MacDonald v. Commissioner

*386 The Commissioner determined a deficiency in petitioners' income tax for the taxable year 1961 in the amount of $ 2,030.32. The sole issue is whether the sum of $ 15,300 received by petitioner John E. MacDonald, under an employer-sponsored education program is excludable from petitioners' gross income under section 117 of the 1954 Code as a "scholarship" *118 or "fellowship grant."

*387 FINDINGS OF FACT

Some of the facts are stipulated and are incorporated herein by reference.

John E. MacDonald, Jr., and his wife, Henrietta E. MacDonald, were residents of Wappingers Falls, N.Y., at the time of the filing of the petition herein. They filed a joint return for the year 1961 with the district director of internal revenue at Springfield, Ill. Since Henrietta is a party to this proceeding solely because she joined in the return of her husband, he will hereinafter be referred to as the petitioner.

Petitioner became an employee of the International Business Machine Co. (IBM) in Poughkeepsie, N.Y., in July, 1952, as an electrical engineer. At that time he held a bachelor of science degree in electrical engineering which he received at Purdue University. In 1958, he received a master of science degree in electrical engineering at Syracuse University.

In 1959, IBM established an advanced education program for its engineers and scientific personnel whereby it would assist such employees in obtaining degrees of master of science (M.S.) or doctor of philosophy (Ph. D.). The terms and scope of the program were set forth in a basic IBM memorandum*119 of "Corporate Instruction" together with several attachments relating thereto. Under the program IBM selected from among its various divisions a small number of employees (normally with several years of employment at IBM but with a minimum of 1 year) to pursue their studies for a Ph. D. degree at a university "mutually selected by [the] employee and [IBM]." During the period that the employee was thus enrolled as a candidate for the degree IBM continued to pay his regular salary in full; it also paid his tuition and institutional billed charges, as well as moving and other related expenses. The program contemplated 3 years full-time study, but the arrangement had to be renewed annually.

IBM imposed as a condition that the student "meet institutional requirements, achieve a good academic record, [and] maintain company contact." And although IBM did not exact any written undertaking on the part of the employee to return to IBM upon completion of his studies, it explicitly stated that the employee was "expected to return to the sponsoring division [of IBM]."

An employee desiring to participate in the program was required to file an application on a form provided by IBM. The form called*120 for a description of the applicant's personal and academic background as well as his past and present work assignments at IBM. In addition, the application form asked the applicant to answer the following *388 questions: "Why do you wish to undertake this program?" and "Why is the field you are choosing important to IBM?"

The announced objectives of the program were listed in the basic IBM memorandum as follows:

1. To develop a spirit of inquiry and creativity, and maintain a high level of technical competence.

2. To increase technical competence through study of fundamental sciences and advanced technical subjects of particular interest to the company.

3. To provide an environment which encourages full professional development and attracts personnel of the highest quality.

The selection process consisted of a series of screening stages in which various factors were evaluated. This process was outlined in one of the attachments to the basic IBM memorandum as follows:

(1) Evaluation of transcripts of undergraduate and graduate academic grades to determine qualification for graduate study. Normally, successful completion of two graduate level courses, not necessarily*121 degree credit courses, within the last two years will be required.

(2) Evaluation of the Graduate Record Examination, aptitude test score, with 500 considered as a normal minimum.

(3) Management evaluation of the individual's potential as a student.

(4) Determination of eligibility with respect to minimum length of Service.

(1) Evaluation of work performance history through discussions with the immediate manager and reference to personnel records and appraisal information.

(2) Evaluation of professional activities, including patents, papers, professional society activity, and participation in Company education programs through study or teaching.

(3) Determination of relationship of the employee's field of graduate study interest to the prime areas of interest of the company.

(4) Evaluation of the employee's educational goals and motivation for graduate study through analysis of written application, and interview, if necessary.

(1) Interview by a local management team, normally including the manager of education (or the person responsible for education) as a permanent member.

(2) Division review of persons proposed by locations to determine adequacy*122 of selection process; to evaluate criteria decisions; to equate numbers selected with available financial support and to assure equitable distribution of selectees and applications.

(3) Management contact with the universities about the selectees to answer acceptance questions where necessary.

(1) The divisions will review their selection with the Vice President of Research and Engineering and the IBM Director of Personnel to insure uniformity of administration, equitable distribution among locations, and proper relationship of fields of interest to engineering needs.

(2) The division will inform the employees of their selection.

[Emphasis supplied.]

