T.C. Memo. 2011-83

UNITED STATES TAX COURT

BRUCE A. AND CAROL ANFINSON BROWN, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 6825-08. Filed April 12, 2011.

Carol L. Anfinson, for petitioners.

Frederic J. Fernandez and Mark J. Miller, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

MORRISON, Judge: In 2005, Bruce Brown held a life insurance

contract with Northwestern Mutual Life Insurance Company. On

December 18, 2005, Northwestern terminated the contract, using

its entire cash value of $37,365.06 to pay policy debt. 

Petitioners (the Browns) did not report any gain or loss on their
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2005 federal income tax return from the termination of the life

insurance contract. 

In a notice dated December 24, 2007, respondent (the IRS)

determined a deficiency in tax of $8,553 for tax year 2005. The

deficiency was the result of the IRS’s determination that Mr.

Brown recognized a taxable gain of $29,093.30 on termination of

the Northwestern contract. The IRS also determined that the

Browns were liable for a penalty of $1,711 under section 6662.1

The Browns dispute those determinations.

FINDINGS OF FACT

The parties stipulated some facts; those facts are so found. 

The Browns

Bruce Brown is a commercial litigation attorney who has been

licensed since 1973. His wife, Carol Anfinson Brown, is also an

attorney. She has a master of laws degree (LL.M.) in taxation

and does appellate work in state court.

The Insurance Contract

On March 16, 1982, Mr. Brown purchased a life insurance

policy from Northwestern with a $1,837 annual premium and a

$100,000 death benefit. The policy listed Mr. Brown as the

insured and as the policy’s owner, and it listed Mrs. Brown as

its direct beneficiary. 

1All section references are to the Internal Revenue Code, as

amended, effective during the year at issue, unless otherwise

indicated. 
- 3 -

The policy was eligible for dividends, meaning that if

Northwestern had a divisible surplus, the policyholder (here, Mr.

Brown) was entitled to receive a fraction of the divisible

surplus in the form of a dividend. The policy listed four

options for how Mr. Brown could direct Northwestern to pay the

dividends; he could direct Northwestern to (i) pay dividends

directly to him, (ii) allow dividends to accumulate, (iii) apply

dividends to premiums, or (iv) apply dividends to purchase

paid-up additional insurance. Besides the four listed options,

the policy also stated that “[o]ther uses of dividends may be

made available by * * * [Northwestern].” The policy provided

that if Mr. Brown did not direct otherwise, Northwestern would

apply the dividends to purchase paid-up additional insurance. 

Paid-up additional insurance is single premium insurance;

for a one-time payment, it increases the policy’s death benefit

and share of divisible surplus without increasing the annual

premium. The policy allowed Mr. Brown to surrender the paid-up

additional insurance in exchange for its cash value. 

Over time, the policy accumulated “cash value”. Cash value

was important because, as explained below, (i) the policy allowed

Mr. Brown to borrow from Northwestern against its cash value and

(ii) if the policy terminated before Mr. Brown died, Northwestern

would pay Mr. Brown the policy’s cash value minus any outstanding

loans. 
- 4 -

Assuming Mr. Brown paid all premiums, the policy’s “cash

value” at the end of any policy year would be the sum of (i) any

dividend accumulations, (ii) the value from the table of

guaranteed values, and (iii) the cash value of any paid-up

additional insurance. The table of guaranteed values was in the

contract; it gave the cash value for the end of each policy

year,2 a value which increased over time. The contract stated

that during the year values would “reflect any portion of the

year’s premium paid and the time elapsed in that year.”

The policy allowed Mr. Brown to borrow from Northwestern

against the policy’s cash value. The policy labeled these loans

“premium loan[s]” if they were applied to policy premiums or

“policy loan[s]” if they were used for anything else. Both types

of loans accrued interest at an annual effective rate of 8

percent. If unpaid, the interest was capitalized, meaning

Northwestern added accrued interest to principal. If Mr. Brown

died while the loans were outstanding, Northwestern would reduce

the death benefit by the balance of the loans.

