T.C. Memo. 1996-93

UNITED STATES TAX COURT

ESTATE OF JAMES F. HALL, JR., DECEASED, HARRIETT HALL, EXECUTRIX,

AND HARRIETT NIXON HALL, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 26270-92. Filed March 4, 1996.

Neal A. Sanders and Gerard J. Serzega, for petitioners.

Julia L. Wahl, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

RUWE, Judge: Respondent determined a deficiency of

$287,624.41 in petitioners' 1988 Federal income tax.

The issues for decision are whether petitioners properly

excluded from income the 1988 distribution from the Hadd-Too,
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1Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the taxable year in

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

 

2At the time they filed their petition herein, petitioners

were involved in divorce proceedings and did not reside together. 

Inc., Pension Plan under section 105(c)1 and, if not, whether

petitioner Harriett Nixon Hall is entitled to relief from

liability as an "innocent spouse" under section 6013(e).

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. 

The stipulation of facts and attached exhibits are incorporated

herein by this reference. At the time of the filing of the

petition in this case, petitioners resided in Carnegie,

Pennsylvania.2 Petitioner James F. Hall, Jr., died on January

12, 1994, after the petition was filed but before trial. His

estate filed a Motion for Substitution of Party and to Change

Caption, which was granted by the Court. 

Together petitioners owned 100 percent of the stock of HaddToo, Inc. (Hadd-Too). Hadd-Too adopted a defined benefit pension

plan (Plan or Hadd-Too Plan) and trust, effective January 1,

1981, which was subsequently amended and restated, effective

January 1, 1984. The Plan was a qualified plan within the

meaning of section 401(a). On November 19, 1986, Hadd-Too

resolved to terminate its Plan, effective December 31, 1986,
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because it believed that the Plan was overfunded and that by

terminating the Plan, it would permit the company to distribute

Plan assets without violating new funding limits under the Tax

Reform Act of 1986. However, the Plan assets were not completely

distributed until 1988. 

During 1987 and 1988, the IRS audited the Hadd-Too Plan. 

During the course of this audit, Hadd-Too and Mr. Hall were

represented by attorney Susan Foreman Jordan. Ms. Jordan

represented Mr. Hall and the company in pension matters from the

fall of 1984 until sometime after March 1989. The IRS determined

that Mr. Hall engaged in prohibited transactions with respect to

certain Plan assets and that Mr. Hall was required to make

restitution to the Plan or face liability for excise taxes. The

IRS agreed to resolve the audit issues by having the Plan

distribute all its assets to Mr. Hall, who was the sole

participant in the Plan in 1988, rather than requiring Mr. Hall

to pay actual restitution or excise taxes. The entire balance to

Mr. Hall's credit in the Plan was distributed to him in 1988. 

The distribution consisted of cash and property in the amount of

$1,027,229.45. At the time of this distribution, the Plan was

still a qualified plan within the meaning of section 401(a). 

The Plan provided for the payment of retirement benefits to

Hadd-Too employees. In addition to the payment of ordinary

retirement benefits, the Plan contained the following provision
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for the payment of retirement benefits in the event an employee

ceased employment with Hadd-Too due to total disability:

4.05 Disability: A participant whose service with the

Employer ceases due to a total disability for a period

of twelve (12) months or more, prior to his normal, or

where applicable, late retirement date, shall receive

the actuarial equivalent of his Accrued Benefit. A

participant is deemed disabled, if he is receiving

Social Security disability payments or is receiving

disability insurance payments from any duly organized

insurance company by reason of total disability as

defined by the payor of the disability benefit. * * *

A participant's "accrued benefit" was defined by the Plan as the

normal benefit as of normal retirement age multiplied by a

fraction, the numerator of which is the number of years of

participation in the Plan, and the denominator of which is the

number of years of participation if the participant had continued

to his normal retirement age. 

At the time of the distribution to Mr. Hall, he had a

diseased foot, which later required amputation below the knee. 

Mr. Hall essentially lost the use of his right foot prior to

1988. He remained employed with Hadd-Too until his retirement in

1988. As of December 31, 1988, Mr. Hall was fully vested in the

Plan. 

In 1992, Mr. and Mrs. Hall separated, and Mrs. Hall

initiated divorce proceedings. They lived separate and apart

from 1992 until late 1993. At the time of Mr. Hall's death in

January 1994, however, Mrs. Hall had returned to live with and
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take care of Mr. Hall, and Mr. and Mrs. Hall were still legally

married. 

