TAX COURT OPINION

Case: Patrick Edward Rady & Jonna E. Rady
Docket Number: 24547-17
Judge: Gale
Opinion Type: bench
Filed: 04/22/2019
Pages: 14

CT UNITED STATES TAX COURT WASHINGTON, DC 20217 PATRICK EDWARD RADY & JONNA E. RADY, Petitioners, ) ) ) ) v. ) Docket No. 24547-17. COMMISSIONER OF INTERNAL REVENUE, Respondent ORDER ) ) ) Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit to petitioners and to respondent a copy of the pages of the transcript of the proceedings of the above case before Judge Joseph H. Gale at Indianapolis, Indiana, on March 18, 2019, containing the Court's oral Findings of Fact and Opinion. In accordance with the oral Findings of Fact and Opinion, decision will be entered for respondent. (Signed) Joseph H. Gale Judge Dated: Washington, D.C. April 22, 2019 SERVED Apr 23 2019 Bench Opinion by Judge Joseph H. Gale March 18, 2019 Patrick Edward Rady & Jonna E. Rady v. Commissioner of 3 Internal Revenue Docket No. 24547-17 THE COURT: The Court has decided to render the following as its oral Findings of Fact and Opinion in this case. The oral Findings of Fact and Opinion shall not be relied upon as precedent in any other case. 1 2 3 4 5 6 7 8 9 10 This bench opinion is made pursuant to the 11 authority granted by section 7459(b) of the Internal 12 Revenue Code of 1986 as amended and Rule 152 of the Tax 13 Court Rules of Practice and Procedure. Unless otherwise 14 15 16 17 indicated, subsequent section references made in this bench opinion are to the Internal Revenue Code of 1986 as amended and in effect for the relevant period, and Rule references are to the Tax Court Rules of Practice and 18 Procedure. 19 By notice of deficiency dated August 28, 2017, 20 respondent determined a deficiency of $2,218 in 21 Petitioners' Federal income tax for the 2015 taxable year. 22 Respondent also determined that petitioners were liable 23 for an additional tax under section 72(t)(1) of $801. 24 Petitioners, while residing in Indiana, timely filed a 25 Petition. The issues for decision are whether EEIElB (973)406-2250|operations@escribers.netlwww.esaibersaet petitioners: (1) 4 received a taxable deemed distribution of $8,009 resulting from the reclassification of loans from petitioner Patrick Edward Rady's qualified employer plan account; and (2) are liable for an additional tax under section 72(t)(1) of $801. FINDINGS OF FACT The facts in this case have been fully stipulated pursuant to Rule 122. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. Petitioner Patrick Edward Rady (hereinafter 1 2 3 4 5 6 7 8 9 10 11 12 Petitioner) participated in a section 403(b) qualified 13 14 15 16 employer plan through his employer during all relevant years. The plan was administered by Metropolitan Life Insurance Company (MetLife). During the 2012, 2013, and 2015 taxable years, 17 petitioner received loans in the amounts of $5,025, 18 19 $1,125, and $5,125, respectively, from his qualified employer plan. The terms of the loans were set forth in 20 loan agreements signed by petitioner and approved by the 21 Plan administrator. (The record contains a copy of a 22 23 24 25 sample loan agreement secured by petitioner from MetLife in April 2015. While petitioner has not proffered signed copies of the loan agreements, we are satisfied that the terms of the sample agreement are the same as those that (9733406-2250}operations©escribersnet|www.escribersnet governed his loans.) Under the terms of the loan agreements, petitioner was required to make quarterly 5 payments. The loan agreements included a disclosure statement section with the following among its provisions: ******* 8. Loan Default: If I do not make a repayment by its due date, MetLife will notify me that my loan is in the process of being defaulted. I understand my entire remaining loan balance will default if MetLife does not receive a loan repayment by the 45th day after it is due and, under Code § 72 (p), will be treated as a taxable 1 2 3 4 5 6 7 8 9 10 11 12 13 deemed distribution to me for the year in which the grace 14 period ends. If I am under age 59 1/2, a 10% IRS tax 15 penalty may apply. 