Mr. Brown could surrender the policy in exchange for its

cash value. If he did so, the contract would terminate and

Northwestern would use the policy’s cash value to pay policy

2The table gave a value for each of the first 20 years and

then values for the years in which Mr. Brown would turn 60, 65,

and 70 (that is for the policy years ending in 2007, 2012, and

2017). The contract stated that the values in the table assumed

the policyholder paid all premiums when due. 
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debt, which was the total of all outstanding loans and

accumulated interest. Then, if the policy’s cash value exceeded

policy debt, Northwestern would pay Mr. Brown the excess. 

If, at any time, policy debt exceeded cash value,

Northwestern could apply the policy’s cash value to the policy

debt and terminate the contract. 

Premium Payments

Each year Mr. Brown paid premiums by check, loans, or

dividends. 

C From 1982 through 1986, he paid $1,837 each year by

check.

C From 1987 through 2000, he paid $1,837 each year by

taking loans against the policy’s cash value.

C From 2001 through 2003, he paid each year’s premiums in

semiannual installments of $938.3 Each year he paid

the first installment by taking loans and the second

installment by check.

C In 2004 and 2005, he paid the annual premium of $1,837

by directing Northwestern to apply dividends to

premiums. 

3The product of $938 and 2 is $1,876, which is $39 greater

than $1,837. The record does not make clear why the premium for

these 3 years is higher than $1,837.
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In total Mr. Brown paid $44,205 in premiums: $11,999 by

check, $28,532 by loans, and $3,674 by dividends. The following

table shows how he paid the premium each year:

Year Paid by Check Paid by Loan Paid by Dividend

1982 $1,837 -0- -0-

1983 1,837 -0- -0-

1984 1,837 -0- -0-

1985 1,837 -0- -0-

1986 1,837 -0- -0-

1987 -0- $1,837 -0-

1988 -0- 1,837 -0-

1989 -0- 1,837 -0-

1990 -0- 1,837 -0-

1991 -0- 1,837 -0-

1992 -0- 1,837 -0-

1993 -0- 1,837 -0-

1994 -0- 1,837 -0-

1995 -0- 1,837 -0-

1996 -0- 1,837 -0-

1997 -0- 1,837 -0-

1998 -0- 1,837 -0-

1999 -0- 1,837 -0-

2000 -0- 1,837 -0-

2001 938 938 -0-

2002 938 938 -0-

2003 938 938 -0-

2004 -0- -0- $1,837

2005 -0- -0- 1,837

Subtotal 11,999 28,532 3,674

 Total premiums 44,205
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Dividend Use

Initially Mr. Brown did not direct the dividends’ use, so

Northwestern applied them to purchase paid-up additional

insurance. In March 2004 Mr. Brown executed a change-of-dividend

form, electing to have Northwestern apply dividends first to

premiums and then to policy debt. In 2004 the total dividend was

$2,986.94; in accordance with the new election, Northwestern

applied $1,837 to the policy premium and $1,149.94 to interest on

the loans. In 2005 the total dividend was $1,883; Northwestern

applied $1,837 to the policy premium and $46 to interest on the

loans. On their income tax returns, the Browns properly excluded

all of the dividends from gross income. 

Policy Debt and Termination

Mr. Brown increased the policy debt by taking loans and by

allowing unpaid interest to capitalize. By borrowing to pay the

premiums, he added $1,837 to the policy debt in May of each year

from 1987 through 2000 and $938 to the policy debt in May of

2001, 2002, and 2003. Before 2004 interest was capitalized each

year because he made no interest payments. By 1997 the annual

interest accrual exceeded the premium; by 2002, it was twice the

premium. As previously discussed, the policy provided that

Northwestern could terminate it if the policy debt exceeded cash

value. Policy debt first exceeded cash value in November 2004. 

Mr. Brown reduced the policy debt on December 29, 2004, by
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surrendering the paid-up additional insurance for its cash value

of $31,063.30. Of that $31,063.30, Northwestern applied

$27,252.49 to principal and $3,810.81 to interest. Surrendering

the paid-up additional insurance, however, reduced the policy’s

cash value and the policy debt by the same amount because the

policy’s cash value included the cash value of the paid-up

additional insurance.4 Thus policy debt continued to exceed the

policy’s cash value, and Northwestern terminated the policy on

January 6, 2005. 

