Court Opinion

ID: 4337571
Source: CourtListenerOpinion
Date Created: 2018-11-14 03:26:34.166625+00
Date Added: 2024-06-11T14:46:54.020863
License: Public Domain

132 T.C. No. 15

                UNITED STATES TAX COURT

      GREGORY T. AND KIM D. BENZ, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 15867-07.                Filed May 11, 2009.

     In 2002 P-W elected to receive a series of
substantially equal periodic payments from her
individual retirement account (IRA) that qualified for
a statutory exception to the 10-percent additional tax
imposed on early distributions pursuant to sec.
72(t)(2)(A)(iv), I.R.C. Sec. 72(t)(4), I.R.C.,
provides that an employee who modifies a series of
periodic payments within the first 5 years (other than
by reason of the employee’s death or disability) is
liable for the 10-percent additional tax. In 2004 P-W
received distributions from her IRA for higher
education expenses pursuant to sec. 72(t)(2)(E),
I.R.C., in addition to the elected periodic payment
that qualified for a statutory exception to the 10-
percent additional tax. R determined that P-W no
longer qualifies for the periodic payment exception for
2004 because the distribution for higher education
expenses is an impermissible modification of her
election to receive a series of substantially equal
periodic payments.
                                 - 2 -

          Held: A distribution for higher education
     expenses is not a modification of P-W’s election to
     receive a series of substantially equal periodic
     payments.

     Howard S. Levy, for petitioners.

     Richard J. Hassebrock, for respondent.

                              OPINION

     GOEKE, Judge:   Respondent determined a Federal income tax

deficiency of $8,959 for 2004.    The deficiency results from the

imposition of the 10-percent additional tax under section 72(t)

on early distributions from an individual retirement account

(IRA).1   The sole issue for decision is whether a distribution

for qualified higher education expenses is an impermissible

modification of a series of substantially equal periodic

payments.   We hold that a distribution for qualified higher

education expenses is not a modification of a series of

substantially equal periodic payments.

                            Background

     This case was submitted to the Court fully stipulated

pursuant to Rule 122.   The stipulation of facts and the attached

     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
                               - 3 -

exhibits are incorporated herein by this reference.    Petitioners

resided in Ohio at the time the petition was filed.

      While employed by Proctor & Gamble, petitioner wife

maintained an IRA.   In January 2002 after separating from her

employment with Proctor & Gamble, petitioner wife made an

election to receive distributions from her IRA in a series of

substantially equal periodic payments.    This election included an

annual fixed distribution of $102,311.50 to be made on January 15

each year for a period based on petitioner wife’s life

expectancy.   On or before January 15, 2004, petitioner wife

received a $102,311.50 distribution from her IRA in accordance

with her election to receive a series of substantially equal

periodic payments.   During 2004 petitioner wife received two

additional distributions from the IRA:    A $20,000 distribution in

January 2004 and a $2,500 distribution in December 2004.

Petitioner wife had not attained age 59-1/2 when she received

these additional distributions.   Petitioner wife used the $20,000

and $2,500 distributions for qualified higher education expenses

as defined in section 72(t)(7) relating to her son’s college

expenses.   For 2004 petitioners spent $35,221.50 in qualified

higher education expenses for their son.

     Petitioners timely filed Form 1040, U.S. Individual Income

Tax Return, for 2004, reporting the $124,811.50 in distributions

from petitioner wife’s IRA during 2004.    Petitioners did not
                                - 4 -

report the 10-percent additional tax for an early withdrawal from

an IRA pursuant to section 72(t) with respect to any portion of

the distributions.   Petitioners attached Form 5329, Additional

Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored

Accounts, to their return and reported that the withdrawals were

not subject to any additional tax under section 72(t)(2).

     On June 22, 2007, respondent issued a notice of deficiency

to petitioners for 2004, determining a Federal income tax

deficiency of $8,959.    Respondent determined that $89,590 of the

$124,811.50 distributed from petitioner wife’s IRA was subject to

the 10-percent additional tax imposed by section 72(t)(1) on

early distributions.    Respondent determined that the exception

for qualified higher education expenses under section 72(t)(2)(E)

applied to the remaining $35,221.50.

                             Discussion

     In general, amounts distributed from an IRA are includable

in gross income as provided in section 72.    Sec. 408(d)(1).

