# U ni te d S ta te s Co ur t of A pp ea ls For the Eig hth Circu it

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No. 1 6- 11 68

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DNA Pro Ven tu res , Inc . Em pl oyee Sto ck Owner sh ip Pla n

ll ll ll ll ll ll ll ll ll ll l Peti ti on er

- App el la nt

v.

Co m m is si on er o f In te rn al Rev en ue

ll ll ll ll ll ll ll ll ll ll l Resp on de nt - App el le e

__ __ __ __ __ __ App eal fro m

th e Uni te d S ta te s Tax Co ur t

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Su bm it te d: Decem

be r 12 , 20 16 Fil ed : M ay

9, 2 01 7

__ __ __ __ __ __ Befo re LOKEN, MURPHY, and KELLY , Cir cu it Ju dg es

.

__ __ __ __ __ __ LOKEN, Ci rcu it Ju dg e.

Dr. Dan ie l Pro ha sk a an d hi s wife fo rm ed DNA Pro Ven tu res , In c. (“ DNA”),

an d es ta bl is he d th e DNA Pro Ven tu res , In c. Em pl oyee St oc k Owner sh ip Pl an (“ ESOP”) i n No ve m

be r 20 08 . After an in ve st ig at io n, th e In te rn al Rev en ue Serv ic e (“ IRS” ) is su e d a N ot ic e of Defi ci en cy to th e ESOP’s Trus t ba se d on a fin al de te rm in at io n th at th e Trus t was no t pa rt of a q ua li fie d pe ns io n, pr of it -s ha rin g, or
st oc k bo nu s pl an un de r 26 U.S.C. (“ I.R.C.”) § 40 1, an d th eref or e th e Trus t’s in co m e

was no t ex em

pt fro m ta xa ti on un de r I.R.C. § 5 0 1( a) in cal en da r y ears 20 08 -2 01 1.The ESOP pe ti ti on ed th e Uni te d St at es Tax Co ur t fo r a de cl arat or y jud gm en t th at th e

ESOP was qu al ifi ed un de r § 40 1( a) du rin g th e 20 08 -2 01 0 ta x y ears , an d th eref or e th e Trus t was ta x ex em

pt un de r § 50 1( a). See I.R.C. § 74 76 (a)( 1)

. Ru li ng wit ho ut a tri al

on a st ip ul at ed fact reco rd
, se e Tax Co ur t Ru le 12 2, th e Tax Co ur t su st ai ne d th e IRS de te rm in at io n. The ESOP ap pe al s. Rev ie win g th e Tax Co ur t’s le ga l co nc lu si on s de

no vo an d fact ua l fin di ng s fo r cl ear erro r, we affi rm

. See Tran sp

. Lab or Co nt ract /Lea si ng , In c. v. Co m m ’r, 46 1 F.3 d 10 30
, 10 32 (8 th Ci r. 20 06 ) (s ta nd ard of

rev ie w); I.R .C. § 7 48 2( a)(1 ).

A. An em

pl oyee st oc k own ers hi p pl an is a ret ire m en t p l a n t ha t “ in ve st s
pr im ari ly in qu al ifyin g em pl oyer se cu rit ie s, typic al ly st oc k of th e em pl oyer crea ti ng th e pl an .” Mar ti n v. Fei le n, 96 5 F.2 d 66 0, 66 4 (8 th Ci r. 19 92 ) (q uo ta ti on s om it te d)

. A tru st as so ci at ed wit h a qu al ifi ed pl an is ex em pt fro m ta xa ti on , I.R.C. § 50 1( a), an d pl an pa rti ci pa nt s are no t ta xe d on co nt rib ut io ns un t i l pl an be ne fit s are di st rib ut ed
, I.R.C. § 40 2( a). Fo r a tru st to qu al ify fo r th e § 50 1( a) ex em pt io n, th e pl an m

us t m eet th e req ui rem en ts in I.R.C. § 40 1( a). A p l a n may be di sq ua li fie d fo r op erat io na l fai lu res , whi ch oc cu r if a pl an fai ls to op erat e in acco rd an ce with § 40 1( a) s ta tu to ry
req ui rem en ts , se e Mar ti n Fi rep ro of in g Pro fit -Sh ari ng Pl an & Tr. v. Co m m ’r, 92 T.C.
11 73
, 11 79 -8 0 (1 98 9)
, or fai ls to fo ll ow th e te rm s of th e pl an do cu m en t, se e Mi ch ael
C. Hol le n, D.D.S., P.C. v. Co m m ’r, T.C. Mem o 20 11 -2
, 20 11 W L 13 63 7, at *4
, aff’d

pe r cu ria m , 43 7 F . App ’x 52 5 (8 th Cir . 20 11 ).

