TAX COURT OPINION

Case: David William Pond & Allison Lee Pond
Docket Number: 27641-12
Judge: Gustafson
Opinion Type: bench
Filed: 12/04/2014
Pages: 21

RS UNITED STATES TAX COURT WASHINGTON, DC 20217 DAVID WILLIAM POND & ALLISON LEE POND, Petitioners, v. ) ) ) ) ) Docket No. 27641-12. COMMISSIONER OF INTERNAL REVENUE, Respondent ) ) ) ORDER Pursuant to the opinion of the Court as set forth in the pages of the transcript of the proceedings before Judge David Gustafson at Cincinnati, Ohio, on November 19, 2014, containing his oral findings of fact and opinion, it is ORDERED that the Clerk of the Court shall transmit herewith to petitioner and to respondent a copy of the pages of the transcript of the trial in the above case before Judge Gustafson at Cincinnati, Ohio, containing his oral findings of fact and opinion rendered at the trial session at which the case was heard. In accordance with the oral findings of fact and opinion, decision will be entered for respondent. (Signed) David Gustafson Judge Dated: Washington, D.C. December 4, 2014 SERVED Dec 05 2014 Capital Reporting Company 3 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Bench Opinion by Judge David Gustafson November 19, 2014 David *1-ltstrre Pond & Allison Lee pond v. Commissioner Docket No. 27641-12 The Court has decided to render the following as its oral Findings of Fact and Opinion in this case. This Bench Opinion is made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code, and Tax Court Rule 152; and it shall not be relied on as precedent in any other case. Petitioners Allison and David Pond filed a timely tax return for the year 2010. (Stip. 2, Ex. 1-J.) By a notice of deficiency dated August 13, 2012 (Stip. 3, Ex. 2-J), the Internal Revenue Service ("IRS") determined a deficiency in the Ponds' 2010 Federal income tax, plus an accuracy-related penalty. The case was tried in Cincinnati, Ohio, on November 18, 2014. The Ponds represented themselves, and respondent was represented by Angela J. Kennedy. The issues for decision are (1) whether and to what extend the Ponds received taxable income from the discharge of indebtedness, (2) whether the Ponds are entitled to a deduction for a contribution to a 25 Health Savings Account, and (3) whether the Ponds are 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company liable for the accuracy-related penalty. We hold in 4 favor of the IRS on all these issues. FINDINGS OF EACT In advance of trial the parties filed a comprehensive and helpful stipulation of facts, which is now in evidence pursuant to Rule 91(c) and is incorporated in this opinion by reference. Knowledge of those stipulated facts is presumed in this opinion, and we therefore recite the facts only summarily. The petitioners Petitioners David Pond and Allison Pond are both physicians. (Stip. 4, 28.) During their 1 2 3 4 5 6 7 8 9 10 11 12 13 14 medical studies, both incurred student loan debt. 15 16 17 18 19 20 21 22 (Stip. 9, 31.) Both did their medical residency at the Graduate Medical Education Program at Mount Carmel Health System ("MCHS")(Stip. 7, 33). MCHS MCHS is a non-profit corporation exempt from tax under section 501(a) and (c)(3). (Stip. 48, 50.) MCHS has a graduate medical education program that includes a fully-accredited three-year Family 23 Medicine Residency Program that was first established 24 25 in 1975. (Stip. 51-55.) For purposes of this case, respondent does not dispute that MCHS is an 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 5 "educational organization" for purposes of sections 170(b) (1) (A)(ii) and 108(f)(2). MCHS maintains a Physician Practice Assistance Program ("PPAP") (Stip. 56), under which program it made loans to both the Ponds (Stip. 13, 36). The principal issue in this case involves MCHS's forgiveness of portions of those loans. PPAP benefits MCHS's PPAP "provides[s] financial 1 2 3 4 5 6 7 8 9 10 assistance to attract physicians in underserved areas 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 of communities served by MCHS...as well as underserved areas in the surrounding regions ... in limited circumstances". (Ex. 20-J at 1.) This financial assistance took the form of two loan benefits relevant here that might be offered to a student completing MCHS's residency: First, the PPAP could make "Student Loan Payments" toward the student's existing student loan debt, which the student would then repay over a period of years. Second, the PPAP could make an "Income Advance", by which the PPAP advanced money to the new physician in installments over a two-year period, which the new physician would then repay over a period of years. (Ijd. at 2.) In pre-suit years, both of the Ponds received both of these kinds of loan benefits in the amounts and on 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 6 the dates that the parties have stipulated. (Stip. 21, 23, 42, 43.) Dr. David Pond received a student loan benefit in an amount greater than his actual student loans (see Stip. 32, 43), but we assume that the entire student loan amount he received from MCHS was for student loans, since that assumption does not change the outcome here. Under the PPAP, a physician's periodic obligation to make repayment of his or her loans could be "forgiven at the discretion