Court Opinion

ID: 4337981
Source: CourtListenerOpinion
Date Created: 2018-11-14 03:39:13.97155+00
Date Added: 2024-06-11T08:47:33.364844
License: Public Domain

T.C. Memo. 2010-20

                      UNITED STATES TAX COURT

           GREGORY A. AND CAROLYN S. PROUGH, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent

     Docket No. 11114-07.               Filed February 3, 2010.

     Edith F. Moates, for petitioners.

     Huong T. Bailie, for respondent.

                         MEMORANDUM OPINION

     KROUPA, Judge:   Respondent determined an $8,700 deficiency

in petitioners’ Federal income tax and a $1,740 accuracy-related

penalty under section 66621 for 2004.    We are asked to decide

whether distributions petitioner husband (petitioner) received

     1
      All section references are to the Internal Revenue Code in
effect for 2004, and all Rule references are to the Tax Court
Rules of Practice and Procedure, unless otherwise indicated.
                                  -2-

from his retirement accounts are subject to the 10-percent

additional tax on early distributions if they fail to qualify for

the exception for substantially equal periodic payments under

section 72(t)(2)(A)(iv).    We find that they are subject to the

additional tax.    We are also asked to decide whether petitioners

are liable for the accuracy-related penalty under section

6662(a).    We hold that they are.

                             Background

     This case was submitted fully stipulated under Rule 122.

The stipulation of facts and the accompanying exhibits are

incorporated by this reference.      The facts are so found.

Petitioners resided in Nevada at the time they filed the

petition.

     Petitioner was born in 1951.       He retired from Southwestern

Bell Telephone in 2003 when he was 52 and received almost $1

million of lump-sum distributions from qualified retirement

plans.   The lump-sum distributions consisted of $37,025,2

$13,296, $669,665, and $187,857.      He rolled over the

distributions tax free to qualified individual retirement

annuities from Jefferson National Life Insurance (Jefferson

National annuity) and Nationwide Life Insurance Company

(Nationwide annuity) in 2003.    Petitioner had a life expectancy

     2
      All monetary amounts are rounded to the nearest dollar.
                                -3-

of 32.3 years at that time.   See sec. 1.401(a)(9)-9, Q&A-1,

Income Tax Regs.

The Jefferson National Life Insurance Annuity

     Petitioner rolled over the $669,665 distribution to the

Jefferson National annuity.   The annuity contract contained an

individual retirement annuity (IRA) endorsement (IRA endorsement)

providing that the contract is governed by section 408(b).     An

IRA endorsement meant that early distributions would be subject

to the 10-percent additional tax under section 72(t).

     Petitioner signed a One-Time or Systematic Partial

Withdrawal Request Form (withdrawal form) approximately one week

after entering into the Jefferson National annuity contract.     The

withdrawal form, prepared by Aspen Retirement Planning Services

(Aspen Retirement), authorized monthly distributions of $5,600

from the Jefferson National annuity.   The record does not

indicate how the $5,600 monthly distribution amount was

determined.   The withdrawal form indicates, however, that the

distributions qualify for section 72(t).   Jefferson National

started making the $5,600 monthly distributions to petitioner on

August 17, 2003.   The Jefferson National annuity had a fair

market value of $716,676 as of the end of 2003.

     Petitioner signed another withdrawal form on February 4,

2004, authorizing a one-time “hardship withdrawal” of $45,000

from the Jefferson National annuity.   Petitioners concede that
                                -4-

the $45,000 hardship withdrawal distribution is subject to the

10-percent additional tax for early distributions even though

they failed to report the additional tax on the return for 2004.

     Jefferson National issued to petitioners a Form 1099-R,

Distributions from Pensions, Annuities, Retirement or Profit-

Sharing Plans, IRAs, Insurance Contracts, etc. (1099-R), for 2004

reporting a gross distribution of $112,200 from the annuity.    The

gross distribution amount for 2004 included the $45,000 hardship

withdrawal and $67,200 of systematic partial withdrawal payments

(the $5,600 monthly amount times 12 months).   The 1099-R

indicated that the distribution was from an “IRA/SEP/SIMPLE” and

listed a distribution code of “1” indicating that it was an early

distribution for which there was no known exception to the

additional tax.   See IRS Announcement 2004-3, 2004-1 C.B. 294.

Petitioners reported the total distribution on the return for

2004 but failed to report that any portion was subject to the

additional tax.

