                       T.C. Memo. 1998-318



                     UNITED STATES TAX COURT



            HOWARD E. CLENDENEN, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 18155-96R.                 Filed September 3, 1998.



     Paul F. Christoffers, for petitioner.

     Lawrence H. Ackerman, for respondent.



                          MEMORANDUM OPINION


     TANNENWALD, Judge:    This is an action for a declaratory

judgment regarding the qualification of petitioner's employee

stock ownership plan and trust.    On May 22, 1996, respondent

issued a final revocation letter to petitioner stating that the

Howard E. Clendenen, Inc. Employee Stock Ownership Plan (the
                               - 2 -


ESOP) failed to meet the requirements of section 401(a)1 for the

plan years beginning after June 30, 1985, and that its related

trust (the trust) was not tax exempt under section 501(a) for

those years.

     The issue for decision is whether amounts contributed to the

trust and allocated to one of the ESOP's participants exceed the

limitations in section 415, thereby causing the trust not to

constitute a qualified trust under section 401(a).

Background

     Petitioner is a corporation with its principal place of

business located in West Des Moines, Iowa, at the time of the

filing of the petition in this case.   It filed its Federal tax

returns for the years in issue with the Internal Revenue Service

Center in Kansas City, Missouri.   Petitioner utilizes the accrual

method of accounting with a fiscal year ending June 30 as its

taxable year.

     Petitioner was incorporated on July 15, 1983, and its

principal business activity is insurance consulting.   It is the

employer and plan administrator with respect to the ESOP, a

defined contribution plan.   It established the ESOP and the trust

on September 6, 1983, effective for plan years beginning on or


     1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code as in effect for the years in issue,
and all Rule references are to the Tax Court Rules of Practice
and Procedure.
                               - 3 -


after July 15, 1983, and amended the ESOP effective June 30,

1985, and July 1, 1989.   Petitioner received favorable

determination letters with respect to the ESOP and trust dated

December 8, 1983, March 24, 1986, and March 22, 1990.     The plan

year and limitation year of the ESOP and the trust are the fiscal

year ending June 30.

     The trust is and has been petitioner's sole shareholder

since petitioner's incorporation.   Petitioner issued shares of

its stock to the trust in payment of the contributions to the

trust and in exchange for cash.

     Howard E. Clendenen (Mr. Clendenen) is and has been

petitioner's president.   On June 28, 1986, petitioner's board of

directors resolved:

     That Howard E. Clendenen has advised the Corporation
     that he desires to forego [sic] one-half of his salary
     and bonuses for the fiscal year ended June 30, 1986
     with the understanding that said one-half of his salary
     and bonuses shall be contributed to * * * [the trust].
     It is further understood that this transaction shall be
     considered an employee contribution.

On June 29, 1987, petitioner's board passed a resolution

identical to that of June 28, 1986, resolution except for the

1987 year.

     The ESOP's records reflect the following contributions to

the trust allocated to petitioner's employees as shown:
                                 - 4 -


     Plan                                  Employer         Employee
     Year      Employee                  Contribution     Contribution

     1986      Howard E. Clendenen            0           $17,029.38

     1987      Howard E. Clendenen        $ 9,000.00          30,000.00

     1988      Howard E. Clendenen             0                  0

     1989      Howard E. Clendenen         11,250.00              0
               Paul Clendenen               1,949.82              0

                    1989 total             13,199.82              0

     1990      Howard E. Clendenen          9,000.00              0
               Paul Clendenen               3,299.88              0

                    1990 total             12,299.88              0

     1991      Howard E. Clendenen          8,250.00              0
               Paul Clendenen               3,975.00              0

                    1991 total             12,225.00              0

     These contributions were reflected in the trust's Forms

5500-C Return/Report of Employee Benefit Plan for each of such

years.

     Petitioner reported the following expenditures on its U.S.

Corporation Income Tax Returns:

                  Total                         Pension,
               Compensa-                         profit-
                 tion of     Salaries           sharing,
    Year        Officers    and Wages         etc., plans

    1986      $34,058.76         0                   n/a
    1987       36,697.01         0                $9,000.00
    1988            0            0                      0
    1989            0      $12,998.80             13,199.82
    1990            0       21,999.20             12,299.88
    1991            0       26,500.00             12,225.00
                               - 5 -


In addition, petitioner reported the following expenses under

"Other Deductions":

     Year             Item                   Amount

     1987       Sec. 401(k) bonuses       $30,000.00

     1989       Commission expenses         75,000.00

     1990       Bonuses                     60,000.00

     1991       Commissions                 41,660.28
                Bonuses                     55,000.00

     For the calendar years 1986 and 1987, Mr. Clendenen filed

joint U.S. Individual Income Tax Returns.    For 1988 through 1991,

he filed his returns with a filing status of single.2   Mr.

