                       T.C. Memo. 1996-337



                     UNITED STATES TAX COURT



           PARKER-HANNIFIN CORPORATION, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 22121-93.                      Filed July 24, 1996.



     William R. Stewart, Kent L. Mann, Karen E. Rubin, Stephen F.

Gladstone, and Dena M. Kobasic, for petitioner.

     Elsie Hall, Randall P. Andreozzi, and Katherine L.

Wambsgans, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     COHEN, Chief Judge:     Respondent determined a deficiency of

$15,007,108 in petitioner’s 1987 Federal income tax.    Unless

otherwise indicated, all section references are to the Internal

Revenue Code in effect for the year in issue, and all Rule
                              - 2 -

references are to the Tax Court Rules of Practice and Procedure.

The use of the term “reserve” in this opinion is for convenience

and is not conclusive as to characterization for tax purposes.

     After a concession by respondent, the issue for decision is

whether and to what extent, if any, Parker-Hannifin Corporation

may deduct $32,498,684 in contributions it made to a welfare

benefit trust on June 30, 1987.

                        FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulated

facts are incorporated herein by this reference.1   At the time

the petition in this case was filed, Parker-Hannifin Corporation

had its principal place of business in Cleveland, Ohio.

     Petitioner is an accrual basis taxpayer and files its

Federal income tax return on a fiscal year ending June 30.

Petitioner filed timely its Form 1120, U.S. Corporation Income

Tax Return, and an associated amended return, Form 1120X, for its

taxable year ended June 30, 1987, with the Internal Revenue

Service Center at Cincinnati, Ohio.

     Petitioner and its subsidiaries are engaged in, among other

things, the design, manufacture, and marketing of components and

systems for builders and users of durable goods, including

     1
      The stipulation contained objections to many documents
offered by respondent, and those objections were sustained during
trial. Nonetheless, respondent proposed findings and presented
arguments as if those documents were in evidence. Such conduct
makes our task more difficult and respondent’s brief less
reliable.
                                - 3 -

products controlling motion, flow, and pressure.    On June 30,

1987, petitioner had approximately 28,708 employees, of whom

approximately 1,854 were represented by unions.

     On June 30, 1987, petitioner established the Parker-Hannifin

Employees Welfare Benefit Trust (the VEBA Trust) with Ameritrust

Company National Association (Ameritrust) as trustee.    The VEBA

Trust was to serve as the funding medium for certain employee

welfare benefit plans that petitioner intended to make up a

Voluntary Employees’ Beneficiary Association (VEBA).    Petitioner

established the VEBA Trust pursuant to the terms of the Trust

Agreement Creating the Parker-Hannifin Corporation Voluntary

Employees’ Beneficiary Association (Trust Agreement).

     The VEBA Trust was created to provide “health care,

disability, life, and other welfare benefits under the Plans to

Members, Dependents, and Beneficiaries, other than post-

retirement health care and life benefits for ‘key employees,’ as

that term is defined in Section 416(i) of the Code.”    Under the

terms of the Trust Agreement:

     The Corporation [petitioner intended] to make
     contributions, on a sound actuarial basis, to the
     Trustee, on or before the last day of the Corporation’s
     fiscal year, in such amounts as determined to be
     necessary to provide benefits required under the Plans.
     The Corporation’s determination of such contributions
     shall be final and conclusive upon all persons. * * *

The Trust Agreement also provided that “Notwithstanding any

provision of this Agreement to the contrary, in no event shall

the Corporation be required to continue to fund benefits under

any Plan through the Trust.”    Contributions to the VEBA Trust
                                - 4 -

were irrevocable and could not revert to petitioner under the

terms of the Trust Agreement.

     The VEBA Trust uses the cash method of accounting and has a

fiscal year ending June 30.   The VEBA Trust qualifies as a

welfare benefit fund under section 419(e).      The Parker-Hannifin

Group Insurance Plan and the Long-Term Disability Plan for

Salaried Employees of Parker-Hannifin Corporation were funded by

the VEBA Trust.

     Pursuant to an administrative services agreement dated

February 24, 1981, Provident Life and Accident Insurance Company

(Provident) agreed to provide administrative services for certain

of petitioner’s employee benefits.      Provident continued to

provide such services during the year in issue.