of MCHS. Any forgiveness in such agreement shall be conditioned on the physician's continuation of practice in the MCHS Service Area and compliance with all of the other terms and conditions of the PPAP agreement." (Ex. 20- J at 2.) PPAP conditions The Ponds received PPAP loans and loan forgiveness because they complied with the PPAP terms. Under the PPAP, "Physicians must provide all reports required by MCHS from time-to-time in order to receive PPAP benefits. For example, in order to receive a monthly income advance payment, physicians 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 must submit an income. report requested by MCHS 24 25 personnel from time-to-time. The applicable MCHS finance department will diligently monitor the PPAP 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 7 1 2 3 benefits and any repayments required by physicians through the program. MCHS will issue all appropriate Form W-2s and Form 1099s to physicians in connection 4 with PPAP benefits provided and/or applicable 5 6 7 forgiveness. Finally, MCHS will diligently monitor compliance of all agreements by physicians receiving PPAP benefits. Without limiting the foregoing, MCHS 8 will ensure physicians practice in underserved 9 communities on a full-time basis, as applicable." 10 11 12 13 14 15 (Ex. 20-J at 3.) Furthermore, "A physician receiving PPAP benefits must agree to maintain medical staff privileges or maintain employment at a MCHS hospital facility or an affiliated facility throughout the term of his/her PPAP participation in order to meet community need and must agree to treat Medicare and 16 Medicaid beneficiaries." (Ex 20-J at 1.) See also 17 18 19 20 21 22 23 24 25 Ex. 5-J at 1-2, 5-6. However, the PPAP did not entitle MCHS to oversee or direct the Ponds' provision of medical services. Although they maintained staff privileges at an MCHS hospital, the Ponds never admitted a patient. The Ponds made to MCHS no accounting for, and did not consult with MCHS concerning, any of their diagnostic or treatment decisions. MCHS was entitled to no access to their records or patient 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 8 1 2 3 4 5 information. The conditions imposed by the PPAP related solely to business and financial considerations. In 2006 MCHS prompted a "Practice Assessment" of the Ponds' medical office, which involved an on-site visit by an evaluator; but the . 6 visit was by a Mr. (not Dr.) Scott Strager, and his 7 written report addressed non-medical issues such as 8 9 personnel, billing, recordkeeping, insurance, etc. The parties essentially agree that MCHS's involvement 10 with the Ponds' medical practice was business-related 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 and not medical. The Ponds' loan forgiveness benefits In the case of both of the Ponds, MCHS forgave the repayment obligations as expected. Each year MCHS issued Forms 2DCL to both Ponds (Stip. 25, 44), reporting as taxable income the entire loan forgiveness, i.e., both the student loan forgiveness and the income advance forgiveness. Dr. David Pond was dismayed at the effect of the reported taxable income on their tax liability; and his self- deprecating description of his response is that he frequently "whined" at MCHS about this characterization, but to no avail. He also "whined" to his return preparer accountant, pressing him for information, arguments, or strategies that might 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 9 1 2 3 4 5 6 7 8 9 10 11 12 13 14 reduce or eliminate this taxable income from their returns. The accountant finally dismissed him as a client because of his "whining" on this subject. In 2010, the year at issue, MCHS forgave a total of $48,525 for Dr. Allison Pond and $77,882 for Dr. David Pond. Of Dr. Allison Pond's total, $2,682 was characterized as student loan forgiveness (Ex. 8- J); and of Dr. David Pond's total, $12,413 was characterized as student loan forgiveness (Ex. 17-J); and the remainder of both totals was characterized as forgiveness of income advances. Dr. David Pond received his Form W-2 from MCHS as usual; but for reasons the Ponds do not know, Dr. Allison Pond did not receive a Form W-2 from MCHS. 15 Medical plan contributions 16 17 18 By means of payroll withholding by her employer in 2010, Dr. Allison Pond contributed toward two health expense-related accounts under the "Ohio 19 Healthy Medical Plan" administered by Aetna. One 20 21 22 account is identified on her pay stub as "Medical - PCA" (to which she contributed $2,595) and the other is identified as "FSA - Health Care Account" (to 23 which she contributed $130). "PCA" apparently stands 24 25 for "personal care account", and "FSA" stands for "flexible spending account". The organizing 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 10 1 2 3 4 5 6 7 8 9 documents for this plan were not offered into evidence, and Dr. Allison Pond indicated some uncertainty about what amounts of what kinds of expenses could be paid from these accounts. Income tax reporting Dr. David Pond prepared the couple's joint income tax return for 2010. On that return (Ex. 1- J), he duly reported the discharge of indebtedness income that MCHS had reported on his W-2. He did not 10 report such income for Dr. Allison Pond. From her 11 12 13 14 15 16 17 18 19 20 21 22 non-receipt of Form W-2, he inferred that she had no taxable income from forgiveness. He thought it might be possible that his "whining" had finally caused MCHS to change its treatment of the matter, or that perhaps his wife's forgiveness had been allocated to a later year and would be accounted for then. He did not inquire of MCHS to find out if his wife's non- receipt of Form W-2 was simply an accident or oversight, and he did not consult with any tax professional to learn any justification for reporting discharge of indebtedness income for himself but not reporting the equivalent income for his wife. 23 Rather, he evidently considered the non-receipt of 24 25 Form W-2 as decisive, and he did not report such income for her. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 11 1 2 On the return, Dr. David Pond also reported on line 24- a deduction of $2,595, the amount Dr. 3 Allison Pond had contributed by payroll withholding 4 5 6 7 for "Medical - PCA". On the return the deduction was labeled either "MSA" (for "medical savings account") or "HSA" (for health savings account"), and we are unable to tell which. 8 Notice of deficiency and petition 9 10 11 12 The IRS examined the Ponds' 2010 return. On August 13, 2012, the IRS issued a notice of deficiency (Ex. 2-J) that determined an increase of tax resulting from the proposed addition of Dr. 13 Allison Pond's discharge of indebtedness income and 14 15 16 17 18 19 20 21 22 23 24 25 the proposed disallowance of the claimed health savings account deduction. The IRS also determined that the Ponds are liable for an accuracy-related penalty under section 6662(a). On November 13, 2012, the Ponds timely filed their petition in this Court, commencing this case. The petition challenged the IRS's determinations and further asserted that Dr. David Pond's discharge of indebtedness should not be treated as taxable income. OPINION I. General evidentiary principles 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 12 1 2 3 4 5 6 7 As a general rule, the IRS's determination in the notice of deficiency is presumed correct, and the taxpayer has the burden of proof. See Rule 142(a)(1). The Ponds contend that the burden of proof has shifted to respondent under section 7491(a)(1), which applies "[i]f, in any court proceeding, a taxpayer introduces credible evidence 8 with respect to any factual issue"--but only on the 9 condition that "the taxpayer has complied with the 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 requirements under this title to substantiate any item", sec. 7491(a)(2) (A), and on the condition that "the taxpayer has maintained all records required under this title and has cooperated with reasonable requests by the Secretary for witnesses, information, documents, meetings, and interviews", sec. 7491(c)(2)(B). Petitioners did not make a showing that they satisfy these conditions. Moreover, as we discuss below, petitioners did not produce credible evidence to show their entitlement to the HSA deduction. As to the discharge of indebtedness issue, there is little actual dispute of fact, and we are able to determine the facts by the preponderance of the evidence. We hold that the burden of proof has not shifted. II. Discharge of indebtedness income 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 13 The general rule of section 61(a)(12) is that income from the discharge of indebtedness must be included in gross income. Petitioners invoke an exception in section 108(f)(1) that excludes income that results from the discharge of some student loans. We consider their arguments in light of the principle, stated by the Supreme Court, that exclusions from income must be narrowly construed. Commissioner v. Schleier, 515 U.S. 323, 328 (1995). A. Section 108(f) For certain "Student Loans" under certain conditions, section 108(f) excepts them from the general rule that discharge of indebtedness yields taxable income. The loan must be made "to assist the individual in attending an educational organization" like the medical school the Ponds attended. Sec. 108(f)(2). The loan must be from a certain sort of 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 entity (including an organization exempt under 20 21 22 23 24 25 section 501(c)(3), sec. 108(f)(2)(D)), and the IRS does not dispute that MCHS is such an entity. The doctor receiving the loan must practice in an area of "unmet needs", sec. 108(f)(2)(D)(ii), and the IRS does not dispute this qualification. The loan may be a "refinancing" of an education loan, as the 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 14 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 Ponds' loans from MCHS were. Sec. 108(f)(2) (flush language). The loan must be made as part of a program "under which the services provided by the student r former students) are for or under the direction of" a qualifying organization like MCHS. Sec. 108(f)(2)(D)(ii). B. Forgiveness of income advances. MCHS's forgiveness of the income advance loans made to the Ponds does not escape taxability under section 108(f) for the simple reason that these advances are not student loans. That is, the advances were not made "to assist the individual in attending an educational