PUBLISHED

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

ALLAN R. POWELL; JOAN K. POWELL,

Petitioners-Appellants,

v. No. 96-2549

COMMISSIONER OF INTERNAL REVENUE,

Respondent-Appellee.

RICHARD J. MONTGOMERY; ADELE S.

MONTGOMERY,

Petitioners-Appellants,

No. 96-2554

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent-Appellee.

Appeals from the United States Tax Court.

(Tax Ct. Nos. 93-3499, 96-8028)

Argued: June 6, 1997

Decided: October 16, 1997

Before HAMILTON and LUTTIG, Circuit Judges, and

GARBIS, United States District Judge for the

District of Maryland, sitting by designation.

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Affirmed by published opinion. Judge Garbis wrote the opinion, in

which Judge Hamilton and Judge Luttig joined.

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COUNSEL

ARGUED: Edward L. Blanton, Jr., Baltimore, Maryland, for Appellants. Kenneth W. Rosenberg, Tax Division, UNITED STATES

DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee. ON

BRIEF: Loretta C. Argrett, Assistant Attorney General, Richard Farber, Tax Division, UNITED STATES DEPARTMENT OF JUSTICE,

Washington, D.C., for Appellee.

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OPINION

GARBIS, District Judge:

Appellants Allan R. and Joan K. Powell and Appellants Richard J.

and Adele S. Montgomery appeal from decisions of the United States

Tax Court holding them liable for assessed taxes on excess distributions from their respective retirement plans.

I. INTRODUCTION

A. In General

Succinctly put, the Internal Revenue Code permits employers to

place part of the compensation paid to an employee into a qualified,

tax-sheltered retirement account. The employer obtains a deduction

for the contribution at the time it is made. However, the employee

does not treat the amount of compensation placed into the plan as current income, and does not report the income earned in the plan prior

to distribution. Only at the time the employee receives a distribution

from the plan does he/she recognize income with regard to the distribution.

There are various restrictions upon the timing and amounts of distributions from a qualified pension plan. "Early" distributions1 are

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1 That is, distributions made before the employee reaches a specified

age or certain other events occur.

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subject to additional tax burdens, as are distributions in excess of permissible amounts.

The instant cases arise because the taxpayers chose to switch from

one retirement plan to another and, in connection with their switches,

received distributions of the funds in their accounts. These distributions were subject to income tax and resulted in Internal Revenue Service ("IRS") determinations of liability for the additional tax burdens

at issue in these cases.

B. Statutory Framework

A "retirement distribution" is an amount distributed under an individual retirement plan or under a qualified employer plan. See

§ 4980A(e)(1).2 A qualified employer plan is a "plan described in section 401(a) which includes a trust exempt from tax under section

501(a)," § 4980A(e)(2)(A), that the Commissioner has at any time

determined to be a qualified pension plan pursuant to section 401. See

§ 4980A(e)(2).

Section 4980A imposes a fifteen percent excise tax on "excess distributions" from qualified retirement plans. An"excess distribution"

is the amount of a retirement distribution which exceeds an exempt

threshold. See § 4980A(c)(1). The exemption is normally $150,000.

See § 4980A(c)(1)(A). However, if a distribution qualifies as a "lump

sum distribution," the exempt threshold is increased five fold, to

$750,000. See § 4980(c)(4).

Section 72(t) imposes a ten percent tax on the gross income

included in "early" distributions from qualified retirement plans.3 A

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2 All statutory references herein are to the Internal Revenue Code of

1986, 26 U.S.C., unless otherwise indicated.

3 The term "qualified retirement plan" in § 72(t)(1) includes, as it does

for purposes of § 4980A, "a plan described in Section 401(a) which

includes a trust exempt from tax under section 501(a)." This definition

includes "any plan . . . which, at any time, has been determined by the

Secretary [of the Treasury] to be such a plan." § 4974(c).

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distribution is "early" if made before the employee reaches age

59-1/2. See § 72(t)(2)(A)(I).4

II. BACKGROUND

In 1927, the State of Maryland created a fund to provide retirement

benefits for teachers employed by the state. Maryland created a similar fund in 1941 to provide retirement benefits for all state employees.

The two systems, collectively, are referred to as"the Old Retirement

System." The Old Retirement System required a non-deductible five

percent contribution from all participants. The Old Retirement System

was a "qualified defined benefit plan" within the meaning of 26

U.S.C. § 401(a). Therefore, the trusts maintained by the Old Retirement System were tax-exempt trusts under 26 U.S.C.§ 501(a).

