TAX COURT OPINION

Case: William B. & Patricia Ludowese Ray
Docket Number: 17061-10
Judge: Marvel
Opinion Type: bench
Filed: 03/19/2012
Pages: 11

UNITED STATES TAX COURT WASHINGTON, DC 20217 WILLIAM B. & PATRICIA LUDOWESE ) ) RAY, ) ) ) Docket No. 17061-10. ) ) ) ) COMMISSIONER OF INTERNAL REVENUE, Respondent Petitioners v. ORDE R Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERD 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 L. Paige Marvel at St. Paul, Minnesota, on March 2, 2012, containing her oral findings of fact and opinion. In accordance with the oral findings of fact and opinion, decision will be entered for respondent. (Signed) L. Paige Marvel Judge Dated: Washington, D.C. March 19, 2012 M2 2 32012 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 Bench Opinion by Judge L. Paige Marvel March 2, 2012 Ray v. Commissioner Docket No.: 17061-10 3 The Court has decided to render.oral findings of fact and opinion in this case, and the following represents the Court's oral findings of fact and opinion. This bench opinion is made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code of 1986 as amended and Rule 152 of the Tax Court Rules of Practice and Procedure. Unless otherwise indicated, subsequent section references made in this bench opinion are to the Internal Revenue Code of 1986 as amended in effect for the relevant period, and Rule references are to the Tax Court Rules of Practice and Procedure. Petitioners William B. and Patricia Ludowese Ray appeared pro sese. Melissa J. Hedtke appeared on behalf of respondent. On April 26, 2010, respondent mailed to petitioners a notice of deficiency for 2007, in which he determined that petitioners are liable for an income tax deficiency of $39,121 and an accuracy-related penalty under section 6662 of $7,824. The income tax deficiency is attributable to petitioners' failure to report five premature distributions from their simplified employee pension individual retirement accounts (SEP IRA) during Heritage Reporting Corporation (202) 628-4888 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 2007 totaling $130,311. Although petitioners do not 4 dispute the adjustments giving rise to the tax deficiency, petitioners do dispute the·section 6662(a) accuracy- related penalty determination. Petitioners petitioned this Court for a redetermination claiming that they had reasonable cause for the.ir failure to report the premature distributions as income on their 2007 federal income tax return. Consequently, the only issue for decision is whether petitioners qualify for relief from the section 6662(a) accuracy-related penalty because they had reasonable cause for the underpayment of tax and acted in good faith with respect to the underpayment within the meaning of section 6664(c). FINDINGS OF FACT Some of the facts have been stipulated. The stipulations of fact are incorporated herein by this reference. When petitioners petitioned this Court, they resided in Minnesota. . During 2007 petitioners were involved in a whole-house renovation of their personal residence, a proj.ect that they had started in 2006 and which they expected to last approximately 9 months. Petitioners had moved to an apartment to facilitate the renovation process. Unfortunately, things went dramatically wrong with the renovation, which resulted in considerable Heritage Reporting Corporation (202) 628-4888 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 additional cost, time, and stress to petitioners. Although petitioners blame their contractor for the problems, we need not tackle the reason for the horrible problems petitioners encountered. It is enough to say that the renovation problems were difficult, time- consuming, expensive, and stressful. Because of the renovation problems, petitioners decided to take five premature distributions from their retirement accounts, which they maintained at RBC Dain Rauscher (RBC). Mr. Ray's distributions totaled $44,195.07, and Ms. Ray's distributions totaled $86,116.62. RBC issued a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing.Plans, IRAs, Insurance Contracts, etc., to each petitioner reflecting the total retirement distributions received by each petitioner during 2007. Petitioners maintain that they did not receive the Forms 1099-R before they filed their 2007 Federal income tax return on October 18, 2008. RBC made the distributions after petitioners had signed completed distribution request forms. The forms confirmed that the distributions were premature and subject to a 10-percent addition to tax on early distributions and also reflected that.petitioners had elected not to have any Federal or State income tax withheld from the distributions. Heritage Reporting Corporation (202) 628-4888 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 