Nationwide Life Insurance Company

     Petitioner rolled over $170,000 of the distributions to the

Nationwide annuity.   The Nationwide annuity contract contained an

IRA endorsement providing that the contract is governed by

section 408(b).   The Nationwide annuity contract also contained a

separate IRA Disclosure Statement advising that early

distributions would be subject to the 10-percent additional tax.
                                 -5-

     Petitioner signed a withdrawal form approximately one week

after entering into the annuity contract with Nationwide.   The

withdrawal form, prepared by Aspen Retirement, authorized monthly

distributions of $1,400 from the Nationwide annuity.    The record

does not indicate how the $1,400 monthly amount was calculated.

Nationwide determined that a maximum of $757 could be withdrawn

per month if the distributions were to qualify for an exception

to section 72(t).   Nationwide started making the $1,400 monthly

distributions to petitioner on August 17, 2003.   The Nationwide

annuity had a fair market value of $172,820 at the end of 2003.

     Nationwide issued to petitioners a 1099-R for 2004 reporting

a gross distribution of $16,800 (the $1,400 monthly amount times

12 months).   The 1099-R indicated that the distribution was from

an “IRA/SEP/SIMPLE” and listed a distribution code of “1”

indicating that it was an early distribution for which there was

no known exception to the additional tax.   See IRS Announcement

2004-3, supra.    Petitioners reported the distribution on the

return for 2004 but failed to report that it was subject to the

additional tax.
                                -6-

The Return for 2004

     Petitioners reported taxable pensions and annuities totaling

$136,000 on the return for 2004.3     Petitioners reported that only

$49,000 of the $136,000 constituted an early distribution and

reported additional tax of $4,900.     The record does not indicate

how petitioners determined the taxable amount.     Respondent issued

petitioners a deficiency notice determining that the entire

distribution constituted an early distribution and therefore

determined an $8,700 deficiency.    The deficiency notice also

determined the accuracy-related penalty based on substantial

understatement of income tax.   Petitioners timely filed a

petition to contest the determinations in the deficiency notice.

                            Discussion

     We are asked to determine the taxability of distributions

petitioner received in 2004 when he was 52 years old.     Section

72(t) imposes a 10-percent additional tax on early distributions

from a retirement plan because they “frustrate the intention of

saving for retirement, and * * * [the additional tax] 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).   We are asked to decide whether the

distributions petitioner received qualify for an exception to the

     3
      Petitioners also received a $7,000 distribution from a
Fiserv Securities, Inc. account for which they concede they are
liable for the 10-percent additional tax on early distributions.
                                -7-

10-percent additional tax on early distributions under section

72(t) and whether petitioners are liable for the section 6662(a)

accuracy-related penalty.   We address each of these issues in

turn.

I.   10-Percent Additional Tax for Early Distribution

      Respondent argues that petitioner is liable for the 10-

percent additional tax on early distributions because petitioner

was under 59-1/2 years of age at the time he received the

distributions and the distributions do not qualify for an

exception under section 72(t)(2).     Petitioners argue that section

72(q), rather than section 72(t), applies to the distributions

because the distributions were from annuities.    Petitioners fail

to distinguish between nonqualified and qualified annuity

contracts, however, which are treated under different sections of

the Code.4   The distinction is irrelevant here, though, because

      4
      Sec. 72(q) provides for a 10-percent additional tax on
early distributions from nonqualified annuity contracts while
sec. 72(t) provides for the additional tax on early distributions
from qualified retirement plans described in sec. 4974(c).
Individual retirement annuities described in sec. 408(b)
constitute qualified retirement plans under sec. 4974(c), and are
thus subject to the additional tax for early distribution under
sec. 72(t). Sec. 72(t) applies here because the Jefferson
National and Nationwide annuities were qualified individual
retirement annuities under sec. 408(b). Furthermore, petitioners
are estopped under the duty of consistency from arguing that the
annuities were nonqualified. See Estate of Ashman v.
Commissioner, T.C. Memo. 1998-145, affd. 31 F.3d 41 (9th Cir.
2000). Accordingly, we will apply sec. 72(t), rather than sec.
72(q), to determine whether the distributions qualify for an
exception to the additional tax.
                                -8-

the section 72(q) exception claimed by petitioners also appears

in section 72(t).   See IRS Notice 2004-15, 2004-1 C.B. 526.

     A 10-percent additional tax is generally imposed on a

distribution from a qualified retirement plan to a taxpayer who

has not reached the age of 59-1/2.    Sec. 72(t)(1), (2)(A)(i).