One st at ut or y req ui rem en t is th at an ESOP tru st do es no t qu al ify fo r ta x- ex em pt
st at us if th e ESOP m ak es an nu al co nt rib ut io ns fo r a pl an pa rti ci pa nt in ex ces s of th e le ss er of ei th er a sp ec ifi c do ll ar am ou nt or th e pa rti ci pa nt ’s an nu al co m pe ns at io n. I.R.C. §§ 40 1( a)(1 6)
, 41 5( c); se e Van Ro ek el Farm s, I n c

. v. Co m m ’r, T.C. Mem o. 20 00 -1 71
, 20 00 W L 66 99 75
, at *3
, aff’d pe r cu ria m , 12 F. App ’x 43 9 (8 th Ci r. 20 01 ). If an em pl oyer tra ns fers pr op ert y ot he r th an cas h fo r le ss th an th e pr op ert y ’s fai r

m ark et va lu e, th is co ns ti tu te s an an nu al co nt rib ut io n in th e am ou nt of th e pr op ert y ’s fai r m ark et va lu e. See Tre as . Reg . § 1 .41 5( c)-1 (b )(5 ).

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-B. Dr. Pro ha sk a is an or th op aed ic su rg eo n. Dur in g th e 20 08 -2 01 0 tax y ears ,

he was em

pl oyed by Adv an ced Orth op aed ic s, P.A

. , a n d de ferr ed th e m ax im um in co m e al lo wab le to it s 40 1( k) ret ire m en t pl an

. W he n DNA was fo rm ed as a se pa rat e

co rp or at io n in 20 08
, it crea te d th e ESOP an d a tru st fu nd fo r th e b e n e f i t o f it s

em pl oyees. On th e da y of in co rp or at io n, DNA is su ed fif ty sh ares of Cl as s A co m

m on
st oc k, wit h a pa r va lu e of $1 0 pe r sh are, to Dr. Pro ha sk a an d fif ty sh ares to hi s wife
, in ex ch an ge fo r $5 00 co nt rib ut io ns

. DNA as em pl oyer was ad m in is tra to r an d sp on so r of th e ESOP. The Pl an di rect ed th e Pl an Trus te e to de te rm in e th e fai r m ark et va lu e of th e Trus t Fu nd as se ts on each Valu at io n Date

. Dr. Pro ha sk a was th e Pl an Trus te e.

In Sep te m

be r 2 0 1 1
, t h e IRS in fo rm ed DNA an d Dr. Pro ha sk a th at it wou ld

ex am in e whe th er th e ESOP ha d ad he red to qu al ifi cat io n req ui rem en ts fo r ta x- ex em pt
st at us be gi nn in g in 20 08

. The IRS req ue st ed do cu m en ts in cl ud in g t h e ESOP’s
pa rti ci pa nt al lo cat io n sc he du le s, em pl oyee cen su s rep or ts , an d pa rti ci pa nt acco un t
st at em en ts

. DNA ne ve r pr ov id ed th es e do cu m en ts

. On Nov em be r 13
, 20 12
, th e IRS

n o t ifi ed DNA by cert ifi ed m ai l th at th e ESOP di d no t m eet th ree § 4 0 1 ( a )

req ui rem en ts an d ad vi se d DNA o f i t s rig ht to ap pe al th e pr op os ed di sq ua li fic at io n. The IRS at ta ch ed an Exp la na ti on of Ite m s th at ex pl ai ne d th e th ree is su e s i n d e t a i l
, whi ch an IRS ag en t s en t t o Dr. Pr oh as ka on Decem be r 31 , 20 12

.

