T.C. Sum m ary Opi ni on 20 14 -8 4

UNITED STAT ES TAX COURT

DAVID C. MATTHEW S AND MARCIA K. MATTHEW S, Pet it io ne rs v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 28 10 6- 13 S. Fi le d Au gu st28 , 20 14 .
Dav idC. Mat th ews an d M arci a K. Mat th ews , pro ses e. Edwi n B . Cle ve rd on , forres po nd en t.

SUMM ARY OPINION GUY, Spec ia l Tri al Ju dg e: Thi s ca se was h eardpu rs uantto th e p ro vi si on s of sec ti on 74 63 of t he Int ern al Rev enue Co de ineffe ctwhenth e p et it io n was fil ed . Pur su an t t o s ect io n 7 46 3( b) , th e d eci si on to be en te redis no t re vi ewab le by 1
Unl es s o th erwi se in di cat ed , sec ti on refe ren ces are t o the Int ern al Rev enue 1 (co nt in ue d...)-2
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an y othe r co urt, an d thi s o pi ni on sh al l n otbe tre at edas p rece de ntforan y othe r cas e. Res po nd en t d et erm in eda de fic ie nc y of $ 19 ,46 9 i n p et it io ne rs ’ Fed eral in co m e ta x fo r 20 11 an d a n a ccu racy-rela te d p en al ty und er s ect io n 6 66 2( a). Pet it io ne rs , hu sb an d andwife , fil eda ti m el y pe ti ti on forred et erm in at io n wi th th e Co urt p ur su an t t o s ect io n 6 21 3( a). At the ti m e th e p et it io n was fil ed , th ey res id ed in Alab am a. Afte r co nc es si on s, th e is su e rem ai ni ng forde ci si on is whet he r pe ti ti on ers 2 are l iabl e fo r th e 1 0% a dd it io na l t ax on earl y di st rib ut io ns fro m

qu al ifi ed ret ire m en t p lans un de r se ct io n 7 2( t). Bac kg ro un d So m e o f th e fac ts ha ve be enst ip ul at edan d a re s o fo un d. Th e st ip ul at io n o f fact s, the supp le m en ta l s ti pu la ti on of f act s, an d the acco m

pa nyin g e xh ib it s ar e in co rp or at edhe rei n b y

th is refe ren ce. (...co nt inue d) 1 Co de (Co de ), as am en de d a ndineffe ctfor20 11 , andRu le refe ren ces are t o the Tax Co urt Ru le s o f Prac ti ce an d P ro cedur e. Mo ne tary am ou nt s ar e ro un de d t o the ne ares t d ol lar. Pet it io ne rs co nc ed e th atth ey om it te d fr om

th ei r return $ 2,5 80 of s el f- 2 em pl oym en t i nc om e. Res po nd en t co nc ed es th atpe ti ti on ers are n otli ab le foran accu racy-rela te d p en al ty und er s ec. 6 66 2. Othe r ad jus tm en ts are co m

pu tati on al an d fl ow fr om

our de ci si on inth is cas e.-3
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I. Mr. Ma tthe ws’ Em

pl oym en t Fro m 20 03 un ti l Se pt em

be r 20 10 Mr. Ma tthe ws wo rk edfor Sp art a, In c., a de fen se co nt ract or , inHun ts vi ll e, Alab am a. Duri ng th atti m e Mr. M at th ews pa rti ci pa te d i n S pa rta ’s sec ti on 40 1( k) ret ire m en t s av in gs pl an(40 1( k) pl an acco un t) a dm in is te redby Prud en ti al Ins ur an ce Co . of Am eri ca (P ru de nt ia l). InSep te m

