Adler v. Commissioner

MEMORANDUM FINDINGS OF FACT AND OPINION

DAWSON, Judge: This case was assigned to Special Trial Judge Robert N. Armen, Jr., pursuant to the provisions of section 7443A(b)(4) of the Internal Revenue Code of 1986, as amended, and Rules 180, 181, and 183. ¹ The Court agrees with and adopts the Opinion of the Special Trial Judge, which is set forth below.

OPINION OF THE SPECIAL TRIAL JUDGE

ARMEN, Special Trial Judge: For the taxable year 1990, respondent determined a deficiency in petitioners' Federal income tax, as well as *142 a deficiency in excise tax under section 4973, in the total amount of $ 54,356.99. ²

The only issue for decision is whether the distribution (the Transfer Refund) received by petitioner Rudolph F. Adler from the Employees' Retirement System of the State of Maryland was paid "on account of the employee's separation from the service" under section 402(e)(4)(A)(iii) so that it would qualify as a partial distribution eligible for rollover treatment under section 402(a)(5)(D). The parties agree that if we hold that the Transfer Refund was paid "on account of the employee's separation from the service", then petitioners will not be liable for the deficiencies that respondent determined. Similarly, the parties agree that *143 if we hold that the Transfer Refund was not paid "on account of the employee's separation from the service", then petitioners will be liable for the deficiencies that respondent has determined.

FINDINGS OF FACT

Some of the facts have been stipulated, and they are so found. Petitioners resided in Lanham, Maryland, at the time their petition was filed with the Court.

Petitioner Rudolph F. Adler (petitioner) was an employee of the State of Maryland, Department of the Environment, from 1965 until his retirement, which became effective on July 1, 1990. ³ On May 24, 1990, petitioner applied to transfer from the Employees' Retirement System of the State of Maryland (the Retirement System) to the Employees' Pension System of the State of Maryland (the Pension System). ⁴ On the same day, petitioner applied to retire from employment with the State under the Pension System, effective July 1, 1990.

*144 Petitioner was a member of the Retirement System ⁵ until his election to transfer from the Retirement System to the Pension System became effective on June 1, 1990.

Petitioner received the Transfer Refund in the amount of $ 169,352.98 in the form of three checks dated June 29, 1990 (for $ 164,643.88), August 31, 1990 (for $ 426.20), and September 13, 1990 (for $ 4,282.90). The Transfer Refund consisted of $ 25,186.34 in previously taxed contributions*145 made by petitioner during his employment tenure with the State, $ 139,457.54 of earnings, and $ 4,709.10 of employer "pick-up contributions". The Transfer Refund represented more than 50 percent of petitioner's balance to the credit in the Retirement System for purposes of section 402(e)(4)(A). The earnings and "pick-up contributions", which total $ 144,166.64 and equal approximately 85 percent of the Transfer Refund, constitute the taxable portion of the Transfer Refund.

On August 22, 1990, less than 60 days after receiving the Transfer Refund, petitioner deposited $ 143,705.04 of the Transfer Refund into an individual retirement account (the IRA). This amount remained in the IRA throughout the remainder of 1990.

When petitioner transferred from the Retirement System to the Pension System, he had attained the age of 60. If petitioner had not transferred from the Retirement System to the Pension System but had remained a member of the Retirement System, he would have been entitled to retire and receive a normal service retirement benefit, including a regular monthly annuity. He would not have been entitled to receive the Transfer Refund because the Transfer Refund was payable*146 only as a result of the election to transfer from the Retirement System to the Pension System. Md. Ann. Code art. 73B, secs. 11B(5), 14(1)(g) (1988).

As a result of his election to transfer from the Retirement System to the Pension System, petitioner became, and presently is, a member of the Pension System. As a member of the Pension System, petitioner receives a retirement benefit based upon his salary and his creditable years of service, specifically including those years of creditable service recognized under the Retirement System. However, because petitioner received the Transfer Refund, his monthly annuity is less than the monthly annuity he would have received if he had not transferred to the Pension System but had retired under the Retirement System.

On their income tax return for 1990, petitioners reported that no part of the Transfer Refund was taxable during that year.

In the notice of deficiency, respondent determined that $ 144,165 of the Transfer Refund (the amount by which the Transfer Refund exceeded petitioner's previously taxed contributions) was currently taxable to petitioners and that such amount was subject to the excise tax imposed on excess contributions*147 to an IRA under section 4973. ⁶

OPINION

Petitioners contend that the Transfer Refund received by petitioner from the Retirement System was paid "on account of * * * [petitioner's] separation from the service" within the meaning of section 402(e)(4)(A)(iii). Respondent contends to the contrary. The parties agree that our resolution of this matter will dictate whether or not the Transfer Refund qualifies as a partial distribution eligible for rollover treatment under section 402(a)(5)(D) and consequently whether or not petitioners are liable for the deficiencies that respondent determined.

A "partial distribution" is defined as "any distribution to an employee of all or any portion of the balance to the credit of such employee in*148 a qualified trust; except that such term shall not include any distribution which is a qualified total distribution". Sec. 402(a)(5)(E)(v). The parties agree that the Transfer Refund was not a qualified total distribution.