For the taxable year 1988, Mr. and Mrs. Hall filed a joint

Federal income tax return. They reported a distribution in the

amount of $1,027,229 on line 17a of their return and stated that

no portion of the distribution was includable in income. The

return was signed by both Mr. and Mrs. Hall. Before signing the

return, Mrs. Hall briefly reviewed the first 2 pages of the

return. She noticed the $1,027,229 entry on line 17a, but she

did not question the entry. 

Mrs. Hall knew that a large distribution was made from the

Plan to Mr. Hall during 1988. Of the cash distributed to Mr.

Hall, $474,768.81 was transferred from the pension trust account

to a newly opened bank account in 1988. The new account was held

jointly by Mr. and Mrs. Hall. Both Mr. and Mrs. Hall executed

the deposit agreement for the account. In addition, a

certificate of deposit held by the Plan was redeemed and the

proceeds used to purchase a money market certificate in the

amount of $125,331.63 held jointly by Mr. and Mrs. Hall. The

balance of the property distributed to Mr. Hall appears to have

consisted of real property.

OPINION

Section 105(a) provides generally that amounts received by

an employee through accident or health insurance for personal
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injuries or sickness are includable in gross income. Section

105(c), however, provides an exception to the general rule:

(c) Payments Unrelated to Absence from Work.--Gross

income does not include amounts referred to in

subsection (a) to the extent such amounts--

(1) constitute payment for the permanent loss or

loss of use of a member or function of the body, or the

permanent disfigurement, of the taxpayer, * * * and

(2) are computed with reference to the nature of

the injury without regard to the period the employee is

absent from work.

Respondent determined that the exception in section 105(c) does

not apply to Mr. Hall and that payments from the Plan constituted

income that should have been reported by petitioners in 1988. 

Petitioners bear the burden of proving that they come within the

exception in section 105(c). Rule 142(a); Welch v. Helvering,

290 U.S. 111, 115 (1933).

Section 105(e) equates amounts received through accident or

health insurance with amounts received through an accident or

health plan. Section 1.105-5(a), Income Tax Regs., defines the

term "accident or health plan" broadly as

an arrangement for the payment of amounts to employees

in the event of personal injuries or sickness. A plan

may cover one or more employees, and there may be

different plans for different employees or classes of

employees. An accident or health plan may be either

insured or noninsured, and it is not necessary that the

plan be in writing or that the employee's rights to

benefits under the plan be enforceable. * * *
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Despite this broad definition, we have long held that the term

"accident or health plan" presupposes a predetermined course of

action and that it signifies something more than merely one or

more ad hoc benefit payments. Gordon v. Commissioner, 88 T.C.

630, 635 (1987); American Foundry v. Commissioner, 59 T.C. 231,

238-239 (1972), affd. in part and revd. in part 536 F.2d 289 (9th

Cir. 1976); Lang v. Commissioner, 41 T.C. 352, 356-357 (1963);

Estate of Kaufman v. Commissioner, 35 T.C. 663, 666 (1961), affd.

300 F.2d 128 (6th Cir. 1962).

Generally, deferred compensation plans and accident or

health plans serve distinct purposes. Deferred compensation

plans are designed to remunerate an employee for services

rendered over a substantial period of time. Accident or health

plans, on the other hand, provide payments to employees in the

event of illness or injury, without regard to such factors as

compensation, length of service, and company profitability. 

Thus, in order to come within the scope of section 105,

petitioners must show by "clear indicia" that the deferred

compensation plan in question was intended to serve the dual

purpose of providing accident or health benefits as well as

retirement benefits. Berman v. Commissioner, 925 F.2d 936, 938-

939 (6th Cir. 1991), affg. T.C. Memo. 1989-654; Caplin v. United

States, 718 F.2d 544, 549 (2d Cir. 1983); Gordon v. Commissioner,

supra at 640.
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Several factors have been held relevant in determining

whether a deferred compensation plan was intended to provide

accident or health benefits, including: (1) A statement in a

written plan that its purpose is to qualify as an accident or

health plan within the meaning of the Internal Revenue Code and

that the benefits payable under it are eligible for income tax

exclusion; (2) specification in a plan that the benefits payable

are those amounts incurred for medical care in the event of

personal injury or sickness; (3) terms in a plan that limit the

benefits payable to legitimate medical expenses; and (4) a

provision allowing an employee to be compensated for specific

injuries or illness, such as the loss of a limb. Berman v.

