                              T.C. Memo. 2014-31



                        UNITED STATES TAX COURT



K.H. COMPANY, LLC EMPLOYEE STOCK OWNERSHIP PLAN, Petitioner v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 15819-12R.                       Filed February 24, 2014.



      Carol Tomb (a member), for petitioner.

      John Q. Walsh, Jr., and Michael C. Dancz, for respondent.



                          MEMORANDUM OPINION


      KERRIGAN, Judge: In this declaratory judgment proceeding under section

7476 petitioner challenges respondent’s March 20, 2012, final revocation letter

determining that for its plan years ending September 30, 1995, and its subsequent

plan years, the K.H. Co., LLC Employee Stock Ownership Plan (plan) was not
                                         -2-

[*2] qualified under section 401(a) and that the related trust is not exempt under

section 501(a).

      Unless otherwise indicated, all section references are to the Internal

Revenue Code in effect for the period under consideration, and all Rule references

are to the Tax Court Rules of Practice and Procedure.

      The broad question we consider is whether there was an abuse of discretion

in respondent’s determination. To decide that question, we consider (1) whether

the plan met certain statutory requirements and/or whether the terms of the plan

were amended timely or properly; (2) whether a qualified appraiser was used for

required valuations; and (3) whether the plan operated within its terms.

                                    Background

      The parties submitted this case fully stipulated under Rule 122 on the basis

of the pleadings and the administrative record in accordance with Rule 217(a).

The underlying facts are derived from the administrative record, which the parties

submitted fully stipulated.

      K.H. Co., LLC (K.H. Co.), is an Iowa limited liability company (LLC). Its

principal place of business was in Iowa at the time petitioner filed the petition.

During the period under consideration K.H. Co. was the sponsor, employer, and
                                        -3-

[*3] administrator of the plan. Before October 6, 1994, K.H. Co. operated as K.H.

Co., Inc., an Iowa corporation with its principal place of business in Iowa.

      K.H. Co., Inc., was the original sponsor, employer, and administrator of the

plan. The plan’s original effective date was September 30, 1988. On August 20,

1990, respondent issued K.H. Co., Inc., a favorable determination letter regarding

the 1988 plan.

      For plan years ending September 30, 1992 and 1993, contributions of

$20,700 and $27,081, respectively, were made to the plan. No other contributions

were made during the period under consideration.

      On October 6, 1994, K.H. Co., Inc., began operating as K.H. Co. The

members of K.H. Co. were Carol Tomb (also known as Carol Hoffman) and the

K.H. Co. Inc. employee stock ownership trust. Immediately before the operating

change Ms. Tomb was K.H. Co. Inc.’s registered agent and its only director. After

the operating change Ms. Tomb served as K.H. Co.’s registered agent. During the

period under consideration Ms. Tomb was the only employee of K.H. Co.

      Also on October 6, 1994, K.H. Co. signed, but did not date, a plan

document with a purported effective date of October 6, 1994. The document

refers to the 1994 plan as an employee stock ownership plan (ESOP) and states

that each plan year ends on September 30.
                                         -4-

[*4] On July 9, 1997, K.H. Co. amended the 1994 plan. Ms. Tomb signed, but

did not date, a second amendment to the 1994 plan with a purported effective date

of August 5, 1997.

      On October 1, 2001, K.H. Co. amended the 1994 plan a third time and

created an amended and restated plan document effective October 1, 2001. The

document refers to the 2001 plan as an ESOP.

      Ms. Tomb was the plan’s only participant for plan years ending September

30, 2002 and 2003. Ms. Tomb was also the plan trustee for plan years ending

September 30, 2000 through 2003. The record does not reflect who was the plan

trustee or who participated in the plan for the rest of the period under

consideration.

Plan Specifics

      The 1994 plan document and its amendments and the 2001 plan document

are all titled “K.H. Company, L.L.C. Employee Stock Ownership Plan”, and they

all state: “This Plan is intended to be an Employee Stock Ownership Plan as

defined in Internal Revenue Code, Section 4975(e)”. They also state that “the

assets of the Plan shall be invested primarily in Qualified Employer Securities”.
                                       -5-

[*5] With respect to elective deferrals, the 1994 plan document and its

amendments state:

      No Participant shall be permitted to have Elective Deferrals made
      under this Plan, or any other qualified plan maintained by the
      Employer, during any calendar year, in excess of $7,000 multiplied
      by the Adjustment Factor as provided by the Secretary of the
      Treasury. Other dollar limitations may apply under section 402(g) of
      the Code to the extent that a Participant makes Elective Deferrals to
      arrangements other than qualified cash or deferred adjustments.

The 2001 plan document, however, states:

      No Participant shall be permitted to have Elective Deferrals made
      under this Plan, or any other qualified plan maintained by the
      Employer, during any calendar year, in excess of $7,000 for calendar
      year 2001 and shall be determined for future years in accordance with
      * * * [a table providing for $11,000 for calendar year 2002 and
      increasing $1,000 per calendar year thereafter until 2006].

      The 1994 plan document and its amendments specify that accrued benefits

must be distributed or installment payments must begin no later than April 1 of the

calendar year following the calendar year in which the employee attains age 70½.

The 2001 plan document specifies that the accrued benefits must be distributed or

installment payments must begin not later than April 1 of the calendar year

following the calendar year in which the employee attains age 70½ or in which the

employee retires.
                                        -6-

[*6] The 1994 plan document and its amendments do not include a primary

direction or control test in the definition of a “leased employee”. Likewise, the

2001 plan document does not include a primary direction or control test in the

definition of a “leased employee”.