On February 16, 2005, Northwestern restored the policy

because Mr. Brown made a $559 “minimum interest payment” of which

$428.04 went to interest and $130.96 went to principal. On March

21, 2005, Mr. Brown made a final cash payment of $162.82, all of

which went to interest. 

Mr. Brown made no more payments, and Northwestern again

terminated the policy on December 18, 2005. At that time, the

policy’s cash value was $37,365.06. Northwestern applied the

cash value to the policy debt, which, as of December 18, 2005,

was $37,395.48.5 Because the policy debt of $37,395.48 exceeded

4Applying the cash value of the paid-up additional insurance

to policy debt did have one positive effect for the Browns: it

decreased the annual interest accrual by reducing the principal.

5The policy debt included $35,273.76 of principal as of Dec.

18, 2005 and $2,121.72 of interest, which had accrued between

Mar. 21, 2005 (the date of Mr. Brown’s final payment) and Dec.

18, 2005. There is an unexplained discrepancy because the total

(continued...)
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the policy’s cash value of $37,365.06, Northwestern did not make

a cash payment to the Browns.

Northwestern’s Computation of Taxable Gain

Northwestern sent Mr. Brown a Form 1099-R, Distributions

From Pensions, Annuities, Retirement or Profit-Sharing Plans,

IRAs, Insurance Contracts, etc. The Form 1099-R showed a gross

distribution of $37,365.06 and a taxable amount of $29,093.30. 

The Form 1099-R described the $37,365.06 as “loans repaid at

surrender” and described the $29,093.30 as “taxable amt. at

surrender”. 

According to Northwestern’s calculations, the $29,093.30

taxable amount was equal to the policy’s cash value of $37,365.06

minus what it called “net cost” of $8,271.76. Net cost was

calculated as “total premiums” (the premiums paid by loans,

$28,532; by checks, $11,999; and by dividends, $3,674) minus what

Northwestern called “total dividends” (in which Northwestern

included the $2,986.94 dividend payment to Mr. Brown in 2004, the

$31,063.30 received by Mr. Brown on surrender of the paid-up

additional insurance in 2004, and the $1,883 dividend payment to

Mr. Brown in 2005). 

5(...continued)

policy debt of $37,395.48 exceeds the cash value of $37,365.06 by

$30.42. The record does not reveal whether Mr. Brown paid the

additional policy debt, whether Northwestern forgave the

additional policy debt, or whether Mr. Brown still owes

Northwestern the additional policy debt.
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The Browns’ Reporting for Tax Year 2005

Mr. Brown prepared the Browns’ return, which did not report

any income from terminating the life insurance contract. Before

filing the return, he consulted Mrs. Brown about the Form 1099-R. 

They believed that Northwestern based its report that Mr. Brown

had a $29,093.30 taxable gain on the theory that a debtor has a

taxable gain when a creditor cancels a debt. They believed

Northwestern was incorrect because Northwestern had not forgiven

Mr. Brown’s debt. Having concluded that Northwestern analyzed

the termination of the policy incorrectly, the Browns made no

further attempt to determine the proper tax treatment of the

transaction.

OPINION

I. The IRS Correctly Determined That Mr. Brown Had a $29,093.30

Taxable Gain on Termination of the Life Insurance Contract.

As we describe in greater detail later, the IRS argues that

the tax consequences of the $37,365.06 are controlled by section

72(e)(5)(A) and (C), which provides that an amount received under

a life insurance contract that is not received as an annuity is

included in gross income to the extent it exceeds investment in

the contract. The Browns argue, first, that they did not receive

the $37,365.06 and, second, that if they did, it is not included

in gross income under section 72(e)(4)(B). We disagree. 

For federal income tax purposes, loans against a life

insurance contract’s cash value are true loans from the insurance
- 11 -

company to the policyholder. See Minnis v. Commissioner, 71 T.C.