The IRS is su ed a fin al no n- qu al ifi cat io n le tt er on Ju ne 6, 20 14
, ex pl ai ni ng th at th e ESOP w a s d i s qu al ifi ed (i) fo r two fai lu res to co m pl y wit h th e te rm s of it s pl an do cu m en t, an d (ii ) fo r fai lu re to co m pl y wit h I.R.C. § 41 5 by m ak in g co nt r i b ut io ns
to Dr. and Mrs . Pro ha sk a in 20 08 th at su bs ta nt ia ll y ex ceed ed th ei r co m

pe ns at io n.

C. Deci di ng th e cas e on a st ip ul at ed reco rd th at in cl ud ed th e IRS Exp la na ti on of Ite m s, th e Tax Co ur t co nc lu de d th at th e IRS di d no t ab us e it s di sc r e t i o n i n di sq ua li fy in g th e ESOP be cau se (1 ) it ex ceed ed th e I.R.C. § 41 5 co nt rib ut io n li m it by al lo cat in g cl as s B sh ares t o Dr. Pro ha sk a’s ESOP acco un t in 20 08
, a y ear whe n he

rece iv ed no co m

pe ns at io n fro m DNA; an d (2) vi ol at ed it s pl an do cu m en t by fai li ng

-3

-t o h a v e t h e va lu e of DNA s to ck an nu al ly ap pr ai se d in 20 08 an d la te r y ears

. Eit h e r

gr ou nd is a su ffi ci en t bas is to up ho ld th e Co m m is si on er’s de ci si on to di sq ua li fy th e ESOP, whi ch de nies th e Trus t ta x- ex em pt st at us

. Alt ho ug h th e ESOP ch al le ng es bo th

gr ou nd s on ap pe al
, we wil l li m it ou r rev ie w to th e vi ol at io n of t h e I.R.C. § 41 5

co nt rib ut io n li m it at io n in 20 08

. “ As th e pa r t y ch al le ng in g th e Co m m is si on er’s de te rm in at io n, t he tax pa y er h a[s ] th e bu rd en of pr oo f.” Howa rd E. Clen de ne n, In c. v. Co m m ’r, 20 7 F .3d 10 71 , 10 73 (8t h C ir. 2 00 0)

.

D. In up ho ld in g th e ESOP’s di sq ua li fic at io n fo r ex ceed i n g th e I.R.C. § 41 5

co nt rib ut io n l im it , th e Tax Co ur t fo un d t ha t DNA is su ed 1,1 50 sh ares of it s cl as s B

co m m on st oc k to th e Trus t an d th e sh ares were al lo cat ed to D r. Pro ha sk a’s ESOP

acco un t in 20 08

. The sh ares ha d a pa r va lu e of $1 0 pe r sh are, so th e al lo cat io n of th is

st oc k to hi s ESOP acco un t was an em pl oyer co nt rib ut io n. As Dr. Pro ha sk a rece iv ed

no co m pe ns at io n as an of

fic er or em

pl oyee o f D N A th at y ear, th e li m it on Dr.
Pro ha sk a’s “ an nu al ad di ti on ” w a s e x c eed ed in 20 08

. See I.R.C. § 41 5( c)(1 ), (2 );
Treas . Reg . § 1 .41 5( c)-1 (b )(5 ).

On ap pe al
, th e ESOP arg ue s th e Tax Co ur t erre d in up ho ld in g di sq ua li fic at io n fo r a vi ol at io n of th e § 41 5 co nt rib ut io n li m it be cau se “ th e Co ur t go t th e fact s wro ng .” The ESOP ex pl ai ns th at it pu rch as ed t h e s h a r es fro m DNA on th e da y of it s in co rp or at io n wit h a lo an

. Not hi ng i n t h e r e co rd sh ows a co nt rib ut io n by Dr.
Pro ha sk a to th e ESOP or an al lo cat io n to hi s ESOP acco un t in th e Trus t in 20 08

. In fact , th e ESOP rep ai d th e lo an an d a ll oc at ed th e sh ares to Dr. Pro ha sk a in 20 09 . In

su pp or t of th es e as se rti on s, th e ESOP ci te s do cu m en ts in cl ud ed in it s App en di x th at

were no t pa rt of th e pa rti es ’ st ip ul at ed ad m in is tra ti ve re c o r d i n t h e Tax Co ur t. The refo re, the se do cu m en ts are no t part of th e reco rd we m ay co ns id er on ap pe al to th is co ur t. See Anu fo ro v. Co m m ’r, 61 4 F .3d 79 9, 8 07 (8t h C ir. 2 01 0)

.

