The 2013 Case of the Year for retirement plans

By Nick Paleveda MBA J.D. LL.M

National Pension Partners

Each year, I have a "Case of the Year" for estate planning. Last year, it was Kite v. Commissioner (2013), and before that it was Wandry v. Commissioner (2012). Now I have the Case of the Year for retirement planning in 2013.

The opinion was written by Tax Court judge Robert Wherry, whom I use to clerk for when he was not on the bench. Some of his opinions are great, like Dickerson v. Commissioner, but they never made my Case of the Year until now.

The Case of the Year for retirement plans in 2013 is Thousand Oaks et. al v. Commissioner (T.C. Memo 2013-10), and here is why it is on the must-read list.

Dr. Fletcher owned an assisted living facility. When the facility was sold in 2002 for $3.4 million, Dr. Fletcher entered into a management agreement. The corporation created a defined benefit plan in 2003, listing only Mr. and Mrs. Fletcher and Ms. Strick as plan participants. The total compensation paid was $1,701,287, including tax-deductible contributions to a pension of $450,939. The court held that this was reasonable except the salaries were too high and backed off $282,615.

The IRS asked for penalties and were denied, except a 10 percent excise tax on the amount of the pension that was overfunded due to the back off in salary.

Why is this case important?

The court allowed a pension to be set up after the sale of the business, catch-up compensation to take place, and almost no penalties for the high compensation (note they worked with a CPA — important in tax planning).

Why is the case important to a producer?

The funding of the pension can be accomplished with annuity and insurance contracts — all fixed products.

I would strongly advise working with a tax professional on business sales. There are issues relating to reasonable compensation, active trade or business, allocation of capital gain and ordinary income, and they are all complex. But the Tax Court has given us a basic blue print on using pension plans in business transitions.