be r 20 10 Mr. Ma tthe ws l eftSp art a an d a ccep te d apo si ti on as a se ni oren gi ne er wi th Synaps e Wirel es s (S ynaps e). InMarc h 2 01 1, h owe ve r, he was lai d o ff. Mrs . Mat th ews is pri m ari ly a ho m em ak er. Sh e h as a ba ck gr ou ndin educ at io n a ndho m e sc ho ol s the co up le ’s two ch il dr en . II. Ret ire m en t Acc ou ntLoan an d Di st rib ut io ns So m et im e b efo re 2 01 1 M r. Mat th ews bo rro wed$3 6,2 78 fro m hi s 4 01 (k ) pl anacco un t. Durin g 2 01 1, s ho rtl y aft er l os in g h is job with S ynaps e, Mr. Ma tthe ws re qu es te d adi strib ut io n o f $1 28 ,14 0 fr om hi s 4 01 (k ) pl anacco un t. He un de rs to odth athi s l oa n wo ul d h av e to be rep ai d b efo re h e co ul d re cei ve a di st rib ut io n fr om

th e acc ou nt . In thi s re ga rd , Pru de nt ia l ap pl ie d $ 36 ,27 8 o f Mr. Ma tthe ws’ accru edpl anbe ne fit s t o o ffs ethi s o ut st an di ng lo an , withh el d Fed eral in co m e ta x o f $1 8,3 72 , andtra ns ferr ed$7 3,4 90 (th e b al an ce o f th e reque st ed$1 28 ,14 0 d is tri bu ti on ) to hi m .-4
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Afte r th e tr an sa ct io n d es cri be d abo ve , Mr. Ma tthe ws h ad$6 6,6 29 rem ai ni ng in hi s 4 01 (k ) pl anacco un t. He the n ro ll edth os e fund s o ve r to a Pru de nt ia l in di vi du al ret ire m en t ac co un t (I RA) an d p ro m pt ly requ es te d adi strib ut io n o f $5 5,0 00 . Prud en ti al withh el d F ed eral in co m e ta x o f ap pr ox im at el y $9 ,00 0 a nd tra ns ferr edth e b al an ce o f $4 6,0 00 to Mr. Ma tthe ws. Mr. Ma tthe ws was 49 y ears ol d i n 2 01 1. He ex pl ai ne d at tria l tha t h e d id no t wan t t o app ly for u ne m pl oym en t co m

pe ns at io n a fte r lo si ng hi s jo b wi th Synaps e b ecau se he di d n otwantto be co m e a “bu rd enon so ci ety ” an d tha t h e was co m pe ll edto withd raw fu nd s fr om hi s re ti rem en t ac co un ts to pay th e m ortg ag e an d s up po rt h is fam il y . The p art ie s ag ree t ha t M r. Mat th ews withd rew fu nd s fr om hi s re ti rem en t ac co un ts to all ev ia te eco no m ic ha rd sh ip . III. Pet it io ne rs ’ 20 11 Tax R eturn Pet it io ne rs fil eda Fo rm

10 40 , U.S. Ind iv idua l In co m e Tax Return, fo r 20 11 . The parti es ag ree t ha t p et it io ne rs ha d a dju st edgro ss in co m e (AGI) o f $2 50 ,31 3 fo r 20 11 an d tha t the y

pa idun rei m

bu rs edm ed ic al ex pe ns es of $ 9,1 89 th aty ear. Pet it io ne rs di d n otrep ort an y ad di ti on al tax du e und er s ect io n 7 2( t) i n re sp ectof th e d is tri bu ti on s fr om

Mr. Ma tthe ws’ reti rem en t ac co un ts de sc rib edab ov e.-5 - Dis cu ss io n Pet it io ne rs do no t d is pu te th atth e am ou nt s d is tri bu te d fr om Mr. Ma tthe ws’ ret ire m en t ac co un ts du rin g 2 01 1 c on st itut e g ro ss in co m e subjec t t o F ed eral in co m e ta x. Se e se cs . 61 (a), (b ), 72 (a)( 1) , 40 2( a), 4 08 (d )(1 ); s ee al so Arno ldv. Co m m is si on er, 1 11 T.C. 25 0, 2 53 (19 98 ). The o nl y is su e in di sp ut e is whet he r th e di st rib ut io ns are s ub

ject t o the 10 % ad di ti on al tax im po se d b y sec ti on 72 (t) . As a g en eral rul e, if

