While this case by its terms dealt only with the taxation of a retirement distribution under a now-repealed section of the Internal Revenue Code, it has been used by analogy to determine whether an individual has had a termination of employment that would permit a distribution before age 62 in the case of a pension plan, or before age 59½ in the case of a 401(k) plan. See General Information Letter 2000-0245 (September 6, 2000).
LARKINS, JR., District Judge: This civil action was instituted by the plaintiffs to recover certain income taxes and interest thereon paid to the defendant as a result of certain assessments made by certain of the defendant’s employees.
This Court has jurisdiction pursuant to Title 28 U.S.C.A. sec. 1346(a)(1).
During the year 1962, Alban K. Barrus, one of the plaintiffs, received a certain lump sum distribution from a “Retirement Trust Fund” established under section 401(a) of the Internal Revenue Code of 1954. The plaintiffs filed a joint return of their income for the year 1962. The plaintiffs reported that lump sum distribution as income in the form of a long term gain from the sale or exchange of a capital asset held for more than six months on the their joint return. The Commissioner of Internal Revenue Service subsequently determined that such income was taxable as ordinary income. As a result of that determination, the plaintiffs paid an assessment in the amount of $18,860.44 and interest thereon in the amount of $2,357.56 (part of which appears to have since been refunded to the plaintiffs). In this action, the plaintiffs seek a recovery of the assessment and interest paid.
The defendant, United States of America, has answered and denied the material allegations of the complaint.
Both parties waived their right to trial by jury.
The Court has heard the evidence as presented at the trial, observed the witnesses, reviewed the transcript of the trial, the depositions and exhibits, and has considered the stipulations of the litigants.
Findings of Fact
The plaintiff, Alban K. Barrus, and the plaintiff, Hattie C. Barrus, are citizens of the United States of America. They reside in the City of Kinston, Lenoir County, North Carolina which is within the geographical bounds of the Eastern District of North Carolina. At all times relevant to this action, the plaintiffs were legally married to each other under the laws of the State of North Carolina. (Stip. no. 1)
The plaintiff, Alban K. Barrus, was, on December 31, 1961, and for many years prior thereto had been, a principal officer, stockholder, and director of Barrus Construction Company, a North Carolina corporation, with its principal offices in Kinston, North Carolina. The Barrus Construction Company is principally engaged in the construction of highways.At times hereinabove referred to, Alban K. Barrus was also an employee of Barrus Ready Mix Concrete Company, a North Carolina corporation. (Stip. no. 4)
On December 31, 1961, both of these corporations were contributing employers to the Barrus Construction Company Profit Sharing and Retirement Trust Fund, an employees’ trust established pursuant to section 401(a) of the Internal Revenue Code of 1954 (hereinafter referred to as an “employees trust”). This employees trust has since its inception and to the present time been exempt from taxation pursuant to section 501(a) of the Internal Revenue Code of 1954. (Stip. no. 5)
On March 8, 1961, Alban K. Barrus celebrated his 65th birthday, the customary age of retirement in the present business community. Subsequently, on January 4, 1962, he applied for retirement benefits from this employees trust. Pursuant to this application and an accompanying certification by the appropriate officials of the employees trust program to the trustee of the fund, the Wachovia Bank and Trust Company in its capacity as trustee of the employees trust remitted the sum of $41,628.63 to the plaintiff, Alban K. Barrus. (P. Ex. no. G; Stip. no. 8)
The terms of the employees trust did not permit any benefits to be paid under the trust until an employee had terminated the employment relationship. (Stip. no. 2)
This amount of $41,628.63 paid to the plaintiff, Alban K. Barrus, was reported by the plaintiffs on their 1962 federal income tax joint return as income from the sale or exchange of a capital asset held for more than six months. The Commissioner of the Internal Revenue Service subsequently determined that this amount ($41,628.63) constituted income taxable as ordinary income. (Stip. no. 9) As a result of that determination, the plaintiffs paid to the defendant an assessment in the sum of $18,860.44 and interest thereon in the sum of $2,357.56. All other administrative and jurisdiction prerequisites for the institution of this law suit have been met by the plaintiffs.(Stip. no. 10)
