Court Opinion

ID: 4483224
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:15:58.216643+00
Date Added: 2024-06-11T15:03:40.363262
License: Public Domain

Goffe, J., dissenting: I respectfully dissent. The qualification of petitioner’s profit-sharing plan is predicated upon our interpretation of section 401(c)(3)(B), which defines an "owner-employee.” If any partner "owns more than 10 percent of either the capital interest or the profits interest” in the partnership, such partner is an "owner-employee” and the profit-sharing plan cannot qualify under section 401(a) unless the plan fulfills the requirements of section 401(d). Although authority is delegated to the Secretary to prescribe regulations to describe the circumstances under which an individual will be deemed to be an owner-employee because he has been an owner-employee, the regulations promulgated under that section do not set forth any tests as to when an individual has been an owner-employee nor do the regulations explain what is meant by "owning” an interest in the capital or profits. Sec. 1.401-10(d), Income Tax Regs. The regulations do provide, however, that "a partner’s interest in the profits and the capital of the partnership shall be determined by the partnership agreement.” Section 1.401-10(d), Income Tax Regs., and tests are set forth for instances where the partnership agreement is silent as to the sharing of profits and the distribution of the assets of the partnership. The regulations clearly base the ownership of profits or capital upon the partnership agreement which is the proper focus. The majority looks outside the partnership agreement to see what two partners have received for 2 taxable years and concludes that because they received more than 10 percent of the net profits, they each owned more than a 10-percent interest in the profits and were, therefore, owner-employees within the meaning of section 401(c)(3)(B). In my view the majority has backed into a definition of "owns” which is contrary to the partnership agreement as contemplated by the regulations and has adopted an interpretation which does not aim at the evil to be corrected by the owner-employee test. It is undisputed that none of the partners owns more than a 10-percent interest in the capital of the partnership. The dispute centers around whether any partner owns more than 10 percent of the profits interest in the partnership. Such ownership must be ascertained from the partnership agreement as prescribed by the regulations. If the partnership agreement provided that Mr. X would receive 11 percent of the net profits of the partnership there would be no question that Mr. X would be an owner-employee under section 401(c)(3)(B), and the profit-sharing plan would not qualify. The partnership agreement involved here does not set forth a fixed percentage of the net profits of the partnership which each partner will receive and the agreement is not unusual or unique for a law partnership. Instead, the agreement provides that the net profits of the partnership shall first be divided into two categories of one-third and two-thirds. The one-third portion is allocated among the partners on the basis of their capital interests. Because none of the partners owns more than 10 percent of the capital interest and one-third of the net profits is divided on the percentage of the capital interest, none of the partners is an owner-employee under section 401(c)(3)(B) solely by virtue of the share he owns in the one-third portion of the net profits. The remaining two-thirds portion of the net profits is distributed to the partners in a ratio that the profit from each partner’s services rendered bears to the total of the profit to the firm earned by all of the partners. The division of this two-thirds portion of the net profits is also affected by a policy of the firm which, by reference, is incorporated into the partnership agreement by the firm handbook, which the majority here also interprets. Such stated policy awards to a partner or associate 20 percent of the fees (less overhead) received from a new client produced by such partner or associate. This incentive, which is neither unusual nor unique in law partnerships, prevents any partner from owning a fixed percentage of the net profits of the partnership for any given year because each partner’s share of the profits necessarily rests upon three variables; i.e., the new clients brought to the firm by such partner, the total income earned by the partnership, and the expenses paid by the partnership for the year involved. Because of these three variables it cannot be said that any one partner in a 19-partner firm owns more than 10 percent of the net profits of the partnership. Until all of the fees are received at the end of the year and all expenses are paid no one can determine the percentage of the net profit each partner will receive. Contrast that with a partnership agreement which specifies the percentage of the fees to be received by each. Regardless of the total fees of the firm, the expenses of the firm, or the efforts of each partner in securing new clients for the firm, the partners will receive a fixed percentage of the net profits, regardless of the resulting amount of the net profits. The majority