In the late 1970's, actuarial projections indicated that the Old

Retirement System was dangerously underfunded. In response to

those findings, the State closed eligibility for participation in the Old

Retirement System as of January 1, 1980. The State also developed

the Maryland Employees' Pension System ("the Employees' Pension

System") and the Maryland Teachers' Pension System (the "Teachers' Pension System") to provide retirement benefits for state employees and teachers hired after January 1, 1980. The Teachers' Pension

System required nondeductible contributions only from those participants who had salaries greater than the taxable wage base set for

Social Security benefits. The Teachers' Pension System was a "qualified defined benefit plan" within the meaning of 26 U.S.C. § 401(a),

and the trusts maintained by the Teachers' Pension System were,

therefore, tax-exempt trusts under § 501(a).

In 1989, the State passed further pension reform legislation. At that

point, participants in the Teachers' Pension System had the following

four options:

a. Pay an additional two percent of salary and retain

unlimited cost of living adjustments on their benefits at

the time of retirement;

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4 The § 72(t) tax is subject to various exceptions, none of which are relevant to the instant cases. See § 72(t)(2).

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b. Freeze their rate of contribution at the then-current level

and retain the same benefit formula with the understanding that any future cost of living adjustment would

be limited to a maximum of a five percent increase in

any one year;

c. Participate in a hybrid plan whereby they would receive

benefits based on the Teachers' Pension System formula

to the extent of retirement credit earned up to July 1,

1984, and benefits based on the new pension system

formula for credit earned after that date; or

d. Transfer into a new system ("the New Pension System").

See Conway v. United States, 908 F. Supp. 292, 294 (D. Md. 1995);

Md. State Teachers' Ass'n v. Hughes, 594 F. Supp. 1353 (D. Md.

1984) (providing a detailed description of Maryland pension reform).

Appellants Allan R. Powell ("Powell") and Richard J. Montgomery

("Montgomery") were participants in the Teachers' Pension System

who chose to transfer into the New Pension System.

III. THE CASES ON APPEAL

In 1990, Appellants Powell and Montgomery transferred from the

Teachers' Pension System to the New Pension System. At the time

of the transfer, each received a distribution ("Transfer Refund") of

their paid-in mandatory deductible contribution to the Retirement

System, plus the interest earned on such paid-in contributions. The

Transfer Refunds were:

 Powell Montgomery

Previously Taxed

Contributions $ 20,477.11 $ 37,064.27

Interest5 456,611.19 301,386.746

 ___________ ___________

 $477,088.30 $338,451.01

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5 Interest was computed at the rate of 15.57% per annum.

6 This amount includes $300,984.04 of interest plus $403.70 of "employer pickup contributions" (plus interest thereon).

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Powell and Montgomery filed 1990 joint federal income tax returns

with their respective wives reporting thereon the taxable portion of

their Transfer Refunds. Moreover, Montgomery reported an additional tax of $30,1397 due to the"early" distribution included in the

Transfer Refund.

The Internal Revenue Service reviewed the Powell and Montgomery 1990 federal income tax returns and issued Notices of Deficiency8

determining that additional taxes should be assessed with regard to

each return.

The notice of deficiency issued to Mr. and Mrs. Powell determined

that they would be assessed the § 4980A tax on an excess distribution

from a qualified retirement plan, to wit, a distribution of $456,611.

The tax was computed to be $45,992, being 15% of $306,611 (the net

of $456,611 less an exemption of $150,000). The Powells filed a

timely Tax Court petition denying liability for the§ 4980A tax and

claiming9 that the distribution qualified as a "lump-sum distribution"

under § 402(e)(4)(D). Lump sum treatment would effectively eliminate the § 4980A liability10 and would entitle them to a refund of a

portion of the income taxes which they had reported as due on their

tax return.11 The Tax Court sustained the Commissioner, determined

that there was a deficiency, and denied the claim for refund of income

tax.

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7 That is, ten percent of the net of the $338,048.31 Transfer Refund less

the $37,064.27 of previously taxed contributions.

8 A notice of deficiency is issued pursuant to § 6213 of the Internal

Revenue Code. A taxpayer has a period, generally 90 days from the issuance of the notice of deficiency (§ 6213(a)), to petition the United States

Tax Court and obtain preassessment judicial review of the Commissioner's determination. See PAULA M. JUNGHANS AND JOYCE K.