a ta xp ay er rec ei ve s a d is tri bu ti onfro m a qu al ifi ed ret ire m en t p lan b efo re at ta in in g the ag e o f 59 -1 /2 , sec ti on 72 (t) im po se s an ad di ti on al tax equa l t o 1 0% o f th e p orti on of t he di st rib ut io n wh ic h i s i nc lu di bl e in th e ta xp ay er’s g ro ss in co m e. Sec. 7 2( t)( 1) an d (2 ). The ad di ti on al tax is in te nd ed 3 to di sc ou rag e ta xp ay ers fro m tak in g p rem atur e d is tri bu ti on s fr om ret ire m en t pl an s- -act io ns th atfru st rat e p ub li c p ol ic y en co ur ag in g s av in g fo r ret ire m en t. See Dwy er v . Comm is si on er, 1 06 T.C. 33 7, 3 40 (19 96 ) (ci ti ng an d d is cu ss in g the le gi sl at iv e h is to ry

un de rlyin g s ect io n 4 08 (f), the st atut ory pre de ces so r to sec ti on 72 (t) ); M il ne r v. C omm is si on er, T.C. Mem o. 2 00 4- 11 1. Sect io n 7 2( t)( 2) (B) p ro vi de s an ex cep ti on to th e im po si ti on of a dd it io na l t ax to th e ex te ntth atret ire m en t p lan d is tri bu ti on s “ do no t ex ceedth e am ou nt The de fin it io n o f “ qu al ifi edret ire m en t p lan” in cl ud es 40 1( k) pl anacco un ts 3 an d IRAs. See sec s. 7 2( t)( 1) , 40 1( a), (k )(1 ), 49 74 (c); Usci ns ki v. Co m m is si on er, T.C. Mem o. 2 00 5- 12 4.-6
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al lo wab le as ade du ct io n u nd er s ect io n 2 13 to th e em pl oyee fo r am ou nt s p ai d du rin g the tax ab le y ear f

orm ed ic al care (de te rm in edwitho utreg ardto whethe r th e em pl oyee it em iz es de du ct io ns forsu chtax ab le y ear) .” Sect io n 2 13 intu rnall ows as a de du ct io n “ th e ex pe ns es pa iddu rin g the tax ab le y ear, n otco m pe ns at edforby in su ran ce o r ot he rwis e, fo r m ed ic al care of t he tax pay er, h is sp ou se , or a de pe nd en t * * * to th e ex te ntth atsu chex pe ns es ex ceed7.5 pe rcen t o f ad jus te d gr os s i nc om e.” 4 Pet it io ne rs ’ AGI for20 11 was $ 25 0,3 13 , andth ey pa id$9 ,18 9 i n un rei m bu rs edm ed ic al expe ns es th aty ear. Be cau se pe ti ti on ers ’ un rei m bu rs ed
m ed ic al ex pe ns es di d n otex ceed$1 8,7 73 (7.5 % of $ 25 0,3 13 )--the flo orfor an al lo wab le de du ct io n u nd er s ect io n 2 13 --i t fo ll ows th atth ey are i ne li gi bl e fo r th e m ed ic al ex pe ns e ex cep ti on pre sc rib edinsec ti on 72 (t) (2 )(B) . See Dwy er v . Co m m is si on er, 1 06 T.C. at 3 43 ; M cGraw v . Comm is si on er, T.C. Mem o. 2 01 3- 15 2. Pet it io ne rs m ai nt ai n tha t the y sh ou ldbe ex cu se d fr om

th e ad di ti on al tax pr es cri be d i n s ect io n 7 2( t) b ecau se Mr. Ma tthe ws was ob li ge d t o t ak e th e
Fo r ta xabl e y ears be gi nn in g a fte r Decem be r 31 , 20 12 , sec . 21 3( a) p ro vi de s 4 th ateli gi bl e m ed ic al expe ns es m ay be de du ct edto th e ex te ntth ey ex ceed10 % of AGI. See Pat ie ntPro te ct io n a ndAffo rd ab le Care Act, Pub. L. No. 1 11 -1 48 , sec . 90 13 (a), 1 24 Sta t. at86 8.-7 -

di st rib ut io ns un de r co ns id erat io n t o a ll ev ia te eco no m ic ha rd sh ip . W e h av e co ns id eredsi m il ar cl ai m s i n the pa stan d h av e o bs erv edth atth ere i s n o aut ho rit y in th e Co de , th e le gi sl at iv e h is to ry , or c as el aw fo r a g en eral fin an ci al ha rd sh ip ex cep ti on to th e im

