924 F.3d 1111
10th Cir.2019Background
- Petersen Inc. was an S corporation; Taxpayers (majority shareholders in 2009) reported pass-through items on their individual returns. The corporation’s ESOP held the remaining (and later all) stock.
- The corporation used accrual accounting; ESOP participants (employees) used cash-basis accounting. The corporation deducted accrued wages, salaries, and vacation liabilities in 2009 that were paid to ESOP participants in 2010.
- IRC § 461 governs accrual-basis deductions; IRC § 267(a)(2) limits deductions for amounts payable to related cash-basis payees until those amounts are includible in the payee’s gross income.
- IRS audited and disallowed the 2009 deductions, treating the ESOP (a trust under ERISA) and its participants as "related" to the S corporation under § 267(e) and § 267(c) constructive-ownership rules. Taxpayers lost in Tax Court and appealed.
- The Tenth Circuit affirmed that an ERISA ESOP trust qualifies as a “trust” under § 267 and that ESOP participants are beneficiaries (thus constructively own the S-corp stock), but remanded for recalculation of deficiency amounts.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether an ESOP trust is a "trust" for § 267 purposes | ESOPs are special/qualified and ERISA uses different terms (participant vs beneficiary); not a common-law trust; § 1132(d) shows plan, not trust, is the entity | ERISA mandates plan assets be held in trust, ERISA trusts meet trust-law elements and the IRC regulatory definition | ESOP trust is a "trust" under § 267; ERISA terminology and special tax treatment do not exclude it |
| Whether ESOP participants are beneficiaries who constructively own S-corp stock under § 267(c) | § 318 exclusion for employee-benefit trusts shows employees should not be treated as constructive owners | § 318 applies only to provisions of Subchapter C where expressly made applicable; § 267 is independent and its constructive-ownership rules apply | ESOP participants are beneficiaries and constructively own stock for § 267(c) purposes; § 318 does not bar § 267’s application |
| Whether § 267(a)(2) prevents accrual deductions in 2009 for amounts paid to ESOP participants in 2010 | Deductions were proper when accrued by an accrual-basis S corporation | § 267(a)(2) requires matching: if payee is related and on cash method, deduction delayed until payee includes income | § 267(a)(2) applies; deductions for accrued but unpaid amounts payable to related ESOP participants must be deferred until payee income inclusion |
| Whether application of § 267 conflicts with Subchapter D (ESOP rules) or other IRC provisions | Applying § 267 to ESOPs contradicts Subchapter D/§ 404 and creates absurd taxation/attribution results | No direct conflict shown; § 267 and Subchapter D operate in their spheres and § 267 explicitly applies to trusts and passthru entities | No conflict found; § 267 applies and does not impose extra taxation beyond timing adjustments |
Key Cases Cited
- Donovan v. Cunningham, 716 F.2d 1455 (5th Cir. 1983) (describes ESOP structure and operation)
- Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014) (Congress’s support for ESOPs and their policy context)
- Brindle v. Wilmington Trust, N.A., 919 F.3d 763 (4th Cir. 2019) (treatment of employer contributions to ESOPs as tax-deductible)
- Tate & Lyle, Inc. v. C.I.R., 87 F.3d 99 (3d Cir. 1996) (purpose of § 267 to match deductions and payee income)
- Katz v. C.I.R., 335 F.3d 1121 (10th Cir. 2003) (standard of review for Tax Court decisions)
- Metzger Trust v. C.I.R., 76 T.C. 42 (1981) (discussion of § 267’s purpose to prevent differing reporting methods between related parties)
- Central States, Southeast and Southwest Areas Pension Fund v. Central Transport, Inc., 472 U.S. 559 (1985) (ERISA’s use of trust-law terminology)
- Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101 (1989) (ERISA’s trust-law characteristics and remedial scheme)
- Varity Corp. v. Howe, 516 U.S. 489 (1996) (ERISA’s incorporation of trust-law principles and special standards)
- Massachusetts v. Morash, 490 U.S. 107 (1989) (ERISA’s purpose to protect plan assets)
- Boise Cascade Corp. v. United States, 329 F.3d 751 (9th Cir. 2003) (applied § 318 in a Subchapter C context; distinguished in this case)