      Section 414(u) specifies that a qualified plan must include provisions

concerning special rules for veterans’ reemployment rights and for differential

wage payments to members on active duty under the Uniformed Services

Employment and Reemployment Rights Act of 1994, Pub. L. No. 103-353, 108

Stat. 3149. The 1994 plan document and its amendments do not include

provisions addressing section 414(u); however, the 2001 plan document includes

those provisions by reference.

      The 1994 plan document defines “compensation” as:

      Compensation paid by the Employer to the Participant during the
      taxable year ending with or within the Plan Year which is required to
      be reported as wages on the Participant’s Form W-2 and shall include
      compensation which is not currently includible in the Participant’s
      gross income by reason of the application of sections 125, 402(a)(8),
      402(h)(1)(B), or 403(b) of the Code, but shall not exceed $200,000,
       * * * for any Plan Year * * * .

The 1994 plan document defines “participant’s compensation” as “within the

meaning of Section 415(c)(3) of the Code”.
                                       -7-

[*7] The first amendment to the 1994 plan, effective October 6, 1994, defines

compensation as including “any elective deferral and any amount which is

contributed or deferred by the Employer at the election of the Employee by reason

of section 125 or 147”.

      The 2001 plan document defines “compensation” as:

      All W-2 wages paid to the Participant by the employer for the Plan
      Year and all earned income paid to self-employed individuals who are
      considered to be employees under the provisions of the Internal
      Revenue Code section 401(c)(1). Compensation also includes any
      elective deferral and any amount which is contributed or deferred by
      the Employer under the provisions of sections 125 and 401(k). Total
      compensation does not include any amounts paid to a Participant in
      excess of $200,000 plus any future cost of living or inflation
      increases permitted by the Internal Revenue Service.

The 2001 plan document defines “participant’s compensation” as “within the

meaning of Section 415(c)(3) of the Code”.

      The 1994 plan document does not define “eligible rollover distribution”.

The first amendment to the 1994 plan document defines “eligible rollover

distribution”, but the definition does not exclude hardship distributions. The 2001

plan document excludes hardship distributions from the definition of an eligible

rollover distribution.
                                        -8-

[*8] Plan Appraisals

      John L. Henss was chosen to appraise K.H. Co. The administrative record

includes appraisals and appraisal summaries for only 2000, 2001, and 2002.

Written on “JLH” letterhead, the cover letter of each appraisal states: “At your

request, we have prepared an appraisal valuation of KH Company, L.L.C.” The

cover letters refer to the “appraised value of common stock of KH Company,

L.L.C.” The cover letters are all dated, but none of them are signed.

      Mr. Henss’ qualifications are not described in the appraisals. The appraisal

summaries state merely: “The undersigned holds himself out to be an appraiser.

The undersigned is an accountant who is familiar with the assets being appraised.”

Mr. Henss did not sign or date the appraisals or the appraisal summaries.

Proposed Disqualification and Final Revocation Letter

      On July 15, 2004, the Internal Revenue Service (IRS) began an examination

of the plan. On January 6, 2006, the IRS proposed to disqualify the plan for the

following reasons: (1) the plan ceased to be a qualified ESOP when K.H. Co.

became an LLC; (2) Mr. Henss was not a qualified independent appraiser for

purposes of section 401(a)(28); (3) the plan failed to allocate employer securities

to individual participants’ accounts as specified in section 409(b) and therefore
                                        -9-

[*9] failed to follow its own terms; and (4) the plan failed to amend timely with

respect to certain statutory requirements.

      On March 20, 2012, respondent issued a final revocation letter, determining

that the plan failed to meet the requirements of section 401 for “the plan years

ending September 30, 1995, and subsequent” and determining that the related trust

was no longer exempt under section 501(a). Respondent determined that the plan

contained disqualifying provisions because it failed to amend timely or properly

the plan with respect to the following: (1) elective deferrals requirements under

section 402(g)(5); (2) minimum distribution requirements under section 401(a)(9);

(3) employee leasing under section 414(n); (4) special rules for veterans under

section 414(u); (5) the definition of compensation under section 415(c); (6) early

retirement benefit under section 401(a)(1); and (7) eligible rollover distributions

under section 401(a)(14). Respondent also determined that Mr. Henss was not a

qualified independent appraiser for purposes of section 401(a)(28)(C) and that the

plan failed to allocate employer securities to individual participants’ accounts.

                                     Discussion

      In this declaratory judgment proceeding we review respondent’s

determination that the plan was not qualified.
                                        - 10 -

[*10] Section 7476(a) authorizes this Court to make a declaration with respect to

the initial or continuing qualification of certain retirement plans when the

limitations of section 7476(b) are met. Neither party disputes that those

limitations have been met in this case, and we are satisfied that we have

jurisdiction over the petition. See generally Efco Tool Co. v. Commissioner, 81

T.C. 976 (1983) (discussing this Court’s jurisdiction in the setting of a similar

declaratory judgment case).

      We set forth the standard for our review in Buzzetta Constr. Corp. v.

Commissioner, 92 T.C. 641, 648 (1989), as follows:

      When reviewing discretionary administrative acts * * * this Court
      may not substitute its judgment for that of the Commissioner. The
      exercise of discretionary power will not be disturbed unless the
      Commissioner has abused his discretion, i.e., his determination is
      unreasonable, arbitrary, or capricious. Whether the Commissioner
      has abused his discretion is a question of fact, and petitioner’s burden
      of proof of abuse of discretion is greater than that of the usual
      preponderance of the evidence. Estate of Gardner v. Commissioner,
      82 T.C. 989, 1000 (1984); Oakton Distributors, Inc. v. Commissioner,
      73 T.C. 182, 188 (1979).

See also Churchill, Ltd. Emp. Stock Ownership Plan & Trust v. Commissioner,

T.C. Memo. 2012-300, at *6-*7.

