                        T.C. Memo. 2001-234



                      UNITED STATES TAX COURT



          BEALS BROS. MANAGEMENT CORP., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 10871-99R.               Filed September 6, 2001.


     David R. Rhein, for petitioner.

     Michael J. Roach and James S. Stanis, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     LARO, Judge:   Respondent determined that the employee stock

ownership plan (MGMT ESOP) operated by petitioner did not meet

the requirements of section 401(a)(3) or (4)1 for its plan year



     1
       Unless otherwise indicated, section references are to
sections of the Internal Revenue Code in effect for the years in
issue. Rule references are to the Tax Court Rules of Practice
and Procedure.
                                - 2 -

ended June 30, 1987, and subsequent years.    Respondent also

determined that the trust that constituted a part of the MGMT

ESOP was consequently not exempt from taxation under section

501(a) for the same years.   Following these determinations,

respondent revoked a favorable determination letter previously

issued to petitioner with respect to the MGMT ESOP.

     Petitioner timely invoked the Court’s jurisdiction under

section 7476.   Petitioner seeks a declaratory judgment that

respondent erred in his determination that the MGMT ESOP does not

meet the requirements of section 401.    We hold that respondent

did not err as averred.

                          FINDINGS OF FACT2

     When the petition was filed, petitioner maintained a

principal place of business in Des Moines, Iowa.    Petitioner was

incorporated to provide management and advisory services to Beals

Brothers Manufacturing Co. (MFG).    At all relevant times,

petitioner’s officers and directors consisted of one or more of

the following persons:    Richard Faye Beals, Donald Wayne Beals,

Fay J. Beals (collectively, the Bealses), and Gayle D. Isaac

(collectively with the Bealses, the management officers).

Petitioner had no other officers or employees during that time.



     2
       Some of the facts have been stipulated and are so found.
The exhibits accompanying the stipulation of facts and the
stipulated administrative record are incorporated by this
reference.
                                 - 3 -

Nor during that time did petitioner pay its officers any

compensation.

     Petitioner established the MGMT ESOP on February 1, 1987.

By way of a trust agreement of the same day, petitioner also

established under Iowa law a trust (ESOT) that was part of the

MGMT ESOP.    Under the MGMT ESOP, petitioner made contributions to

the ESOT for the purpose of distributing the trust’s corpus and

income to petitioner’s employees or their beneficiaries in

accordance with the MGMT ESOP.    Under the trust agreement, the

ESOT’s corpus and income could not be used for purposes other

than the exclusive benefit of petitioner’s employees or their

beneficiaries.    At all relevant times, the only participants of

the MGMT ESOP were the management officers.

     The MGMT ESOP owned all of petitioner’s stock as of June 30,

1987.

     On July 8, 1987, petitioner purchased all of the stock of

MFG from its then-current shareholders.     MFG is an Iowa

corporation engaged in the business of manufacturing wood

products.    MFG operates a sawmill and manufactures commercial

packaging wood products, such as pallets and crating materials.

It also finishes graded lumber used for the construction of

furniture and other finished items.      During MGMT ESOP’s plan year

ended June 30, 1987, MFG had at least 45 employees, 39 of whom

were part time and at least 6 of whom were full time.     The full-
                                 - 4 -

time employees included the Bealses, Jeffrie Beals, Jack D.

Richard, and Daryl W. Sable.    During MGMT ESOP’s plan year ended

June 30, 1988, MFG had 43 employees, 36 of whom were part time

and 7 of whom were full time.    The full-time employees were the

management officers, Jeffrie Beals, Jack D. Richard, and Daryl W.

Sable.

                                OPINION

     Respondent argues that the MGMT ESOP failed to meet the

requirements of:   (1) Section 401(a)(3) (a plan must satisfy the

minimum participation standards of section 410), (2) section

401(a)(4) (contributions to and benefits of a plan may not

discriminate in favor of highly compensated employees), and (3)

section 415 (contributions may not exceed a certain percentage of

compensation.)   Only the first two grounds were mentioned

specifically in the notice of revocation.   Because we agree with

respondent that the MGMT ESOP does not meet the requirements of

section 401(a)(3) for plan years ended June 30, 1987, and

thereafter, we do not consider the other arguments which

respondent has advanced to support his determination.3

Petitioner bears the burden of going forward and the burden of

persuasion in disproving respondent’s determinations.    Rule

217(c)(1)(A).