po si ti on of t he 10 % ad di ti on al tax on earl y di st rib ut io ns . See Arn ol d v . Comm is si on er, 1 11 T.C. at 2 55 ; Do ll an de r v. C ommis si on er, T.C. Mem o. 2 00 9- 18 7; Mi ln er v . Commis si on er, T.C. Mem o. 2 00 4- 11 1. Whil e we are sym pa th et ic to pe ti ti on ers ’ po si ti on , th e Co urt m ay no t ad d a n e xc ep ti on to sec ti on 72 (t) by j ud ic ia l fi at , andwe are o bl ig edto ap pl y th e la w as wri tt en . See Is el in v. Uni te d S tate s, 2 70 U.S. 24 5, 2 50 -2 51 (19 26 ). As a fi na l m at te r, pe ti ti on ers co nt en d tha t, i na sm uc h a s the y

di d n otactua ll y rece iv e th e $ 36 ,27 8 tha t Prud en ti al ap pl ie d t o o ffs etMr. Ma tthe ws’ ou ts tand in g lo an , th e ad di ti on al 10 % tax sh ou ldno t b e ap pl ie d i n re sp ectof t ha t am ou nt . W e di sa gr ee. Und er the ge ne ral rul e o f se ct io n 7 2( p) (1 )(A), the m ak in g o f a l oan fr om a qu al ifi edret ire m en t p lan g iv es ris e to a de em eddi st rib ut io n tha t i s t ax ab le inth e y ear i n wh ic h the tax pay er re cei ve s the lo an . Howev er, s ect io n 7 2( p) (2 ) pr ov id es anex cep ti on to th e g en eral rul e fo r lo an s tha t s at is fy cert ai n re qu ire m en ts . The 5 Sec. 7 2( p) (2 ) pr ov id es anex cep ti on wher e th e fo ll owi ng requi rem en ts are 5 m et : (1 ) th e lo ando es no t ex ceedth e le ss er o f th e am ou ntsetforthinsec . (co nt in ue d...)-8
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reco rddo es no t d is cl os e whe n M r. Mat th ews to okth e lo anfro m hi s 4 01 (k ) pl an acco un t o r th e res pe ct iv e te rm s o f th e lo anor t he 40 1( k) pl anit se lf. Be cau se th e pa rti es do no t d is pu te th atMr. Ma tthe ws’ lo ansat is fie d the requi rem en ts of se ct io n 7 2( p) (2 ), we ha ve no reas on to de lv e in to th atm at te r. Altho ug h alo anm ay

in it ia ll y sat is fy th e requi rem en ts of s ect io n 7 2( p) (2 ) at th e ti m e th atitis m ad e an d b e ex cep te d fr om th e g en eral rul e o f se ct io n 72 (p )(1 )(A), a d eem eddi strib ut io n m ay ne ve rth el es s ar is e in acco rd an ce wi th se ct io n 1 .72 (p )-1 , Q&A-4 (a), In co m e Tax Reg s., as th e res ul t o f a fai lu re o f on e o f th e afo rem en ti on edrequi rem en ts , see Owus u v . Commis si on er, T.C. Mem o. 2 01 0- 18 6, o r anactua l d is tri bu ti on m ay oc cu r in acco rd an ce wi th sec ti on 1.7 2( p) -1 , Q&A-1 3( a) an d (b ), In co m e Tax Reg s., i n the ev en t o f a “pl anlo anoff se t” , see Ro y al v. Co m

m is si on er, T.C. Mem o. 2 00 6- 72 . Sect io n 7 2( t) app li es to a de em ed 6 (...co nt inue d) 5 72 (p )(2 )(A)(i ) or(ii ); ( 2) th e lo an , by it s t erm s, m us t b e rep ai d wi th in fiv e y ears fro m th e d at e o f it s i nc ep ti on or i s m ad e to fin an ce the acqui si ti on of aho m e whi chis th e p rin ci pa l re si de nc e o f th e p art ic ip an t; an d (3 ) th e lo anm us t h av e subs tant ia ll y