      Respondent determined that the plan and the related trust failed to qualify

under sections 401(a) and 501(a), respectively, for the following reasons: (1) the
                                        - 11 -

[*11] terms of the plan were not amended timely or properly to include certain

provisions; (2) the plan failed to use an independent appraiser to appraise

employer securities as specified in section 401(a)(28)(C); and (3) the plan, which

purported to be an ESOP, failed to invest primarily in employer securities as

specified in section 4975(e)(7). A plan and a related trust may fail to qualify

under sections 401(a) and 501(a) if any one of the above factors is missing. See

secs. 401(a), 4975(e)(7); see also Hollen v. Commissioner, T.C. Memo. 2011-2,

slip op. at 8, 10 (holding that a plan that did not amend certain provisions timely

failed to qualify under section 401(a) and holding that a plan that did not use an

independent appraiser failed to qualify under section 401(a)), aff’d per curiam,

437 Fed. Appx. 525 (8th Cir. 2011).

      Section 401(a) lists requirements which must be met in order for a trust to

be considered a qualified trust entitled to preferential tax treatment under section

501(a). See Hollen v. Commissioner, slip op. at 5. In order for a plan to be

qualified, both its terms and its operations must meet the statutory requirements.

Buzzetta Constr. Corp. v. Commissioner, 92 T.C. at 646; see also Churchill, Ltd.

Emp. Stock Ownership Plan & Trust v. Commissioner, at *7. We need not discuss

specifically the qualification of the related trust under section 501(a) because the
                                        - 12 -

[*12] exemption of the trust under section 501(a) follows from the qualification of

the plan under section 401(a). See Hollen v. Commissioner, slip op. at 6.

I.    Whether the Terms of the Plan Were Amended Timely or Properly

      Respondent argues that petitioner failed to timely or properly amend the

terms of the plan. Petitioner contends that employee benefit rights were restored

to appropriate levels under the statutes and the regulations. To the extent that the

terms of the plan were not amended timely, petitioner claims that the

Commissioner normally allows retroactive amendments to comply with various

statutory changes. Respondent counters that, even if we were to consider the

amendments petitioner made to be timely, the amendments did not comport

adequately with the statutory changes and requirements.

      During the 1990s and into the year 2000 various legislation affected

existing employee benefit plans. Those legislative enactments are sometimes

known commonly and collectively as “GUST”.1 Where the GUST legislative

      1
        GUST is an acronym for the following legislation: (1) the Uruguay Round
Agreements Act (URAA), Pub. L. No. 103-465, 108 Stat. 4809 (1994), which
implemented the Uruguay Round of the General Agreement on Tariffs and Trade;
(2) the Uniformed Services Employment and Reemployment Rights Act of 1994,
Pub. L. No. 103-353, 108 Stat. 3149; (3) the Small Business Job Protection Act of
1996, Pub. L. No. 104-188, 110 Stat. 1755; (4) the Taxpayer Relief Act of 1997
(TRA 97), Pub. L. No. 105-34, 111 Stat. 788; (5) the Internal Revenue Service
Restructuring and Reform Act of 1998, Pub. L. No. 105-206, 112 Stat. 685; and
                                                                     (continued...)
                                        - 13 -

[*13] changes placed plans in a position of noncompliance, section 401(b) permits

a remedial period within which to make plan amendments to comply with new

legislation. The GUST remedial amendment period for the type of plan under

consideration here ended on the later of February 28, 2002, or the last day of the

first plan year beginning on or after January 1, 2001. See Rev. Proc. 2001-55,

2001-2 C.B. 552, modifying Rev. Proc. 2000-27, 2000-1 C. B. 1272.

      If the employer files a request for a determination letter with respect to the

qualification of the plan on or before the end of the remedial amendment period,

the remedial amendment period is extended until 91 days after the date on which

(1) the Commissioner issued the notice of the final determination with respect to

that request, (2) the employer withdraws the request, (3) the Commissioner

otherwise finally disposes of that request, or (4) if the employer files a timely

declaratory judgment petition with respect to the Commissioner’s final

determination (or failure to make such a determination), a decision of this Court

becomes final. See sec. 1.401(b)-1(e)(3), Income Tax Regs. Here, the last day of

the first plan year beginning after January 1, 2001, was September 30, 2002.

Although respondent received a submission for a favorable determination letter

      1
        (...continued)
(6) the Community Renewal Tax Relief Act of 2000, app. G of the Consolidated
Appropriations Act, 2001, Pub. L. No. 106-554, 114 Stat. at 2763A-587 (2000).
                                       - 14 -

[*14] with a postmark date of January 9, 2003, the remedial amendment period

had already expired on September 30, 2002. Therefore, the deadline for the plan

to adopt the various GUST requirements was September 30, 2002.

      Respondent concedes that petitioner adopted a timely good-faith

amendment for the required provisions in the Economic Growth and Tax Relief

Reconciliation Act of 2001, Pub. L. No. 107-16, 115 Stat. 38.2 We address

individually each aspect of the plan that respondent determined not to be in

compliance.

      A.      URAA Statutory Change That Affected the Plan

      The Uruguay Round Agreements Act (URAA), Pub. L. No. 103-465, 108

Stat. 4809 (1994), implementing the Uruguay Round of the General Agreement on

Tariffs and Trade, as pertinent to this case, changed plan requirements under

section 402(g)(5).

      Section 402(g) provides general limitations on the amounts of elective

deferrals an individual may exclude from gross income. For years beginning after

December 31, 1994, URAA sec. 732(c), 108 Stat. at 5005, amended section

402(g)(5), which provided that elective deferrals be limited to $7,000, as adjusted


      2
       Respondent also concedes that the terms of the plan were amended timely
for “early retirement benefit” pursuant to sec. 401(a)(14).
                                       - 15 -

[*15] by the Secretary at the same time and in the same manner as under section

415(d), to require additionally that an increase not a multiple of $500 be rounded

to the next lowest multiple of $500 ($500 adjustments).3 See also URAA sec.