BECKER, Federal Tax Litigation ¶ 3.04 (1992); MICHAEL SALTZMAN, IRS Practice and Procedure ¶ 10.02[a][ii] (2nd Ed. 1991).

9 In an amended petition.

10 By virtue of the $750,000 exemption afforded "lump sum distributions" in § 4980A(c)(4).

11 A "lump sum distribution" could qualify for preferential ten year forward averaging treatment which, in effect, reduces the income tax payable with regard to the distribution. See§ 402(e)(1).

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The notice of deficiency issued to Mr. and Mrs. Montgomery indicated that they would be assessed the § 4980A excess distribution tax,

which in their case amounted to $7,569.12 Upon receipt of the deficiency notice, Mr. & Mrs. Montgomery filed a timely Tax Court petition denying liability for the § 4980A tax. They also claimed that they

had erroneously reported liability for the § 72(t) tax and, therefore,

sought a refund of their payment of $30,139 of such tax. The Tax

Court sustained the Commissioner, decided that there was a deficiency of $7,569 as had been determined in the notice of deficiency,

and denied the claim for refund of the § 72(t) tax.

On appeal, the Appellants assert that the Transfer Refunds were not

distributions from a qualified plan subject to the§ 4980A excise tax

and the § 72(t) tax. In addition, the Powell Appellants contend that

even if the Transfer Refund were a distribution from a qualified plan,

it was a lump sum distribution that created an increased exemption

from the § 4980A tax and would be eligible for preferential forward

averaging treatment for income tax purposes.

IV. DISCUSSION

A. Were the Transfer Refunds Amounts Distributed

Under A Qualified Employer Plan?

Appellants state that a distribution from a qualified employer plan

of an amount in excess of the actual earnings on employee contributions automatically disqualifies the plan. Consequently, they argue,

the Transfer Refunds could not have been distributions from a "qualified" plan subject to the taxes imposed by §§ 72(t) and 4980A. This

boils down to the contention that because the distributions in question

would by their nature disqualify the plan when made, then logically

the plan could not have been qualified at the time of distribution.

Therefore, according to the Appellants, the Transfer Refunds were

merely "withdrawal(s) of contributions and interest in excess of that

actually earned." In making this argument, the Appellants seek to

have the Court ignore the plain language of the statute.

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12 This is 15% of the excess distribution of $301,387 (i.e. $22,708), less

an offset of $15,139 by virtue of the concomitant liability for the § 72(t)

tax.

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For purposes of the excise taxes imposed by #8E8E # 72(t) and 4980A,

a retirement plan is deemed to be a "qualified plan," even if it is not

qualified on the date of the distribution, so long as the Commissioner

at any time had determined that the plan was qualified. See

§§ 4974(c), 4980A(e)(2). In this case, the New Pension System had

been determined to be a plan described in § 401(a) that included a

trust exempt from tax under § 501(a) on June 23, 1982. Therefore, the

Court must apply the statute as written and reject Appellants' "logical" argument.

As a second line of defense, Appellants, relying on certain temporary regulations issued by the Commissioner, argue that the term

"qualified employer plan" does not include government plans because

they are not required to file a federal income tax return.

Section 54.4981A-1T(a-3)(c)(2)(I), Temporary Qualified Pension

Plan Excise Tax Regs., 52 Fed. Reg. 46750 (1987) provides that an

employee plan that is maintained by an employer who"has at any

time filed an income tax return and claimed deductions that would be

allowable under section 404," is a "qualified" plan. However, the

cited Temporary Regulations do not provide an exclusive definition

of those plans that will be considered "qualified employer plans."

Rather, the Temporary Regulations merely advise that even a plan

which has not been the subject of an express IRS determination will

be considered a "qualified employer plan" so long as the employer

itself has filed an income tax return and claimed deductions based

upon the plan's asserted qualified status.13 The fact that the New Pension System is a government plan, and thus not one as to which the

employer has claimed an income tax deduction, does not change its

status as a "qualified employer plan" under the statutory provisions

here at issue.

For the foregoing reasons, we conclude that the Transfer Refunds

were distributions from a "qualified employer plan" and, therefore,

that the § 4980A tax is applicable to the Appellants. Moreover, as to

Montgomery, who was less than 59-1/2 years of age at the time of

distribution, the § 72(t) tax is applicable.