equates what each partner has received from the firm with what the Code and regulations require; what each pártner owns in the net income interest of the partnership. The majority accomplishes this by concluding that you must look at the facts at the end of the year because section 401(c)(3)(B) prescribes that an owner-employee means a partner who "has been” an owner-employee. I fail to see how this equates ownership in an unknown percentage of net profits to actual receipt of the net profits after all of the facts are known. The majority looks not to the partnership agreement to see how much each partner owns, as prescribed by the regulations, but instead looks outside the partnership agreement to the final determination of what each has received and relates the receipt back to ownership. It is true that a partner may sell his rights to the partnership profits but no partner could sell a specific percentage thereof. The majority equates 1 year’s "distributive share” with "profits interests.” Arguably, this is correct under the facts if a temporal approach is taken; i.e., over a period of years. However, to equate a "distributive share” of profits in any one taxable year with "profits interest” in the partnership seems unjustified because of the uncertain fluctuation and variation of such interests. The interpretation by the majority is contrary to the identical uses of the word "owns” in the preceding portion of the sentence which describes an owner-employee of an unincorporated business as the employee who owns the entire interest. Sec. 401(c)(3)(A). In the case of an unincorporated business it is possible to identify the employee who owns the entire interest and he is, therefore, identified as the owner-employee. Under the construction of section 401(c)(3)(B) made by the majority, the identity of the owner-employee cannot be made until the close of the taxable year; the identity of an owner-employee may vary from year-to-year depending upon the productivity of each partner, the amount of fees earned, and expenses paid by the firm; and in some years, there may be no owner-employee at all. Such a construction would cause a firm not to know whether its plan qualifies from year-to-year because of the variations in the efforts of the partners, the total fees earned, and the expenses paid by the firm. That is the obvious reason for not looking beyond the terms of the partnership agreement, as the regulations provide, to see if any partner owns more than 10 percent of the net profits of the partnership. Surely the variables of each partner’s productivity, the total fees earned and expenses paid for each year, should not determine qualification of a plan on a year-to-year basis. A determination based upon the partnership agreement applies to all years and provides the certainty that is necessarily required for a viable, functioning, profit-sharing plan and in the instant case the partnership agreement specifies the method of distributing the net profit. The regulations do not call for an examination of all the facts and circumstances to determine the respective interests in net profits but focus only on the partnership agreement or absence thereof. The majority embellishes the regulations while only recently we described as our task, "[applying] the provisions of respondent’s regulations as we find them and not as we think they might or ought to have been written.” Phillip G. Larson, 66 T.C. 159, 185 (1976). Nor do I conclude that the situation can fit within the provision of the regulations where there is an "absence of any provision regarding the sharing of profits.” Sec. 1.401-10(d), Income Tax Regs. The partnership agreement specifically provides for the method of distributing profits. To require a law partnership to provide for specific percentages as an alternative to qualification of its plan under section 401(d) by straining to apply the language of the regulations is too much. The evils described by the majority which the owner-employee test was designed to thwart are ongoing throughout the taxable year; if the owner-employee cannot be identified until the end of the year when the accounting is completed and such owner-employee may or may not be an owner-» employee in the subsequent taxable year, how can it be determined who is going to commit the abusive acts that the definition of owner-employee was designed to correct? In the preceding part of the sentence of section 401(c)(3)(B) which is 401(c)(3)(A), the identity of the owner-employee is ascertainable throughout each year and for all years not by such extrinsic facts as his efforts and the amounts of income and expense of the unincorporated business. I would not ascribe a different meaning to the word "owns” as used twice in the same sentence of section 401(c)(3). I conclude that the partnership agreement, the point of reference prescribed by the regulations, does not confer ownership to more than 10-percent interest in the profits of the partnership upon any partner within the intendment of section 401(c)(3)(B) of the Code and section 1.401-10(d), Income Tax Regs., and, therefore, none of the partners is an "owner-employee.” We should, therefore, hold the plan to be qualified. Drennen, Sterrett, and Wiles, JJ., agree with this dissent.