Commissioner, supra at 939; Caplin v. United States, supra.

The Hadd-Too Amended and Restated Plan contains only two

references to the provision of benefits in the event of

disability. The summary description of the Plan states:

The basic purpose of the Plan continues to be to

give retirement income to the employees to supplement

the benefits they will receive under the Social

Security laws. The plan gives an additional measure of

security to participants and their beneficiaries by

providing benefits which help to insure against loss

caused by disability. In addition, the Plan provides

for payments to employees, under certain circumstances,

if they die or terminate their employment prior to

their retirement. * * *

The second reference appears in the Plan itself:
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4.05 Disability: A participant whose service with the

Employer ceases due to a total disability for a period

of twelve (12) months or more, prior to his normal, or

where applicable, late retirement date, shall receive

the actuarial equivalent of his Accrued Benefit. * * *

None of the indicia listed above appear in the Plan, and there is

no proof that there was any definite program to provide accident

or health coverage that would rise to the level of an accident or

health plan.

The defined benefit plan at issue in Berman v. Commissioner,

supra, is remarkably similar to the Hadd-Too Plan. In Berman,

the defined benefit plan provided for the payment of the present

value of a participant's accrued benefit if the participant

became totally and permanently disabled for a 6-month period. 

Id., at 937. The summary description of the defined benefit plan

stated: "The purpose of the Plan is to reward eligible employees

for long and loyal service to the Company by providing for their

financial security at retirement. It may also provide some

additional protection in the event of death, disability, or other

termination of employment." Id. at 939. The Court of Appeals

for the Sixth Circuit affirmed this Court's holding that the plan

did not constitute a dual purpose plan; rather, the permanent

disability provision was merely one of several provisions that

could trigger a participant's claim to accrued retirement

benefits. Id. at 940. The Court of Appeals for the Sixth

Circuit noted that the statement in the summary description was
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3In Beisler v. United States, 814 F.2d 1304, 1308 (9th Cir.

1987), affg. T.C. Memo. 1985-25, the Court of Appeals for the

Ninth Circuit subsequently clarified its holding in Wood v.

United States, 590 F.2d 321 (9th Cir. 1979). In Beisler, the

Court of Appeals for the Ninth Circuit stated "The Wood court

itself recognized that it was not addressing the entire body of

section 105(c) law. See 590 F.2d at 323 (court assumes for

purposes of litigation that plan qualifies as accident or health

plan)." Beisler v. United States, supra.

ambiguous and did not provide clear indicia of a dual purpose. 

Id. at 939.

Petitioners rely on Wood v. United States, 590 F.2d 321 (9th

Cir. 1979) and Masterson v. United States, 478 F. Supp. 454 (N.D.

Ill. 1979), both holding that distributions from pension plans

were excludable from income under section 105(c). These cases,

however, are not controlling. See Caplin v. United States, 718

F.2d at 547-548; Gordon v. Commissioner, 88 T.C. at 636-638 (both

rejecting the application of these cases under similar facts). 

In Wood, the status of the plan as an accident or health plan had

been conceded by the Government and was not in dispute. Wood v.

United States, supra at 323.3 In Masterson, the court simply

proceeded on the assumption that the distributing profit-sharing

plan was a dual purpose plan without any analysis. The court

relied on a statement in Wood that the precise nature and taxable

status of these payments is uncertain until the funds are

disbursed. Because the taxpayer received the payments after he

became disabled, the court concluded that they represented

compensation for a disability. Masterson v. United States, supra

at 455. However, this conclusion has been criticized by this and
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other courts. Caplin v. United States, supra at 547; Gordon v.

Commissioner, supra at 637-638.

We conclude that the disability provision in the Hadd-Too

Plan was merely one of several events that could trigger a

participant's claim to accrued retirement benefits. Petitioners

have simply failed to meet their burden of proving by "clear

indicia" that the Plan was intended to serve the dual purpose of

providing accident or health benefits as well as retirement

benefits. Accordingly, the $1,027,229.45 distribution received

by Mr. Hall is taxable as deferred compensation and not

excludable from gross income as accident or health benefits under

section 105.