1049, 1054 (1979); Sanders v. Commissioner, T.C. Memo. 2010-279;

McGowen v. Commissioner, T.C. Memo. 2009-285; Barr v.

Commissioner, T.C. Memo. 2009-250; Atwood v. Commissioner, T.C.

Memo. 1999-61. Thus, using the policy’s proceeds to satisfy the

loans has the same effect as paying the proceeds directly to the

policyholder. See, e.g., Atwood v. Commissioner, supra. For

example, in Barr and Atwood the insurance companies credited the

cash value of the terminated life insurance policies against

existing policy debt. The policyholders had incurred the policy

debt for reasons other than the payment of premiums. The Court

held that the policyholders constructively received the amounts

used to satisfy the loans because the policy proceeds paid

genuine debts. See, e.g., Barr v. Commissioner, supra; Atwood v.

Commissioner, supra. On December 18, 2005, Northwestern

terminated the life insurance contract with Mr. Brown. At that

time the policy’s cash value was $37,365.06. On termination, the

policy’s only proceeds were its cash value. Northwestern applied

the entire cash value to pay policy debt, and Mr. Brown thus

constructively received $37,365.06--the amount of the policy

proceeds Northwestern used to satisfy policy debt. The Browns

argue that Mr. Brown did not constructively receive the amount

applied to satisfy the policy debt because Mr. Brown incurred

that debt to pay premiums. They point out that the taxpayers in
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Barr v. Commissioner, supra, and Atwood v. Commissioner, supra,

did not incur policy debt to pay premiums. But it does not

matter why Mr. Brown incurred the debt. All that matters it that

the policy debt was genuine. See Atwood v. Commissioner, supra. 

Mr. Brown’s policy debt was genuine: Northwestern lent him the

policy premiums, allowing him to continue to enjoy the benefits

of the policy without paying premiums out of pocket. Because the

policy debt was genuine, Mr. Brown constructively received the

proceeds that Northwestern used to satisfy that debt. Thus the

$37,365.06 cash value Northwestern used to satisfy Mr. Brown’s

policy debt is an amount received under a life insurance

contract. 

We now turn to the tax treatment of that $37,365.06. Any

amounts received under a life insurance contract that were paid

because of the death of the insured are excludable from the gross

income of the recipient; that is, they are not taxable. Sec.

101(a)(1).6 The tax treatment of amounts received under a life

6As the House conference report on the Technical and

Miscellaneous Revenue Act of 1988, Pub. L. 100-647, 102 Stat.

3342, correctly summarizes:

the undistributed investment income (“inside buildup”)

earned on premiums credited under a contract that

satisfies a statutory definition of life insurance is

not subject to current taxation to the owner of the

contract. In addition, death benefits paid under a

contract that satisfies the statutory definition are

excluded from the gross income of the recipient, so

that neither the owner of the contract nor the

(continued...)
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insurance contract, but before the death of the insured, is found

in section 72. 

Section 72 determines the taxation of amounts received under

annuity contracts, endowment contracts, and life insurance

contracts. Section 72 gives several rules for the tax treatment

of various types of amounts. How these rules apply to a

particular amount depends on (i) the type of payment (i.e.

whether the payment is received as an annuity, a part of a series

of payments over time); (ii) the type of contract (i.e. whether

the contract was an annuity contract, endowment contract, or life

insurance contract); and (iii) the time of payment (i.e. whether

the payment was made before or after a date referred to as the

annuity starting date7). 

If the type of payment is an annuity, the payment’s tax

treatment is governed by the rule of section 72(a). Payments

that are not received as an annuity are governed by section

72(e). Under section 72(e), the tax treatment of such nonannuity

6(...continued)

beneficiary of the contract is ever taxed on the inside

buildup * * * . 

H. Conf. Rept. 100-1104 (Vol. II), at 96 (1988), 1988-3 C.B. 473,

586.

7Generally, the annuity starting date is the latter of “the

date upon which the obligations under the contract became fixed”

or “the first day of the period (year, half-year, quarter, month,

or otherwise, depending on whether payments are to be made

annually, semiannually, quarterly, monthly, or otherwise) which

ends on the date of the first annuity payment.” Sec.

