reversion to an employer that has at all times been tax-exempt. Of course, this exception does not apply to the extent that such employer has been subject to unrelated business income tax or has otherwise derived a tax benefit from the qualified plan.’ H.R. Conf. Rept. No. 99-841 (Vol. II), at II-483 (1986), 1986-3 C.B. (Vol. 4) 1, 483.” 138 T.C. 7, at p. 16. IRS says the sentence is disjunctive, and therefore either portion applies; so if Research ever paid UBIT, they must pay excise tax on the whole unrolled-over reversion.
No, says Judge Haines: “We do not agree with respondent’s argument. Respondent [IRS] ignores the phrase “to the extent”. That phrase limits the application of the legislative history to a specific set of facts. When coupled with the phrase “or has otherwise” the legislative history addresses a set of facts where the tax-exempt organization, whether it incurred unrelated business income tax or not, derived a tax benefit from the qualified plan. Respondent has conceded that petitioner did not derive a tax benefit from the plan.” 138 T.C. 7, at pp. 16-17.
So Research loses the $14K refund in Tax Court, but dodges the $4.4 million bullet. Not a bad swap.