                          T.C. Memo. 1996-36




                        UNITED STATES TAX COURT



ORVIL M. WEDDEL AND KAREN L. WEDDEL, Petitioners v. COMMISSIONER
                 OF INTERNAL REVENUE, Respondent



     Docket No. 18187-92.                      Filed January 30, 1996.


     Robert D. Forrester, for petitioners.

     Douglas R. Fortney, for respondent.



                          MEMORANDUM OPINION


     WRIGHT, Judge:     Respondent determined a deficiency in

petitioners’ Federal income tax for taxable year 1988 in the

amount of $21,486.55.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year at issue, and

all Rule references are to the Tax Court Rules of Practice and
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Procedure.   After concessions by both parties, which will be

given effect in the Rule 155 computation, the issues for decision

for taxable year 1988 are:

     (1)   Whether distributions received by petitioners in the

amount of $74,813 from their defined contribution profit-sharing

plan are includable in gross income as determined by respondent.

We hold that they are.

     (2)   Whether respondent abused her discretion in failing to

offer to enter into a closing agreement with petitioner Orvil

Weddel’s employer, in accordance with the Internal Revenue

Service Employee Plans Closing Agreements Pilot Program, in order

to avoid plan disqualification under section 401(a).    We hold

that respondent did not abuse her discretion.

     Petitioners resided in Amarillo, Texas, at the time the

petition was filed in the instant case.    Petitioners’ joint

Federal income tax return for taxable year 1988 was timely filed.

     Mr. Weddel is employed as a machinery operator at Ace

Machine Co. (Ace), a Texas corporation.    Mr. Weddel began working

for Ace in 1972.   Mrs. Weddel was employed by Ace; however, the

dates of her employment are not clear in the record.    Ace is

involved in the business of oilfield welding.    On June 1, 1977,

Ace adopted a defined contribution profit-sharing plan (Plan).

The Plan received a favorable determination letter from the

Internal Revenue Service (IRS) on November 11, 1977.    Mr. Weddel

was a participant in the Plan.    The trustee of the Plan was an
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unrelated third party.    Petitioners were not fiduciaries of the

Plan and exercised no authority, control, responsibility, or

discretion over its administration or operation.

     Petitioners consistently relied on the Plan trustee to

handle all required Plan filings, take all steps necessary to

maintain the Plan’s qualified status, and provide petitioners

with pertinent Plan information.    Prior to 1985, petitioners

owned no interest in Ace; all issued and outstanding shares were

owned by third parties.    In June 1985, petitioners acquired 100

shares of Ace.

     The Plan was amended in 1980, changing its eligibility

requirements to age 21 and 6 months of service.    The Plan was

again amended in 1986, changing the vesting to 4-year “cliff”

vesting.    Both amendments were approved by the IRS; no other

amendments were made to the Plan.

     Effective May 31, 1984, the Plan was frozen, and no further

employer contributions were made.    No employee contributions were

made to the Plan at any time.    The Plan was terminated effective

June 1, 1987.    Ace was adversely affected by the economic

hardship faced by the Texas oil industry in the 1980's, and it

was for this reason that Ace discontinued making contributions to

the Plan.

     On behalf of the Plan, the trustee filed a final Form 5500-

C, Return/Report of Employee Benefit Plan (with fewer than 100
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participants) for fiscal year ending May 31, 1988.   There were

five Plan participants at the time the Plan was terminated.

     In June 1988, petitioners received two lump-sum

distributions from the Plan in the total amount of $74,813,

representing petitioners’ entire balance to their credit in the

Plan.   In July 1988, petitioners timely rolled over the entire

amount into nonparticipating flexible premium-deferred annuities

at Western National Life Insurance Co.   The annuities are still

in place; no withdrawals from or additional contributions to the

annuities have been made.

     On March 12, 1990, the IRS advised Ace that it proposed to

disqualify the Plan for Plan years ending May 31, 1985 through

1987.   On March 14, 1991, Ace received a final revocation letter

revoking the Plan’s exemption for the above-mentioned Plan years.

The Plan lost its exemption because the Plan was not timely

amended to comply with changes in the law resulting from the Tax

Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-

248, 96 Stat. 324, the Deficit Reduction Act of 1984 (DEFRA),

Pub. L. 98-369, 98 Stat. 494, and the Retirement Equity Act of

1984 (REA), Pub. L. 98-397, 98 Stat. 1426.   Ace has not contested

the Plan revocation.

     Section 401(a) sets forth the requirements that a trust

forming part of a retirement plan such as a pension or profit-

sharing plan must meet for the trust to be a qualified trust

entitled to receive favorable tax treatment.   Both the employer
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adopting such a retirement plan and the employees participating

in the plan receive favorable tax treatment.     Income earned by a

qualified plan is not subject to taxation while the plan’s assets

are held in a trust which is tax exempt under section 501(a).

Sec. 401(a).   Under section 404(a), the employer, subject to

certain limitations, receives an immediate tax deduction for

contributions to a qualified plan.     Under section 402(a),

employees are not taxed on any employer contributions that are

made on their behalf until the benefits are actually distributed

to them from the plan.   If the plan does not meet the

requirements set forth in section 401(a), however, the earnings

of the plan are subject to tax and employer deductions for

contributions may be deferred or eliminated.      Moreover, if

contributions to an employees’ trust are made by an employer

during a taxble year for which the trust is not exempt from tax,

the employees are taxed on the value of such employer

contributions under section 83.   Sec. 402(b).

     Respondent determined that the lump-sum distributions

received by petitioners from their profit-sharing plan are

includable in petitioners’ gross income for taxable year 1988

because, at the time of the distributions, the Plan failed to

meet the requirements of a “qualified trust” under section

401(a).   See Fazi v. Commissioner, 102 T.C. 695 (1994).