1.72-4(b)(1), Income Tax Regs.
- 14 -

amounts is governed by the general rule of section 72(e)(2),8

and, if applicable, the special rule of section 72(e)(5). The

special rule of section 72(e)(5) governs amounts received under a

life insurance contract. Sec. 72(e)(5)(C).

Here, the amount was received before Mr. Brown’s death, so

section 72 governs its tax treatment. The amount was not

received as an annuity, so section 72(e)--not section 72(a)--

governs its tax treatment. And the amount was received under a

life insurance contract, so the special rule of section 72(e)(5)

governs the tax treatment of the $37,365.06 Mr. Brown received. 

We turn next to how section 72(e)(5) affects the tax

treatment of the $37,365.06. Section 72(e)(5)(A) provides that

(A) In general. In any case to which this

paragraph applies--

(i) paragraphs (2)(B) and (4)(A) shall

not apply, and

(ii) if paragraph (2)(A) does not apply,

the amount shall be included in gross income, but

only to the extent it exceeds the investment in

the contract.

Two points of explanation are required. First, “[paragraph]

(2)(B)” is section 72(e)(2)(B), the general rule for amounts

received before the annuity starting date that are not received

as an annuity. Thus for amounts governed by the special rule of

8Under that general rule, sec. 72(e)(2)(A) governs amounts

received on or after the annuity start date and sec. 72(e)(2)(B)

governs amounts received before.
- 15 -

section 72(e)(5) that are received before the annuity starting

date, the general rule is expressly not applicable. Sec.

72(e)(5)(A)(i). Second, “paragraph (2)(A)” is section

72(e)(2)(A), the general rule for amounts received after the

annuity starting date that are not received as an annuity. Thus

an amount governed by the special rule of section 72(e)(5) to

which section 72(e)(2)(A) “does not apply” is included in gross

income to the extent it exceeds investment in the contract. Sec.

72(e)(5)(A). Mr. Brown received the $37,365.06 before the

annuity starting date, so section 72(e)(2)(A) “does not apply”. 

Thus under the special rule of section 72(e)(5), the $37,365.06

is included in gross income to the extent it exceeds Mr. Brown’s

investment in the contract. Sec. 72(e)(5)(A).

Section 72(e)(6) defines “investment in the contract”. 

Section 72(e)(6) provides:

For purposes of this subsection, the investment in the

contract as of any date is--

(A) the aggregate amount of premiums or

other consideration paid for the contract

before such date, minus

(B) the aggregate amount received under

the contract before such date, to the extent

that such amount was excludable from gross

income under this subtitle or prior income

tax laws.

Thus investment in the contract is (i) the total premiums or

other consideration paid minus (ii) the total amount (a) received

under the contract and (b) excludable from gross income.
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Mr. Brown’s investment in the contract was $8,271.76. He

paid total premiums of $44,205: $11,999 paid by check, $28,532

paid by loans, and $3,674 paid by applying dividends to premiums. 

Before terminating the contract, he received $35,933.24 that was

excludable from gross income: the $2,986.94 dividend payment in

2004; the $31,063.30 proceeds from the 2004 surrender of the

paid-up additional insurance; and the $1,883 dividend payment in

2005. Hence his investment in the contract was $8,271.76: the

$44,205 total premiums paid minus the $35,933.24 he had received

under the contract that was excludable from gross income.9

9Our calculation of Mr. Brown’s investment in the contract

does not include the dividends (up to 2003) that purchased paidup additional insurance (distinguished from the cash value of

that paid-up additional insurance on surrender) for two reasons. 

First, with the exception of dividends received in 1987, 1988,

and 1995, the record does not give the amounts of those

dividends. Second, as we explain below, regardless of the

amounts, those dividends did not affect Mr. Brown’s investment in

the contract. 

Investment in the contract is (i) the total premiums or

other consideration paid minus (ii) the total amount (a) received

under the contract and (b) excludable from gross income. Sec.