Clendenen's returns reflect the following:

                 Wages,        Business
     Year       Salaries        Income    Type of Business

     1986       $12,938              0
     1987        30,000              0
     1988             0              0
     1989             0        $75,000    Insurance consulting
     1990             0         60,000    Consultant
     1991             0         55,000    Consultant

For the plan year ending June 30, 1986, and his taxable year

ending December 31, 1986, Mr. Clendenen treated $17,029.38 as an

elective deferral of compensation into the ESOP.

Discussion

     Section 401(a)(16) provides:

     A trust shall not constitute a qualified trust under
     this section if the plan of which such trust is a part

     2
         Mr. Clendenen was divorced on Jan. 11, 1988.
                               - 6 -


     provides for benefits or contributions which exceed the
     limitations of section 415.

     Section 415(a)(1) provides that a trust which is part of a

pension, profit-sharing, or stock bonus plan shall not constitute

a qualified trust under section 401(a) if--

                (B) in the case of a defined contribution
           plan, contributions and other additions under the
           plan with respect to any participant for any
           taxable year exceed the limitation of subsection
           (c) * * * [.]

Section 415(c)(1) provides:

     Contributions and other additions with respect to a
     participant exceed the limitation of this subsection
     if, when expressed as an annual addition (within the
     meaning of paragraph (2)) to the participant's account,
     such annual addition is greater than the lesser of --

                (A) $30,000,[3] or

                (B) 25 percent of the participant's compensation.

Section 415(c)(2) provides that "annual addition" means the sum

for any year of--

     (A)   employer contributions,




     3
        Sec. 415(c)(1)(A) was amended by the Tax Reform Act of
1986, Pub. L. 99-514, sec. 1106(a), 1106(i), 100 Stat. 2420,
2425, effective for years beginning after Dec. 31, 1986, to read
"$30,000 (or, if greater, 1/4 of the dollar limitation [$90,000]
in effect under subsection (b)(1)(A))". It was further amended
to eliminate the parenthetical language effective for years
commencing after Dec. 31, 1994. Uruguay Round Agreements Act,
Pub. L. 103-465, sec. 732(b)(2), 108 Stat. 5005 (1994).
                               - 7 -


     (B)   the lesser of--

                (i) the amount of the employee contributions
           in excess of 6 percent of his compensation, or

                (ii) one-half of the employee
           contributions,[4] and

     (C) forfeitures.

     The dispute in this case focuses on the amount of the

contributions to the trust allocated to Mr. Clendenen.   The

parties disagree as to what constitutes participant compensation

and as to whether elective deferral amounts constitute employee

or employer contributions.   It is petitioner's position that the

amounts of elective deferrals are employee contributions and

should be included in "participant's compensation".   Petitioner

also asserts that "participant's compensation" includes amounts

petitioner paid as commissions and bonuses to Mr. Clendenen as an

independent contractor.   As a consequence, petitioner maintains

that the limitations of section 415(c)(1) have not been exceeded

with the result that the plan and trust were qualified during the

years at issue.

     Respondent asserts that the amounts of elective deferrals

constitute employer, not employee, contributions and that these

amounts and the commissions and bonuses do not constitute

     4
        Sec. 415(c)(2)(B) was amended by the Tax Reform Act of
1986, Pub. L. 99-514, sec. 1106(e)(1), 1106(i), 100 Stat. 2424,
2425, for the years beginning after Dec. 31, 1986, to include the
entire employee contribution in the computation of the annual
addition.
                                - 8 -


"participant's compensation".   Such being the case, respondent

contends that the limits of section 415(c)(1) were exceeded, and

the plan and trust were not qualified during the years at issue.

     Section 415(c)(3)(A) simply defines participant's

compensation as "the compensation of the participant from the

employer for the year."   However, section 402(a)(8) provides:

     For purposes of this title, contributions made by an
     employer on behalf of an employee to a trust which is a
     part of a qualified cash or deferred arrangement (as
     defined in section 401(k)(2)) shall not be treated as
     distributed or made available to the employee nor as
     contributions made to the trust by the employee merely
     because the arrangement includes provisions under which
     the employee has an election whether the contribution
     will be made to the trust or received by the employee
     in cash. [Emphasis added.]

Also, section 1.415-2(d)(2)(i), Income Tax Regs.,5 provides that

compensation does not include "Contributions made by the employer

to a plan of deferred compensation to the extent that, before the

application of the section 415 limitations to that plan, the

contributions are not includable in the gross income of the

employee for the taxable year in which contributed."

Furthermore, section 1.401(k)-1(a)(4)(ii), Income Tax Regs.,

provides:

     Except as provided in paragraph (f) of this section,
     [dealing with the correction of excess contributions]
     elective contributions under a qualified cash or
     deferred arrangement are treated as employer

     5
        This provision was renumbered as sec. 1.415-2(d)(3)(i),
Income Tax Regs., effective for years after Jan. 1, 1987. T.D.
8361, 1991-2 C.B. 310, 318.
                                 - 9 -


     contributions. Thus, for example, elective
     contributions are treated as employer contributions for
     purposes of sections 401(a) and 401(k), 402, 404, 409,
     411, 412, 415, 416, and 417.

