DNA Pro Ventures, Inc. Employee Stock Ownership Plan Petitioner-Appellant
Commissioner of Internal Revenue Respondent-Appellee
Submitted: December 12, 2016
from the United States Tax Court.
LOKEN, MURPHY, and KELLY, Circuit Judges.
Daniel Prohaska and his wife formed DNA Pro Ventures, Inc.
("DNA"), and established the DNA Pro Ventures, Inc.
Employee Stock Ownership Plan ("ESOP") in November
2008. After an investigation, the Internal Revenue Service
("IRS") issued a Notice of Deficiency to the
ESOP's Trust based on a final determination that the
Trust was not part of a qualified pension, profit-sharing, or
stock bonus plan under 26 U.S.C. ("I.R.C.") §
401, and therefore the Trust's income was not exempt from
taxation under I.R.C. § 501(a) in calendar years
2008-2011. The ESOP petitioned the United States Tax Court
for a declaratory judgment that the ESOP was qualified under
§ 401(a) during the 2008-2010 tax years, and therefore
the Trust was tax exempt under § 501(a). See
I.R.C. § 7476(a)(1). Ruling without a trial on a
stipulated fact record, see Tax Court Rule 122, the
Tax Court sustained the IRS determination. The ESOP appeals.
Reviewing the Tax Court's legal conclusions de
novo and factual findings for clear error, we affirm.
See Transp. Labor Contract/Leasing, Inc. v.
Comm'r, 461 F.3d 1030, 1032 (8th Cir. 2006)
(standard of review); I.R.C. § 7482(a)(1).
An employee stock ownership plan is a retirement plan that
"invests primarily in qualifying employer securities,
typically stock of the employer creating the plan."
Martin v. Feilen, 965 F.2d 660, 664 (8th Cir. 1992)
(quotations omitted). A trust associated with a qualified
plan is exempt from taxation, I.R.C. § 501(a), and plan
participants are not taxed on contributions until plan
benefits are distributed, I.R.C. § 402(a). For a trust
to qualify for the § 501(a) exemption, the plan must
meet the requirements in I.R.C. § 401(a). A plan may be
disqualified for operational failures, which occur if a plan
fails to operate in accordance with § 401(a) statutory
requirements, see Martin Fireproofing Profit-Sharing Plan
& Tr. v. Comm'r, 92 T.C. 1173, 1179-80 (1989),
or fails to follow the terms of the plan document, see
Michael C. Hollen, D.D.S., P.C. v. Comm'r, T.C. Memo
2011-2, 2011 WL 13637, at *4, aff'd per curiam,
437 F.App'x 525 (8th Cir. 2011).
statutory requirement is that an ESOP trust does not qualify
for tax-exempt status if the ESOP makes annual contributions
for a plan participant in excess of the lesser of either a
specific dollar amount or the participant's annual
compensation. I.R.C. §§ 401(a)(16), 415(c); see
Van Roekel Farms, Inc. v. Comm'r, T.C. Memo.
2000-171, 2000 WL 669975, at *3, aff'd per
curiam, 12 F.App'x 439 (8th Cir. 2001). If an
employer transfers property other than cash for less than the
property's fair market value, this constitutes an annual
contribution in the amount of the property's fair market
value. See Treas. Reg. § 1.415(c)-1(b)(5).
Dr. Prohaska is an orthopaedic surgeon. During the 2008-2010
tax years, he was employed by Advanced Orthopaedics, P.A.,
and deferred the maximum income allowable to its 401(k)
retirement plan. When DNA was formed as a separate
corporation in 2008, it created the ESOP and a trust fund for
the benefit of its employees. On the day of incorporation,
DNA issued fifty shares of Class A common stock, with a par
value of $10 per share, to Dr. Prohaska and fifty shares to
his wife, in exchange for $500 contributions. DNA as employer
was administrator and sponsor of the ESOP. The Plan directed
the Plan Trustee to determine the fair market value of the
Trust Fund assets on each Valuation Date. Dr. Prohaska was
the Plan Trustee.
September 2011, the IRS informed DNA and Dr. Prohaska that it
would examine whether the ESOP had adhered to qualification
requirements for tax-exempt status beginning in 2008. The IRS
requested documents including the ESOP's participant
allocation schedules, employee census reports, and
participant account statements. DNA never provided these
documents. On November 13, 2012, the IRS notified DNA by
certified mail that the ESOP did not meet three § 401(a)
requirements and advised DNA of its right to appeal the
proposed disqualification. The IRS attached an Explanation of
Items that explained the three issues in detail, which an IRS
agent sent to Dr. Prohaska on December 31, 2012.
issued a final non-qualification letter on June 6, 2014,
explaining that the ESOP was disqualified (i) for two
failures to comply with the terms of its plan document, and
(ii) for failure to comply with I.R.C. § 415 by making
contributions to Dr. and Mrs. Prohaska in 2008 that
substantially exceeded their compensation.
Deciding the case on a stipulated record that included the
IRS Explanation of Items, the Tax Court concluded that the
IRS did not abuse its discretion in disqualifying the ESOP
because (1) it exceeded the I.R.C. § 415 contribution
limit by allocating class B shares to Dr. Prohaska's ESOP
account in 2008, a year when he received no compensation from
DNA; and (2) violated its plan document by failing to have
the value of DNA stock annually appraised in 2008 and later
years. Either ground is a sufficient basis to uphold the
Commissioner's decision to disqualify the ESOP, which
denies the Trust tax-exempt status. Although the ESOP
challenges both grounds on appeal, we will limit our review
to the violation of the I.R.C. § 415 contribution
limitation in 2008. "As the party challenging the
Commissioner's determination, the taxpayer ha[s] the
burden of proof." Howard E. Clendenen, Inc. v.
Comm'r, 207 F.3d 1071, 1073 (8th Cir. 2000).
In upholding the ESOP's disqualification for exceeding
the I.R.C. § 415 contribution limit, the Tax Court found
that DNA issued 1, 150 shares of its class B common stock to
the Trust and the shares were allocated to Dr. Prohaska's
ESOP account in 2008. The shares had a par value of $10 per
share, so the allocation of this stock to his ESOP account
was an employer contribution. As Dr. Prohaska received no
compensation as an officer or employee of DNA that year, the
limit on Dr. Prohaska's "annual addition" was
exceeded in 2008. See I.R.C. § 415(c)(1), (2);
Treas. Reg. § 1.415(c)-1(b)(5).
appeal, the ESOP argues the Tax Court erred in upholding
disqualification for a violation of the § 415
contribution limit because "the Court got the facts
wrong." The ESOP explains that it purchased the shares
from DNA on the day of its incorporation with a loan. Nothing
in the record shows a contribution by Dr. Prohaska to the
ESOP or an allocation to his ESOP account in the Trust in
2008. In fact, the ESOP repaid the loan and allocated the
shares to Dr. Prohaska in 2009. In support of these
assertions, the ESOP cites documents included in its Appendix
that were not part of the parties' stipulated
administrative record in the Tax Court. Therefore, these
documents are not part of the record we may consider on
appeal to this court. See Anuforo v. Comm'r, 614
F.3d 799, 807 (8th Cir. 2010).
ESOP cites nothing in the stipulated Tax Court record
supporting its contention that the ESOP acquired the class-B
shares it contributed to the Trust with a loan, and that the
contribution was not allocated to Dr. Prohaska's ESOP
account in 2008. To the contrary, the stipulated record