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13 This closes a potential loophole for an employer plan which was

placed in operation without an advance ruling of qualification.

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B. Was the Transfer Refund to Powell a Lump Sum Distribution?

As discussed above, the § 4980A tax applies to the extent that a

distribution exceeds a threshold exemption of $150,000. If the distribution is a "lump sum distribution" to which an election under

§ 402(e)(4)(B) applies, then the exemption is increased to $750,000.

See § 4980(c)(4).

Section 402(e)(4)(A) defines a "lump sum distribution" as a:

distribution or payment within one taxable year of the recipient of the balance to the credit of an employee which

becomes payable to the recipient

 * * *

 (ii) after the employee attains age 59-1/2,

 * * *

from a trust which forms a part of a plan described in section 401(a) and which is exempt from tax under section 501.

(emphasis added). In this case, if the Transfer Refund to Powell (who

was at the time over 59-1/2 years of age) constituted a payment of

"the balance to the credit" of Powell, it would be a lump sum distribution under § 402(e)(4)(A).

Section 402(e)(4)(D)(ii) provides that "[f]or purposes of determining the balance to the credit of an employee . . . all pension plans

maintained by the employer shall be treated as a single plan." The

Teacher's Pension System and the New Pension System are maintained by the same employer, the State of Maryland. Therefore, the

Teacher's Pension System and the New Pension System must be

treated as a single plan. See Dorsey v. Commissioner, T.C. Memo

1995-97; Brown v. Commissioner, T.C. Memo 1995-93; Hoppe v.

Commissioner, T.C. Memo 1994-635; Hamilton v. Commissioner,

T.C. Memo 1994-633.

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Under Maryland law, Powell's monthly annuity from the New Pension Plan is calculated by taking into account his"average final compensation" and his years of "creditable service," including the years

under the Teachers' Pension Retirement System. Upon transfer to the

New Pension System, Powell did not forfeit his right to receive future

monthly annuities, but rather agreed to receive a large single payment

followed by reduced monthly annuities. Moreover, any transferee

who had a contribution not eligible for refund would have the contribution transferred into the transferee's New Pension System account,

"along with his or her service credits, salary level, and relevant past

information accumulated by the Retirement Agency." Conway v.

United States, 908 F. Supp. 292, 296 (D. Md. 1995); see Md. Code

Ann. art. 73B, § 32. In addition, as stated in Conway, "although intangibles such as service credits and salary level may not have a definite

or immediately discernible pecuniary worth, they nonetheless represent real value in the calculation of future New Pension System benefits." Conway, 908 F. Supp. at 296. Accordingly, when Powell

transferred from the Teacher's Pension System to the New Pension

System he received the balance to his credit in two parts, the Transfer

Refund payment at issue and the right to receive a monthly annuity

from the New Pension System upon retirement.

In the case at bar, Powell did not receive the final and complete

payout of his benefits at the time of transfer because he remained entitled to receive monthly annuities. Therefore, the Transfer Refund

received by Powell did not constitute the entire balance to the credit

of his account. Accordingly, it is not a "lump sum distribution" within

the meaning of § 4980A. For this reason, we affirm the Tax Court's

determination that Appellant Powell is not entitled to an increased

exemption of $750,000 from the § 4980A tax penalty under

§ 4980A(c)(4).

C. Can Powell Obtain Preferential Ten Year Forward

Averaging Treatment?

Powell contends that he is entitled to preferential ten year forward

averaging treatment pursuant to § 402(e)(1) so as effectively to reduce

his income tax liability on the Transfer Refund.

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Generally, the taxable portions of distributions from a qualified

plan are subjected to income tax for the year of receipt.14 However,

if a distribution is a "lump sum distribution," then it is eligible for

preferential ten year forward averaging treatment pursuant to

§ 402(e)(1).15 However, as discussed above, the Transfer Refund was

not a "lump sum distribution" within the meaning of 402(e)(4)(A).

Therefore, Powell is not entitled to the preferential forward averaging

treatment provided by § 402(e)(1).

For the foregoing reasons, the decisions of the Tax Court are, in all

respects,

AFFIRMED.

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14 Unless rolled over to another qualified plan or into an IRA.

15 The Tax Reform Act of 1986 replaced ten year forward averaging

with five year forward averaging of lump sum distributions made after

December 31, 1986. However, individuals (such as Powell) who were

fifty years old before January 1, 1986, are eligible for ten year forward

averaging.

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