There are some exceptions to the additional tax, however, and

taxpayers bear the burden of proving that a particular exception

applies.   Bunney v. Commissioner, 114 T.C. 259, 265 (2000).

There is an exception for distributions that are part of a series

of substantially equal periodic payments made for the life or

life expectancy of the taxpayer or the joint lives or joint life

expectancies of the taxpayer and his designated beneficiary.

Sec. 72(t)(2)(A)(iv).   Petitioners argue that the monthly

distributions from the Jefferson National and Nationwide

annuities qualify for this exception.    We disagree.

     The Internal Revenue Service has issued guidance that

amounts calculated under one of three methods (the IRS Notice 89-

25 methods) may qualify for the exception.    IRS Notice 89-25,

Q&A-12, 1989-1 C.B. 662, 666.   Additionally, this Court has held

that conforming to one of the IRS Notice 89-25 methods may

relieve a taxpayer of the 10-percent additional tax.    See Arnold

v. Commissioner, 111 T.C. 250, 252 n.1 (1998).    The IRS Notice

89-25 methods include: (1) the required minimum distribution

method, (2) the fixed amortization method, or (3) the fixed
                                 -9-

annuitization method.5   See IRS Notice 89-25, Q&A-12, supra; Rev.

Rul. 2002-62, 2002-2 C.B. 710.   Each of these three methods takes

into account the taxpayer’s life expectancy.     See IRS Notice 89-

25, Q&A-12, supra.

     Petitioners have failed to prove that the distribution

amounts were based on any of the IRS Notice 89-25 methods.      The

record does not identify which, if any, method Aspen Retirement

used in calculating the amount of distributions.    In fact, the

monthly distributions petitioner received were more than double

the maximum amounts determined by respondent under the fixed

amortization and fixed annuitization methods.6    Petitioners

     5
      Maximum payments under the fixed amortization method are
determined by amortizing the account balance over the taxpayer’s
life expectancy at a reasonable interest rate. Rev. Rul. 2002-
62, sec. 2.01(b), 2002-2 C.B. at 710. Maximum payments under the
fixed annuitization method are determined by dividing the account
balance by an annuity factor based on the taxpayer’s life
expectancy and a reasonable interest rate. Id. sec. 2.01(c),
2002-2 C.B. at 710. A reasonable interest rate for each method
is not more than 120 percent of the Federal midterm rate
determined in accordance with sec. 1274(d) for either of the two
months preceding the month in which the distribution begins. Id.
sec. 2.02(c), 2002-2 C.B. at 711.
     6
      Respondent applied interest rates of 3.68 percent and 3.06
percent, reflecting 120 percent of the Federal midterm rates for
June 2003 and July 2003. See Rev. Rul. 2003-60, 2003-1 C.B. 987,
988; Rev. Rul. 2003-71, 2003-2 C.B. 1, 2. Respondent determined
the maximum monthly distribution amount from the Jefferson
National annuity under the fixed amortization method was $2,981
per month and the maximum monthly amount under the fixed
annuitization method was $2,963. Respondent determined the
maximum monthly distribution amount from the Nationwide annuity
under the fixed amortization amount was $757 per month, and the
maximum monthly amount under the fixed annuitization method was
                                                   (continued...)
                                -10-

assert that Aspen Retirement based the monthly distributions on a

10-percent annual rate of return for variable annuities but have

not established that a 10-percent rate of return is reasonable.

In comparison, a reasonable rate of return for annuity

distributions beginning in August 2003 under either the fixed

amortization or fixed annuitization methods would be 3.06 percent

or 3.68 percent.    See Rev. Rul. 2002-62, sec. 2.02(c), 2002-2

C.B. at 711; Rev. Rul. 2003-60, 2003-1 C.B. 987, 988; Rev. Rul.

2003-71, 2003-2 C.B. 1, 2.    Petitioners also claim that the

distributions were calculated so as to continue over petitioner’s

lifetime without depleting the account.    Petitioners have not

provided any documentation or testimony from Aspen Retirement

explaining what factors they considered in determining the

distribution amount for either annuity.

     Furthermore, it is unclear how the distributions could have

been substantially equal periodic payments made for petitioner’s

life expectancy, given the annuity account balances and

petitioner’s age and life expectancy in 2003.    Petitioner was 52

years of age and had a life expectancy of 32.3 years at the time

the distributions commenced in 2003.    See sec. 1.401(a)(9)-9,

Q&A-1, Income Tax Regs.7   The Jefferson National annuity had a

     6
        (...continued)
$752.
     7
        The single life expectancy table found at sec. 1.401(a)(9)-
                                                     (continued...)
                                 -11-

value of $716,676 and the Nationwide annuity had a value of

$172,820 at the end of 2003.     Petitioner could receive

distributions of only $1,849 per month from the Jefferson

National annuity, rather than $5,600, to avoid depleting the

account during his lifetime.8    Similarly, petitioner could

receive monthly distributions of only $425, rather than $1,400,

from the Nationwide annuity.