organization" but rather were made to someone who had finished his education, was no longer "attending an educational organization", and was no longer a student. The Ponds would achieve a different result by focusing on the phrase "any loan" as it appears in the flush language of section 108(f)(2)--i.e., "The term 'student loan' includes any loan made by" a qualified educational organization. But the sentence does not end there. Rather, it makes a specialized provision that "[t]he term 'student loan' includes any loan made by an educational organization ... to refinance a loan to an individual to assist the 866.488.DEPO www.Capita1ReportingCompany.com Capital Reporting Company 15 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 individual in attending any such educational organization". There is no reason to stop the sentence in mid-stream, as petitioners' argument requires. The Ponds also seem to make an additional argument: They point out that under the PPAP the amount of potential advances is measured by the operating the expenses of the new medical practice other than compensation for the doctor. From this fact they conclude that the forgiveness of those advances should not be taxable income to the doctor. This conclusion does not follow, either as a matter of logic or as a matter of statutory interpretation. As a logical matter, a loan for a doctor's medical practice's overhead expenses pays for expenses that he would otherwise have paid himself. (Moreover, there is every reason to suppose that, in the years they received the advances, the Ponds duly deducted for income tax purposes the expenses that those advances were intended to cover.) Even if an advance is not compensation above expenses, it is a benefit that ultimately and clearly enriches the doctor. And even if that were not so, the obligation to repay the advances is certainly an obligation of the doctor; and as a statutory matter, that is all we need to 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 16 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 know: The Ponds were obligated to repay those debts, however, they arose; and when instead the debts were discharged, section 61(a)(12) called for those amounts to be treated as income--unless a relevant statutory exception provides otherwise. C. Forgiveness of student loans As we have noted, the student loans at issue had many of the characteristics required to qualify for tax-free forgiveness under section 108(f). However, we find that they were not made as part of a program "under which the services provided by the students (or former students) are for or under the direction of" a qualifying organization like MCHS, as required by section 108(f)(2)(D)(ii). The services to be provided by MCHS's graduates are obviously medical services, so the question is 17 whether those medical services were provided "under 18 19 the direction" of MCHS. (The Ponds do not claim that their services were provided "for" MCHS, and they 20 plainly were not, since MCHS did not employ the 21 22 23 24 Ponds. (Stip. 60-61.)) The Ponds point to the aspects of their work as to which MCHS did provide "direction" to doctors in the PPAP. While that direction was not at 25 all negligible, it was--as the Ponds themselves 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 17 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 insist--entirely business-related. The Ponds themselves are quick to explain that, as trained and licensed professionals, they did not submit themselves to MCHS's instructions about diagnosis or treatment of patients nor make themselves accountable to MCHS's medical review. The relevant medical "services" were thus not "under the direction of" MCHS, and the loans therefore do not qualify under section 108(f). The Ponds argue for a looser construction of "direction". During closing argument after trial, we indicated some interest in and sympathy for this approach, since even a doctor employed by MCHS at one of its hospitals may take little direction from MCHS on strictly medical decisions; but we conclude that this construction fails for two reasons: First, the term "direction" seems to connote an authority over one's substantive work rather than over just his business methods. We find elsewhere in the Internal Revenue Code no instance of the phrase "under the direction" where anything but plenary authority is implied. See sec. 7404 ("the balance shall be paid under its direction to the person entitled thereto"); sec. 7456(a)(2) ("the testimony shall be reduced to 25 writing by the individual taking the deposition or 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 18 1 2 3 4 under his direction"); sec. 7609(e)(1) ("the agent, nominee, or other person acting under the direction or control of such person"); sec. 7651(2) (A) ("Such tax shall be collected under the direction of the 5 Secretary"). Second, the more problematic term for 6 petitioners' approach is "services". The services 7 over which MCHS had oversight were bookkeeping, 8 billing, expense-reporting, and the like. While such 9 functions are necessary for any medical practice, 10 they are hardly "the services provided by" the 11 medical professionals whose student loans are to be 12 13 14 15 16 17 