     3
       On brief, petitioner did not address respondent’s argument
that MFG and MGMT were members of a controlled group.
                               - 5 -

     In relevant part, section 401(a) provides:

          SEC. 401(a). Requirements for Qualification.--A
     trust created or organized in the United States and
     forming part of a stock bonus, pension, or profit-
     sharing plan of an employer for the exclusive benefit
     of his employees or their beneficiaries shall
     constitute a qualified trust under this section--

            *       *      *      *      *     *      *

               (3) if the plan of which such trust is a
          part satisfies the requirements of section
          410 (relating to minimum participation
          standards); * * *

     Section 410(b)(1)(A), as applicable for plan years beginning

before January 1, 1989,4 generally provided that a trust was not

a qualified trust under section 401(a) unless the trust benefited

either 70 percent or more of all employees or 80 percent or more

of the employees who were eligible to benefit under the plan if

70 percent or more of all the employees were eligible to benefit

under the plan.5   Section 414(b) and (m) provides:



     4
       The coverage requirement under sec. 410(b) was amended by
the Tax Reform Act of 1986 (TRA), Pub. L. 99-514, sec. 1112(a)
and (e), 100 Stat. 2440, 2445, effective for plan years beginning
after Dec. 31, 1988.
     5
        Sec. 410(b)(1)(B), as in effect before the enactment of
the TRA amendments in 1986, provided that a plan can
alternatively meet the coverage requirements by benefiting such
employees as qualify under a classification set up by the
employer and found by the Secretary not to be discriminatory in
favor of employees who are officers, shareholders, or highly
compensated. Such provision is not relevant here inasmuch as
there is no evidence that petitioner set up a separate
classification of employees to be covered by the MGMT ESOP or
that the Secretary approved any such designation as
nondiscriminatory.
                         - 6 -

     SEC. 414(b). Employees of Controlled Group of
Corporations.--For purposes of sections 401, 408(k),
410, 411, 415, and 416, all employees of all
corporations which are members of a controlled group of
corporations (within the meaning of section 1563(a),
determined without regard to section 1563(a)(4) and
(e)(3)(C)) shall be treated as employed by a single
employer. With respect to a plan adopted by more than
one such corporation, the applicable limitations
provided by section 404(a) shall be determined as if
all such employers were a single employer, and
allocated to each employer in accordance with
regulations prescribed by the Secretary. [Emphasis
added.]
     *      *      *      *      *      *      *

     (m) Employees of an Affiliated Service Group.

          (1) In general.--For purposes of the
     employee benefit requirements listed in
     paragraph (4), except to the extent otherwise
     provided in regulations, all employees of the
     members of an affiliated service group shall
     be treated as employed by a single employer.

     *      *      *      *      *     *        *

           (4) Employee benefit requirements.--For
     purposes of this subsection, the employee
     benefit requirements listed in this paragraph
     are--

               (A) paragraphs (3), (4), (7),
          and (16) of section 401(a),

               (B) sections 408(k), 410, 411,
          415, and 416,

     *      *      *      *      *      *        *

          (5) Certain organizations performing
     management functions.--For purposes of this
     subsection, the term “affiliated service
     group” also includes a group consisting of--

               (A) an organization the
          principal business of which is
          performing, on a regular and
                                 - 7 -

                continuing basis, management
                functions for 1 organization (or
                for 1 organization and other
                organizations related to such 1
                organization), and

                     (B) the organization (and
                related organizations) for which
                such functions are so performed by
                the organization described in
                subparagraph (A).

          For purposes of this paragraph, the term
          “related organizations” has the same meaning
          as the term “related persons” when used in
          section 144(a)(3).

               (6) Other definitions.--For purposes of
          this subsection--

                     (A) Organization defined.--The
                term “organization” means a
                corporation, partnership, or other
                organization.

                     (B) Ownership.--In determining
                ownership, the principles of
                section 318(a) shall apply.
                [Emphasis added.]