*389 Another attachment to the basic IBM memorandum which set forth "Principles" with respect to the IBM advanced education program for engineers and scientific personnel contained the following:

5. The program should be administered in a manner which will aid the employee at school to continue identifying himself with the Company. It is suggested that one manager be responsible for all employees in scholarship and fellowship programs; normally, the engineering education manager. The employee should*123 be encouraged to periodically visit the laboratory for technological interchange and he should be visited on campus during study.

6. Through negotiation with the university local management should take steps necessary to protect IBM's interests in theses, dissertations and doctoral research.

7. A grant to the institution of $ 1,000.00 for each IBM scholarship or fellowship student per year should be made.

8. The division should normally pay all university billed tuition and fees, including grants, directly to the University.

9. The employee's salary should be reviewed prior to beginning study to assure that he has been rewarded for his work achievement. Salaries may be adjusted during his course of study if management determines the need to reward. Upon the employee's return, his salary should be reviewed to assure competitive remuneration for his increased educational achievement.

[Emphasis supplied.]

Petitioner applied for participation in the advanced education program and was notified of his acceptance by letter dated February 12, 1960. The letter indicated that there had been more than 180 applications within the Data Systems Division of IBM, in which petitioner*124 was employed, and that the division had selected 12 M.S. candidates and 11 Ph. D. candidates (including petitioner) for programs commencing in 1960. The letter also informed petitioner that he was "entitled to feel honored that your job accomplishments and academic promise have been recognized by your inclusion within the limited number of appointments."

In September 1960 petitioner left his regular duties at IBM at Poughkeepsie, N.Y., and took his wife and children to Urbana, Ill., where he began his studies at the University of Illinois leading to a Ph. D. degree in electrical engineering. He had meanwhile leased his house at Wappingers Falls, N.Y., in the Poughkeepsie area. Petitioner completed all requirements for the degree except the thesis and left the university in June 1962, returning to his home in Wappingers Falls. He did not immediately resume his regular duties at IBM at that time, but continued to work on his thesis until the spring of 1963, when he again began to work at his previous IBM job.

Throughout the period from September 1960 to about April 1963, when petitioner attended the university in Illinois and thereafter worked on his thesis in New York, IBM continued*125 to pay him his regular salary at the rate of $ 15,300 a year. He received such payments twice a month in the same manner that he would have received his *390 compensation had he continued to perform his regular duties in Poughkeepsie. IBM withheld a portion of these payments for Federal income taxes and petitioner was furnished with a Form W-2 withholding tax statement in respect of such amounts. IBM also paid petitioner's travel expenses to and from Illinois, and it paid his tuition and other fees directly to the university. During this period (September 1960 to April 1963) petitioner was entitled to employee benefits, such as health insurance. While registered at the university petitioner's regular salary payments would have been curtailed during the summer months if he did not attend classes at that time. However, petitioner was enrolled for courses during the summer of 1961, and he continued to receive his salary payments throughout the year. If he had not attended the summer classes, he could have performed temporary services for IBM, for which he would have been separately compensated.

During the period June 1962 to April 1963 when petitioner was working on his thesis*126 in New York, he performed no regular services for IBM although he was still receiving his previous salary at the annual rate of $ 15,300. However, in the fall of 1962 he did teach a few courses at IBM but he was separately compensated therefor.

Petitioner returned to his regular duties at IBM in Poughkeepsie, N.Y., in the spring of 1963, because he thought that he was making little progress in the completion of his thesis. Upon his return he did the same type of work he had done when he left IBM in 1960. His duties, position, and salary remained the same as before. Petitioner finally completed his thesis in 1965 and he received a Ph. D. degree in September 1965 from the university. During the period 1963-65 petitioner traveled to Illinois several times in connection with his thesis. IBM did not reimburse him for travel expenses incurred on such occasions.

Although petitioner was not legally obligated to return to his job at IBM after completing his work at the university, IBM expected him to do so, as noted above. Petitioner nevertheless entertained the idea of becoming a college professor when he obtained his Ph. D. In 1966, he was offered a job as an associate professor *127 at the University of Florida, but he declined the offer and remained with IBM.

Petitioner filed a joint return for the taxable year 1961. He excluded the sum of $ 15,300 received from IBM under the educational program described above from his gross income in that year. Petitioner claimed that this amount represented a "fellowship or scholarship" under section 117, I.R.C. 1954. The Commissioner determined a deficiency against petitioners of $ 2,030.32 by reason of this exclusion, asserting that the sum of $ 15,300 represented taxable income in the year 1961. The amounts paid by IBM to cover tuition, fees, and travel expenses are not in issue.