72(e)(6). The dividends used to purchase the paid-up additional

insurance--which were excludable from gross income--did not

affect Mr. Brown’s investment in the contract because the

dividends increased both the total premiums or other

consideration paid and the total amount received under the

contract and excludable from gross income by the same amount, the

amount of the dividends. 

For example, suppose a policyholder paid $10 in total

premiums for a life insurance contract. Suppose further that the

first amount the policyholder received under the contract was a

$1 dividend that the policyholder received before the annuity

start date and used to purchase paid-up additional insurance. 

Before the policyholder received the dividend, the policyholder’s

(continued...)
- 17 -

Thus under the special rule of section 72(e)(5), Mr. Brown

had gross income of $29,093.30, which is the amount by which the

$37,365.06 he received exceeded his $8,271.76 investment in the

contract. The IRS was therefore correct in determining that the

Browns were required to include $29,093.30 in gross income from

the termination of the Northwestern life insurance contract. 

The Browns contend that even if Mr. Brown received the

$37,365.06, the tax treatment of that amount is governed by

section 72(e)(2)(B) and that the $37,365.06 is not included in

gross income under section 72(e)(4)(B). We have already

explained why the special rule of section 72(e)(5)--not the

general rule of section 72(e)(2)--controls the tax treatment of

the $37,365.06. So the Browns are wrong. 

But even if they were right that section 72(e)(2)(B)

controlled, they would still be wrong: section 72(e)(4)(B) would

not exclude any part of the $37,365.06 from gross income. 

9(...continued)

investment in the contract would be $10, the $10 total

consideration paid minus the $0 received under the contract and

excludable from gross income. When the policyholder received the

dividend, it would be excludable from gross income because it

would be less than the policyholder’s investment in the contract

at the time (the $10 total consideration paid minus the $0

received under the contract and excludable from gross income). 

See sec. 72(e)(5)(A). After the policyholder received the

dividend, the policyholder’s investment in the contract would

still be $10, the $11 total consideration paid minus the $1

received under the contract and excludable from gross income. 

Thus dividends used to purchase paid-up additional insurance do

not affect the policyholder’s investment in the contract.
- 18 -

Section 72(e)(4)(B) provides that for purposes of section 72(e)(2)(B):

Any amount described in * * * [section 72(e)(1)(B)]

shall not be included in gross income under * * *

[section 72(e)(2)(B)(i)] to the extent such amount is

retained by the insurer as a premium or other

consideration paid for the contract.

An amount described in section 72(e)(1)(B) is “any amount

received which is in the nature of a dividend or similar

distribution”. Thus section 72(e)(4)(B) excludes from income

only amounts received that are in the nature of a dividend or

similar distribution. The $37,365.06 that Mr. Brown received was

not a dividend, was not in the nature of a dividend, and was not

a similar distribution. It was the cash value of the policy, and

it was unrelated to Northwestern’s divisible surplus. Moreover,

Northwestern did not retain the $37,365.06 to pay premiums but to

pay policy debt. So even if section 72(e)(2)(B) controlled--

which it does not--section 72(e)(4)(B) would not prevent any part

of the $37,365.06 from being included in gross income. 

As we have discussed, we agree with the IRS that the Browns

were required to include $29,093.30 in gross income from the

termination of the Northwestern life insurance contract. The IRS

contends that the tax required to be shown on the return was

$52,995 and that the deficiency in income tax was $8,553. This

$8,553 amount reflected on the notice of deficiency is equal to

the difference between the $52,995 required to be shown on the
- 19 -

return and the $44,442 supposedly shown as tax on the return. 

Yet the record shows that the amount of tax shown on the return

was not $44,442, but $43,763.67. The amount of the deficiency

reflected in the deficiency notice was therefore probably in

error; it probably understated the deficiency by several hundred

dollars. Even though the IRS may have presented evidence showing

that the correct amount of tax should be $52,995, and therefore

that the deficiency should be several hundred dollars more than

what is reflected on the deficiency notice, we question whether

we have jurisdiction to redetermine a deficiency of more than

$8,553. As explained below, we conclude that we lack such

jurisdiction. Section 6214(a) provides: 

Except as provided by section 7463, the Tax Court shall

have jurisdiction to redetermine the correct amount of

the deficiency even if the amount so redetermined is

greater than the amount of the deficiency, notice of

which has been mailed to the taxpayer, and to determine

whether any additional amount, or any addition to the

tax should be assessed, if claim therefor is asserted

by the Secretary at or before the hearing or a

rehearing.