     On June 30, 1987, petitioner contributed $42 million (the

1987 contribution) to the VEBA Trust.      Effective July 1, 1987,

the maximum Federal corporate income tax rate decreased from 46

to 34 percent.    Petitioner’s 1987 contribution to the VEBA trust

included the following amounts:

     Incurred but unpaid medical, dental, &
                                                      1
          short-term disability benefits               $9,022,227
                                                         2
     Administration fees                                   479,089
     Long-term disability benefits                      2,500,000
     Union medical benefits                             3,210,991
     Postretirement benefits
          Retirees                                      10,779,650
          Active employees                              16,133,508
                                                     3
       Total                                           $42,125,465
          1
            Respondent has allowed a deduction for this amount.
          2
            Respondent has allowed a deduction for this amount.
          3
            Petitioner’s chief financial officer suggested
     rounding the 1987 contribution to $42 million.
                               - 5 -

     The person primarily responsible for the implementation and

funding of the VEBA Trust was Joseph B. Dorn (Dorn).    Dorn was

director of taxation for petitioner on June 30, 1987.    Dorn

computed the VEBA contribution and claimed deduction on a single

sheet of paper.   Dorn is not an actuary.

     The explanation of the calculation of each portion of the

1987 contribution follows below.

Incurred But Unpaid Medical, Dental, and Short-Term Disability
Benefits

     Dorn contacted Provident to obtain an estimate of the

reserve for medical, dental, life, and short-term disability

expenses incurred but unpaid before June 30, 1987.   Provident

provided Dorn with the amount of $9,022,227.

     Expenses incurred but unpaid before June 30, 1987, for

employees covered under collective bargaining agreements were

included in the $9,022,227.   Expenses estimated to be incurred

but unpaid after June 30, 1987, for employees covered under a

collective bargaining agreement were included in the $3,210,000

contribution for union medical benefits.

     Petitioner's 1987 contribution included $9,022,227 for

incurred but unpaid medical, dental, and short-term disability

benefits.

Postretirement Benefits--Retirees

     Reserve Computation

     Dorn obtained the actual fiscal 1987 expenses incurred

through April 1987 for benefits paid to hourly and salaried
                                   - 6 -

retired employees.       Dorn annualized this number to take into

account the remainder of fiscal 1987 and arrived at expenses of

$2,093,462.   Dorn then subtracted employee contributions of

$547,110 and $6,402 related to key employees.             (Plans covering

key employees must be funded separately.          See sec. 419A(d).)     The

result of the above calculations was $1,539,950.             At this point,

Dorn consulted with Harry A. Don (Don), an actuary with the Wyatt

Company.   During a telephone conversation, Don told Dorn that the

use of a factor of 7 would be appropriate.             Dorn multiplied

$1,539,950 by 7 and arrived at $10,779,650, which was used in

calculating the 1987 contribution.

     Actual Expenditures

     For its 1987, 1988, and 1989 fiscal years, petitioner’s

financial statements reported expenses for retiree health care

and life insurance benefits of $2,575,000, $2,494,000, and

$2,899,000, respectively.       The following amounts were paid by

Provident, on behalf of the VEBA Trust, for postretirement

benefits and administrative expenses for retired employees:

            Year Ended                       Amount1

           June   30,   1988               $2,607,511
                                           2
           June   30,   1989                 3,069,240
           June   30,   1990                 3,528,896
           June   30,   1991                 4,275,589

                1
                  Because the VEBA Trust reimbursed
           Provident for these payments, there is a
           slight timing difference resulting from these
           disbursements.
                2
                  Expenses for July and August 1988
           totaled $412,467.
                                 - 7 -

Postretirement Benefits--Active Employees

     Reserve Calculation

     To calculate the postretirement reserve amount for active

employees, Dorn started with the $10,779,650 that he calculated

for retirees.   He then divided by the number of current retired

employees (1,163) to get a cost per employee.     Dorn once again

consulted with Don by telephone to ask for a factor to determine

the cost for covered active employees.     Don told him to divide

the cost per retired employee by 10.     Dorn followed Don’s

direction and arrived at $927.    He then multiplied $927 by the

number of active employees (not including key employees),

resulting in $16,133,508.   This amount was used in calculating

the 1987 contribution.

Medical Benefits for Union Members

     Reserve Computation

     Petitioner’s benefits department supplied Dorn with the

fiscal 1987 expenses through April 1987 for short-term disability

and medical, dental, and life insurance benefits paid under

collective bargaining agreements.    Dorn looked at all of the

collective bargaining agreements in effect and determined the

remaining length of each contract after June 30, 1987.     He then

annualized the expense amounts that were given to him by the

benefits department.   This amount was then multiplied by the

remaining length of each contract to arrive at $3,210,991.
                                 - 8 -

     None of petitioner's collective bargaining agreements

required use of a welfare benefit fund or prefunding of the

negotiated benefits.     Petitioner's 1987 contribution included

$3,210,991 for union medical benefits estimated to be incurred

but unpaid after June 30, 1987.