In order to be eligible for tax-free rollover treatment, the "partial distribution" must be "payable as provided in clause (i), (iii), or (iv) of subsection (e)(4)(A) (without regard to the second sentence thereof)". Sec. 402(a)(5)(D)(i)(I). As relevant herein, section 402(e)(4)(A) provides that a distribution must be made either "(i) on account of the employee's death", "(iii) on account of the employee's separation from the service", or "(iv) after the employee has become disabled". Petitioners do not contend that the Transfer Refund was received either on account of petitioner's death or after any disability. Therefore, our analysis is limited to section 402(e)(4)(A)(iii); i.e., the requirement that the distribution be made "on account of the employee's separation from the service".

The phrase "on account of" is not defined in either the Internal Revenue Code or in the accompanying regulations.⁷*150 See Burton v. Commissioner, 99 T.C. 622, 626 (1992).*149 The burden of proving that the Transfer Refund was received "on account of" petitioner's separation from the service is on petitioners. Rule 142(a); Burton v. Commissioner, supra at 632; Sarmir v. Commissioner, 66 T.C. 82, 88 (1976). This burden is particularly heavy because we have recently held, in a case involving virtually identical facts and circumstances, that a taxpayer's receipt of a distribution from the Maryland State Teachers' Retirement System (the Teachers' Retirement System) upon transferring to the Maryland State Teachers' Pension System (the Teachers' Pension System) was not received on account of his retirement but rather on account of the transfer from the Teachers' Retirement System to the Teachers' Pension System. Hylton v. Commissioner, T.C. Memo. 1995-27. ⁸ Accord Dorsey v. Commissioner, T.C. Memo. 1995-97.

Petitioners' principal contentions (the only contentions that warrant discussion) are that: (1) The Court's decision in Hylton v. Commissioner, supra, was*151 incorrect; and (2) the facts in this case are distinguishable from those in Hylton v. Commissioner, supra, because petitioner's election to retire from employment with the State and to transfer from the Retirement System to the Pension System were made on the same day, and he did not continue working after receiving the Transfer Refund.

With regard to petitioners' first contention, petitioners mischaracterize our holding in Hylton v. Commissioner, supra. We did not hold, as suggested by petitioners, that a distribution must be solely "on account of the employee's separation from the service" in order to satisfy the requirements of section 402(e)(4)(A)(iii). Rather, we held that the distribution from the Teachers' Retirement System to the taxpayer did not satisfy the requirements of section 402(e)(4)(A)(iii) because it was not made "on account of * * * [the taxpayer's] separation from the service" but rather on account of the taxpayer's election to transfer from the Teachers' Retirement System to the Teachers' Pension System.⁹

*152 Petitioners' second contention is similarly without merit. In Hylton v. Commissioner, supra, we found that the taxpayers had shown that the taxpayer's election to transfer from the Teachers' Retirement System to the Teachers' Pension System was related to his retirement planning and that he had in fact retired within 6 months of receiving the distribution which accompanied his transfer to the Teachers' Pension System. Similarly, in this case, we are satisfied that petitioners have shown that petitioner's election to transfer from the Retirement System to the Pension System was related to his retirement planning. However, neither the fact that petitioner's election to transfer and petitioner's election to retire were made on the same day, nor the fact the petitioner did not continue working after receiving the Transfer Refund, alters the fact that the Transfer Refund was made on account of petitioner's election to transfer from the Retirement System to the Pension System. Absent that election, no such distribution would have been made. ¹⁰

*153 As we discussed in Hylton v. Commissioner, supra, there is no direct causal link under Maryland law between a taxpayer's election to transfer from the Retirement System to the Pension System and a taxpayer's election to retire. Similarly, under Maryland law, there is no direct causal link between the receipt of the Transfer Refund and a taxpayer's retirement. No such causal link exists because a taxpayer is not obliged, under Maryland law, to transfer from the Retirement System to the Pension System either in order to continue working or in order to retire. Similarly, under Maryland law, a taxpayer is not obliged to retire upon electing to transfer from the Retirement System to the Pension System. In other words, petitioner could have transferred from the Retirement System to the Pension System and received the Transfer Refund at any time during his employment tenure with the State; he was under no obligation whatsoever to retire solely by virtue of having transferred from the Retirement System to the Pension System.

Upon electing to transfer from the Retirement System to the Pension System and receiving the Transfer Refund, petitioner was *154 at liberty to dispose of the Transfer Refund as he saw fit. In other words, Maryland law did not prescribe or otherwise limit the options available to petitioner in disposing of the Transfer Refund. Hylton v. Commissioner, supra.¹¹

Petitioners offer no compelling reason for us to depart from either our analysis or conclusion in Hylton v. Commissioner, supra. Therefore, we hold that petitioner did not receive the Transfer Refund "on account of * * * [petitioner's] separation from the service". Rather, we hold that petitioner received the Transfer Refund on account of his election to transfer from the Retirement System to the Pension System, an*155 election that, under Maryland law, lacked the requisite connection to petitioner's separation from the service.

Having concluded that the Transfer Refund was not eligible for tax-free rollover treatment under section 402(a)(5) as a "partial distribution", we sustain respondent's income tax and excise tax determinations for the year in issue (with the reduction indicated supra note 6).

In order to give effect to the foregoing,

Decision will be entered for respondent for the deficiency in income tax as determined in the notice of deficiency and for respondent for the deficiency in excise tax in the reduced amount.