Thus if the IRS asserts a greater deficiency than is reflected on

the notice and the IRS does so before the hearing or a rehearing,

we have jurisdiction to redetermine a deficiency or addition to

tax greater than the amount shown on the notice. See, e.g.,

Brooks v. Commissioner, T.C. Memo. 1975-295 (holding that the Tax

Court had jurisdiction to redetermine an increased deficiency

where the IRS asserted the higher deficiency in its answer),
- 20 -

affd. without published opinion 552 F.2d 367 (5th Cir. 1977). 

Here, the IRS failed to assert that the deficiency is greater

than $8,553, and we therefore lack jurisdiction to redetermine a

greater deficiency. See sec. 6214(a); see also Browning v.

Commissioner, T.C. Memo. 1991-93 n.3 (“Although the evidence

indicates a higher deficiency than determined on the notice of

deficiency, because respondent did not assert this higher amount

before trial, we are without jurisdiction to redetermine a

greater amount.”). We therefore uphold the IRS’s determination

that the Browns had a deficiency in tax of $8,553 for tax year

2005. The remaining issue is whether the Browns are liable for a

penalty.

II. Penalty

The IRS determined that the Browns were liable for the

accuracy-related penalty under section 6662. Section 6662 adds

to the tax 20 percent of any underpayment attributable to a

substantial understatement of income tax. 

Section 6662(d) defines “substantial understatement”. 

Generally, an “understatement” is the excess of tax required to

be shown on the return over the tax shown on the return. Sec.

6662(d)(2)(A); sec. 1.6662-4(b)(2), Income Tax Regs. An

understatement is substantial if it exceeds $5,000 and it exceeds

10 percent of the tax required to be shown on the return. Sec.

6662(d)(1)(A); sec. 1.6662-4(b)(1), Income Tax Regs.
- 21 -

A. The IRS Met Its Burden of Producing Evidence That the

Browns Are Liable for the Accuracy-Related Penalty.

The IRS bears the burden of producing evidence that the

taxpayer is liable for penalties. Sec. 7491(c). This burden is

satisfied if the IRS comes forward with “sufficient evidence

indicating that it is appropriate to impose the relevant

penalty.” Higbee v. Commissioner, 116 T.C. 438, 446 (2001). We

have upheld the IRS’s determination that the Browns understated

their income tax by $8,553, which exceeds both $5,000 and 10

percent of the tax required to be shown on the return.10 The IRS

has therefore met its burden of producing evidence showing that

the Browns are liable for the accuracy-related penalty. 

B. The Browns Have Not Proven That They Are Not Liable for

the Penalty.

Once the IRS satisfies its burden of production, the

taxpayers must prove they are not liable for penalties. Id. at

446-447. The taxpayer bears the burdens of both production and

proof regarding exceptions to the substantial understatement

penalty. See id. at 446 (stating that the IRS “need not

introduce evidence regarding reasonable cause, substantial

authority, or similar provisions”). The Browns have not

10As discussed above, the notice of deficiency states that

the Browns’ return showed tax of $44,442, but the tax shown on

the return is $43,763.67. To the extent the discrepancy might

increase the penalty, the IRS did not assert the issue. We

therefore lack jurisdiction to impose any additional amount. See

sec. 6214(a).
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satisfied their burden to show that they are not liable for the

penalty. And, as we explain below, they have not shown that any

of the exceptions to the substantial understatement penalty

applies to them.

i. Substantial Authority

If there is substantial authority for the taxpayer’s

treatment of an item on the return, the tax attributable to the

item is not included in the understatement. Sec. 6662(d)(2)(B);

sec. 1.6662-4(d)(1), Income Tax Regs. There is substantial

authority for the taxpayer’s treatment of an item if substantial

authority exists either (i) when the taxpayer files the return or

(ii) on the last day of the taxable year to which the return

relates. Sec. 1.6662-4(d)(3)(iv)(C), Income Tax Regs.