732(e), 108 Stat. at 5005.

      The 1994 plan amendments4 failed to refer to the $500 adjustments or to

state that the elective deferral limits would be adjusted under section 415(d). The

2001 plan document likewise failed to refer to the $500 adjustments or to state that

the elective deferral limits would be adjusted under section 415(d) for years

beginning after December 31, 1994, and on or before December 31, 2001.

      Petitioner nonetheless contends that the plan qualified under section 401(a)

and that respondent has overlooked Rev. Rul. 82-66, 1982-1 C.B. 61, which

allows a retroactive amendment to a qualifying retirement plan after the remedial

period in certain circumstances. Petitioner’s contention misses the point that no



      3
       The Economic Growth and Tax Relief Reconciliation Act of 2001
(EGTRRA), Pub. L. No. 107-16, sec. 611(d)(1) and (2), 115 Stat. at 97, later
amended sec. 402(g)(5), effective for years beginning after December 31, 2001.
See also EGTRRA sec. 611(i), 115 Stat. at 100. Respondent concedes that URAA
sec. 732(c) does not apply to plan years that began after December 31, 2001.
URAA sec. 732(c) still applied to the 2001 plan document because its relevant
plan year began on September 30, 2001.
      4
       The 1994 plan document and the second amendment to the 1994 plan were
not dated. We will assume for sake of argument that they were valid.
                                        - 16 -

[*16] correcting amendments addressing elective deferrals were made for the

relevant plan years.

      Accordingly, petitioner has not shown that respondent’s reliance on this part

of the determination as part of the basis for revocation was unreasonable or

arbitrary. See Churchill, Ltd. Emp. Stock Ownership Plan & Trust v.

Commissioner, at *10.

      B.     SBJPA Statutory Changes That Affected the Plan

      The Small Business Job Protection Act of 1996 (SBJPA), Pub. L. No. 104-

188, 110 Stat. 1755, as pertinent to this case, changed plan requirements under (1)

section 401(a)(9) concerning required minimum distributions; (2) section

414(n)(2)(C) concerning the definition of “employee leasing”; (3) section 414(u)

concerning special rules for veterans; and (4) section 415(c)(3)(D) concerning a

participant’s compensation.5

             1.    Required Minimum Distributions

      Section 401(a)(9) provides for required minimum distributions and,

additionally, that the entire interest of each employee must distributed not later

      5
       In respondent’s opening brief respondent claims that the plan also failed to
define properly “compensation” under sec. 414(q)(6) (concerning family
aggregation rules in connection with “highly compensated employees”). This
argument, however, is not in the final revocation letter, and respondent does not
discuss it further on brief.
                                        - 17 -

[*17] than the required beginning date or beginning not later than the required

beginning date over the life of the employee or over the lives of the employee and

the employee’s designated beneficiary. See sec. 401(a)(9)(A)(i) and (ii). SBJPA

sec. 1404(a), 110 Stat. at 1791, changed the required beginning date for

participants other than a “5-percent owner” to April 1 of the year following the

year in which the participant reaches age 70½ or, if later, following the year in

which the employee retires. See sec. 401(a)(9)(C)(i) and (ii). This change was

effective for years beginning after December 31, 1996. SBJPA sec. 1404(b), 110

Stat. at 1792; see also Churchill, Ltd. Emp. Stock Ownership Plan & Trust v.

Commissioner, at *11. With respect to “5-percent owners” SBJPA sec. 1404(a)

specified the beginning distribution date would be April 1 of the calendar year

following the year in which the participant reaches age 70½.

      The 1994 plan amendments and the 2001 plan document failed to

distinguish between 5% owners and non-5% owners and therefore failed to

specified properly the required distribution beginning dates. The 1994 plan

amendments stated that, for all participants, accrued benefits be distributed or

installments begin not later than April 1 following the calendar year in which the

employee attains age 70½. The 1994 plan amendments thus failed to specify that

benefits for non-5% employees would begin not later than April 1 following the
                                        - 18 -

[*18] calendar year in which the employee attains age 70½ or the calendar year in

which the employee retires. The 2001 plan document, however, states that for all

participants, accrued benefits be distributed or installments begin not later than

April 1 of the calendar year following the calendar year in which the employee

attains age 70½ or the calendar year in which the employee retires. Thus, the 2001

plan document failed to specify that benefits for 5% owners would begin not later

than April 1 of the calendar year following the calendar year in which the

employee attains age 70½.

      Petitioner did not make correcting amendments by September 30, 2002, the

deadline to adopt the GUST amendments, or any other retroactive amendments as

Rev. Rul. 82-66, supra, provides.

      Accordingly, petitioner has not shown that respondent’s reliance on this part

of the determination as part of the basis supporting the determination for

revocation was unreasonable or arbitrary. See Churchill, Ltd. Emp. Stock

Ownership Plan & Trust v. Commissioner, at *11-*13.

             2.    Employee Leasing

      Section 414(n) concerns circumstances where a “leased employee” performs

services for another person (recipient) and may be treated as the recipient’s

employee for certain employee benefit provisions. SBJPA sec. 1454(a), 110 Stat.
                                       - 19 -

[*19] at 1817, amended section 414(n)(2)(C) with respect to the test to determine

whether a “leased employee” would be considered the recipient’s employee. This

new test for whether a “leased employee” would be treated as recipient’s employee

(referred to as the “primary direction and control test”) considered whether the

“services are performed under the primary direction or control by the recipient.”

SBJPA sec. 1454(a). The primary direction and control test was effective for

years beginning after December 31, 1996. Id. sec. 1454(b), 110 Stat. at 1817; see

also Churchill, Ltd. Emp. Stock Ownership Plan & Trust v. Commissioner, at *19.

