62 T.C. 456">*456 Respondent has determined the following deficiencies in petitioner's Federal income taxes:

The only issue remaining for our decision is whether that part of the vacation plan provided for in the labor agreement between petitioner1974 U.S. Tax Ct. LEXIS 80">*82 and a labor union whereby petitioner's employees were entitled to extended vacation benefits constituted a plan deferring the receipt of compensation within the meaning of section 404(a).

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly.

Petitioner Latrobe Steel Co. (hereinafter sometimes referred to as the company) is a Pennsylvania corporation engaged in the business of manufacturing and selling high-speed steels, die steels, mold steels, 62 T.C. 456">*457 carbon tool steels, and other specialty steels. It had its principal place of business at Latrobe, Pa., at the time the petition was filed. Petitioner computes its Federal income under the accrual method of accounting and files its Federal income tax returns on the basis of a calendar year. Petitioner filed its Federal income tax returns for its taxable years 1964 and 1965 with the district director of internal revenue at Pittsburgh, Pa.

Petitioner and the United Steelworkers of America (hereinafter referred to as the union) had entered into a basic labor agreement effective July 26, 1962 (hereinafter referred to as the 1962 agreement). With regard to vacations, the 1962 agreement provided only for1974 U.S. Tax Ct. LEXIS 80">*83 regular vacations of from 1 to 4 weeks depending on years of service. The 1962 agreement between petitioner and the union was amended on July 31, 1963, and on October 29, 1963. The purpose of the October 29, 1963, amendment was to adopt a vacation plan that provided for both regular and extended vacation benefits. The 1962 agreement as amended on July 31, 1963, and October 29, 1963, is hereinafter referred to as the amended agreement.

With respect to regular vacations the amended agreement provided in pertinent part that any employee who had 1 or more years of continuous service and had not been absent from work for 6 consecutive months or more in the preceding calendar year would be eligible for a regular vacation as follows:

An employee otherwise eligible to receive regular vacation benefits forfeited the right to receive such benefits if he quit, retired, or was discharged prior to January 1 of the vacation year.

With respect to extended vacations, the amended agreement stated that1974 U.S. Tax Ct. LEXIS 80">*84 the purpose of extended vacations was to provide expanded employment opportunities by granting each employee, whose rights became vested, not less than 7 or more than 13 consecutive weeks of time off with 13 weeks of vacation pay once in each 5-year period beginning January 1, 1964. An extended vacation, in any calendar year, would include the regular vacation in that year.

Vesting of an extended vacation would be determined as follows:

1. Fifty percent of all those employees, in order of accumulated continuous service, who were eligible on December 31, 1963, for a regular vacation in 1964, would become entitled to 13 weeks of extended vacation pay on January 1, 1964.

62 T.C. 456">*458 2. Fifty percent of all those employees, in order of accumulated continuous service, who were eligible on December 31, 1964, for a regular vacation in 1965, exclusive of those employees who became vested for the 13 weeks of extended vacation pay in 1964, would be entitled to 13 weeks of extended vacation pay on January 1, 1965.

3. All those employees who were eligible on December 31, 1965, for a regular vacation in 1966, exclusive of those employees who became vested for the 13 weeks of vacation pay in 19641974 U.S. Tax Ct. LEXIS 80">*85 or 1965 would be entitled to 13 weeks of extended vacation pay on January 1, 1966.

4. In addition, an employee who was not eligible on December 31 of either 1963 or 1964, for a regular vacation in 1964 or 1965, but, who became eligible for such regular vacation during 1964 or 1965, would then be entitled to 13 weeks of extended vacation pay provided his accumulated continuous service was equal to or greater than that of the employee with the least seniority.

5. An employee who had not become entitled to an extended vacation in accordance with paragraphs 1 through 4 above would be entitled to 13 weeks of extended vacation pay when he became eligible for a regular vacation during 1966, 1967, or 1968.

6. In addition, an employee who retired on pension on or after December 31, 1963, and who had not been entitled previously to the 13 weeks of extended vacation pay, would become entitled to such pay upon retirement.

Upon vesting of an extended vacation in accordance with the criteria described above, an employee's rights to 13 weeks of vacation pay became nonforfeitable. In the event of death of an employee who was eligible for such a vacation, the amount of vacation pay to which he would1974 U.S. Tax Ct. LEXIS 80">*86 have been entitled would be paid to his wife or his estate. After his rights to 13 weeks of extended vacation pay became vested, an employee would not forfeit this pay if his employment were terminated by reason of resignation or discharge.

Promptly after the union was notified of the company's intentions regarding a plant shutdown for vacations, each eligible employee would be requested to specify the vacation period he desired for his regular vacation. An employee desiring to take his regular vacation prior to April 1 was to notify the company prior to January 1 of the vacation year of the vacation period he desired. Vacations were granted (so far as possible) at the time most desired by employees on a seniority basis but the final right to allotment of vacation periods was exclusively reserved to the company in order to insure the orderly operation of the plant.