16 17 18 ******* The loans that petitioner received in 2012 and 2013 initially met the requirements of section 2 (p)(2) 19 and were not treated as distributions to petitioner from 20 21 22 23 24 25 2012 through 2014, and from 2013 through 2014, respectively. The loan that he received in 2015 also initially met the requirements of section 72(p) (2), and was not treated as a distribution to petitioner at the time it was made. During 2015 petitioner failed to make quarterly À cdbers (973)406-2250!operations@escribers.net jwwwesaibersaet 6 payments on the 2012, 2013, and 2015 loans as required by the loan agreements. Petitioner's 2012 loan was in default before June 19, 2015, and a MetLife loan statement dated September 21, 2015, covering the subsequent period from June 19, 2015 to September 19, 2015, reflects no loan payment activity for that period. The statement reflects a loan balance as of that date of $2,830.17. A MetLife loan statement dated August 24, 2015, warned petitioner that his 2013 loan would go into default if he failed to make the required payment within 45 days. The statement reflects a loan balance as of that date of $698.86. Petitioner did not make the required payment, and his 2013 loan went into default on October 8, 2015. Petitioner's first loan payment for the 2015 loan was due July 15, 2015. A MetLife loan statement dated September 21, 2015, covering the period from June 19, 2015, to September 19, 2015, reflects no loan payment 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 activity for that period. The statement reflects a loan 19 balance as of that date of $5,233. Petitioner's 2015 loan 20 went into default on August 31, 2015. 21 22 23 24 On December 18, 2015, petitioner wrote two checks to MetLife in the amounts of $5,300 and $2,900, respectively. MetLife issued petitioner a Form 1099-R, 25 Distributions from Pensions, Annuities, Retirement or From 4 N (973)406-2250|operations@escribers.net|vnvw.escribers.net Profit-Sharing Plans, IRAs, Insurance Contracts, etc., 7 for 2015 in the amount of $8,009. The Form 1099-R designated that amount as representing loans treated as deemed distributions under section 72(p). Petitioners did not report the income reported by MetLife as a deemed distribution on their timely filed joint Federal income tax return for 2015. During 2015 petitioner did not attain age 59. I. Burden of Proof OPINION Generally, the Commissioner's determination of a 1 2 3 4 5 6 7 8 9 10 11 12 deficiency is presumed correct, and the taxpayer bears the 13 burden of proving otherwise. Rule 142(a); Welch v. 14 Helvering, 290 U.S. 111, 115 (1933). For this presumption 15 to adhere in cases involving receipt of unreported income, 16 the Commissioner must provide some reasonable foundation 17 connecting the taxpayer with the income-producing 18 activity. Pittman v. Commissioner, 100 F.3d 1308, 1313 19 (7th Cir. 1996), aff'g T.C. Memo. 1995-243. Once the 20 Commissioner has produced evidence linking the taxpayer 21 with an income-producing activity, the burden of proof 22 shifts to the taxpayer to prove by a preponderance of the 23 evidence that the Commissioner's determinations are 24 arbitrary or erroneous. Pittman v. Commissioner, 100 F.3d 25 at 1314. (973)406-2250!operations@escribers.net|www.escribers.net The parties agree that petitioner received the 8 unreported income at issue in the form of loans from his qualified employer plan in 2012, 2013, and 2015, Respondent's determination is based on a Form 1099-R he received from MetLife reporting deemed distributions under section 72(p) of $8,009 to petitioner for 2015. In support of his determination, respondent has proffered a copy of petitioner's Wage and Income Transcript for 2015. The Wage & Income Transcript reflects that the 1 2 3 4 5 6 7 8 9 10 Form 1099-R issued by MetLife reported a gross 11 distribution of $8,009 and included a distribution code 12 indicating that the amount represented loans treated as a 13 deemed distribution under section 72(p). The Wage & 14 15 Income Transcript further reflects that MetLife categorized the amount as an early distribution with no 16 known exception to the additional tax under section 72(t), 17 18 19 and that the IRA/SEP/SIMPLE box on the Form 1099-R was not checked. We find that the Wage & Income Transcript 20 constitutes sufficient evidence connecting petitioner to 21 the unreported income in question, particularly in view of 22 petitioner's failure to deny that he received such income. 