      The 1994 plan amendments did not include the primary direction and

control test. The 2001 plan document adds the primary direction and control test

to the definition of “leased employee”, but the 2001 plan document became

effective on July 1, 2001, and did not apply to the years beginning after December

31, 1996, as specified in the SBJPA.

      Accordingly, petitioner has not shown that respondent’s reliance on this part

of the determination as part of the basis for revocation was unreasonable or

arbitrary. See Churchill, Ltd. Emp. Stock Ownership Plan & Trust v.

Commissioner, at *9-*10.
                                        - 20 -

[*20]         3.    Special Rules for Veterans

        SBJPA sec. 1704(n)(1), 110 Stat. at 1883, added section 414(u), which

restores certain pension benefits, profit-sharing benefits, and similar benefits that

would have accrued but for the employee’s absence due to “qualified military

service.” These provisions were effective December 12, 1994. SBJPA sec.

1704(n)(3), 110 Stat. at 1886; see also Churchill, Ltd. Emp. Stock Ownership Plan

& Trust v. Commissioner, at *10-*11.

        The 1994 plan amendments did not incorporate the section 414(u)

provisions. The 2001 plan document adds the section 414(u) provisions, but the

2001 plan document became effective on October 1, 2001, and not December 12,

1994, as specified in the SBJPA. Thus, petitioner failed to make the section

414(u) changes for plan years before October 1, 2001.

        Accordingly, petitioner has not shown that respondent’s reliance on this

aspect of the determination as the basis for revocation was unreasonable or

arbitrary. See Churchill, Ltd. Emp. Stock Ownership Plan & Trust v.

Commissioner, at *10-*11.

              4.    Participant’s Compensation

        SBJPA sec. 1434(a), 110 Stat. at 1807, added section 415(c)(3)(D)

concerning “participant’s compensation”. Section 415(c)(3)(D) was effective for
                                       - 21 -

[*21] years beginning after December 31, 1997. SBJPA sec. 1434(c), 110 Stat. at

1807; see also Churchill, Ltd. Emp. Stock Ownership Plan & Trust v.

Commissioner, at *14.

      Section 415(c) provides limitations for defined contribution plans. Section

415(c)(1) currently provides:

             (1) In general.--Contributions and other additions with respect
      to a participant exceed the limitation of this section if, when
      expressed as an annual addition * * * to the participant’s account,
      such annual addition is greater than the lesser of--

            (A) $40,000, or

            (B) 100 percent of the participant’s compensation.6

Section 415(c)(3) defines the phrase “participant’s compensation” generally as

“the compensation of the participant from the employer for the year.” Section

415(c)(3)(D), as SBJPA sec. 1434(a) added it, further provides:


      6
        URAA sec. 732(b)(2), 108 Stat. at 5005, amended sec. 415(c)(1)(A) by
removing a reference to “1/4 of the dollar limitation in effect under subsection
(b)(1)(A)”. URAA sec. 732(b)(2) was effective for years beginning after
December 31, 1994. URAA sec. 732(e), 108 Stat. at 5005. Later, EGTRRA sec.
611(b), 115 Stat. at 97, amended sec. 415(c)(1)(A) by increasing the dollar limit
from $30,000 to $40,000. EGTRRA sec. 611(b) is effective for years beginning
after December 31, 2001. EGTRRA sec. 611(i), 115 Stat. at 100.
       EGTRRA sec. 632(a)(1), 115 Stat. at 113, amended sec. 415(c)(1)(B) by
increasing the percentage limit from 25% to 100%. EGTRRA sec. 632(a)(1) is
effective for years beginning after December 31, 2001. EGTRAA sec. 632(a)(4),
115 Stat. at 115.
                                       - 22 -

      [*22] (D) Certain deferrals included.--The term “participant’s
      compensation” shall include--

                   (i) any elective deferral (as defined in section 402(g)(3)),
            and

                  (ii) any amount which is contributed or deferred by the
            employer at the election of the employee and which is not
            includible in the gross income of the employee by reason of
            section 125 or 457.

Thus, section 415(c)(3)(D) defines generally elective deferrals as those defined in

section 402(g)(3) and any amount an employer deferred at the election of the

employee that is not includible in gross income. Churchill, Ltd. Emp. Stock

Ownership Plan & Trust v. Commissioner, at *14.

      Respondent contends that neither the 1994 plan amendments nor the 2001

plan document referred to any amounts which the employer contributed or

deferred at the election of the employee and which are not includible in the gross

income of the employee by reason of section 125 or 457. Respondent further

contends that petitioner did not make the required amendments by September 30,

2002. Petitioner made no argument on brief concerning this issue.

      The 1994 plan document defines “compensation” as:

      Compensation paid by the Employer to the Participant during the
      taxable year ending with or within the Plan Year which is required to
      be reported as wages on the Participant’s Form W-2 and shall include
      compensation which is not currently includible in the Participant’s
                                        - 23 -

      [*23] gross income by reason of the application of sections 125,
      402(a)(8), 402(h)(1)(B), or 403(b) of the Code, but shall not exceed
      $200,000 for any Plan Year * * * .

The first amendment to the 1994 plan amended the definition of compensation to

include “any elective deferral and any amount which is contributed or deferred by

the Employer at the election of the Employee by reason of section 125 or 147”.

The 2001 plan document, however, amends the definition of compensation to

include “any elective deferral and any amount which is contributed or deferred by

the Employer under the provisions of sections 125 and 401(k).”

      The first amendment to the 1994 plan thus addressed some of the changes to

the definition of “compensation” that section 415(c)(3)(D) specified, but it failed

to include amounts which the employer contributed or deferred at the election of

the employee and which are not includible in the gross income of the employee

within the meaning of section 457. The 2001 plan document failed to address the

changes that section 415(c)(3)(D) specified. Petitioner did not make amendments

addressing the section 415(c)(3)(D) changes by September 30, 2002, or any other

retroactive amendments as Rev. Rul. 82-66, supra, provides.