     Respondent argues that the MGMT ESOP failed to meet the

minimum participation standards mandated by section 410 beginning

with its plan year ended June 30, 1987.   Respondent relies on

MGMT’s affiliation with MFG and the special rules contained in

section 414.   Generally, in the case of affiliated service groups

and controlled groups, section 414 requires that all employees of

the members of the group be treated as employed by a single

employer for the purpose of the section 410 minimum participation

standards.   Sec. 414(b), (m).
                               - 8 -

     In the plan year ended June 30, 1987, respondent determined

that MGMT and MFG were members of an affiliated group.     Section

414(m)(5) provides that an affiliated service group includes a

group consisting of an organization the principal business of

which is performing, on a regular and continuing basis,

management functions for one organization and the one

organization for which such management functions are provided.

The parties stipulate that MGMT was established on February 1,

1987, to provide management services to MFG.   Respondent

determined MFG and MGMT were members of an affiliated service

group, and petitioner introduced no evidence that would indicate

that the determination was incorrect.   Indeed, petitioner even

acknowledges on brief that the record is barren of any evidence

as to the nature of petitioner’s principal business or business

activities.   We sustain respondent’s determination that

petitioner and MFG were members of an affiliated service group

for the year ended June 30, 1987.   As a consequence, section 410

applies as if MFG and petitioner were a single employer.    For

that plan year, only four of six (66.6 percent) of the eligible

employees were covered by the MGMT ESOP.   Because less than 70

percent of the combined employees of petitioner and MFG were

participants in the MGMT ESOP, the MGMT ESOP did not satisfy the

requirements of section 410(b).
                               - 9 -

     In plan years after June 30, 1987, petitioner owned all of

the issued shares in MFG.   Therefore petitioner and MFG are

members of a controlled group,6 and the provisions of section 410

again apply as if MFG and petitioner were a single employer.

See, e.g., Achiro v. Commissioner, 77 T.C. 881, 906 (1981).     The

combined number of eligible employees of the two companies was

seven for the plan year commencing July 1, 1987.     The MGMT ESOP

covered only four of seven (57.1 percent) of the eligible

employees.   Because less than 70 percent of the combined

employees of petitioner and MFG were participants in the MGMT




     6
       The definition of a controlled group for these purposes is
contained in sec. 1563(a). Sec. 1563(a) in relevant part
provides:

          SEC. 1563(a). (a) Controlled Group of Corporations.--
For purposes of this part, the term “controlled group of
corporations” means any group of–-

               (1) Parent-subsidiary controlled
     group.--One or more chains of corporations connected
     through stock ownership with a common parent corporation
     if–-

                     (A) stock possessing at least
                80 percent of the total combined
                voting power of all classes of
                stock entitled to vote or at least
                80 percent of the total value of
                shares of all classes of stock of
                each of the corporations, except
                the common parent corporation, is
                owned (within the meaning of
                subsection (d)(1)) by one or more
                of the other corporations; * * *
                                - 10 -

ESOP, the MGMT ESOP did not satisfy the requirements of section

410(b).

     We conclude that respondent’s revocation of the MGMT ESOP’s

qualification was justified.7    We note in passing that two or

more plans may sometimes be aggregated so that the number of

participants benefiting in both plans may be taken into

consideration when determining whether minimum participation

standards have been met.   Sec. 410(b)(6)(B).   Petitioner has

failed to produce credible evidence that the MGMT ESOP can be

aggregated with the MFG ESOP for this purpose.    Nor has

petitioner produced, and the record does not contain, evidence

that would support a conclusion that the MGMT ESOP would qualify

for subsequent plan years.

     To reflect the foregoing,

                                          Decision will be entered

                                     for respondent.


     7
       Our holding complies with the intent of Congress in
enacting sec. 414(b) as expressed in H. Rept. 93-779, at 49
(1974), 1974-3 C.B. 244, 292:

     The committee, by this provision, intends to make it
     clear that the coverage and antidiscrimination
     provisions cannot be avoided by operating through
     separate corporations instead of separate branches of
     one corporation. For example, if managerial functions
     were performed through one corporation employing highly
     compensated personnel, which has a generous pension
     plan, and assembly-line functions were performed
     through one or more other corporations employing lower-
     paid employees, which have less generous plans or no
     plans at all, this would generally constitute an
     impermissible discrimination.* * *