23 24 see Nelson v. Commissioner, T.C. Memo. 2018-95, at *5-*6 (finding that a notice of deficiency and wage and income 25 transcript indicating third-party payers paid the taxpayer (973)406-2250|operations@escribers.net|vnvw.escribers.net the amounts in question sufficiently connected him to an 9 income-producing activity); see also Parker v. Commissioner, 117 F.3d 785, 787 (5th Cir. 1997) ("The Commissioner has no duty to investigate a third-party payment report that is not disputed by the taxpayer."); Schaeffer v. Commissioner, T.C. Memo. 1994-206, 1994 WL 175736, at *3-*4 (rejecting the taxpayers' argument that it was arbitrary for the Commissioner to rely on third-party information in determining unreported income 1 2 3 4 5 6 7 8 9 10 where the taxpayers, among other things, "did not even 11 attempt to deny that they received the income in 12 question"). While it is unclear from the record how 13 MetLife arrived at the $8,009, petitioner conceded receipt 14 of this amount in his petition. Accordingly, we conclude 15 that respondent's notice of deficiency is entitled to the 16 presumption of correctness, and petitioner must come 17 forward with proof that respondent's determination is 18 arbitrary or erroneous *M4 that or the income is nontaxable. 19 20 21 II. Deemed Distribution If a participant or beneficiary receives a loan from a qualified employer plan, the amount of the loan is 22 generally treated as a taxable distribution in the year 23 received. Secs. 402(a), 72(p) (1) (A). However, this 24 general rule does not apply where the loan: (1) is 25 evidenced by a legally enforceable agreement; (2) does not JEMER (973)406-2250|operations@erribersnet|wwwescribersnet exceed a statutorily defined maximum amount; (3) by its 10 terms is to be repaid within five years (unless it is a home loan); and (4) has substantially level amortization over the term of the loan with payments made at least quarterly. Sec. 72 (p) (2); sec. 1.72(p)-1, Q&A-3, Income Tax Regs. If a loan fails to satisfy these requirements, a deemed distribution will occur at the first time those requirements are not satisfied, either in form or in operation. Sec. 1.72(p)-1, Q&A-4(a), Income Tax Regs. The burden is on the taxpayer to establish that the requirements of the section 72(p) (2) exception have been 1 2 3 4 5 6 7 8 9 10 11 12 met. Rule 142(a); Bormet v. Commissioner, T.C. Memo. 13 14 15 2017-201; Olagunju v. Commissioner, T.C. Memo. 2012-119. If a loan initially satisfies all four requirements, but one or more installment payments are not 16 made when due in accordance with the terms of the loan, 17 the failure to make such payments violates the level 18 amortization requirement of section 72(p) (2)(C). Sec. 19 1.72(p)-1, Q&A-10(a), Income Tax Regs.; Frias v. 20 Commissioner, T.C. Memo. 2017-139; Martinez v. 21 Commissioner, T.C. Memo. 2016-182; Owusu v. Commissioner, 22 T.C. Memo. 2010-186. Therefore, a deemed distribution 23 occurs at the time of the failure. Sec. 1.72(p)-1, 24 Q&A-4(a), Q&A-10(a), Income Tax Regs.; Frias v. 25 Commissioner, T.C. Memo. 2017-139; Martinez v. (973)406-2250!operations@escribers.net jwww,escríbersnet Commissioner, T.C. Memo. 2016-182; Owusu v. Commissioner, 11 T.C. Memo. 2010-186. The amount of the deemed distribution equals the entire outstanding balance of the loan (including accrued interest) at the time of the failure to make the required payment. Sec. 1.72(p)-1, Q&A-10(b), Income Tax Regs. However, the plan administrator may grant the participant a cure period. Sec. 1.72(p)-1, Q&A-10(a), Income Tax Regs. If the administrator does so, section 72(p) (2)(C) is not considered violated until the last day of the cure period. Id. The cure period may not extend past the last day of the calendar quarter following the calendar quarter in which the required installment payment was due. Id. The parties agree that petitioner's 2012, 2013, and 2015 loans were not distributions at the time the loans were made. Respondent argues that the loans became deemed distributions for 2015 when petitioner failed to 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 make the required quarterly payments and did not correct 20 those failures within the prescribed 45-day cure periods 21 under the loan agreements, thereby causing the loans to 22 violate the level amortization requirement of section 23 24 72(p) (2) (C). Petitioners do not dispute that petitioner failed to make the quarterly payments as required under 25 the loan agreements, or to cure those failures within the shum $73)406-2250loperationseescribetsmet|wwwesciibersaet prescribed 45-day grace periods, but they argue in the petition that petitioner repaid the loans in full by the end of the taxable year and that the loans are therefore 12 not properly includible in income for 2015. We agree with respondent. The parties agree that petitioner failed to make quarter payments during 2015 as required by the loan SW agreements for the 2012, 2013, and 2015 loans. With respect to the 2012 loan, the record reflects that 1 2 3 4 5 6 7 8 9 10 petitioner defaulted