Even if the Hadd-Too Plan had constituted a dual purpose

plan, the distribution in question fails to meet the requirement

of section 105(c)(2) that the amount of any payment be computed

with reference to the nature of the injury. This requirement is

met only if the plan varies the benefits according to the type

and severity of the taxpayer's injury. Berman v. Commissioner,

925 F.2d at 940; Rosen v. United States, 829 F.2d 506, 509-510

(4th Cir. 1987); Beisler v. Commissioner, 814 F.2d 1304, 1308

(9th Cir. 1987), affg. T.C. Memo. 1985-25; Hines v. Commissioner,

72 T.C. 715, 720 (1979).

Rather than computing benefits with reference to the type

and severity of the injury, the Hadd-Too Plan, upon a showing of

a total disability, determines the benefits solely on the basis
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4On brief, as support for their claim that the payment was

computed with reference to the nature of the injury, petitioners

refer to a document entitled "Informal Action and Consent in

Writing by Board of Directors", dated Jan. 10, 1988, wherein the

board of directors of Hadd-Too determined that Mr. Hall had

presented evidence of a total disability as required under the

Plan and stated that "in evaluating the degree and severity of

the disability of James F. Hall, Jr., it is hereby determined

that the total value of James F. Hall, Jr.'s accrued benefits in

the Plan shall be paid as a disability payment from the Plan".

The document was not actually prepared until March 1989, well

over 1 year after its purported execution and long after the

distribution to Mr. Hall. In any event, in light of our holding

that the Plan itself must calculate the benefits with reference

to the nature of the injury, we find the document to be

irrelevant. 

of the participant's accrued benefit. The Plan makes no attempt

to distinguish among the various "total disabilities", even

though the types and severity of such injuries can vary greatly. 

Thus, the Plan fails to compute the amount of the disability

payments with reference to the nature of the injury as required

by section 105(c)(2).

Petitioners argue that Mr. Hall had lost the use of his

right foot prior to the distribution from the Plan in 1988, and

that the Plan administrators were aware of his loss and made the

distribution to Mr. Hall because of it. However, the actual

disability is irrelevant to a determination of whether a plan

computes the amount of disability benefits with reference to the

nature of the injury. Rather, "the instrument or agreement under

which the amounts are paid must itself provide specificity as to

the permanent loss or injury suffered and the corresponding

amount of payments to be provided." Rosen v. United States,

supra at 509 (emphasis added).4
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Because we find that petitioners improperly excluded from

income the 1988 distribution, the next issue we must decide is

whether petitioner Harriett Nixon Hall is entitled to relief from

liability as an "innocent spouse" under section 6013(e).

Section 6013(d)(3) provides that when a joint return is

filed, the parties are jointly and severally liable for the

amount of the tax due. One exception to this rule is the

innocent spouse provision contained in section 6013(e) which

provides:

(e) Spouse Relieved of Liability in Certain Cases.--

(1) In General.--Under regulations prescribed by

the Secretary, if--

(A) a joint return has been made under this

section for a taxable year,

(B) on such return there is a substantial

understatement of tax attributable to grossly

erroneous items of one spouse,

(C) the other spouse establishes that in

signing the return he or she did not know, and had

no reason to know, that there was such substantial

understatement, and

(D) taking into account all the facts and

circumstances, it is inequitable to hold the other

spouse liable for the deficiency in tax for such

taxable year attributable to such substantial

understatement,

then the other spouse shall be relieved of liability

for tax (including interest, penalties, and other

amounts) for such taxable year to the extent such

liability is attributable to such substantial

understatement.
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Petitioners bear the burden of proving that Mrs. Hall satisfies

each statutory requirement of section 6013(e). Stevens v.

Commissioner, 872 F.2d 1499, 1504 (11th Cir. 1989), affg. T.C.

Memo. 1988-63; Purcell v. Commissioner, 826 F.2d 470, 473 (6th

Cir. 1987), affg. 86 T.C. 228 (1986); Bokum v. Commissioner, 94

T.C. 126, 138 (1990), affd. 992 F.2d 1132 (11th Cir. 1993). The

parties agree that the requirements of section 6013(e)(1)(A) and

(B) have been met. At issue are the knowledge and inequity

requirements of section 6013(e)(1)(C) and (D). 