The Browns cite several sources as substantial authority: 

(i) section 72(e); (ii) Barr v. Commissioner, T.C. Memo.

2009-250; (iii) Atwood v. Commissioner, T.C. Memo. 1999-61; (iv)

a Field Service Advice Memorandum, and (v) an excerpt from Brody

et al., Insurance-Related Compensation, 386-3d Tax Mgmt. (BNA). 

As we explain below, these sources do not provide substantial

authority for the Browns’ position.

A position may have substantial authority if its support is

“a well-reasoned construction of the applicable statutory

provision.” Sec. 1.6662-4(d)(3)(ii), Income Tax Regs. But the
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Browns failed to give a well-reasoned construction of section

72(e). 

Judicial opinions can be substantial authority for a

taxpayer’s position. Sec. 1.6662-4(d)(3)(iii), Income Tax Regs. 

But neither opinion cited by the Browns (Barr v. Commissioner,

supra, and Atwood v. Commissioner, supra) supports their

position. In both cases we held that policy proceeds

constructively received through the payment of policy debt should

be included in gross income. See Barr v. Commissioner, supra;

Atwood v. Commissioner, supra. And even if those cases supported

the Browns, only Atwood could be “authority” for their position

because Barr--issued in 2009--did not exist when the Browns filed

their return. See sec. 1.6662-4(d)(3)(iv)(C), Income Tax Regs.

Finally, neither the Field Service Advice Memorandum nor the

treatise excerpt provides substantial authority. Section

1.6662-4(d)(3)(iii) and (iv)(A), Income Tax Regs., lists the

types of sources that are “authority” for the purpose of the

substantial authority exception. Neither a Field Service Advice

Memorandum nor a conclusion reached in a treatise is a source

that serves as “authority”. Yet the authorities underlying those

sources may still give rise to substantial authority if they are

“applicable to the facts of a particular case”. Sec.

1.6662-4(d)(3)(iii), Income Tax Regs. But the treatise and the

Field Service Advice Memorandum do not cite authorities other
- 24 -

than section 72, and we have already explained why section 72

does not support the Browns. Thus the authority underlying both

sources does not give rise to substantial authority.

The Browns have not shown that there was substantial

authority for their position.

ii. Reasonable Cause and Good Faith

If the taxpayer both (i) had reasonable cause for and (ii)

acted in good faith regarding part of the underpayment, no

penalty is imposed on that part. See sec. 6664(c)(1); sec.

1.6664-4(a), Income Tax Regs. The Browns argue that they did not

report the item because they believed that Northwestern based the

Form 1099-R on the theory that a debtor has a taxable gain when a

creditor cancels a debt, a theory that would not apply here

because Northwestern did not discharge the loan. But even if the

Browns’ mistake about why Northwestern reported income was

reasonable, the mistake was not reasonable cause for their

underpayment. One of the most important factors in demonstrating

reasonable cause and good faith is the extent of the taxpayer’s

effort to determine the proper tax liability. Sec.

1.6664-4(b)(1), Income Tax Regs. The Browns exerted little

effort. They understood correctly that there was no discharge of

debt. They therefore concluded that Northwestern’s information

return, which they misconstrued as having been based on a

discharge-of-debt theory, was wrong. Yet they did not research
- 25 -

the proper tax treatment of the transaction. They did not even

make the simple effort of asking Northwestern why it reported

income where there was no discharge of debt. And, finally, the

Browns’ experience, knowledge, and education weigh against them: 

both are licensed attorneys, and one has a master of laws degree

(LL.M.) in taxation. In short, the Browns have failed to show

that they had reasonable cause for and acted in good faith

regarding the underpayment.

We therefore find that the IRS correctly determined that the

Browns are liable for the substantial understatement penalty

under section 6662(a).

To reflect the foregoing,

Decision will be entered

for respondent.