Opinion ID: 766121
Heading Depth: 1
Heading Rank: 1

Heading: introduction

Text: 1 This matter is before this court on appeal from an order entered on January 15, 1999, on the parties' cross motions for summary judgment in the district court in this tax refund case. The district court entered the order in accordance with its accompanying memorandum opinion. The district court had jurisdiction under I.R.C.§ 7422(a) and 28 U.S.C. § 1346(a)(1). We have jurisdiction under 28 U.S.C. § 1291. We exercise plenary review on this appeal, which involves only legal Conclusions. See ACM Partnership v. Comissioner, 157 F.3d 231, 245 (3d Cir. 1998), cert. denied, 119 S.Ct. 1251 (1999). 2 The case arises out of the interplay between state and federal law and involves the application of the ten percent tax imposed by I.R.C. § 72(t) on a taxpayer on a nonperiodic distribution constituting an early withdrawal from a qualified I.R.C. § 401(a) retirement plan. The germane facts are not in dispute. 1 In 1974, the Commonwealth of Pennsylvania enacted the State Employees' Retirement Code (Retirement Code), 71 Pa. Cons. Stat. Ann.§§ 5101-5956 (West 1990), which continued the earlier established State Employees' Retirement System (Retirement System) and the State Employees' Retirement Fund (Fund). See id. §§ 5102, 5932. A Board of Directors (Retirement Board) administers the Retirement System and the Fund. See id. §§ 5901-5931. The Retirement Board has the authority to adopt and promulgate rules and regulations for the uniform administration of the system. See id. § 5902(h). 3 In April 1987, the Fraternal Order of Police (FOP), Kute's bargaining agent, initiated collective bargaining procedures with the Commonwealth to obtain a successor agreement to its contract effective for 1986 through 1988. Inasmuch as the negotiations reached an impasse, the FOP invoked the binding arbitration provisions of 43 Pa. Cons. Stat. Ann. § 217.4(a) (West 1992). On February 17, 1988, the arbitration panel awarded a change in pension benefits to Pennsylvania state troopers with at least 20 years of service who retire on or after July 1, 1989, eliminating any requirement that a trooper attain a specific age before retiring. The award further provided that in lieu of the standard single life annuity provided under 71 Pa. Cons. Stat. Ann. § 5702(a)(1), a trooper retiring after at least 20 years of service was entitled to receive an annuity of 50% of his highest yearly salary and that a trooper retiring after at least 25 years of service was entitled to receive an annuity of 75% of his highest yearly salary. The award also provided that if a court invalidated the pension benefit increase it would be replaced by a $1,000 pay increase with appropriate adjustments to reflect rank differential provisions. The parties refer to the award as the DiLauro Award in recognition of the chairperson of the arbitration panel. 4 The Commonwealth judicially challenged the DiLauro Award on the ground that 71 Pa. Cons. Stat. Ann.§ 5955 barred collective bargaining over pension benefits. The Supreme Court of Pennsylvania, however, upheld the award. See Commonwealth of Pennsylvania v. State Conference of State Police Lodges of the Fraternal Order of Police, 575 A.2d 94, 97 (Pa. 1990) (Fraternal Order of Police). In particular, the court held that the Retirement Code prohibits only collective bargaining agreements from determining pension rights but does not prohibit bargaining over pension benefits [nor] pension benefits from being affected by arbitration awards. Id. at 96-97. The court further concluded that the award was a mandate to the legislature to enact whatever legislation [was] necessary to implement or fund the arbitration award. Id. at 97. 5 In response to Fraternal Order of Police, the Retirement Board voted to implement the DiLauro Award as follows: 6 The awarded benefits of 50% of the highest year's salary after 20 years of service or 75% of the highest year's salary after 25 years of service shall be inserted into the Retirement Code structure in lieu of the standard single life annuity for purposes of calculating a withdrawal or superannuation annuity under Section 5702(a)(1). 7 The resolution further provided that [a]ll other [Retirement] Code benefits remain in full force and effect and all optional benefit payment plans . . . remain in effect. 8 The legislature then amended section 5955, effective August 5, 1991, to provide in relevant part: 9 Regardless of any other provision of law, pension rights of State employees shall be determined solely by this part or any amendment thereto, and no collective bargaining agreement nor any arbitration award between the Commonwealth and its employees or their collective bargaining representatives shall be construed to change any of the provisions herein, to require the [Retirement Board] to administer pension or retirement benefits not set forth in this part, or otherwise require action by any other government body pertaining to pension or retirement benefits or rights of State employees. Notwithstanding the foregoing, any pension or retirement benefits or rights previously so established by or as a result of an arbitration award shall remain in effect after the expiration of the current collective bargaining agreement between the State employees so affected and the Commonwealth. 