     Actual Expenditures

     The following amounts were paid by Provident, on behalf of

the VEBA Trust, for medical, short-term disability, dental and

life benefits, and administrative fees for employees covered by

collective bargaining agreements:

           Year Ended                      Amount1

          June   30,   1988              $2,881,637
          June   30,   1989               3,869,076
          June   30,   1990               5,728,512
          June   30,   1991               4,189,156
                 1
                These amounts include payments made
          relative to contracts not in force on
          June 30, 1987. Also, because the VEBA Trust
          reimbursed Provident for these payments,
          there is a slight timing difference resulting
          from these disbursements.

During fiscal 1988, 1989, and 1990, Provident, on behalf of the

VEBA Trust, paid the following amounts for medical, short-term

disability, dental and life benefits, and administrative fees for

employees covered by collective bargaining agreements in effect

on June 30, 1987:
                                 - 9 -

             Year Ended                    Amount1

            June 30, 1988                $2,474,363
            June 30, 1989                   797,211
            June 30, 1990                   243,086
              Total                      $3,514,660
                 1
                  These amounts have been rounded to the
            nearest whole dollar. Also, because the VEBA
            Trust reimbursed Provident for these
            payments, there is a slight timing difference
            resulting from these disbursements.

Petitioner commingled its $3,210,991 VEBA contribution for union

medical benefits with all other VEBA assets.

Long-Term Disability

     Reserve Computation

     William H. Mercer (Mercer) was an employee benefit

compensation and actuarial consulting firm.          In 1986, petitioner

asked Terrence McManamon (McManamon), a principal with the

Cleveland office of Mercer, to perform calculations to quantify

the disabled life reserve for long-term disability coverage for

salaried and nonunion hourly employees.        Using source information

from petitioner, McManamon was able to determine the net monthly

and annual benefits payable to petitioner’s then currently

disabled employees.    McManamon then took into account offsets for

Social Security and workers’ compensation and offsets received by

any other employer-sponsored program or State disability

programs.    McManamon’s calculations assumed that all currently

disabled employees included in the calculation would continue to

receive benefits until age 65.    The calculation did not take into
                              - 10 -

account employees who might recover from their disability or die

in the interim and stop receiving payments.

     Petitioner’s benefits department forwarded the fiscal 1986

reserve amount that was calculated by Mercer to Dorn.    After Dorn

reviewed how employees went on and came off long-term disability,

which he felt was infrequently, Dorn determined that the 1986

reserve adjusted by some factor would be acceptable as a 1987

reserve.   Dorn increased the reserve by 6 percent and arrived at

$2.5 million.   Mercer confirmed that 6 percent was a conservative

factor to use in the adjustment.    Dorn used the $2.5 million that

he calculated for long-term disability reserves in calculating

the 1987 contribution.

     Actual Expenditures

     The cost of benefits and administrative fees actually paid

by Provident, on behalf of petitioner, for long-term disability

claims of its employees during its 1986 year was $338,486.     The

cost of benefits and administrative fees actually paid by

Provident, on behalf of petitioner, for long-term disability

claims of its employees during its 1987 year was $442,198.     The

amount of long-term disability benefits and administrative fees

actually paid by Provident, on behalf of the VEBA Trust, through

August 31, 1988, with respect to employees who were disabled as

of June 30, 1987, was $487,651.    The VEBA Trust reimbursed

Provident for such payments, and, thus, there is a slight timing

difference.
                              - 11 -

     The following amounts of long-term disability benefits and

administrative fees were paid by Provident, on behalf of the VEBA

Trust:

           Year Ended                  Amount1

          June   30,   1988       $     529,543
          June   30,   1989             574,034
          June   30,   1990             694,697
          June   30,   1991             739,874
          June   30,   1992             871,953
          June   30,   1993             926,162
          June   30,   1994           1,158,574
                 1
                Because the VEBA Trust reimbursed
          Provident for these payments, there is a
          slight timing difference resulting from these
          disbursements.

Petitioner’s long-term disability plan required any disability

payments payable by petitioner to be offset by any amounts

received by claimants from Social Security or other listed third-

party sources.

     In a July 2, 1987, letter to Adrian V. Wallace, vice

president of Ameritrust, petitioner’s treasurer, W.C. Young,

stated:

     Disbursements from this Trust will take the form of
     wire transfers to the Provident Insurance Company on
     Wednesday of each week and will run between $500,000
     and $1,000,000 per transfer. Based on such a schedule
     it is anticipated that the $42,000,000 deposited in the
     Trust will be paid out within 12 to 18 months. * * *

     Beginning in September 1987, petitioner deposited into the

VEBA Trust amounts withheld from its employees for their share of

the cost of providing the covered benefits.       The VEBA Trust used

its assets, consisting solely of the 1987 contribution, employee
                                            - 12 -

contributions, and interest income, to pay the current cost of

providing benefits to petitioner’s employees and retirees as

benefits came due during fiscal 1988 and the first 2 months of

fiscal 1989.        Beginning in August 1988, the VEBA Trust used its

assets, consisting solely of amounts that were currently

contributed and currently deducted by petitioner along with

employee contributions, to pay the current cost of providing

benefits to petitioner’s employees and retirees as benefits

became due.

