Court Opinion

ID: 4331934
Source: CourtListenerOpinion
Date Created: 2018-11-14 00:25:46.227974+00
Date Added: 2024-06-11T14:47:14.791702
License: Public Domain

111 T.C. No. 12

                UNITED STATES TAX COURT

     ROBERT C. AND NANCY L. ARNOLD, Petitioners v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 16855-97.                 Filed September 28, 1998.

     In December 1989, following P's retirement, P began
receiving annual distributions from his individual
retirement account (IRA). At that time, P was 55 years
old. The distributions were intended to constitute a
series of substantially equal periodic payments within
the purview of sec. 72(t)(2)(A)(iv), I.R.C., so as to
avoid P's having to pay the 10-percent tax pursuant to
sec. 72(t)(1), I.R.C. In November 1993, after five
distributions of $44,000 each had been made, and when P
attained age 59-1/2, P received $6,776 from his IRA. In
the notice of deficiency, R determined that the November
1993 distribution impermissibly modified the series of
substantially equal periodic payments within the 5-year
period beginning on the date of the first distribution,
and therefore the 10-percent recapture tax under sec.
72(t)(4), I.R.C., should be imposed on all distributions
P received prior to attaining age 59-1/2. P contends
that the series of substantially equal periodic payments
                               - 2 -

     was completed with the fifth distribution in January
     1993, or in the alternative, that the November 1993
     distribution represented a cost-of-living adjustment.
     Held:   P modified the series of substantially equal
     periodic payments by receiving the $6,776 from his IRA in
     November 1993 prior to the close of the 5-year period
     beginning on the date of the first distribution in
     December 1989, and is therefore subject to the 10-percent
     recapture tax on all distributions received prior to
     attaining age 59-1/2, as provided in sec. 72(t)(4),
     I.R.C.   Held, further:    P failed to prove that the
     November 1993 distribution constituted a permissible
     cost-of-living adjustment.

     Robert C. and Nancy L. Arnold, pro sese.

     Michael F. O'Donnell and George W. Bezold, for respondent.

     JACOBS, Judge:   Respondent determined a $21,221 deficiency in

petitioners' Federal income tax for 1993.    The deficiency arises

due to the imposition of the 10-percent recapture tax under section

72(t)(4), which was triggered by a November 1993 distribution to

Robert C. Arnold (hereinafter petitioner) from his individual

retirement account.   The sole issue for decision is whether the

November 1993 distribution impermissibly modified a series of

substantially equal periodic payments.

     All section references are to the Internal Revenue Code in

effect for the year in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.
                                     - 3 -

       Some of the facts have been stipulated and are so found.               The

stipulated      facts   are   incorporated     in   our    findings    by    this

reference.

                              FINDINGS OF FACT

       At the time petitioners filed their petition, they resided in

Delafield, Wisconsin.

Background

       From approximately 1956 until 1987, petitioner was a 50-

percent shareholder and vice president of ARCO Industries (ARCO),

a   Wisconsin      corporation    that   manufactured     chemicals    for   the

swimming pool industry.          Carl Ulrich, who served as president of

ARCO, owned the remaining 50-percent interest in ARCO.

       In 1987, petitioner and Mr. Ulrich sold their interests in

ARCO    to   Sowhite    Chemical    Corp.    (Sowhite     Chemical),    another

Wisconsin corporation in the same business as ARCO, and petitioner

then retired.       Sowhite Chemical agreed to pay the purchase price

for petitioner's and Mr. Ulrich's interests in ARCO through monthly

installments over an 11-year period.           The amount of petitioner's

monthly installment was approximately $7,488.               In October 1993,

Sowhite Chemical filed for bankruptcy protection and stopped making

payments to petitioner.

IRA Distributions

       When petitioner sold ARCO, he rolled his qualified pension

plan into     an    individual    retirement   account     (IRA).      In   1989,
                                 - 4 -

petitioner retained EMJAY Corp. (EMJAY), an actuary, to calculate

the needed series of substantially equal periodic payments from his

IRA (pursuant to section 72(t)(2)(A)(iv)) to avoid the imposition

of the 10-percent tax on premature distributions under section

72(t)(1).     In a December 5, 1989, letter, an executive vice

president of EMJAY advised petitioner of the different calculation

methods     petitioner   could   employ.1   Petitioner   elected   the

calculation method that allowed him to receive annual distributions

of approximately $44,000.