Petitioners assert, however, that they are entitled to relief
                               - 6 -

under the IRS Employee Plans Closing Agreements Pilot Program

(CAP Program).

     On December 21, 1990, approximately 3 months prior to the

issuance of the final revocation letter in the instant case, the

IRS introduced the CAP Program.   The CAP Program was designed to

resolve disputes regarding a plan’s qualified status such as plan

disqualification due to the failure to timely amend under TEFRA,

DEFRA, and REA.   The CAP Program was made permanent on October 9,

1991.

     The CAP Program is outlined in an internal IRS memorandum

dated December 21, 1990.   The CAP Program allows plan employers

and key district offices of the IRS to resolve cases of plan

disqualification in a manner that allows for the continued

qualification of a plan.   The closing agreement provides for the

correction of the disqualifying defect in a plan and the

imposition of sanctions on the employer for noncompliance.    Under

the CAP Program, key district offices were given discretion to

enter into closing agreements as a possible alternative to

revocation of a plan’s qualified status.   In entering into such

closing agreements, the general procedures to be followed were

those set forth in IRM 8(13)10, Closing Agreement Handbook, and

in Rev. Proc. 68-16, 1968-1 C.B. 770.

     Under the CAP Program, the closing agreement procedure

requires the Employee Plans agent (EP agent) to notify the plan

sponsor of any proposals to disqualify a plan.   The EP agent is
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then required to advise the sponsor of the existence of the CAP

Program and the possibility of using a closing agreement to avoid

plan disqualification.   In addition to retroactive and

prospective correction of the plan under the CAP Program, the

party or parties to the closing agreement must agree to make a

nondeductible payment to the U.S. Treasury in order to avoid

having the plan’s qualified status revoked.   The maximum amount

to be paid under the CAP Program equals the total tax resulting

from (1) the disallowance of the plan sponsor’s deduction for

contributions to the plan, (2) the treatment of the plan’s trust

income as taxable income, and (3) the inclusion, in the gross

income of the participants, of their appropriate shares of plan

contributions as determined under the facts of the case.

     The EP agent in the instant case, who audited the Plan and

subsequently recommended and obtained its disqualification, did

not notify Ace or the Plan trustee of the CAP Program, did not

discuss the CAP Program with Ace or the Plan trustee, and did not

provide either with the option to utilize the program as an

alternative to the Plan’s disqualification.   During examination

of the Plan, no significant operational defects existed that

would have prohibited the use of a closing agreement under the

terms of the CAP Program.

     There is no dispute in the instant case that Ace failed to

make amendments to the Plan in order to comply with changes in

the law resulting from TEFRA, DEFRA, and REA.   Thus, there is no
                               - 8 -

dispute that, at the time petitioners received their lump-sum

distributions from the Plan, the Plan was not qualified under

section 401(a).

     Petitioners assert, however, that the distributions they

received from the Plan should not be taxable because respondent

failed to give notice to the Plan sponsor of the possibility of

using the CAP Program in order to avoid plan disqualification.

Petitioners argue that this notice is mandatory under the CAP

Program, which was in place at the time Ace received its final

determination letter revoking the Plan’s qualified status.

Petitioners’ argument is without merit.

     The IRS will, at the request of the taxpayer, issue an

initial determination letter stating whether a plan qualifies

under section 401(a).   The Commissioner has broad authority,

however, to revoke a determination letter retroactively.   Sec.

7805(b).   As stated above, a plan, in order to be qualified, must

initially meet the formal requirements of section 401(a) and must

be continually amended to comport with subsequent changes to the

statutory requirements.    Buzzetta Constr. Corp. v. Commissioner,

92 T.C. 641, 646 (1989).   It is clear from the record, and there

is no dispute between the parties, that Ace failed to meet these

requirements, and it was for this reason that the Plan’s tax-

exempt status was revoked.

     While it appears that respondent did not handle the instant

case in accordance with the guidelines set forth under the CAP
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Program, this factor does not provide relief for petitioners.

See Mills, Mitchell & Turner v. Commissioner, T.C. Memo. 1993-99.

The CAP Program was a completely discretionary program.    It is

well settled that a court may not order an agency to perform a

discretionary act.     Capitol Fed. Sav. & Loan v. Commissioner, 96

T.C. 204, 212 (1991); Buzzetta Constr. Corp. v. Commissioner,

supra at 648; Oakton Distribs., Inc. v. Commissioner, 73 T.C.

182, 188 (1979).

     Moreover, this Court may not substitute its judgment for

that of the Commissioner when reviewing discretionary acts.

Buzzetta Constr. Corp. v. Commissioner, supra.     The

Commissioner’s exercise of discretionary power will not be

disturbed unless the Commissioner abuses such discretion by

making a determination that is unreasonable, arbitrary, or

capricious.   Id.    Whether the Commissioner has abused her

discretion is a question of fact, and the taxpayer’s burden of

proving an abuse of discretion is greater than that of the usual

preponderance of the evidence.     Pulver Roofing Co. v.

Commissioner, 70 T.C. 1001, 1011 (1978).

     We find that petitioners have failed to meet their burden of

proof in the instant case.    We find further that the lump-sum

distributions received by petitioners in 1988 from their profit-

sharing plan are includable in gross income for taxable year 1988

under sections 402(b)(1) and 83, and this result cannot be
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avoided by any claimed relief under the CAP Program.

Accordingly, respondent’s determination is sustained.

     To reflect the foregoing,

                                             Decision will be

                                        entered under Rule 155.