Petitioners failed to include the distribution in their

reported gross income because they erroneously believed that it

fell within the provisions of section 105(c). However, it is

clear that when the grossly erroneous items giving rise to an

understatement of tax are unreported gross income, the knowledge

contemplated by section 6013(e)(1)(C) is knowledge of the

transaction itself as opposed to knowledge of the tax

consequences of the transaction. Purcell v. Commissioner, supra

at 474; Quinn v. Commissioner, 524 F.2d 617, 626 (7th Cir. 1975),

affg. 62 T.C. 223 (1974); Bokum v. Commissioner, supra at 146;

Smith v. Commissioner, 70 T.C. 651, 672-673 (1978).

We have found that Mrs. Hall knew of the distribution that

was made to Mr. Hall from the Plan during 1988. Mrs. Hall's

claim that she qualifies as an innocent spouse stems from her

misapprehension of the tax consequences and not from ignorance of

the fact of the distribution. Mrs. Hall knew of the
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circumstances giving rise to the substantial understatement and,

thus, does not qualify as an innocent spouse under section

6013(e)(1)(C). 

Moreover, we find that Mrs. Hall failed to meet the inequity

requirements of section 6013(e)(1)(D). Whether it is inequitable

to hold a spouse liable is to be determined on the basis of all

the facts and circumstances. Sec. 6013(e)(1)(D); sec. 1.6013-

5(b), Income Tax Regs. Although section 6013(e), as amended, no

longer specifically requires us to determine whether a spouse

significantly benefited from the omitted income, this factor is

still to be taken into account in determining whether it is

inequitable to hold a spouse liable. Estate of Krock v.

Commissioner, 93 T.C. 672, 678 (1989). Mrs. Hall bears the

burden of proving that she did not significantly benefit from the

omitted income. Id.

Mrs. Hall argues that it would be inequitable to hold her

liable, because she did not receive any benefit from the

distribution in the form of better day-to-day living conditions. 

Mrs. Hall's day-to-day living conditions do not appear to have

improved as a result of the distribution. However, of the cash

distributed from the Plan in 1988, $474,768.81 was transferred to

an account held jointly by Mr. and Mrs. Hall. Both Mr. and Mrs.

Hall executed the deposit agreement for the account. In

addition, a certificate of deposit held by the Plan was redeemed

and the proceeds were used to purchase a money market certificate
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5The balance of the distribution appears to have consisted

of real property. No evidence was offered by petitioners to show

who held title to this real property after the distribution.

in the amount of $125,331.63 held jointly by Mr. and Mrs. Hall. 

As a result, Mrs. Hall had over $500,000 of the distribution

proceeds available to her in the form of joint accounts. No

evidence was presented reflecting the ultimate disposition of the

funds in these accounts.5

The acquisition of joint saving or investment assets has

been held to constitute a significant benefit, thereby precluding

innocent spouse relief. Purificato v. Commissioner, 9 F.3d 290,

294 (3d Cir. 1993), affg. T.C. Memo. 1992-580. We believe the

facts here indicate that significant funds from the distribution

were available to Mrs. Hall via these joint accounts, and,

therefore, she has failed to demonstrate that she did not

significantly benefit from the omitted income.

Furthermore, where the understatement results from a

misapprehension of the tax laws by both spouses, then both

spouses are perceived to be "innocent", and there is no inequity

in holding them both to joint liability. Bokum v. Commissioner,

992 F.2d 1132, 1134-1135 (11th Cir. 1993), affg. 94 T.C. 126,

156-157 (1990); Hayman v. Commissioner, 992 F.2d 1256, 1262 (2d

Cir. 1993), affg. T.C. Memo. 1992-228; Lessinger v. Commissioner,

85 T.C. 824, 838 (1985), revd. on other grounds 872 F.2d 519 (2d

Cir. 1989); McCoy v. Commissioner, 57 T.C. 732, 734-735 (1972).

The record indicates that both Mr. and Mrs. Hall were aware
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of the distribution of $1,027,229.45 from the Plan, that they

both relied on professional advice when they filed their 1988

income tax return, and that neither of the Halls was aware of the

correct tax consequences flowing from the distribution from Mr.

Hall's pension plan. Accordingly, we perceive no inequity in

holding both Mr. and Mrs. Hall liable for their misapprehension

of the tax laws.

Decision will be entered

for respondent.