     In December 1989 when petitioner was 55 years old,2 he began

receiving annual distributions from his IRA.       The distributions

from petitioner's IRA were as follows:

                 December 1989        $44,000
                 January 1990          44,000
                 January 1991          44,000
                 January 1992          44,000
                 January 1993          44,000
                 November 1993          6,776

Petitioner received the $6,776 distribution in November 1993 to

compensate for the lack of payment by Sowhite Chemical after it

filed for bankruptcy.     In November 1993, petitioner was over the

age of 59-1/2.

     1
          The three permissible methods for calculating the
series of substantially equal periodic payments under sec.
72(t)(2)(A)(iv) are provided in Notice 89-25, Q&A-12, 1989-1 C.B.
662, 666. The parties agree that the method selected by
petitioner satisfies the requirements of Notice 89-25.
     2
            Petitioner was born on Mar. 3, 1934.
                                   - 5 -

Notice of Deficiency

     In the notice of deficiency, respondent determined that the

November 1993 distribution to petitioner was an impermissible

modification of a series of substantially equal periodic payments.

As a result, respondent determined that the 10-percent recapture

tax under section 72(t)(4) should be imposed on all distributions

made prior to the date petitioner attained age 59-1/2.

                                  OPINION

     The sole issue for decision is whether the November 1993

distribution from petitioner's IRA impermissibly modified a series

of substantially equal periodic payments so as to trigger the

imposition of the 10-percent recapture tax under section 72(t)(4).

     Generally, amounts distributed from an IRA are includable in

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

Additionally, a 10-percent tax is imposed under section 72(t)(1) on

any distribution that fails to satisfy one of the exceptions for

premature distributions as provided in section 72(t)(2).              Section

72(t)(2) states in pertinent part:

     (2) Subsection not to apply to certain distributions.
     --Except as provided in paragraphs (3) and (4),
     paragraph (1) shall not apply to any of the following
     distributions:

            (A)   In general.--Distributions which are--

        *         *       *        *        *          *          *

                  (iv) part of a series of
                  substantially equal periodic
                  payments (not less frequently than
                                - 6 -

                 annually) made for the life (or
                 life expectancy) of the employee or
                 the joint lives (or joint life
                 expectancies) of such employee and
                 his designated beneficiary * * *

     Section 72(t)(4)3 dictates, however, that if the series of

substantially equal periodic payments (which otherwise is excepted

from the 10-percent tax) is subsequently modified (other than by

reason of death or disability) within a 5-year period beginning on

the date of the first distribution, then the 10-percent tax under

     3
           Sec. 72(t)(4) states in part:

     (4)   Change in substantially equal payments.--

           (A)   In general.--If--

                 (i) paragraph (1) does not apply
                 to a distribution by reason of
                 paragraph (2)(A)(iv), and

                 (ii) the series of payments under
                 such paragraph are subsequently
                 modified (other than by reason of
                 death or disability)--

                      (I) before the close of
                      the 5-year period
                      beginning with the date
                      of the first payment and
                      after the employee
                      attains age 59-1/2, or

                      (II) before the employee
                      attains age 59-1/2,

     the taxpayer's tax for the 1st taxable year in which
     such modification occurs shall be increased by an
     amount, determined under regulations, equal to the tax
     which (but for paragraph (2)(A)(iv)) would have been
     imposed, plus interest for the deferral period.
                                  - 7 -

section   72(t)(1)   will    be   imposed   retroactively   on   prior

distributions made before the taxpayer attains age 59-1/2, plus

interest. This retroactive application of the 10-percent tax under

section 72(t)(4) is known generally as a recapture tax.     See infra.

     Petitioners contend that the November 1993 distribution of

$6,776 did not impermissibly modify a series of substantially equal

periodic payments.   Petitioners make two principal arguments in

support of this claim.