Alban K. Barrus terminated his employment with the Barrus Construction Company and its subsidiaries on January 1, 1962. This termination was motivated by several factors. First, he had reached the age of 65, the customary age of retirement in business circles. As a self-made man who had worked his way to the top of the construction industry, he relished the time when he could leave to others the operation of the Barrus construction interests. Secondly, Alban K. Barrus was in poor health from 1952 to 1962 as a result of an infection in the tissues of his bladder. This physical infirmity caused him considerable discomfort and pain. It resulted in his disability to be an active participant in the management of the Barrus construction interests. Alban K. Barrus retired on January 1, 1962 to preserve his health and prevent further deterioration of his physical condition. (P. Ex. B, Tr. 22-23)
During the period of time from January 1, 1962 and June 4, 1962, Alban K. Barrus was not employed by the Barrus Construction Company or its subsidiaries. He received no salary or compensation of any type from that company during this period. He did retain, however, his interests in certain business affairs not related to the Barrus Construction Company and its subsidiaries. Included among these were rental property, securities and stock.For his personal use, he retained an office in a building which he owned and which he leased to the Barrus Construction Company for use as a corporate headquarters. He employed a bookkeeper to assist him and paid the salary of this person out of his own pocket. (Tr. 26-27, 33-34)
There was no agreement of any type, written or oral, between Alban K. Barrus and the Barrus Construction Company and its subsidiaries relative to the rendition of services of any type by Alban K. Barrus on their behalf between January 1, 1962 and June 4, 1962 (Tr. 33-34). There is no evidence on which to base a finding or to support a finding that Alban K. Barrus performed any business function for the Barrus Construction Company or its subsidiaries between January 1, 1962 and June 4, 1962.
The record before this Court does reveal that from January 1, 1962 to June 4, 1962, the plaintiff Alban K. Barrus rendered opinions on certain business matters relating to Barrus Construction Company on occasions when specifically asked by his son, Alban K. Barrus, Jr., or Marion R. Cowper, a fellow stockholder in the Barrus construction interests (Tr. 62-77). However, in each instance, Alban K. Barrus made it clear that the decision was to be made by someone other than himself (Tr. 113-114). The Court does not feel that there is anything unusual about these conversations since the plaintiff was at all times a stockholder in the Barrus Construction Company.
There is no evidence before this Court other than circumstantial and speculative evidence which would in any way support the Government’s contention that there was, in fact, no termination of the employment relationship.
In the early spring of 1962, Alban K. Barrus’ physical condition began to improve. This appears to have resulted from certain medical attention and help he had received since January 1, 1962. (P. Ex. J, Tr. 30, 55, 59) Consonant with and as a result of this improvement in his physical condition, Alban K. Barrus was requested by his son, Alban K. Barrus, Jr., and Marion R. Cowper to consider returning to his old job at the Barrus Construction Company. This request was based upon a lack of executive talent within the company, the expanding highway construction program of the State of North Carolina as a direct result of a $200 million dollar road bond issue approved by the voters in late 1961, and the acquisition of a large number of paving contracts in the winter of 1962 by the Barrus Construction Company. As a result of this request by his son and Mr. Cowper and following that request, Alban K. Barrus determined to resume his employment relationship with the Barrus Construction Company. (Tr. 30-31, 55-56, 106-108) The main reason that Alban K. Barrus returned to work was the improved condition of his health (Tr. 66, 106-107).Additionally, he desired to assist in the work of the Barrus Construction Company as an active participant in management.
On June 4, 1962, Alban K. Barrus resumed his employment relationship with the Barrus Construction Company and was thereupon elected Chairman of the Board of Directors of the corporation (P. Ex. C). From January 1, 1962 to June 4, 1962, Alban K. Barrus did not receive any compensation from the Barrus Construction Company or its subsidiaries nor did he hold any position with these firms except as a stockholder.
The plaintiff applied for and received social security benefits for the period from January 1, 1962 through June 1, 1962.
The unimpeached testimony of every witness who appeared before the Court and who were deposed, is that the plaintiff, Alban K. Barrus, did in fact terminate his employment relationship with the Barrus Construction Company and its subsidiaries on January 1, 1962.
