Attorney-at-Law

VESTED OR DIVESTED?

In Uncategorized on 10/25/2018 at 15:39

No opinions today, but Judge Holmes has an order that should be a designated hitter if it isn’t already, Rui-Kang Zhang & Jau-Fei Chen, Docket No. 10488-10, filed 10/25/18. No, that’s not a typo; this case is older than most Bourbon.

R-K & J-F were in the infamous National Benefit Plan, which tried to disguise individual employer insurance purchases as multiemployer plans via Sections 419 and 419A. When IRS blew this dodge up, R-K & J-F folded their plan and took in their policies, paying tax on the $160K FMV of policies plus some cash they got, for a total around $200K.

But IRS is hunting bigger game, and socks R-K & J-F for $550K, claiming that the policies were “vested” as well as “distributed,” thus triggering both Section 402(b)(1) and 402(b)(2). If that’s so, then the policies must be valued without regard to any provision triggering a lapse of the policy.

A policy that can never lapse is clearly worth more than one which can. So IRS wants to avoid dealing with surrender charges (which take place during the early years of a policy but which phase out the longer the policy is in effect; this is to compensate for the insurance company’s sales costs, which typically run for some years after a policy is issued), which Section 402(b)(1) does, using Section 83(a) not-subject-to-forfeiture rules.

R-K & J-F want to focus on Section 402(b)(2), which limits a distribution to the FMV of what the distributee actually got.

“Even the Commissioner’s textual argument specific to this case doesn’t cohere once one looks at it. He argues that according to the Plan’s terms, once petitioners’ corporation notified the Plan of its withdrawal, petitioners became ‘beneficial owners’ of the policies. The reason is that the notification triggered the Plan’s obligation to identify petitioners and fix their claim to the Plan’s assets, creating ‘a separate [vesting] event’ at ‘a slightly different moment in time’ than distribution. But this Plan had an unusual feature — the notification didn’t take effect immediately, but only started a 23-month waiting period during which petitioners could forfeit their benefits by dying or leaving the corporation’s employ.

“The Commissioner admits that this meant there wasn’t really vesting right away. But, he says, petitioners in this case agreed to an amendment to the Trust to waive the 23-month waiting period. This means that there really wasn’t a risk of forfeiture, and so the vesting rules of section 402(b)(1) apply.” Order, at p. 4.

The waiver of the 23-month hold was in a standard form given to every withdrawing employer as part of the exit package. Thus, says IRS, vesting becomes part of withdrawal and distribution.

Judge Holmes isn’t buying.

This is like saying when the Plan administrator cuts a check and puts it in a stamped envelope, the money is “vested,” and when the taxpayer gets the envelope and opens it, there’s a “distribution.”

Nope, the caselaw says the two subsections of Section 402(b) are disjunctive. Section 402(b)(1) deals with transfers of policies from one trustee to another, whereby they are no longer subject to surrender charges or the like, and vest per Section 83(a). In that case the employee never gets the policy or cash or anything else in hand. But when the lucky employee gets money in hand, it’s a distribution, and the FMV of cash is cash.

IRS loses. But I will give IRS’ inventive counsel a Taishoff “good try, third class.”

Judge Holmes asks, somewhat plaintively, if the parties are going to settle, or will he have to try this case the next time he goes to Buffalo. C’mon, guys, spare Senior Judge Holmes the Buffalo Waterfront in the winter.

 

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