on the loan some time before June 19, 11 2015, and there is no evidence to suggest that he made any 12 Payment before December 18, 2015. With respect to the 13 2013 loan, the record reflects that petitioner was 14 notified on August 24, 2015, that if he did not make the 15 required quarterly payment within 45 days, he would 16 default on the loan. The parties agree that petitioner 17 18 failed to make the required payment, and there is no evidence to suggest that petitioner made any payment 19 before December 18, 2015. With respect to the 2015 loan, 20 21 the record reflects that petitioner's first payment was due July 15, 2015, and that he defaulted on the loan on 22 August 31, 2015. There is no evidence to suggest that he 23 made any payment on the 2015 loan before December 18, 2015. 24 25 Under the loan agreements, petitioner was } 51|ElllE (973)406-2250loperationseescribers.net|wwwæscribers.net required to make quarterly payments for each of 13 the loans. The record is clear that he failed to do so during 2015 and as a result fully defaulted on each of the loans. The loan agreements provided for 45-day cure periods, but petitioner failed to repay the loans within those periods. As noted, the regulations provide that the failure to make any installment payment when due in accordance with the terms of the loan violates the level amortization requirement of section 72(p)(2) (C). Sec. 1.72(p)-1, 1 2 3 4 5 6 7 8 9 10 Q&A-10(a), Income Tax Regs. Accordingly, we hold 11 Petitioner's failure to make quarterly payments as 12 13 14 15 required under the 2012, 2013, and 2015 loan agreements caused deemed distributions from his qualified employer plan under section 72(p) for each of the loans for 2015. See Frias v. Commissioner, T.C. Memo. 2017-139, at *7-*10; 16 Martinez v. Commissioner, T.C. Memo. 2016-182 at *6-*12; 17 Owusu v. Commissioner, T.C. Memo. 2010-186,slip op. at 7-10. III. Section 72 (t) Additional Tax A Section 72(t) (1) imposes a 10% additional tax on 18 19 20 21 early distributions from qualified retirement plans. The 22 10% additional tax applies when the distribution is a 23 deemed distribution under section 72(p). Sec. 1.72(p)-1, 24 Q&A-11(b), Income Tax Regs. Section 72(t) (2), however, 25 sets forth specific exceptions to the general rule that EEEE (973)406-2250|operations@escribers.net|www.escribersnet 14 1 2 3 4 5 6 7 8 9 the 10% additional tax applies, including where the distribution is made on or after the date on which the distributee attains age 59-1/2. Sec. 72(t) (2) (A) (i). The parties agree that petitioner received the distribution before age 59-1/2. Moreover, petitioners have not argued or shown that any other statutory exception applies, and we find no evidence in the record to suggest that one does. Rather, the preponderance of the evidence establishes that the distribution was a 10 deemed distribution resulting from petitioner's failure to 11 make quarterly payments as required by the loan 12 agreements. Accordingly, we sustain respondent's 13 determination as to the section 72(t) additional tax. See 14 Bormet v. Commissioner, T.C. Memo. 2017-201, at *8; Frias 15 16 v. Commissioner, T.C. Memo. 2017-139, at *14-*15; Martinez v. Commissioner, T.C. Memo. 2016-182, at *12-*13; Ryan v. 17 Commissioner, T.C. Memo. 2011-139, slip op. at 19, aff'd, 18 19 482 F. App'x 881 (5th Cir. 2012); Owusu v. Commissioner, T.C. Memo. 2010-186, slip op. at 10-12; Plotkin v. 20 Commissioner, T.C. Memo. 2001-71, slip op. at 11-12. IV. Coda 21 22 In view of petitioner's repayment in full of the 23 loans, the result reached herein may seem harsh. To that 24 point, we note that the regulations provide that where a 25 taxpayer repays a loan that is no longer a loan but rather (973)406-2250|operations@escribersmet|www.escribersnet a deemed distribution, he has tax basis in any cash repayments to his plan account. Sec. 1.72(p)-1, Q&A-21(a), Income Tax Regs.; see also Frias v. 15 Commissioner, T.C. Memo. 2017-139, at *14 n.11 (noting that a taxpayer had tax basis in any cash repayments to her 401(k) plan a,ccount where she paid off a defaulted loan that the Court determined was a deemed distribution). Consequently, these amounts will not be taxable when eventually distributed. To reflect the foregoing, decision will be entered for respondent. This concludes the Court's oral Findings of Fact and Opinion in this case. (Whereupon, at 10:45 a.m., the above-entitled matter was concluded.) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 (973)406-2250loperationseescribers.net|www.escribers.net