There is certain evidence before this Court concerning the request made on behalf of Alban K. Barrus for a ruling from the Internal Revenue Service relating to a redemption by the Barrus Construction Company of certain of its stock owned by the plaintiffs. This ruling was requested prior to January 1, 1962, although it represented the impending retirement of Alban K. Barrus. (D. Ex. no. 3) As late as April 6, 1962, the accountant for Alban K. Barrus advised the Internal Revenue Service that Alban K. Barrus had resigned on January 1, 1962 as an officer, director, and employee of the Barrus Construction Company and its subsidiaries. (Govt. Ex. no. 4) On April 24, 1962, the plaintiff’s accountant corresponded with Alban K. Barrus relative to expediting the ruling of the Internal Revenue Service. It was not until after the plaintiff, Alban K. Barrus, had resumed his employment that the request for this ruling was withdrawn. The Court therefore finds as a fact that the stock redemption ruling and the termination of employment of Alban K. Barrus and the subsequent resumption of employment of Alban K. Barrus were not contingent one upon the other in any way.
Conclusions of Law
Section 402 of the Internal Revenue Code of 1954 provides in part:
SEC. 402. TAXABILITY OF BENEFICIARY OF EMPLOYEES’ TRUST.
(a) Taxability of Beneficiary of Exempt Trust. –
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(2) Capital gains treatment for certain distributions. – In the case of an employees’ trust described in section 401(a) which is exempt from tax under section 501(a), if the total distributions payable with respect to any employee are paid to the distributee within 1 taxable year of the distributee on account of the employee’s death or other separation from the service, or on account of the death of the employee after his separation from the service, the amount of such distribution, to the extent exceeding the amounts contributed by the employee (determined by applying section 72(f)), which employee contributions shall be reduced by any amounts theretofore distributed to him which were not includible in gross income, shall be considered a gain from the sale or exchange of a capital asset held for more than 6 months. [HN2] Where such total distributions include securities of the employer corporation, there shall be excluded from such excess the net unrealized appreciation attributable to that part of the total distributions which consists of the securities of the employer corporation so distributed. The amount of such net unrealized appreciation and the resulting adjustments to basis of the securities of the employer corporation so distributed shall be determined in accordance with regulations prescribed by the Secretary or his delegate.
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It is clear that the Congress intended that capital gains treatment be given to lump sum distributions made from qualified employees trusts (such as the trust in this case) when such funds are paid to the distributee within one taxable year “on account of… separation from service.”
The evidence in this case reveals that a lump sum distribution was made from a qualified employees’ trust to Alban K. Barrus, the distributee, and that such distribution was made within one year from the date of his separation from the service of Barrus Construction Company, whether that date be January 1, 1962 (as the plaintiff contends) or March 20, 1962 (as the Government contends).
The Court is of the opinion that [HN4] the critical date for the determination of the final and absolute termination of the employment relationship is the date of retirement, and not the date that the lump sum distribution was made. The date of distribution is determined by many factors, the majority of which are not within the control of the employee or employer. [HN5] Distribution involves computation and calculation on the part of the trustee. The trustee writes the check and makes the payment. Absent a showing as in this case, that the trustee and employer have engaged in devious conduct or deliberate slow down tactics, this Court can see no good reason why the date of actual distribution should be the crucial point in time. The date on which the distribution is made has no bearing on the date the employment relationship is terminated.The [HN6] Congress has provided in what appears to be clear and concise language that if the lump sum distribution is to be accorded capital gains treatment it must be made within one year of the termination of the employment relationship. Revenue rulings, such as Rev. Rul. 56-214, 1956-1 Cum. Bull. 196, 197, which seek to change the obvious Congressional intent, will not be accorded judicial sanction. Indeed, the evidence in this case reveals that the employment relationship was terminated prior to the date of distribution and that, in fact, the employment relationship had not been re-established on the date of distribution. The Government’s contention is not, therefore, well taken.
Although the term “separation from service” has not been clearly defined by administrative, congressional or judicial authorities, the facts heretofore found by this Court give rise to an inescapable conclusion in law that on January 1, 1962, the plaintiff-Alban K. Barrus was separated from the service of Barrus Construction Company.
The circumstances weighing against this conclusion are both meager and extremely conjectural. At no time during this Judge’s career has a witness appeared to strive so hard “to tell it like it is” regardless of the consequences to his case than did this plaintiff-Alban K. Barrus. His candor and apparent honesty, his obvious credibility, were like a breath of fresh air in a chamber accustomed to seemingly rehearsed examinations of witnesses who speedily deny obvious facts lest such an admission do damage to their cause.This Court is of the opinion that Alban K. Barrus sincerely and honestly terminated in every respect his employment relationship with Barrus Construction Company on January 1, 1962; and that he did not intend to resume this relationship at any later date. In essence, the Court is of the opinion that the termination of employment on January 1, 1962 was in every respect a separation by Alban K. Barrus from the service of Barrus Construction Company.