Section 72(t) provides for a 10-percent additional tax on early

distributions from qualified retirement plans, unless the

distribution falls within a statutory exception.    Sec. 72(t)(1)

and (2).   Section 72(t)(2)(A)(iv) provides an exception from the

10-percent additional tax for distributions that are “part of a

series of substantially equal periodic payments (not less

frequently than annually) made for the life (or life expectancy)
                               - 5 -

of the employee or the joint lives (or joint life expectancies)

of such employee and his designated beneficiary”.2   If the series

of substantially equal periodic payments is modified within 5

years of the date of the first distribution (other than by reason

of death or disability), then the 10-percent additional tax will

be imposed retroactively on prior distributions made before the

taxpayer attains age 59-1/2 (referred to as the recapture tax),

plus interest.   Sec. 72(t)(4)(A)(ii)(I).   The recapture tax also

applies when a modification occurs after the initial 5-year

period but before the employee has attained age 59-1/2.   Sec.

72(t)(4)(A)(ii)(II).

     Independent from the equal periodic payment exception,

section 72(t)(2)(E) provides an exception from the 10-percent

additional tax for distributions for qualified higher education

expenses.   Section 72(t)(2)(E) provides:

     Distributions from individual retirement plans for
     higher education expenses.--Distributions to an
     individual from an individual retirement plan to the
     extent such distributions do not exceed the qualified
     higher education expenses (as defined in paragraph (7))
     of the taxpayer for the taxable year. Distributions
     shall not be taken into account under the preceding
     sentence if such distributions are described in

     2
      The Internal Revenue Service has provided three examples of
methods to determine a series of substantially equal periodic
payments for purposes of sec. 72(t)(2)(A)(iv). See Notice 89-25,
Q&A-12, 1989-1 C.B. 662, 666, modified by Rev. Rul. 2002-62, sec.
2.01, 2002-2 C.B. 710. Rev. Rul. 2002-62, sec. 2.02(e), 2002-2
C.B. at 711, provides specific instances that would cause a
modification to occur. They focus on tax-free additions to or
distributions from the account and are not applicable here.
                                - 6 -

     subparagraph (A), (C), or (D) or to the extent
     paragraph (1) does not apply to such distributions by
     reason of subparagraph (B).

By specifically creating an exception for distributions used for

higher education expenses, Congress recognized “it is appropriate

and important to allow individuals to withdraw amounts from their

IRAs for purposes of paying higher education expenses without

incurring an additional 10-percent early withdrawal tax.”     H.

Rept. 105-148, at 330 (1997), 1997-4 (Vol. 1) C.B. 319, 652.

Distributions for qualified higher education expenses serve one

of numerous purposes Congress identified as deserving special

treatment.    Those purposes include paying a tax levy, paying for

medical care, paying for health insurance during periods of

unemployment, and purchasing a first home.   Sec.

72(t)(2)(A)(vii), (B), (C), (D), and (F).

     Petitioner wife’s two additional distributions for qualified

higher education expenses were made within 5 years of the first

annual periodic payment and before petitioner wife had attained

age 59-1/2.   Respondent maintains that the two additional

distributions constitute an impermissible modification to the

periodic payment election under section 72(t)(4).   According to

respondent, the substantially equal periodic payment exception is

no longer effective for the 2004 distribution.   Respondent

concedes that $35,221.50 of the total 2004 distributions

satisfied the exception for qualified higher education expenses
                                 - 7 -

under section 72(t)(2)(E) and is not subject to the 10-percent

additional tax.

     The sole issue for decision is whether a distribution that

qualifies for a statutory exception to the 10-percent additional

tax under section 72(t)(1) constitutes a modification of a series

of substantially equal periodic payments triggering the recapture

tax under section 72(t)(4).    Respondent argues that an employee

who elects a series of substantially equal periodic payments is

not allowed any further distributions within the first 5 years of

the election irrespective of whether the distribution would

qualify for another statutory exception to the section 72(t) tax

unless the employee dies or becomes disabled.     Petitioners argue

that a distribution used for a purpose that qualifies for a

statutory exception is not a modification of a series of

substantially equal periodic payments that triggers the recapture

tax under section 72(t)(4).    In Arnold v. Commissioner, 111 T.C.