10 71 Pa. Cons. Stat. Ann. § 5955 (West Supp. 1999) (emphasis added). In 1992, after nearly 30 years of service as a state trooper, Kute retired at the age of 51 years, and became eligible to receive retirement benefits. 11 Kute elected an alternative annuity option (Option 4) under 71 Pa. Cons. Stat. Ann. § 5705(a)(4)(iii), which was the actuarial equivalent of the maximum single life annuity provided by section 5702. Under Option 4, a portion of the retirement benefit (not in excess of the total accumulated deductions standing to the member's credit) may be paid as a lump sum, and the balance of the present value of the maximum single life annuity is paid as an annuity. Consequently, Kute received a monthly retirement benefit of $3,132.42 and a one-time payment of $49,607.13, as well as post-termination interest of $385.20. The $49,607.13 payment was composed of nontaxable member contributions of $13,593.94, taxable member contributions of $19,079.34, and interest on the contributions of $16,933.90. The ten percent tax on a portion of the payment of $49,607.13 is at issue here. 12 On his 1992 federal income tax return Kute reported and paid the ten percent additional tax in the amount of $3,700 under I.R.C. § 72(t), attributable to the distribution of $36,998 in taxable member contributions and interest. Kute then filed an administrative claim for refund of the additional tax. The IRS disallowed the claim, and Kute then brought this timely suit for refund. 2 13 The parties thereafter submitted a stipulation of uncontested material facts and exhibits and served and filed cross-motions for summary judgment. The exhibits included a declaration of Dale Everhart, Assistant Executive Director of the Retirement System, setting forth that the IRS has treated the Retirement System as a qualified plan under I.R.C. § 401(a) since at least 1982 and that because the IRS has treated the Retirement System as a qualified plan, the Retirement System had not requested a determination letter from the IRS regarding its status as a qualified plan. Kute does not contest this point on this appeal. 14 Kute argued in the district court that I.R.C. § 72(t) did not apply to his lump sum one-time distribution. In this regard, he contended that the section applies only to distributions from qualified plans under I.R.C. § 401(a), so that in his view the tax was not applicable as his distribution came from the DiLauro Award rather than from the Retirement System. The government argued that the payment fell within I.R.C. § 72(t) as it was from a qualified plan and resulted from Kute's election of an alternative annuity option provided in the Retirement Code. 15 The district court granted the government's motion for summary judgment, holding that I.R.C. § 72(t) applied to the distribution. The court rejected Kute's assertion that the arbitration award created a benefit distinct from the Commonwealth's qualified pension plan. The district court held that the DiLauro Award was integrated into the Commonwealth's qualified pension plan. It pointed out that the Pennsylvania Supreme Court had determined that the arbitration board had the authority to issue an award affecting police retirement benefits and that the award was a mandate to the legislature to enact whatever legislation [was] necessary to implement or fund the arbitration award. The district court further noted that the legislature had recognized the award when it amended section 5955 of the Retirement Code prospectively to prohibit arbitration awards from amending the Retirement Code by including language stating that any pension or retirement benefits or rights previously so established by or as a result of an arbitration award shall remain in effect after the expiration of the current collective bargaining agreement between the State employees so affected and the Commonwealth. 71 Pa. Cons. Stat. Ann. § 5955. 16 The district court concluded that, in upholding the DiLauro Award, the Pennsylvania Supreme Court determined that pension benefits under the Retirement Code could be modified by an arbitration award governing the contract between the Commonwealth and the state police. The court further observed that [p]ursuant to the terms of the [Retirement] Board resolution, the increased pension benefits were `inserted' into the Retirement Code. The court also noted that Kute's lump sum payment was made pursuant to an option provided under the Retirement Code. See 71 Pa. Cons. Stat. Ann. § 5705(a)(4)(iii). 17 The court rejected Kute's argument that his retirement payments must be allocated between amounts received under the arbitration award and amounts received under the Retirement Code, as it concluded that Pennsylvania State Troopers Ass'n v. Pennsylvania State Employees' Retirement Board, 677 A.2d 1329, 1330 (Pa. Commw. Ct. 1996), alloc. denied, 689 A.2d 237 (Pa. 1997), prohibited such a result. The court determined that, under that decision, the arbitration award and formulas replaced the other benefits to state troopers under the Retirement Code and were not separate from benefits payable under the Code. 3