This separation was not a carefully directed plot to gain the benefit of capital gains treatment. If such plotting was his nature, Alban K. Barrus would not have retained an office in the same building with the Barrus Construction Company nor would he have so readily admitted to discussing business affairs with the new management team. If he had meant to retain control of the Barrus Construction Company, he could have relied upon an office at home and telephonic communications. Additionally, the Court notes that he personally paid a bookkeeper to assist him. This civil action is simply a case of a man who kept an office to maintain his other business interests and who never thought anything was wrong with keeping his old office.The conversations he held with the new management team are normal and do not give rise to any presumption that there was an employment relationship. The evidence makes clear that Alban K. Barrus did not make any business decision relating to the Barrus Construction Company.
The Court will concede the Government’s point that these circumstances are deserving of attention. However, the facts before the Court and the credibility of the plaintiff and his witnesses lead to the inescapable conclusion that these are merely circumstances that will not support in any way a finding or conclusion adverse to the plaintiffs.
A separation from service exists, as in this case, when there is a complete and good faith termination of the employment relationship. Indeed, the meaning of these two terms are for the most part the same. The [HN7] separation and termination occur when the employer no longer pays the employee in any way for services rendered, when decisions which affect the business operation are no longer made by, directed or carried out by the employee, and when the employee is no longer under the direction and control of the employer. The fact that the ex-employee retains his office for the conduct of personal business, that he may be asked for advice on occasion about the business, that he frequents his former place of employment, and that he subsequently renews the employment relationship when the original termination and separation was made in good faith is not sufficient to support a finding that there was not an original, absolute, and good faith termination and separation.
Therefore, the Court concludes as a matter of law based upon the facts heretofore found that on January 1, 1962, Alban K. Barrus was separated from the service of the Barrus Construction Company as those terms are used in section 402(a)(2) of the Internal Revenue Code of 1954; and that the lump sum distribution made to Alban K. Barrus from the employee trust as a result of that separation should be taxed as a gain from the sale or exchange of a capital asset held for more than six months.
The Court is aware of the Government’s concern that employees may retire in “bad faith” and as a sham to attain preferred tax treatment of the subsequent distribution from a qualified employees trust; and having received such favorable tax treatment, resume the employment relationship. That concern is understandable. But that situation does not confront the Court in this action.
This plaintiff was the beneficiary of the rapidly advancing field of modern medicine. His physical condition improved to such an extent that he could again participate in the active management of the Barrus Construction Company. To interpret the law to mean that persons such as this plaintiff-Alban K. Barrus could not return to work without severe tax penalties when there had been a substantial change in conditions and when the original termination and separation was absolute and in good faith would subvert both the Congressional intent and good common sense.
Accordingly, the order filed consonant with this Opinion directs that a judgment be entered in favor of the plaintiffs. The original assessment and interest paid by the plaintiffs in May 1965 totaled $21,218.00.It would appear from the pleadings and other records on file that certain refunds have since been made to the plaintiffs because of an overassessment. Because the exact amounts of such refunds do not fully appear in the records on file, the ORDER filed consonant with this Opinion directs counsel to confer and submit a judgment to the Court containing the correct figures. The plaintiffs are entitled to recover interest on the total amount of the proper assessment and interest as provided by law. The costs in this action shall be borne by the defendant.
It is THEREFORE ORDERED that the plaintiffs, Alban K. Barrus and Hattie C. Barrus, recover of the defendant, United States of America, the total amount of assessments and interest paid to the defendant by the plaintiff with interest as provided by law; and that the plaintiffs, Alban K. Barrus and Hattie C. Barrus, recover of the defendant, United States of America, the costs of this action and that such costs be borne by the defendant.
It is FURTHER ORDERED that within ten days after service of this OPINION and ORDER upon all counsel of record that the same shall confer and submit to the undersigned United States District Judge for signature a judgment in accord with the provisions of this OPINION and ORDER.
It is FURTHER ORDERED that the Clerk serve a certified copy of this OPINION and ORDER upon all counsel of record, return receipt requested.
Let this ORDER be entered forthwith.