       The following table reflects the deposits, earnings, and

withdrawals affecting the VEBA Trust for fiscal 1987, 1988, 1989,

and 1990:
                                                     Fiscal Years
                           1987               1988                  1989                1990

Employer
                                                            1                   2
  contributions       $42,000,000.00           -0-           $40,737,374.59      $50,783,404.03

Employee
  contributions             -0-          $ 1,555,626.86          1,841,554.51        2,505,955.35
                             3
Interest earned               773.98       1,749,030.80             78,641.10           -0-

Benefits paid               -0-           39,153,640.83         48,808,587.03       53,289,359.38

Ending balance         42,000,773.98       6,151,016.83              -0-                -0-
   1
     Represents the total of petitioner’s monthly contributions to the VEBA Trust.
   2
     Represents the total of petitioner’s monthly contributions to the VEBA Trust.
   3
     The amounts to which the parties have stipulated in later years ignore this amount.


       In August 1988, petitioner filed Form 1024, Application for

Recognition of Exemption, for the VEBA.                         Unaudited financial

statement information for petitioner’s 1988 year that was

included with the application indicated that, on June 30, 1988,

the VEBA Trust had a balance of $6,378,125.82.                             Benefits paid

were shown as $42,450,649.30.                 The only contributions to the VEBA

Trust were those from employees and from investment income.
                               - 13 -

Petitioner received a determination letter from the District

Director of the Internal Revenue Service on November 29, 1988,

stating that the application for recognition of exemption under

section 501(c)(9) had been approved.    The determination letter

states:    “No opinion is expressed or implied as to whether

employer contributions to * * * [the VEBA Trust] are deductible

under the Code.”

     Petitioner did not generate a contemporaneous census of its

employees for whom benefits were to be provided through the VEBA

Trust.    Such a census would have included the date of birth,

gender, family coverage, and date of hire for each employee for

purposes of funding the VEBA in petitioner’s 1987 fiscal year.

     Petitioner reflected $33.6 million of the 1987 contribution

on its balance sheet as a “prepaid expense” under the category of

current assets and $8.4 million of the 1987 contribution on its

balance sheet as an “other asset”.

     The Financial Accounting Standards Board Statement No. 81

relating to "Disclosure of Postretirement Health Care and Life

Insurance Benefits" (FASB 81) was in effect during the years in

issue.    FASB 81 required that, at a minimum, the following

information be disclosed:    (1) A description of the benefits

provided and the employee groups covered; (2) a description of

the accounting and funding policies followed for those benefits;

(3) the cost of those benefits recognized for the period, unless

the provisions of paragraph 7 apply; and (4) the effect of
                             - 14 -

significant matters affecting the comparability of the costs

recognized for all periods presented.   FASB 81 provided several

illustrative disclosures, including the following to be used

where benefits are annually funded based on estimated accruals:

          In addition to providing pension benefits, the
     company and its subsidiaries provide certain health
     care and life insurance benefits for retired employees.
     Substantially all of the company's employees, including
     employees in foreign countries, may become eligible for
     those benefits if they reach normal retirement age
     while working for the company. The estimated cost of
     such benefits is accrued over the working lives of
     those employees expected to qualify for such benefits
     as a level percentage of their payroll costs. Accrued
     costs are funded annually and were $XXX for 19X4.

     FASB 81 also provided the following illustrative disclosure

for use where benefit costs are expensed when paid:

          In addition to providing pension benefits, the
     company and its subsidiaries provide certain health
     care and life insurance benefits for retired employees.
     Substantially all of the company's employees, including
     employees in foreign countries, may become eligible for
     those benefits if they reach normal retirement age
     while working for the company. The cost of retiree
     health care and life insurance benefits is recognized
     as expense as claims are paid. For 19X4, those costs
     totaled $XXX.

     Petitioner's 1987 financial statement stated the following

regarding its provision of health care and life insurance

benefits:

     In addition to providing pension benefits, the Company
     provides certain health care and life insurance
     benefits for retired employees. Substantially all of
     the Company's employees may become eligible for those
     benefits if they become eligible for retirement while
     working for the Company. The cost of retiree health
     care and life insurance benefits is recognized as
     expense as claims are paid. * * *
                              - 15 -

     Petitioner never notified any of the labor unions, or

representatives thereof, that represented employees of petitioner

or its subsidiaries of the existence of the VEBA Trust,

petitioner’s contribution to the VEBA Trust, or the existence of

any reserves of the VEBA Trust.   Petitioner never notified any of

its employees or retirees of the existence of the VEBA Trust,

petitioner’s 1987 contribution to the VEBA Trust, or the

existence of any reserves of the VEBA Trust, except for

petitioner’s employees who were involved in the implementation of

the VEBA Trust.   Petitioner never disclosed the existence of the

VEBA Trust or any reserves of the VEBA Trust on any of the

summary plan descriptions provided by petitioner to its employees

to notify them of its pension and retirement plans.