forgiven. If it is true that, because doctors take so little medical "direction", this statute so interpreted gives limited benefit for doctors and their work, it must be observed that the statute applies not only to doctors and not even only to 18 medical professionals but broadly, and we do not let 19 20 21 22 23 24 25 the facts of this öne case dictate the meaning of the statute. D. Prior allowance The Ponds also seem to argue that they should prevail on this issue because the IRS and State tax authorities have previously allowed the non-inclusion of discharge of indebtedness in their 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 19 1 2 taxable income. They produced no documentary evidence at all to support this assertion, but it 3 matters not. What IRS or State officials may have 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 previously allowed, even if the facts were identical to ours and were fully disclosed to the authorities, does not affect the proper interpretation of the law nor estop the IRS from arguing correctly in this case (as it has). Just as the Ponds are free to take a position different from what they have taken in prior years, so the IRS is free to correct its position. We sustain the IRS's position that all of the discharged debt--both student loan and income advances--of both of the Ponds is taxable income that they were obliged to report on their return. III. HSA deductions A taxpayer must satisfy the specific requirements for any deduction he claims. See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Section 233(a) provides for a deduction for certain amounts paid "to a health savings account" ("HSA"). Section 233(d)(1) provides: "The term 'health savings account' means a trust created or organized in the United States as a health savings account exclusively for the purpose of paying the qualified medical expenses of the account 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 20 1 2 3 4 beneficiary, but only if the written governing instrument creating the trust meets the following requirements". Those "requirements" are stated in five subparagraphs in the statute, one of which has 5 multiple clauses and subclauses. If there is a 6 "written governing instrument" that created the Ohio 7 Healthy Medical Plan to which Dr. Allison Pond 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 contributed, it is not in the trial record. We cannot tell whether the plan or account to which she contributed is a qualifying health savings account that meets the statutory requirements, and we therefore must sustain the IRS's determination. IV. Penalty Subsection (a) of section 6662 imposes an accuracy-related penalty of 20 percent of any underpayment that is attributable to causes specified in subsection (b). Section 7491(c) imposes on respondent the burden of production with respect to petitioners' liability for that penalty. This means that respondent "must come forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty." Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Respondent meets that burden here: Among the causes justifying the imposition of the penalty is any "substantial understatement" of 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company income tax as defined in section 6662(d). There is a 21 "substantial understatement" of income tax for any taxable year where the amount of the understatement exceeds the greater of (1) 10 percent of the tax required to be shown on the return for the taxable year or (2) $5,000. Sec. 6662(d)(1)(A). The Ponds reported a tax liability of $22,891 (see Ex. 1-J), and the deficiency we uphold--$14,984--is much more than 10 percent of that reported amount and is obviously greater than $5,000. Respondent has thus made a showing that the Ponds are liable for the penalty. However, the penalty is not imposed if a taxpayer can demonstrate (1) that he had reasonable cause for the underpayment and (2) that he acted in good faith with respect to the underpayment. Sec. 6664(c)(1). Regulations promulgated under section 6664(c) further provide that the determination of reasonable cause and good faith "is made on a case- by-case basis, taking into account all pertinent facts and circumstances." 26 C.F. R. sec. 1.6664- .4(b)(1). Petitioners invoke this "reasonable cause" defense, but it does not carry the day. The only tax professional that Dr. David Pond had consulted 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 22 rightly insisted--over Dr. Pond's "whining"--that the loan forgiveness was taxable. MCHS likewise resisted his "whining" and rightly continued to treat it as taxable. Dr. David Pond admits that the only basis for his doing other than as these others had insisted was his wife's non-receipt of a Form W-2. We conclude that, in latching on to this non-event, Dr. David Pond was guided not by a genuine desire to report his tax correctly but by his careless and self-interested desire for this handy outcome. We therefore sustain the penalty that the IRS determined. Decision will be entered for Respondent. This concludes the Court's oral findings of Fact and Opinion in this case. (Whereupon, at 10:03 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 2 4 25 866.488.DEPO www.CapitalReportingCompany.com