lev el am orti zat io n wi th qu art erl y or m or e fre qu en t p aym en ts requi red ov er the term

of t he lo an . In ad di ti on , th e lo anm us t b e ev id en cedby a leg al ly en fo rceabl e ag reem en t. Sec . 1.7 2( p) -1 , Q&A-3 (b ), In co m e Tax Reg s. Sec. 1 .72 (p )-1 , Q&A-1 3( a)(2 ), In co m e Tax Reg s., p ro vi de s i n re le va ntpa rt: 6 A di st rib ut io n o f a p lan l oa n o ffs etam ou nt(as de fin edinsec . 1.4 02 (c)- 2, Q&A- 9( b) ) oc cu rs when , un de r th e te rm s g ov ern in g a (co nt in ue d...)-9
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di st rib ut io n u nd er s ect io n 7 2( p) inth e sa m e m an ne r as anactua l d is tri bu ti on . Sec. 1.7 2( p) -1 , Q&A-1 1( b) , Inc om e Tax Reg s. Mr. Ma tthe ws u nd ers to odth athi s 4 01 (k ) pl anacco un t l oa n wo ul d h av e to be rep ai d b efo re h e wou ldbe pe rm it te d t o t ak e a d is tri bu ti on fro m th e acc ou ntin 20 11 . Alth ou gh we can no t b e en ti rel y cert ai n o n thi s re co rd , th e ci rcu m st an ces st ro ng ly sug ge stth at , as aco ns eque nc e o f Mr. M at th ews ’ se pa rat io n fr om Sp art a orhi s re qu es t fo r a d is tri bu ti on , Pru de nt ia l o ffs eta po rti onof h is accr ue d p lan be ne fit s t o re pa y

hi s l oa n a s d es cri be d i n s ect io n 1 .72 (p )-1 , Q&A-1 3( a) an d (b ), In co m e Tax Reg s. As di sc us se d abo ve , a pl anlo anoff se t co ns ti tu te s an actua l pl andi st rib ut io n tha t i s s ub ject t o a dd it io na l t ax un de r se ct io n 7 2( t) no twi th st an di ng th atth e lo anwas t ak eninanearl ie r y ear. Pe ti ti on ers ha ve no t

(...co nt inue d) 6 pl anlo an , th e acc ru edbe ne fitof t he pa rti ci pantor b en efi ci ary is reduc ed(of

fs et ) in ord er t o re pa y

th e lo an(in cl ud in g the en fo rcem en t of th e p lan’s s ecu rit y

in te res t i n the accrue d b en efi t). A d is tri bu ti on of a pl anlo anoff

se t am ou ntco ul d o ccu r in a va rie ty of ci rcu m st an ces , su chas wh ere t he term s g ov ern in g the pl anlo an requi re tha t, i n the ev en t o f th e p art ic ip an t’s re qu es t fo r a d is tri bu ti on , a lo anbe rep ai d i m

m ed ia te ly or tr eat edas i n d efau lt . The am ou ntof t he acco un t b al an ce tha t i s o ffs etag ai ns t a l oa n i s an actua l di st rib ut io n a s o pp os edto a de em eddi st rib ut io n u nd er s ec. 7 2( p) . Sec. 1 .72 (p )-1 , Q&A-1 3( b) , Inc om e Tax Reg s.; see Ro y al v. Co m m is si on er, T.C. Mem o. 2 00 6- 72 .-1 0-

po in te d t o a n e xc ep ti on to th e ap pl ic at io n o f se ct io n 7 2( t) i n thi s i ns tanc e, an d we are a ware o f no ne . Insu m , des pi te pe ti ti on ers ’ eco no m ic ha rd sh ip , Mr. Ma tthe ws’ di st rib ut io ns fro m hi s 4 01 (k ) pl anacco un t an d IRA are s ub ject t o a dd it io na l t ax un de r se ct io n 72 (t) . Res po nd en t’s d et erm in at io n o n thi s i ss ue is su st ai ne d. To re fle ctth e fo reg oi ng , An ap pr op ria te de ci si on wil l b e en te red .