During 2007 Ms. Ray owned and operated a business, Ray Ink, LLC, that provided marketing and advertising services. Mr. Ray also worked in the business. The business experienced a substantial decrease in gross revenue during 2007, which complicated petitioners' already difficult financial circumstances. Although petitioners had 2m obligation to make estimated tax payments with respect to their business income for 2007, they did not do so. At some point during 2008, Ms. Ray collected and organized information for petitioners' 2007 tax return. She collected the various information returns petitioners had received, such as Forms 1099 (other than the Forms 1099-R) and Forms 1098, Mortgage Interest Statement. She summarized the income and expense information for her business. She did not open the envelopes containing the Forms 1099 before she provided the summaries and the information returns to the accounting firm, William Mork & Company, Ltd., which had prepared their returns for several previous years. Petitioners did not inform the accounting firm or the person in the firm with whom they were dealing, Andrea Lahti, that they had received premature retirement distributions during 2007 in any amount nor did they furnish to the accounting firm any information or records, Heritage Reporting Corporation (202) 628-4888 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 such as RBC account statements, that might have put the return preparer on notice that petitioners had received substantial premature distributions during 2007. When the accounting firm completed the 2007 Federal income tax return, petitioners did not examine the 7 return in any detail before signing and filing it. The first page of the 2007 return showed total income of $98,138, including $97,649 of Schedule C, Profit or Loss From Business, net income, and zero IRA distributions. The second page showed adjusted gross income of $80,963, total itemized deductions of $72,451, and taxable income of $1,712. The return also.reflected a total tax liability of $13,797 that consisted entirely of self- employment tax, a section 6654 addition to tax for.failure to pay estimated tax of $628, a $7,000 payment made with a request for extension to file, and an unpaid tax liability of $7,425. Attached to the return was a Form 9465, Installment Agreement Request, by which petitioners requested an installment.agreement proposing to pay their reported but unpaid 2007 liability at the rate of $130 per month. Sometime before July 22, 2010, petitioners were contacted by the Internal Revenue Service about the unreported premature distributions from their SEP IRAs during 2007. On April 26, 2010, respondent Heritage Reporting Corporation (202) 628-4888 issued the 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 8 notice of deficiency for 2007. On July 22, 2010, petitioners submitted a Form 1040X, Amended U.S. Individual Income Tax Return, which, among other things, increased their taxable income by the amount of the premature di.stributions received during 2007. The amended return showed a total tax liability for 2007 of $52,587, which included, among other items, $13,032 of additional tax on early distributions under section 72(t), as well as a section 6654 addition to tax for failure to pay estimated.income tax of $2,393, and a total underpayment remaining of $38,790. OPINION Respondent determined that petitioners are (cid:16)042 liable for the accuracy-related penalty under section 6662(a) and (b) (2) because there was a substantial understatement of income tax. Section 6662(a) and (b) (2) authorizes the Commissioner to impose a 20-percent penalty if there is a substantial understatement of income tax. An understatement is substantial in the case of an individual if the amount of the understatement for the taxable year exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000. Sec. 6662(d) (1) (A). Respondent bears the burden of production with respect to petitioners'' liability for the section 6662(a) Heritage Reporting Corporation (202) 628-4888 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 penalty and must produce sufficient evidence indicating that it is appropriate to impose the penalty. See sec. 7491(c). Once respondent meets his burden of production, petitioners must come forward with persuasive evidence that respondent's determination is incorrect or that petitioners had reasonable cause or substantial authority for their position. See Higbee v. Commissioner, 116 T.C. 438, 447 (2001). Respondent has met his burden of production. The parties agree on the amount of the understatement, and the amount of the understatement was substantial. Because respondent has met his burden of production, petitioners must produce sufficient evidence to prove that respondent's