     Petitioner made no specific disclosure to its shareholders

or the public that it prefunded the VEBA Trust.   Petitioner

disclosed to its shareholders and to the public the prefunding of

certain future employee benefits under the heading “Other” in

petitioner’s Annual Reports for 1987, 1988, and 1989.    The

explanation of "Other" in petitioner's 1987 Annual Report stated:

     Other increases in assets included an increase in
     "Prepaid expenses" and "Investment in joint ventures
     and other assets" as a result of prefunding certain
     future employee benefits. "Excess cost of investments"
     increased primarily as a result of the acquisition of
     United Aircraft Products, Inc.

     On its Form 1120 for 1987, petitioner deducted the full

amount of the 1987 contribution to the VEBA Trust.    Petitioner

also claimed a deduction on its 1987 return for the actual cost
                               - 16 -

of providing employee medical and life insurance, long-term

disability benefits, and union medical benefits during 1987.

      In the notice of deficiency, respondent allowed petitioner

partial deductions in the amount of $9,022,227 for incurred but

unpaid medical, dental, and short-term disability benefits and

$353,624 for administrative expenses, none of which are at issue

in this case.    Respondent has conceded that petitioner is

entitled to a deduction in the amount of $125,465 for additional

administrative expenses.    The amount of the 1987 contribution

remaining in dispute is $32,498,684.

                               OPINION

     Section 419 limits the deduction for contributions paid or

accrued by an employer to a welfare benefit fund to the

“qualified cost” for the taxable year.   Sec. 419(b).   “Qualified

cost” includes the qualified direct cost for the taxable year and

any addition to a qualified asset account for the taxable year,

subject to the section 419A(b) limitation.   Sec. 419(c)(1).

Section 419A provides rules governing additions to the qualified

asset account.   “Qualified asset account” is defined as “any

account consisting of assets set aside to provide for the payment

of (1) disability benefits, (2) medical benefits, (3) SUB

[supplemental unemployment compensation benefit] or severance pay

benefits, or (4) life insurance benefits.”   Sec. 419A(a).

Additions to the qualified asset account are constrained by the

account limit, as defined by section 419A(c).    Sec. 419A(b).
                               - 17 -

     The legislative history of section 419A states the

following:

          Limitations on qualified asset account.--The
     conference agreement includes substantial modifications
     to the provisions setting forth the limitation on
     additions to a qualified asset account. Such an
     account consists of assets set aside for the payment of
     disability benefits, medical benefits, supplemental
     unemployment or severance pay benefits, and life
     insurance or death benefits.

          In general, the account limit is the amount
     estimated to be necessary under actuarial assumptions
     that are reasonable in the aggregate, to fund the
     liabilities of the plan for the amount of claims
     incurred but unpaid, for benefits described in the
     previous paragraph and administrative costs of such
     benefits, as of the close of the taxable year. Claims
     are incurred only when an event entitling the employee
     to benefits, such as a medical expense, a separation, a
     disability, or a death actually occurs. The allowable
     reserve includes amounts for claims estimated to have
     been incurred but which have not yet been reported, as
     well as those claims which have been reported but have
     not yet been paid. * * * [H. Conf. Rept. 98-861, at
     1155-1156 (1984), 1984-3 C.B. (Vol. 2) 1, 409-410.]

     Relevant to our determination herein, the account limit

includes:    (1) The “amount reasonably and actuarially necessary

to fund” certain claims incurred but unpaid and the related

administrative costs, sec. 419A(c)(1); and (2) an additional

“reserve funded over the working lives of the covered employees

and actuarially determined on a level basis (using assumptions

that are reasonable in the aggregate) as necessary” for

postretirement medical and life insurance benefits, sec.

419A(c)(2).   No account limit applies to any qualified asset

account for a separate welfare benefit fund maintained pursuant

to a collective bargaining agreement.   Sec. 419A(f)(5)(A); sec.
                                - 18 -

1.419A-2T, Temporary Income Tax Regs., 50 Fed. Reg. 27428

(July 3, 1985).

Postretirement Benefits

     Section 419A(c)(2) provides for an additional reserve for

postretirement medical and life insurance benefits:

               (2) Additional reserve for post-
          retirement medical and life insurance
          benefits.--The account limit for any taxable
          year may include a reserve funded over the
          working lives of the covered employees and
          actuarially determined on a level basis
          (using assumptions that are reasonable in the
          aggregate) as necessary for--

                       (A) post-retirement medical
                  benefits to be provided to covered
                  employees (determined on the basis
                  of current medical costs), or

                       (B) post-retirement life
                  insurance benefits to be provided
                  to covered employees.