250, 255-256 (1998), the Court held that an additional

distribution that did not qualify for a statutory exception was

an impermissible modification to a series of substantially equal

periodic payments.     In Arnold, we stated:   “In order to avoid the

section 72(t) tax, petitioners must show that the November 1993

distribution falls within one of the exceptions provided under

section 72(t)(2)(A).    They have not done so.”    Id. at 255.   Today

we also recognize that distributions under section 72(t)(2)(E),
                                - 8 -

enacted in 1997 and after the year in issue in Arnold, do not

trigger the section 72(t) additional tax where the taxpayer

receives the distribution within 5 years after the taxpayer

begins receiving distributions under a series of substantially

equal periodic payments.

     The last sentence of section 72(t)(2)(E) recognizes that an

employee may qualify for more than one statutory exception to the

10-percent additional tax.    It provides that the amount of

distributions attributable to higher education expenses does not

take into account distributions described in subparagraph (A),

(B), (C), or (D).    Sec. 72(t)(2)(E).   If a distribution qualifies

for more than one statutory exception, the employee is exempt

from the 10-percent additional tax on the basis of the applicable

exception under subparagraph (A), (B), (C), or (D) and need only

rely on the higher education expense exception for the additional

amount of the distribution.    Subparagraph (A) includes the

periodic payments exception.    Similar language is included in

subparagraphs (B) (relating to distributions for medical

expenses) and (F) (relating to distributions for first home

purchases).   Sec. 72(t)(2)(B) and (F).    A modification occurs for

purposes of section 72(t)(4) when the method of determining the

periodic payments changes to a method that no longer qualifies

for the exception.    The legislative history explains the 5-year
                                - 9 -

prohibition of modifications to a series of substantially equal

periodic payments as follows:

     if distributions to an individual are not subject to
     the tax because of application of the substantially
     equal payment exception, the tax will nevertheless be
     imposed if the individual changes the distribution
     method prior to age 59 1/2 to a method which does not
     qualify for the exception. * * * For example, if, at
     age 50, a participant begins receiving payments under a
     distribution method which provides for substantially
     equal payments over the individual's life expectancy,
     and, at age 58, the individual elects to receive the
     remaining benefits in a lump sum, the additional tax
     will apply to the lump sum and to amounts previously
     distributed.

          In addition, the recapture tax will apply if an
     individual does not receive payments under a method
     that qualifies for the exception for at least 5 years,
     even if the method of distribution is modified after
     the individual attains age 59 1/2. Thus, for example,
     if an individual begins receiving payments in
     substantially equal installments at age 56, and alters
     the distribution method to a form that does not qualify
     for the exception prior to attainment of age 61, the
     additional tax will be imposed on amounts distributed
     prior to age 59 1/2 as if the exception had not
     applied.

H. Conf. Rept. 99-841 (Vol. II), at II-457 (1986), 1986-3 C.B.

(Vol. 4) 1, 457 (emphasis added).   The method of calculating

petitioner wife’s annual periodic payments will not change as a

result of the additional distributions for higher education

expenses.   Congress enacted the recapture tax under section

72(t)(4) to apply to prior distributions received under a series

of periodic payments where the employee fails to adhere to the

payment schedule elected for at least 5 years.   There is no

indication that Congress intended to disallow all additional
                             - 10 -

distributions within the first 5 years of the election to receive

periodic payments.

     The legislative purpose of the 10-percent additional tax

under section 72(t) is that “Premature distributions from IRAs

frustrate the intention of saving for retirement, and section

72(t) discourages this from happening.”   Dwyer v. Commissioner,

106 T.C. 337, 340 (1996) (citing S. Rept. 93-383, at 134 (1973),

1974-3 C.B. (Supp.) 80, 213) .   This legislative purpose is not

frustrated where an employee receives distributions for more than

one of the purposes that Congress has recognized as deserving

special treatment.

     We hold that a distribution that satisfies the statutory

exception for higher education expenses is not a modification of

a series of substantially equal periodic payments.   Because we

find that a distribution for higher education expenses is not a

modification, the 5-year rule prohibiting modifications except in

the case of death or disability is not violated.

     To reflect the foregoing,

                                              Decision will be

                                          entered for petitioners.