determination is incorrect. See id. at 446-447. Section 6664 (c) (1) provides an exception to the section 6662(a) accuracy-related penalty with respect to any portion of an underpayment if the taxpayer shows that there was reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion. The determination of reasonable cause and good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances. See 1.6664-4(b) (1), Income Tax Regs. The most important factor is the extent of the taxpayer's effort to assess the proper tax liability. For the reasonable cause exception to Id. Heritage Reporting Corporation (202) 628-4888 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 apply, the taxpayer must prove that he exercised ordinary 10 business care and·prudence as to the disputed item. See Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 98 (2000), aff'd, 299 F.3d 221 (3d Cir. 2002).. Petitioners bear the burden of proving.that they meet the requirements for relief under section 6664 (c) (1). See Higbee v. Commissioner, 116 T.C. at 446-447. Petitioners argue that they should not be liable for the penalty because they qualify for the reasonable cause exception under section 6664 (c) (1). Petitioners contend that they did not receive the Forms 1099 with respect to the unreported early distributions and that they repaid some distributions and therefore believed that the Forms 1099 accurately reflected the distribution amounts. We sympathize with petitioners and understand that they were distracted with the problems with renovation which caused stress and financial difficulties. However, the credible evidence falls far short of establishing that petitioners had reasonable cause for the underpayment or acted in good faith in attempting to file an accurate return. The alleged nonreceipt of the Forms 1099 provides no basis for the reasonable cause exception. When Ms. Ray assembled information for the return preparer, she did not open the envelopes with the Forms Heritage Reporting Corporation (202) 628-4888 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 1099 that they did receive to ensure that she had all of 11 the Forms 1099. Even if petitioners did not receive the Forms 1099, they knew the amounts of the distributions and that the distributions were taxable. They filled out forms authorizing the distributions on which they indicated that no income tax should be withheld. Petitioners also contend that an accounting firm prepared their return and that they, petitioners, gave all information to the return preparer. Generally, reliance upon the advice of a tax professional may establish reasonable cause and good faith for the purpose of avoiding liability for the section 6662(a) penalty. See United States v. Boyle; 469 U.S. 241, 250 (1985). Reliance on a tax professional is not an "absolute defense", but merely "å factor to be considered." Freytag v. Commissioner, 89 T.C. 849, 888 (1987), aff',d, 904 F.2d 1011 (5th Cir. 1990), aff'd, 501 U.S. 868 (1991). Whether reasonable cause exists when a taxpayer has relied on a tax professional to prepare a return must be determined on the basis of all of the facts and circumstances. See Neonatology Assoc ate P.A. v. Commissioner, 115 T.C. at 98. The taxpayer claiming reliance on a tax professional must prove by a preponderance of evidence that the adviser was a competent professional who had sufficient expertise to justify reliance, that the taxpayer provided all Heritage Reporting Corporation (202) 628-4888 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 necessary and accurate information to the adviser, and 12 that the taxpayer relied in good faith on the adviser's judgment. Id. at 99. Reliance on a return preparer is not reasonable where even a cursory review of the return would reveal inaccurate entries. See Pratt v. Commissioner, T.C. Memo. 2002-279. .Petitioners did not provide all information to the tax preparer. Petitioners did not ensure they had all the Fqrms 1099 among the information Ms. Ray took to the return preparer nor did they.alert the return preparer about the substantial early distributions they ,took in 2007. In addition, the amount of the distributions was substantial.relative to other income, and a prudent person exercising ordinary care would notice, upon even a cursory review, that the return was inaccurate. Under such circumstances, we conclude that the reasonable cause exception does not apply. Accordingly, we sustain respondent's determination of the section 6662(a) penalty. . To reflect the foregoing, the decision will be entered for respondent. .This concludes the Court's oral findings of fact and opinion in this case. (Whereupon, at 4:12 p.m., the bench opinion in the above-entitled matter was concluded.) // Heritage Reporting Corporation (202) 628-4888