     Petitioner included $10,779,650 in its 1987 contribution for

postretirement benefits for retirees.    The 1987 contribution

included $16,133,508 for postretirement benefits for active

employees.   Respondent disallowed the deduction of these

contributions on petitioner’s fiscal 1987 Federal income tax

return.

     Petitioner argues that section 419A(c)(2) allows a reserve

funded over the working lives of covered employees for

postretirement benefits to be included in the account limit

without requiring that specific assets be set aside or that a

separate account be created.    Petitioner contends that the
                             - 19 -

“account limit” under section 419A(c) is only a mathematical

computation that limits the deduction, not a requirement that a

segregated reserve be included in the welfare benefit fund.

     However, the VEBA Trust did not retain even general assets

that were sufficient to fund the reserves claimed by petitioner.

Thus, petitioner's position has the same shortcomings as the

position that the Court considered and rejected in General Signal

Corp. & Subs. v. Commissioner, 103 T.C. 216 (1994).   In General

Signal, the taxpayer corporation argued that section 419A(c)(2)

did not require the establishment of a funded reserve in order

for an amount to be included in the account limit.    Id. at 240.

Because of the taxpayer corporation’s “vehement assertion” that

“reserve funded” did not have a commonly understood meaning, the

Court looked to the legislative history of section 419A(c)(2) for

guidance and determined “that Congress intended section

419A(c)(2) to permit the accumulation of funds for purposes of

funding postretirement benefits.”   Id.

     The legislative history of section 419A states, in part:

          Prefunding of life insurance, death benefits, or
     medical benefits for retirees.--The qualified asset
     account limits allow amounts reasonably necessary to
     accumulate reserves under a welfare benefit plan so
     that the medical benefit or life insurance (including
     death benefit) payable to a retired employee during
     retirement is fully funded upon retirement. These
     amounts may be accumulated no more rapidly than on a
     level basis over the working life of the employee, with
     the employer of each employee. * * * The conferees
     intend that the Treasury Department prescribe rules
     requiring that the funding of retiree benefits be based
     on reasonable and consistently applied actuarial cost
     methods, which take into account experience gains and
                              - 20 -

     losses, changes in assumptions, and other similar
     items, and be no more rapid than on a level basis over
     the remaining working lifetimes of the current
     participants (reduced on the basis of reasonable
     turnover and mortality assumptions). [H. Conf. Rept.
     98-861, supra at 1157, 1984-3 C.B. (Vol. 2) at 411;
     emphasis added.]

The legislative history of section 419A thus indicates that an

accumulation of assets, not just a calculation, is intended in a

qualified asset account.   See also National Presto Indus., Inc.

v. Commissioner, 104 T.C. 559, 569-574 (1995).

     Petitioner made no disclosure of the establishment of

reserves for postretirement benefits in its financial reporting

for its 1987 year.   Only those employees involved in the

implementation of the VEBA were informed about the existence of

the VEBA.

     A letter signed by petitioner’s treasurer states that the

1987 contribution was expected to be depleted by benefit payments

over the 12 to 18 months following the creation of the VEBA.     By

the second month of petitioner’s 1989 year, the 1987 contribution

had been depleted.   Petitioner made no contribution during its

1988 year, and, in the following years, petitioner contributed to

the VEBA through monthly contributions approximating the benefits

paid.   The ending balance of the VEBA for each of the years 1989

and 1990 was zero.   Petitioner’s Form 1024, Application for

Recognition of Exemption, did not indicate the establishment of

reserves.   While disclosure is not required by the applicable

Code and regulations, the lack of disclosure, along with
                               - 21 -

petitioner’s other actions regarding the VEBA Trust, shows that

petitioner did not accumulate assets in the VEBA Trust for the

purpose of funding a reserve for postretirement benefits.      See

General Signal Corp. & Subs. v. Commissioner, supra at 239.

     In General Signal, the Court acknowledged that there was no

requirement of a separate account.      Petitioner argues that the

suggestion that money must be maintained in a fund in at least

the amount of the deduction is inconsistent with the Court’s

position in General Signal.    There is no such inconsistency.       In

General Signal, the Court stated:

          With respect to petitioner’s argument that
     respondent’s interpretation of section 419A(c)(2) would
     require a separate accounting requirement, respondent
     contends that it is sufficient that the reserve
     required by section 419A(c)(2) be funded with general
     rather than specific assets. This interpretation
     appears consistent with legislative intent and requires
     only that the overall balance maintained in the VEBA be
     sufficient to support the postretirement reserve. It
     does not appear to require that a separate account be
     established with respect to the reserve. [Id. at 246.]