      Even though the 1994 plan amendments and the 2001 plan document define

“participant’s compensation” as “within the meaning of Section 415(c)(3) of the

Code”, that definition is insufficient to apprise plan participants of the terms and
                                       - 24 -

[*24] conditions of the plan. Cf. Churchill, Ltd. Emp. Stock Ownership Plan &

Trust v. Commissioner, at *12 (finding that a plan’s bare reference to the

minimum distribution requirements of section 1.401(a)(9)-(5), Income Tax Regs.,

would be insufficient to apprise plan participants of the terms and conditions of

the plan). Congress established the writing requirement so that employees, by

examining the plan document, can determine exactly what their rights and

obligations are under the plan. See Curtiss-Wright Corp. v. Schoonejongen, 514

U.S. 73, 83 (1995); H.R. Conf. Rept. No. 93-1280, at 297 (1974), 1974-3 C.B.

415, 458. A generic statement in a plan document that indicates that it complies

with the Internal Revenue Code or even a specific section thereof does not

adequately meet the congressional mandate. Churchill, Ltd. Emp. Stock

Ownership Plan & Trust v. Commissioner, at *12.

      Accordingly, petitioner has not shown that respondent’s reliance on this part

of the determination as part of the basis for revocation was unreasonable or

arbitrary. See id. at *15.

      C.     CRA Statutory Change That Affected the Plan

      The Community Renewal Tax Relief Act of 2000 (CRA), appendix G of the

Consolidated Appropriations Act, 2001, Pub. L. No. 106-554, 114 Stat. at 2763A-

587 (2000), as pertinent to this case, also amended section 415(c)(3)(D).
                                        - 25 -

[*25] CRA sec. 314(e)(1), 114 Stat. at 2763A-643, amended section 415(c)(3)(D)

to require that “compensation” include any amount an employer contributed or

deferred at the election of the employee and which is not includible in the gross

income of the employee by reason of section 125, 132(f)(4), or 457. The addition

of section 132(f) to the definition of participant’s compensation in section

415(c)(3)(D) was effective for taxable years beginning after December 31, 1997.

CRA sec. 314(g), 114 Stat. at 2763A-643 (“The amendments made by this section

shall take effect as if included in the provisions of the Taxpayer Relief Act of 1997

to which they relate.”); Taxpayer Relief Act of 1997 (TRA 97), Pub. L. No. 105-

34, sec. 1072(b), 111 Stat. at 948 (stating that the provision relating to CRA sec.

314(e)(1) is effective for taxable years beginning after December 31, 1997).

      As discussed above, neither the 1994 plan amendments nor the 2001 plan

document addressed the changes CRA sec. 314(e)(1) made or otherwise referred

to section 132(f)(4). Rev. Proc. 2002-73, sec. 5.01, 2002-2 C.B. 932, 934,

extended the time for amending a plan to comply with the CRA to the latest of the

end of the first plan year beginning on or after January 1, 2002, the end of the

plan’s GUST remedial amendment period, or June 30, 2003. There is no

indication in the record that petitioner made amendments addressing the section

415(c)(3)(D) changes by September 30, 2003 (the end of the first plan year
                                       - 26 -

[*26] beginning on or after January 1, 2002), or any other retroactive amendments

as Rev. Rul. 82-66, supra, provides.

      Accordingly, petitioner has not shown that respondent’s reliance on this part

of the determination as part of the basis for revocation was unreasonable or

arbitrary. See Churchill, Ltd. Emp. Stock Ownership Plan & Trust v.

Commissioner, at *15-*16.

      D.    RRA Statutory Change That Affected the Plan

      The Internal Revenue Service Restructuring and Reform Act of 1998

(RRA), Pub. L. No. 105-206, 112 Stat. 685, as pertinent to this case, added section

402(c)(4)(C).

      Section 402(c) provides general rules applicable to rollovers from exempt

trusts. Section 402(c)(4) defines the term “eligible rollover distribution”. RRA

sec. 6005(c)(2)(A), 112 Stat. at 800, amended section 402(c)(4) to exclude from an

eligible rollover distribution any distribution which is made upon hardship of the

employee. Section 402(c)(4)(C) applies to distributions made after December 31,

1998. RRA sec. 6005(c)(2)(C), 112 Stat. at 800.

      The 1994 plan amendments do not exclude hardship withdrawals from the

definition of an eligible rollover distribution. The 2001 plan document excludes
                                         - 27 -

[*27] hardship withdrawals, but the 2001 plan document was effective October 1,

2001, and not December 31, 1998, as specified in RRA sec. 6005(c)(2)(C).

      Accordingly, petitioner has not shown that respondent’s reliance on this part

of the determination as part of the basis for revocation was unreasonable or

arbitrary.

II.   Whether Petitioner Failed To Use an Independent/Qualified Appraiser To
      Perform Valuations of the Securities the Trust Held

      Section 401(a)(28)(C) provides that in the case of an ESOP an “independent

appraiser” must perform all valuations of securities that are not readily tradable on

an established securities market and that the standards for appraisers are similar to

those set forth in the regulations promulgated under section 170(a)(1). Without

going into all of the standards that are set forth in the statutes and the regulations,

we focus on the specific aspects that respondent relied on to determine that the

appraiser was not independent and on petitioner’s response to those aspects.

      Respondent contends that Mr. Henss, the person petitioner chose to appraise

the value of K.H. Co. for plan years ending September 30, 2000 through 2003,

failed to list or disclose his qualifications as specified in section 1.170A-

13(c)(3)(ii)(F) and (5)(i)(B), Income Tax Regs. Respondent also contends that the

appraisal summaries do not contain a declaration that Mr. Henss holds himself out
                                        - 28 -

[*28] to the public as an appraiser or performs appraisals on a regular basis as

specified in section 1.170A-13(c)(5)(i)(A), Income Tax Regs.