      Accordingly, we conclude that petitioners have not shown

that the distributions from the Jefferson National and Nationwide

annuities were substantially equal periodic payments exempt from

the additional tax under section 72(t).

II.   Accuracy-Related Penalty

      We next consider whether petitioners are liable for the

accuracy-related penalty under section 6662(a).     A taxpayer is

liable for an accuracy-related penalty of 20 percent of any

portion of an underpayment attributable to, among other things, a

substantial understatement of income tax under section 6662(b)(2)

if the amount of the understatement exceeds the greater of either

10 percent of the tax required to be shown on the return, or

      7
      (...continued)
9, Q&A-1, Income Tax Regs., is used for determining the life
expectancy of an individual for purposes of these calculations.
      8
      We reach this conclusion without taking into account any
rate of return on the annuity. We have not applied the 10-
percent rate of return used by Aspen Retirement because
petitioners have not established that it was reasonable.
                                -12-

$5,000.    Sec. 6662(a), (b)(2), (d)(1)(A); sec. 1.6662-4(a) and

(b)(i) and (2), Income Tax Regs.    Petitioners reported that they

owed $12,956 of tax for 2004 and respondent determined upon

examination that petitioners owed $21,656.     Petitioners therefore

understated the tax on the return by $8,700, which is greater

than 10 percent of the tax required to be shown on the return, or

$5,000.

     The accuracy-related penalty under section 6662(a) does not

apply to any portion of an underpayment, however, if it is shown

that there was reasonable cause for the taxpayer’s position and

that the taxpayer acted in good faith with respect to that

portion.   Sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs.

The determination of whether a taxpayer acted with reasonable

cause and in good faith is made on a case-by-case basis, taking

into account all the pertinent facts and circumstances, including

the taxpayer’s efforts to assess his or her proper tax liability

and the knowledge and experience of the taxpayer.     Sec. 1.6664-

4(b)(1), Income Tax Regs.    The taxpayer bears the burden of proof

with respect to reasonable cause.      Higbee v. Commissioner, 116
T.C. 438, 446 (2001).

     Petitioners argue that they should be absolved from the

penalty because they had reasonable cause for failing to report
                                 -13-

the entire amount as taxable.9    We disagree.   Nationwide informed

petitioners that the distributions did not qualify as

substantially equal periodic payments exempt from the section

72(t) additional tax and the Jefferson National withdrawal

request specifically indicated that the distribution was subject

to section 72(t).    Moreover, the 1099-Rs issued by Jefferson

National and Nationwide indicated that all the distributions were

early distributions for which no exception to the additional tax

applied.   We find that petitioners have not shown reasonable

cause for failing to report the entire amount as taxable.

     Petitioners also claim that they relied on Aspen

Retirement’s computations to argue that they were eligible for

the substantially equal periodic payments exception.     Good faith

reliance on the advice of an independent, competent professional

as to the tax treatment of an item may fulfill the reasonable

cause requirement.    See Neonatology Associates, P.A. v.

Commissioner, 115 T.C. 43, 98 (2000), affd. 299 F.3d 221 (3d Cir.

2002).   Petitioners have not shown, however, how Aspen Retirement

calculated the distributions, nor have they shown how they could

     9
      Petitioners also seek relief on the grounds that they
disclosed the distributions on the return. See sec.
6662(d)(2)(B)(ii). Disclosure is adequate with respect to an
item or a position on a return only if it was made on a Form
8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure
Statement, attached to the return or on a qualified amended
return for the taxable year.   See Kelly v. Commissioner, T.C.
Memo. 1996-529; sec. 1.6662-4(f)(1), Income Tax Regs. We find
that petitioners failed to adequately disclose the distributions.
                                 -14-

have relied upon any such calculations given the other

documentary evidence that no exception applied.      Accordingly, we

sustain respondent’s determination that petitioners are liable

for the accuracy-related penalty under section 6662(a) for 2004.

     We have considered all remaining arguments the parties made

and, to the extent not addressed, we conclude they are

irrelevant, moot, or meritless.

     To reflect the foregoing,

                                             Decision will be entered

                                        for respondent.