     An interpretation of section 419A(c) that requires such a

reserve to be established, petitioner argues, could prevent the

fund from paying current benefits because the reserves would be

required to be maintained.    Petitioner also believes that such an

interpretation would also result in the imposition of minimum

funding as is required under section 412 for qualified plans.

Petitioner further argues that “funded over the working lives”

describes the manner in which the reserves are to be computed and
                              - 22 -

does not require separate funding or funding over the actual

working lives of the covered employees.

     Petitioner also argues that respondent cannot add

requirements to section 419A(c)(2) when respondent has failed to

prescribe regulations as required by section 419A(i).     Petitioner

contends that it took steps to determine the reasonable and

necessary amount it could deduct as a contribution based on the

guidance provided by the Code.

     These remaining arguments relate to the amount of funding

and the level of funding of the VEBA Trust.      Because petitioner

failed to meet the minimum requirement of establishing a reserve

funded over the working lives of the covered employees, we do not

reach the question of the actuarial correctness of the 1987

contributions and do not discuss the parties’ expert testimony

relating to that issue.

     Petitioner’s situation is not distinguishable from that of

the taxpayer in General Signal.   We decline petitioner’s

invitation to reconsider General Signal.      Therefore, respondent’s

determination that the contribution for postretirement benefits

is not deductible will be sustained.

Medical Benefits for Union Members

     No account limit applies in the case of a qualified asset

account under a separate welfare benefit fund under a collective

bargaining agreement.   Sec. 419A(f)(5)(A).    Prior law called for

the Treasury Department to issue regulations to establish special
                                 - 23 -

reserve limit principles for collectively bargained plans.

Before final regulations were issued, current section

419A(f)(5)(A) was enacted, eliminating the need for such

regulations.   See Tax Reform Act of 1986, Pub. L. 99-514, sec.

1851(a)(13), 100 Stat. 2862.

     Respondent argues that petitioner should not be allowed to

deduct the portion of the contribution related to collectively

bargained employees because a separate fund was not created.

This argument arises out of the language of section 419A(f)(5)

that refers to any “qualified asset account under a separate

welfare benefit fund * * * under a collective bargaining

agreement”.    Emphasis added.   Respondent’s position is that

“separate” means distinct and different from welfare benefits for

noncollectively bargained employees.      Because petitioner

commingled the assets that were contributed for collectively

bargained employees with those for noncollectively bargained

employees, respondent argues that petitioner should not be

allowed to deduct the portion of the 1987 contribution for union

medical benefits.

     Petitioner asserts that the use of “separate” means that the

funds in the VEBA should be separate from the general assets of

petitioner and beyond the reach of petitioner’s creditors.       Under

the terms of the VEBA Trust, such reversion of petitioner’s

contributions was expressly prohibited.
                               - 24 -

     On June 30, 1987, petitioner had 28,708 employees, of whom

approximately 1,854, or 6.46 percent, were represented by unions.

The plan was not the result of collective bargaining or required

by any agreement with the union.   Petitioner attempts to

distinguish between the union and nonunion contributions under

the VEBA by calculating the respective contributions in

isolation.   The plan itself, however, does not make that

distinction and cannot as a whole reasonably be characterized as

a welfare benefit fund maintained pursuant to a collective

bargaining agreement.

     Because the contribution for collectively bargained

employees does not meet the requirements of section 419A(f)(5),

the deductibility of the contribution for union medical benefits

must be tested under section 419A(c)(1).   The analysis of the

treatment of the contribution for medical benefits to union

members and of the contribution for long-term disability claims

is combined below.

Medical Benefits for Union Members and Long-Term Disability
Claims

     In addition to the medical benefits for union members,

petitioner included $2.5 million in the 1987 contribution for

long-term disability claims.   Petitioner alleges that the

long-term disability claims were incurred but unpaid as of the

close of its 1987 fiscal year.

     Section 419A(c)(1) provides the account limit for claims

described in section 419A(a), including disability benefits, sec.
                              - 25 -

419A(a)(1), and medical benefits, sec. 419A(a)(2), that are

incurred but unpaid.   Section 419A(c)(1) provides:

               (1) In general.--Except as otherwise
          provided in this subsection, the account
          limit for any qualified asset account for any
          taxable year is the amount reasonably and
          actuarially necessary to fund--

                    (A) claims incurred but unpaid
               (as of the close of such taxable
               year) for benefits referred to in
               subsection (a), and

                    (B) administrative costs with
               respect to such claims.

     Petitioner asserts that, in General Signal Corp. & Subs. v.