*391 OPINION

At issue is whether petitioner's full salary of $ 15,300 paid to him in 1961 by IBM while he was pursuing his studies towards a Ph. D. degree is excludable from his gross income as a "scholarship" or "fellowship grant" under section 117, I.R.C. 1954. ¹*129 These terms have been defined and limited in Income Tax Regs. section 1.117-3 and 4, ² which have recently been held valid by the Supreme Court in *392 Bingler v. Johnson, 394 U.S. 741 (1969). And under these regulations amounts representing*128 "compensation for past, present, or future employment services" and amounts paid to an individual "to enable him to pursue studies or research primarily for the benefit of the grantor" are not excludable under section 117. Bingler v. Johnson points the way to the application of the regulations to the present case. We hold that petitioner's $ 15,300 salary received in 1961 was not tax-free.

*130 Preliminarily, it may be noted that the Supreme Court regarded as applicable to the provisions before us the statement of the House Ways and Means Committee that the statute was not intended to relieve from tax "those grants which are in effect merely payments of a salary during a period while the recipient is on leave from his regular job," and that scholarships and fellowship grants "generally are of small amount and are usually received by individuals who would have little or no tax liability in any case." H. Rept. No. 1337, 83d Cong., 2d Sess., p. 17; Bingler v. Johnson, 394 U.S. 741 (1969). In respect of both of these criteria petitioner's position is weaker than those of the unsuccessful taxpayers in Bingler v. Johnson. Here petitioner received his full pay while on leave at the university whereas the employees in Bingler received a specified percentage (ranging from 70 percent to 90 percent) of salary, and the amounts received by them ($ 5,670 and $ 9,698.90) were substantially less than petitioner's $ 15,300. In any event, however, petitioner's payments fail to qualify for exclusion under the regulations. As we view the record*131 before us, the "grant" to petitioner was primarily for the benefit of IBM and reflected a recognition of or compensation for past or expected future employment services.

The advanced education program was initiated by IBM plainly for the purpose of receiving the kind of contributions that skilled and gifted employees like petitioner could make to the company as a consequence of their higher levels of education. This was made clear by the explicitly announced objectives of the program:

1. To develop a spirit of inquiry and creativity, and maintain a high level of technical competence.

2. To increase technical competence through study of fundamental sciences and advanced technical subjects of particular interest to the company.

3. To provide an environment which encourages full professional development and attracts personnel of the highest quality.

Participants in the program were selected from among those employees who had worked at least 1 year with IBM and who, by reason of their job accomplishments, offered the greatest promise of future on-the-job achievement. Applicants for the program were asked in effect to explain how their advanced education would benefit the company. In*132 addition, one of the initial stages of the selection process involved a "Determination of [the] relationship of the employee's field of graduate study interest to the prime areas of interest of the company." *393 And at the final stage of selection a review was required at a high level "to insure," among other things, that there was a "proper relationship of [the employee's] fields of interest to [IBM's] engineering needs." The employee was free to choose the university at which he pursued his studies only with the approval of IBM.

Participants in the program were obviously viewed by IBM as undertaking regular job assignments. Accordingly, stipends were in the exact amount as the participants' previous salaries, with no adjustments for need or one's financial ability to meet educational expenses. Payments were made in the same manner as previous salary payments and a portion of these payments was withheld for Federal income tax purpose, such portion being the same as when the payments were salary payments. Further, company benefits, such as health insurance, were continued throughout the period of participation in the program.

In addition, IBM sought to administer the program*133 in such manner as would "aid the employee at school to continue identifying himself with the Company," and instructions were issued to the effect that "The employee should be encouraged to periodically visit the laboratory for technological interchange and he should be visited on campus during study." The employee was required to "maintain company contact." Moreover, the program called for negotiation with the university "to protect IBM's interests in theses, dissertations and doctoral research."

Finally, those selected for participation in the program were "expected to return to the sponsoring division [of IBM]" after completion of their academic work. In this respect the present case is weaker for the Government than Bingler v. Johnson, because in that case the employees were contractually obligated to return to their employer, and the Court stressed this fact. Nevertheless, we think that IBM's clear expectation that the employee would return, when considered in the context of the entire case, is sufficient in reaching the conclusion that the "grant" was primarily for the benefit of the grantor. The Supreme Court certainly did not lay down any indispensable requirement*134 that there be a contractual undertaking, although the presence of such an undertaking would obviously be strong evidence in support of the conclusion that benefit to the grantor was of prime importance. We think that the evidence must be considered as a whole, and when so considered the conclusion is unavoidable that the payments to petitioner did not qualify as a "scholarship" or "fellowship grant" under the statute and regulations. Cf. Ussery v. United States, 296 F. 2d 582 (C.A. 5); Woddail v. Commissioner, 321 F. 2d 721 (C.A. 10); Stewart v. United States, 363 F. 2d 355 (C.A. 6). ³

Decision *135 will be entered for the respondent.