      Although the appraisal summaries state that “[t]he undersigned holds

himself out to be an appraiser”, there is no signature below that statement on any

of the appraisal summaries. Mr. Henss did not sign or date the appraisals. Mr.

Henss also did not set forth his background, experience, education, and

membership, if any, in professional appraisal associations as specified in the

above-cited regulations. The only statement set forth in the appraisals or appraisal

summaries regarding Mr. Henss’ background or qualifications is: “The

undersigned is an accountant who is familiar with the assets being appraised.”

      Petitioner claims that Mr. Henss has degrees in English, accounting, and

law. Petitioner further claims that Mr. Henss “has been preparing appraisals of

stock for employee stock ownership plans for many clients for several years” and

that he is the author of a book on ESOPs. Petitioner also contends that Mr. Henss

was in all other respects a person who was “independent” as set forth in the

statute, the regulations, and the Commissioner’s announcements on the subject.

      Section 1.170A-13(c)(5)(i)(A), Income Tax Regs., provides that a qualified

appraiser is an individual who includes on the appraisal summary a declaration

that he or she holds himself or herself out to the public as an appraiser or performs
                                       - 29 -

[*29] appraisals regularly. Because there is no signature below the statement on

the appraisal summaries that the “undersigned holds himself out to be an

appraiser”, the plan failed to meet this requirement. See Churchill, Ltd. Emp.

Stock Ownership Plan & Trust v. Commissioner, at *22 (finding that the

appraiser, who failed to sign the appraisal summaries, failed to meet the

requirements of section 1.70A-13(c)(5)(i)(A), Income Tax Regs.); Hollen v.

Commissioner, slip op. at 10.

      Additionally, there is nothing in the administrative record to corroborate any

of petitioner’s claims regarding Mr. Henss’ educational background, his

professional experience preparing other plan appraisals for other clients, or his

book. Rule 217 states: “Disposition of an action for declaratory judgment * * *

[such as the one here] will ordinarily be made on the basis of the administrative

record * * *. Only with the permission of the Court, upon good cause shown, will

any party be permitted to introduce before the Court any evidence other than that

presented before the Internal Revenue Service and contained in the administrative

record”. Petitioner has failed to provide any additional evidence to corroborate

these statements or show good cause for us to consider them.

      Section 1.170A-13(c)(3)(ii)(F), Income Tax Regs., provides that the

qualified appraiser who signs the appraisal must list his or her background,
                                         - 30 -

[*30] experience, education, and membership, if any, in professional appraisal

associations. Section 1.170A-13(c)(5)(i)(B), Income Tax Regs., provides that a

qualified appraiser is an individual who includes on the appraisal summary a

declaration that he or she is qualified to make appraisals because of his or her

background, experience, education, and membership, if any, in professional

appraisal associations.

         Because Mr. Henss failed to sign the appraisals, and because neither the

appraisals nor the appraisal summaries list the referenced information, the plan

also failed to meet these requirements. See Churchill, Ltd. Emp. Stock Ownership

Plan & Trust v. Commissioner, at *20-*22 (finding that the appraiser, who failed

to sign the appraisal and failed to list his background, experience, education, and

membership in the appraisal summary, failed to meet section 1.170A-

13(c)(3)(ii)(F) and (5)(i)(B), Income Tax Regs.); Hollen v. Commissioner, slip op.

at 10.

         Petitioner claims that it substantially complied with section 1.170A-13,

Income Tax Regs. In particular, petitioner contends that Mr. Henss was not a

party in donor transactions in the property being appraised, a donee of the

property, or an employee of the donors or donees and that he performs most of his

appraisals for entities other than petitioner. In certain circumstances a taxpayer
                                        - 31 -

[*31] may be deemed to satisfy a statute if the taxpayer “substantially complies”

with its requirements. See Bond v. Commissioner, 100 T.C. 32 (1993). The

doctrine of substantial compliance applies only when the requirement is

procedural or directory and does not relate to the essence of the statute. Taylor v.

Commissioner, 67 T.C. 1071, 1077-1078 (1977).

      Section 401(a)(28)(C) provides that an “independent appraiser” must

perform any valuation of securities not readily tradable on an established securities

market and that the standards for appraisers are similar to those set forth in the

regulations promulgated under section 170(a)(1). Thus, the essence of the statute

involved here is that the appraiser must be independent, which does not inherently

subsume the requirement that the appraiser be qualified. The qualifications

required of an appraiser are in the section 170 regulations and appear to be more

procedural and directory. See Bond v. Commissioner, 100 T.C. at 41; see also

Churchill, Ltd. Emp. Stock Ownership Plan & Trust v. Commissioner, at *24.

      We are not able to find on the administrative record that Mr. Henss was an

independent or qualified appraiser for purposes of section 401(a)(28)(C). There is

no indication that petitioner substantially complied with section 1.170A-13,

Income Tax Regs. Accordingly, petitioner has not shown that respondent’s
                                        - 32 -

[*32] reliance on this part of the determination as part of the basis for revocation

was unreasonable or arbitrary.

III.   Whether Petitioner Failed To Follow Its Own Terms

       Respondent contends that the plan failed to invest primarily in K.H. Co.’s

securities and therefore failed to follow its own terms. Petitioner intended to be an

ESOP. The 1994 plan document and its amendments and the 2001 plan document

are all titled “K.H. Company, L.L.C. Employee Stock Ownership Plan”, and they

all state: “This Plan is intended to be an Employee Stock Ownership Plan as

defined in Internal Revenue Code, Section 4975(e)”.