Commissioner, 103 T.C. 216 (1994), the inclusion of incurred but

unpaid long-term disability claims and union medical benefits in

the account limit was not an issue.    Petitioner argues that the

subsequent history of claims supports Dorn’s calculation of these

portions of the 1987 contribution.

     Petitioner's contribution for medical benefits for union

members fails to meet the requirement of section 419A(c)(1) that

it fund claims incurred but unpaid as of June 30, 1987.   By

petitioner's own admission, the contribution for medical benefits

for union members included expenses estimated to be incurred but

unpaid after June 30, 1987.   Assuming, however, that this

contribution had met the above requirement, the contribution

would nonetheless be nondeductible for the reasons discussed

below with respect to long-term disability benefits.
                              - 26 -

     Under section 419A(a), “‘qualified asset account’ means any

account consisting of assets set aside to provide for the payment

of” certain benefits.   In order to qualify as a deductible

contribution to a welfare benefit fund under section 419(a),

petitioner’s contribution must not exceed the qualified cost of

the fund, i.e., the qualified direct costs plus any qualified

asset account.   Qualified asset accounts are generally subject to

an account limit, which for these purposes is the amount

reasonably and actuarially necessary to fund claims incurred but

unpaid as of the close of the taxable year in which the

contribution is made, and the related administrative costs.    For

petitioner’s 1987 year, no benefits were paid out of the VEBA

Trust, and, thus, no qualified direct costs were incurred.

Petitioner argues that the $2.5 million contribution for

long-term disability is a qualified asset account and is

deductible.

     The parties disagree as to the meaning of the phrase “assets

set aside” in the definition of qualified asset account.

Petitioner contends that the phrase does not require that a

“reserve” be established, pointing out that “reserve” is used

only in the context of postretirement benefits in section 419A.

Respondent argues that petitioner must actually set aside the

assets to include them in the qualified asset account and to

deduct the contribution.
                                - 27 -

     Petitioner has pointed to several other provisions of the

Code that require assets to be “set aside” as examples of

language that Congress would have used if it had intended for the

set-aside of assets.    See secs. 419A(d)(1), 512(a)(3)(E).   In an

analogous context in General Signal Corp. & Subs. v.

Commissioner, supra at 244, we stated:

     However, if the language of section 419A(c)(2) is read
     to require the creation of a reserve funded with
     general assets rather than segregated assets, the
     language of these other provisions would not have been
     appropriate. More importantly, this argument is simply
     not sufficient to overcome the unambiguous statements
     of the legislative history regarding the accumulation
     of assets and the funding of benefits.

The same analysis and conclusion apply here.

     Although section 419A(c)(1) does not use the term “reserve”,

in order for a taxpayer to be entitled to a deduction, the assets

must be set aside.     An interpretation that the requirements of

section 419A are purely computational would ignore the

legislative history of section 419A, which states, in part:

     the conferees wish to emphasize that the principal
     purpose of this provision of the bill is to prevent
     employers from taking premature deductions, for
     expenses which have not yet been incurred, by
     interposing an intermediary organization which holds
     assets which are used to provide benefits to the
     employees of the employer. * * * [H. Conf. Rept.
     98-861, at 1155 (1984), 1984-3 C.B. (Vol. 2) 1, 409
     (1984).]

Petitioner has ignored this requirement and has focused instead

on the reasonableness of the amount of the contribution for

long-term disability.
                              - 28 -

     As in the case of the postretirement benefits, petitioner

did not disclose the establishment of reserves for long-term

disability benefits in its financial reporting for its 1987 year.

Only those employees involved in the implementation of the VEBA

were informed about the existence of the VEBA.    By making the

contribution for long-term disability benefits, petitioner

received a substantial tax savings.    Petitioner’s treasurer

estimated in a July 1987 letter that the 1987 contribution would

be depleted in 12 to 18 months after the VEBA was established.

The 1987 contribution was depleted by the second month of

petitioner’s 1989 year.   Petitioner made no contribution for

long-term disability benefits that were incurred but unpaid

during its 1988 year, and, in the following years, petitioner

contributed to the VEBA through monthly contributions

approximating the benefits that were paid.    No indication of

reserves was shown on petitioner’s Form 1024, Application for

Recognition of Exemption.   Again, while disclosure is not

required by the applicable Code and regulations, the lack of

disclosure, along with petitioner’s other actions regarding the

VEBA Trust, shows that petitioner did not accumulate assets in

the VEBA Trust for the purpose of setting aside assets for the

payment of future long-term disability benefits that were

incurred but unpaid.

     We cannot conclude that these assets were set aside for the

above-stated purposes, and, thus, we need not address the
                             - 29 -

reasonableness of the contributions and the related expert

testimony.

     To reflect the foregoing and a concession by respondent,

                                        Decision will be entered

                                   under Rule 155.