     First, petitioners contend that the November 1993 distribution

occurred after the series of substantially equal periodic payments

was completed in January 1993, and thus no modification occurred.

Respondent asserts that petitioners' contention contradicts the

plain language of section 72(t)(4) which requires no modifications

within a 5-year period.     Respondent notes that in this case the 5-

year period beginning with the date of the first distribution ran

from 1989 through 1994. Thus, respondent argues, the November 1993

distribution was premature and hence impermissibly modified the

series of substantially equal periodic payments.

     Respondent's position is supported by the legislative history

of section 72(t).    The conference report accompanying the Tax

Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, supports the

proposition that the period described in section 72(t)(4)(A)(ii)

must be completed before further distributions can be received to
                                      - 8 -

avoid imposition of the 10-percent recapture tax under section

72(t)(4):

            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. The additional tax will
       not be imposed on amounts distributed after attainment of
       age 59-1/2. This 5-year minimum payout rule is waived
       upon the death or disability of the employee.

H. Conf. Rept. 99-841, at II-457 (1986), 1986-3 C.B. (Vol. 4) 1,

457.     It is evident that the 5-year period in section 72(t)(4)

closes    at   the   end   of   5   years   from   the   date   of   the   first

distribution; it does not end on the date of the fifth annual

distribution pursuant to a series of substantially equal periodic

annual payments.

       In the case herein, petitioner received the fifth distribution

from his IRA in January 1993, slightly more than 3 years from the

date of the first distribution. Under section 72(t)(4), petitioner

was required to wait until sometime in December 1994 before he

could receive additional distributions that would avoid modifying

the prior series of substantially equal periodic payments.                 He did

not meet the required waiting period. Instead, petitioner received

his distribution in November 1993, prior to the close of the 5-year

period as provided in section 72(t)(4).
                              - 9 -

     Next, petitioners argue that the November 1993 distribution

was part of a cost-of-living adjustment which respondent concedes

would be a permissible modification to the series of substantially

equal periodic payments during the applicable 5-year period.   See

Staff of Joint Comm. on Taxation, General Explanation of the Tax

Reform Act of 1986, at 717 (J. Comm. Print 1987).   In this regard,

petitioners note that the $6,776 distribution, spread over the

latter 4 years of distributions, was only a 3.65-percent increase

over the prior $44,000 distributions and "was well within the

limits of a reasonable cost of living adjustment (CLA), and thus

not a modification."

     Respondent claims, and we agree, that petitioners have failed

to prove that the purpose of the November 1993 distribution was to

serve as a cost-of-living adjustment.       Rule 142(a); Welch v.

Helvering, 290 U.S. 111 (1933).   Petitioners did not put forth any

evidence of the appropriate cost-of-living adjustment for the

relevant time period, nor did they explain how they arrived at the

figure calculated or why the adjustment was made in the form of a

lump-sum payment in November 1993 (rather than allocated over each

of the years).

     Petitioner testified that the November 1993 distribution was

received after Sowhite Chemical filed for bankruptcy protection in

October 1993 and ceased making its monthly installment payments to

him. Thus, it is evident that petitioner received the distribution
                                      - 10 -

as a result of a financial hardship when his monthly cash flow was

suddenly reduced. However, no exception exists under section 72(t)

for financial hardship.         See Duffy v. Commissioner, T.C. Memo.

1996-556; Pulliam v. Commissioner, T.C. Memo. 1996-354.

     The legislative purpose underlying the section 72(t) tax is

that "premature distributions from IRA's frustrate the intention of

saving for retirement, and section 72(t) discourages this from

happening."     Dwyer v. Commissioner, 106 T.C. 337, 340 (1996); see

also S. Rept. 93-383, at 134 (1973), 1974-3 C.B. (Supp.) 80, 213.

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.

Consequently,     we   hold    that     the    November    1993    distribution

impermissibly modified a series of substantially equal periodic

payments.     Thus,    the    10-percent       recapture   tax    under    section

72(t)(4) is applicable to all distributions petitioner received

prior to the date he attained 59-1/2.

     To reflect the foregoing,

                                                    Decision will be entered

                                              for respondent.