       A.    Petitioner Was Not an ESOP

       Section 4975(e)(7)(A) defines an ESOP as “a defined contribution plan

* * * which is a stock bonus plan which is qualified, or a stock bonus and a money

purchase plan both of which are qualified under section 401(a) and which are

designed to invest primarily in qualifying employer securities”. Section

4975(e)(8) defines the term “qualifying employer security” as an employer

security within the meaning of section 409(l). Section 409(l) provides, in

pertinent part, as follows:
                                       - 33 -

            [*33] SEC. 409(l). Employer Securities Defined.--For
      purposes of this section--

                  (1) In general.--The term “employer securities” means
            common stock issued by the employer * * * which is readily
            tradable on an established securities market.

                  (2) Special rule where there is no readily tradable
            common stock.--If there is no common stock which meets the
            requirements of paragraph (1), the term “employer securities”
            means common stock issued by the employer * * * having a
            combination of voting power and dividend rights equal to or in
            excess of--

                          (A) that class of common stock of the employer
                   * * * having the greatest voting power, and

                          (B) that class of common stock of the employer
                   * * * having the greatest dividend rights.

                   (3) Preferred stock may be issued in certain cases.--
            Noncallable preferred stock shall be treated as employer
            securities if such stock is convertible at any time into stock
            which meets the requirements of paragraph (1) or (2)
            (whichever is applicable) and if such conversion is at a
            conversion price which * * * is reasonable. * * *

Section 409(l) thus defines “employer securities” narrowly as common stock or

preferred stock that meets certain requirements. Therefore, employer securities for

the purposes of section 4975(e)(7) must be, at the very least, stock the employer

issued.
                                        - 34 -

[*34] Section 7701(a)(7) provides that the term “stock” includes shares in an

association, joint-stock company, or insurance company. Section 7701(a)(3)

provides that the term “corporation” includes associations, joint-stock companies,

and insurance companies. Section 7701(a)(2) provides that the term “partnership”

includes a syndicate, group, pool joint venture, or other unincorporated

organization through or by means of which any business, financial operation, or

venture is carried on and which is not a trust or estate or a corporation. Thus, the

term “stock” generally excludes partnership interests.

      Respondent contends that because K.H. Co. was a partnership for tax

purposes, it did not have qualifying employer securities. The parties do not

dispute that K.H. Co. was a partnership at all relevant times.7 Indeed, K.H. Co.


      7
        Petitioner nonetheless contends that “a limited liability company with two
members is an association”. Petitioner further contends that “it must be concluded
that a limited liability company may adopt and utilize an ESOP”. Petitioner’s first
contention is overly broad. Not all LLCs with two members are associations.
Under the so-called check-the-box regulations, an LLC with at least two members
may elect to be classified as an association or a partnership. See sec. 301.7701-
3(a), Proced. & Admin. Regs.; see also secs. 301.7701-2(b), 301.7701-3(b),
Proced. & Admin. Regs. Even before the check-the-box regulations, the so-called
Kintner Regulations provided that LLCs could be classified as partnerships rather
than corporations for Federal tax purposes. See Pierre v. Commissioner, 133 T.C.
24, 30 n.10 (2009).
       K.H. Co. was classified as a partnership at all relevant times, both before
and after the check-the-box regulations. Therefore, petitioner’s second contention
is not before us.
                                       - 35 -

[*35] admits that it filed Forms 1065, U.S. Return of Partnership Income, for tax

years ended September 30, 1995 through 2004. Because K.H. Co. was a

partnership for tax purposes and did not have any stock, it did not have any

qualifying employer securities for purposes of sections 409(l) and 4975(e)(7) and

(8) in which the plan could invest. Therefore, petitioner failed to operate as an

ESOP pursuant to its terms when K.H. Co. became its employer, sponsor, and

administrator.

      B.     Petitioner Failed To Follow Its Own Terms

      A qualified employee benefit plan is a written program and arrangement.

See sec. 1.401-1(a)(2), Income Tax Regs.; see also Employee Retirement Income

Security Act of 1974, Pub. L. No. 93-406, sec. 402(a)(1), 88 Stat. at 875 (“Every

employee benefit plan shall be established and maintained pursuant to a written

instrument.”). As discussed above, Congress established the writing requirement

so that every employee, on examining the plan document, may determine exactly

what his or her rights and obligations are under the plan and who is responsible for

operating the plan. See Curtiss-Wright Corp., 514 U.S. at 83; H.R. Conf. Rept.

No. 93-1280, supra at 297, 1974-3 C.B. at 458. A plan may be disqualified for

failing to operate in accordance with its terms. See, e.g., Hull v. IRS, 656 F.3d

1174, 1184 (10th Cir. 2011); cf. sec. 1.409(p)-1(b)(2)(iv)(B), Income Tax Regs.
                                         - 36 -

[*36] (“[A] plan that does not operate in accordance with its terms to reflect

section 409(p) fails to satisfy the qualification requirements of section 401(a)”.).

      The 1994 plan document and its amendments and the 2001 plan document

state that the plan is intended to be an ESOP as section 4975(e) defines the term.

They also state that “the assets of the Plan shall be invested primarily in Qualified

Employer Securities”. Because petitioner failed to invest primarily in employer

securities, it failed to follow its own terms.

      Petitioner has not shown that respondent’s reliance on this part of the

determination as part of the basis for revocation was unreasonable or arbitrary.

IV.   Conclusion

      We conclude that there was no abuse of discretion in respondent’s

determination that the plan was not qualified under section 401(a) for its 1994 year

and subsequent plan years and that the trust was not exempt under section 501(a).

      Any contentions we have not addressed are irrelevant, moot, or meritless.

      To reflect the foregoing,


                                                  Decision will be entered for

                                         respondent.