The ESOP ci te s no th in g in th e st ip ul at ed Tax Co ur t rec o r d s u p p o rti ng it s

co nt en ti on th at th e ESOP acq ui red th e cl as s- B sh ares it co nt rib ut ed to th e Trus t wit h

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-a lo an , and th at th e co nt rib ut io n was no t al lo cat ed to Dr. Pro ha sk a’s ESOP acc ou nt

in 20 08

. To th e co nt rary, th e st ip ul at ed reco rd in cl ud es t h e I RS Nov em be r 20 12 Exp la na ti on of I te m s, wh ic h a s t o t hi s i ss ue st at ed :

St oc k cert ifi cat e B-1 sh ows 1,1 50 sh ares of Cl as s B co m m on st oc k were is su ed to th e ES O P o n Decem be r 31
, 20 08

. The bo ok s of th e DNA refl ect th at th e sh ares were val ue d at $1 0.0 0 pe r sh are. The to ta l val ue of DNA st oc k is rep or te d to be $1 1,5 00

. Dan ie l Proh as ka was th e so le

em pl oyee of DNA in 20 08 bu t re cei ve d n o c om pe ns at io n i n 20 08

. All 1,1 50 sh ares of st oc k were al lo cat ed to hi s acco un t in 20 08

. His IRC

se ct io n 41 5 an nu al ad di ti on s in 20 0 8 a r e e q ua l to $1 1,5 00

. His IRC

se ct io n 4 15 li m it in 20 08 is $0

.

* * * * *

The ESOP is no t a le ve rag ed ESOP as th ere was no ex em pt lo an is su ed

.

The ESOP fil ed it s p et it io n t o t he Tax Co ur t i n S ep te m be r 20 14 , and th e Tax Co ur t is su ed it s de ci si on on a st ip ul at ed reco rd in Octo be r 20 15

. At no ti m e di d th e ESOP su bm it ev id en ce to th e Tax Co ur t refu ti ng th e ab ov e-q uo te d fact s in th e Exp la na ti on of I te m s. No r di d th e ESOP se ek to ha ve th os e fact s det erm in ed in th e Tax Co ur t by an ev id en ti ary he ari ng or t ria l. The ESOP was t he pa rty in co nt ro l of th e rel ev an t do cu m en ts , a n d i t h a d fai le d to su bm it th os e do cu m en ts in res po ns e to th e IRS’s req ue st at th e s t a r t of it s in ve st ig at io n. In th es e ci rcu m st an ces , th e Tax Co ur t di d no t cl ea r ly err in ba si ng it s fin di ng s of fact on th e IRS’s un co nt es te d Exp la na ti on of I te m s. Tho se fact s est ab li sh ed th at DNA’ s 2 00 8 c on tri bu ti on to Dr.
Pro ha sk a’s ESOP acco un t su bs ta nt ia ll y ex ceed ed th e § 41 5 co nt rib ut io n li m it fo r th at
y ear. Th us , th e ESOP was no t a § 40 1( a) q ua li fie d p la n. Se e I.R.C. § 40 1( a)(1 6)

.

“ [W] he n a pl an is di sq ua li fie d un de r se ct io n 41 5, th e dis quali fic at io n co nt in ue s

un ti l rem ed ia l act io n is ta ke n.” Cl en de ne n v. Co m m ’r, T.C. M e mo 20 03 -3 2, 20 03
W L 29 90 32
, at *4
, aff’d, 3 45 F.3d 56 8 (8t h Cir. 20 03 ); see Mar ti n Fire pr oo fin g, 92

-5

-T.C. at 11 84 -8 9. Here, th ere is no ev id en ce DNA or th e ESOP to ok co rrec ti ve act io n.

Cf. Hul l v. I.R.S., 65 6 F.3 d 11 74
, 11 84 (1 0t h Ci r. 20 11 )

. A c c o r d i ng ly, th e Co m m is si on er di d no t ab us e hi s di sc ret io n in di sq ua li fy in g th e ESOP fo r 20 08 an d th e su bs eq ue nt pl an y ears in qu es ti on

.

The de ci si on of t he Tax C ou rt i s af fir m ed

.

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