Within a period of 90 days, following notification of vesting of an extended vacation, each eligible employee was to notify the company regarding the number of consecutive weeks of time off he desired, 62 T.C. 456">*459 which time could not be less than 7 weeks, nor more than 13 weeks, and he was to designate, at the same time, 1974 U.S. Tax Ct. LEXIS 80">*87 three periods prior to December 31, 1968, during which he desired to take extended vacation time.

The company was required, to the extent practicable, to schedule employees for extended vacation in approximately equal numbers each year. If such scheduling of extended vacations resulted in undue dilution of experienced employees in a department because of vacations starting in any 1 year, the company was permitted to schedule the starting dates of such extended vacations so that not more than 20 percent of those employees would have such extended vacations starting in any given year.

Under the company's vacation plan, an employee entitled to either a regular or extended vacation would determine at the beginning of the vacation period the number of vacation weeks that he would actually take and the number of weeks he would not take but for which he would be paid. An employee taking an extended vacation would be paid at the beginning of the extended vacation period for the entire 13 weeks. Some employees expended this payment in a manner so that during the last several weeks of the extended vacation period they were without funds. Other employees were not accustomed to such a long1974 U.S. Tax Ct. LEXIS 80">*88 vacation and became bored. As a consequence, a number of employees decided to take an extended vacation of less than the full 13 weeks and be paid for the weeks that were not actually taken. This gave such employees sufficient funds for a good vacation during the period that they were actually off.

Prior to 1964, the average vacation of an employee was approximately 3 weeks. Since an extended vacation included the regular vacation of an employee, the effect of the amended agreement was to increase the average vacation of each employee by approximately 10 weeks during the 5-year period of the amended agreement. The extended vacation plan had the effect of favoring the younger employees. For example, a senior employee entitled to 4 weeks of regular vacation would only be entitled to 9 weeks of extended vacation as compared to a new employee entitled to 1 week of regular vacation who received 12 weeks of extended vacation.

An average employee who received extended vacation pay in the year 1964 received between $ 1,700 to $ 1,800, or 13 weeks of pay, at the start of his vacation period. He would take about 9 weeks of the possible 13 weeks as a vacation. He would return to work 1974 U.S. Tax Ct. LEXIS 80">*89 at the end of the ninth week instead of taking an additional 4 weeks of vacation. Similarly, an average employee who received extended vacation pay in 1965 or 1966, would take about 9 weeks of the possible 13 weeks as a vacation, would return to work at the end of the ninth week. Petitioner had no 62 T.C. 456">*460 policy that would defer the extended vacation benefits of an employee beyond the first year in which the employee became entitled to take an extended vacation.

The number of employees under the amended agreement, the number of employees entitled to regular vacation, the number of employees entitled to extended vacation, and the number of employees who took extended vacations in the calendar years 1964 through 1966 were as follows:

The number of total vacation weeks paid both regular and extended, the number of extended vacation weeks taken, and the number of extended 1974 U.S. Tax Ct. LEXIS 80">*90 vacation weeks paid for but not taken, in the years 1964, 1965, and 1966 were as follows:

The total vacation payments both regular and extended, the total extended vacation payments, and the total extended vacation payments for weeks not taken in the years 1964, 1965, and 1966 were as follows:

A number of petitioner's employees received their extended vacation pay in a year other than the one in which the deduction was claimed therefor. There were 185 employees who were entitled1974 U.S. Tax Ct. LEXIS 80">*91 to receive extended vacation pay in the year 1964 and who did not receive 62 T.C. 456">*461 such pay in 1964. Similarly, there were 53 employees in 1965 and 83 employees in 1966 who were entitled to receive extended vacation pay for the first time in said respective years, but who did not receive such pay in the initial year of eligibility.

Petitioner accrued as a liability and deducted on its Federal income tax returns for 1964 and 1965 the amounts of $ 1,197,752 and $ 662,252, respectively, with respect to the extended vacations provided for in the amended agreement. No part of said amounts was set aside by petitioner in a separate fund or trust account.

OPINION

The issue for our decision is whether that part of the vacation plan provided for in the labor agreement between petitioner and a labor union whereby petitioner's employees are entitled to extended vacation benefits constitutes a plan deferring the receipt of compensation within the meaning of section 404(a). The petitioner contends that the extended vacation plan is not a deferred-compensation plan and that accrued extended vacation pay is deductible in the year of accrual under section 162 and section 1.162-10(a), Income Tax1974 U.S. Tax Ct. LEXIS 80">*92 Regs., which provides that amounts paid or accrued within the taxable year for vacations are deductible under section 162(a) if they are ordinary and necessary expenses of the trade or business. Section 1.162-10(a), Income Tax Regs., further provides, however, that such amounts shall not be deductible under section 162(a) if, under any circumstances, they may be used to provide benefits under a stock bonus, pension, annuity, profit-sharing, or other deferred-compensation plan of the type referred to in section 404(a). Referring to this limitation in the regulations, the respondent contends that the extended vacation plan is a deferred-compensation plan as described in section 404(a) so that the accrued vacation pay may not be deducted until actually paid as required by section 404(a)(5). In the event that this Court holds that section 404 does not control the deduction of the vacation pay in issue, the respondent concedes that the petitioner is entitled to deduct these amounts pursuant to section 162.