     The issue in respect of elective deferrals has been before

this Court under substantially identical circumstances.    See

Steel Balls, Inc. v. Commissioner, T.C. Memo. 1995-266, affd.

without published opinion 89 F.3d 841 (8th Cir. 1996).6    We

rejected the same argument presented herein and concluded that

respondent's position was clearly supported by the statute and

regulations.    We reach the same conclusion herein and hold that

the elective deferrals are employer contributions and not

included in "participant's compensation".   Consequently, the

amounts of the elective deferrals are included in annual

additions.7    Sec. 415(c)(2).

     Petitioner also seeks to include in "participant's

compensation" the amounts of the commissions or bonuses that

     6
        The Small Business Job Protection Act of 1996, Pub. L.
104-188, sec. 1434(a), 110 Stat. 1807, added sec. 415(c)(3)(D)
which includes certain deferrals in participant's compensation,
effective for years beginning after Dec. 31, 1997. This
amendment does not apply to the instant case. We note, however,
that the legislative history makes clear that Congress considered
the provisions of the then-existing law as requiring the result
reached herein and specifically intended to change the law for
future years. H. Rept. 104-586 at 112 (1996), 1996-3 C.B. 331,
450; S. Rept. 104-281 at 80 (1996); H. Conf. Rept. 104-737 at
245-246 (1996), 1996-3 C.B. 741, 985-986.
     7
        Since the years involving the elective deferrals are
fiscal years ending June 30, 1986, and June 30, 1987, only a
portion of the employee contributions would have been included.
Sec. 415(c)(2)(B); see supra note 4.
                               - 10 -


petitioner paid Mr. Clendenen as an independent contractor for

the years 1989 through 1991.    Petitioner argues that Mr.

Clendenen's compensation was his earned income as a self-employed

person.    Petitioner is correct that for a self-employed

individual, "participant's compensation" is the participant's

earned income.    See sec. 415(c)(3)(B).   What petitioner fails to

recognize is that a sole proprietor is considered to be his own

employer.    Sec. 401(c)(4); sec. 1.401-10(e), Income Tax Regs.

Mr. Clendenen, thus, had at least two employers during 1989,

1990, and 1991, himself and petitioner.

     While an individual can be an employee with respect to more

than one business or employer, each employer is considered

separately and only the income the employee earns from the

employer sponsoring the plan may be taken into account for

purposes of that employer's plan.    Sec. 415(c)(3)(A)

(compensation "from the employer"); sec. 1.401-10(b), Income Tax

Regs.    Accordingly, section 1.415-2(d)(2)(i),8 Income Tax Regs.,

provides:

     For purposes of applying the limitations of section
     415, the term "compensation" includes * * * --

          (i) The employee's wages, salaries, fees for
     professional services, and other amounts received * * *
     for personal services actually rendered in the course
     of employment with the employer maintaining the plan to
     the extent that the amounts are includable in gross
     income * * * . [Emphasis added.]

     8
          See supra note 5.
                              - 11 -


For purposes of petitioner's plan, Mr. Clendenen is covered as an

employee of petitioner and thus, only with respect to the

compensation received as petitioner's employee.   We do not

dispute petitioner's argument that Mr. Clendenen was an officer

of petitioner and that an officer is an employee.   But the fact

of the matter is that petitioner adopted an arrangement whereby

Mr. Clendenen was not compensated for whatever services he may

have rendered as an officer-employee but for his services as an

independent contractor.   We hold, therefore, that the amounts

petitioner paid to Mr. Clendenen as an independent contractor are

not includable in compensation.

     We now determine whether the annual additions on behalf of

Mr. Clendenen exceed the section 415(c) limits.   With the

exception of 1988, for which the parties agree Mr. Clendenen's

compensation was $0, the record is not clear as to the exact

amounts of compensation paid to Mr. Clendenen.9   We need not make

any findings with respect to the exact figures, however, for

     9
        The amounts deducted by petitioner as officer
compensation on its returns for 1986 and 1987 do not match those
reported by Mr. Clendenen on his individual returns. While this
could be due to the different tax years involved (year ending
June 30 versus December 31), respondent, in the revocation letter
and in his briefs, uses the lower figures appearing on Mr.
Clendenen's returns due to lack of substantiation. Petitioner
does not address the difference for 1986, and for 1987, uses the
lower figure in its brief. For 1989 through 1991, respondent
treats the amounts shown as salaries and wages on petitioner's
corporate returns as compensation paid to Paul Clendenen.
Petitioner does not argue that these amounts were paid to Mr.
Clendenen.
                             - 12 -


regardless of which amounts we use, the annual additions

allocated to Mr. Clendenen during each of the plan years 1986,

1987, 1989, 1990, and 1991, exceed the section 415 limits.

Petitioner has not argued or established that any corrective

measures were taken to reduce these additions.   See sec. 1.415-

6(b)(6), Income Tax Regs.

     We hold that the trust is not a qualified trust under

section 401(a) beginning with the plan year 1986.

                                        Decision will be entered

                                   for respondent.