Section 404 provides in part:

(a) General Rule. -- If contributions are paid by an employer to or under a stock bonus, pension, profit-sharing, or annuity plan, or if compensation1974 U.S. Tax Ct. LEXIS 80">*93 is paid or accrued on account of any employee under a plan deferring the receipt of such compensation, such contributions or compensation shall not be deductible under section 162 (relating to trade or business expenses) or section 212 (relating to expenses for the production of income); but, if they satisfy the conditions of either of such sections, they shall be deductible under this section, subject, however, to the following limitations as to the amounts deductible in any year:

* * * *

62 T.C. 456">*462 (5) Other plans. -- In the taxable year when paid, if the plan is not one included in paragraph (1), (2), or (3), if the employees' rights to or derived from such employer's contribution or such compensation are nonforfeitable at the time the contribution or compensation is paid.

62 T.C. 456">*468 Fay, J., concurring: I concur with the result in the majority opinion. I must respectively dissent, however, from the reasoning by which the majority arrived at its conclusion.

Although both petitioner and respondent here argued that section 404 applied to the extended vacation plan in this matter, I can see no reason why this Court chose to enter into that discussion. Congress has clearly indicated that vacation benefits are governed by the rules of section 162. Any reference to section 404 is not only unnecessary but inappropriate under these facts.

The majority has aptly pointed out that Congress intended the deduction for vacation benefits to be within the purview of section 162. See sec. 97 of the Technical Amendments Act of 1958, Pub. L. 85-866, and its subsequent reenactments to include any taxable year ending before January 1, 1973. See also S. Rept. No. 92-1290, 92d Cong., 2d Sess. (1972), 1972-2 C.B. 733. See also1974 U.S. Tax Ct. LEXIS 80">*109 S. Rept. No. 1622, to accompany H.R. 8300 (Pub. L. No. 591), 83d Cong., 2d Sess., p. 305 (1954), indicating that vacation pay is one of the items for which a reserve may be set up under section 462. There is no reason to repeat that discussion here. The various legislative reports which indicate that section 162 controls the deduction of vacation benefits do not mention or consider a potential problem with the provisions of section 404. The issue presented here is therefore easily resolved by a proper application of section 162, obviating any analysis of the applicability of section 404 to vacation benefits.

The majority, however, was motivated to approach this matter by first considering the applicability of section 404, which I believe to be unwarranted. ¹ They would have us adopt a rather strict and limiting "similar test" (similar to a stock bonus, pension, profit-sharing, or annuity plan), to determine the applicability of section 404 to various methods of deferring compensation. I find this "similar test" to be erroneous in that it unduly narrows the restrictions Congress originally intended when it enacted this section.

1974 U.S. Tax Ct. LEXIS 80">*110 Congress has clearly indicated that the purpose of enacting section 404 and its predecessors was to encourage employers to adopt qualified ² methods of deferring compensation for its employees. See H. Rept. No. 2333, to accompany H.R. 7378 (Pub. L. No. 753), 77th Cong., 2d Sess. (1942). To this end, section 404(a)(5) provides a less desirable treatment to employers who devise methods of deferring 62 T.C. 456">*469 compensation which are not qualified. ³ To restrict the scope of section 404, as the majority would have us do, would defeat the express purposes for which it was enacted.

Further, I believe the 1974 U.S. Tax Ct. LEXIS 80">*111 majority's gratuitous discussion of section 404 may haunt this Court in the future. The genius of the human mind will undoubtedly be prolific in this area. I anticipate practitioners devising an incalculable number of unqualified arrangements which will clearly have the effect of deferring compensation, yet escaping the clutches of section 404 by not conforming to the "similar test." The impact of the "similar test" advocated by the majority would permit ready evasion of our revenue laws. The potential for abuse in this area is enormous.

In addition, it will be very difficult for the tax bar to ascertain from the majority opinion what standards this Court will adopt in determining what is, or is not, similar. ⁴ In view of this uncertainty, Congress may deem it necessary to clarify its position as to the applicability of section 404 to various methods of deferring compensation. Until such time, however, that the standards for applicability do become clear, taxpayers and their planners face an uncertain and haphazard road in planning their affairs.

1974 U.S. Tax Ct. LEXIS 80">*112