The opinion
T.C. Summary Opinion 2008-86
UNITED STATES TAX COURT
MICHAEL LEON AND KARIN POLICKY TILLEY, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 26450-06S. Filed July 21, 2008.
Michael Leon and Karin Policky Tilley, pro sese.
Frederick Lockhart, Jr., for respondent.
ARMEN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in
effect when the petition was filed.1 Pursuant to section
7463(b), the decision to be entered is not reviewable by any
1
Unless otherwise indicated, all subsequent section
references are to the Internal Revenue Code in effect for 2004,
the taxable year at issue, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
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other court, and this opinion shall not be treated as precedent
for any other case.
Respondent determined a deficiency in petitioners’ Federal
income tax of $28,579, as well as an accuracy-related penalty
under section 6662(a) of $3,555.80, for the taxable year 2004.
The issues for decision are: (1) To what extent the
distributions received from Ms. Tilley’s section 401(k) plan are
taxable; (2) in what year they are taxable; (3) whether
petitioners are liable for the additional tax imposed on early
section 401(k) plan withdrawals under section 72(t); and (4)
whether petitioners are liable for a section 6662(a) negligence
penalty for not having included in gross income the taxable
distributions received from Ms. Tilley’s section 401(k) plan in
2004 on their 2004 Federal income tax return.
Background
Some of the facts have been stipulated, and they are so
found. We incorporate by reference the parties’ stipulation of
facts and accompanying exhibits.
Petitioners resided in Colorado at the time the petition was
filed.
Ms. Tilley began employment with American City Business
Journals, Inc. in 1992, and she participated in the company’s
section 401(k) plan (401(k) plan or the plan) until her
employment was terminated in October 2003. In late 1999, Ms.
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Tilley borrowed $40,958 from her plan account to purchase a home.
She signed a Promissory Note and Security Agreement in respect of
the loan which was governed by the terms of the plan. The loan
was repayable with interest through semimonthly payroll
deductions over a 10-year term. Ms. Tilley made the scheduled
payments until her employment was terminated.
The outstanding balance of the loan became due and payable
at the time of Ms. Tilley’s termination, but petitioners did not
have the money to satisfy the obligation. No payments were made
on the loan after her termination. Pursuant to the terms of the
loan and the plan, the loan went into default in early 2004,
after the expiration of the 90-day grace, or cure, period.
In March 2004, Fidelity Investments sent Ms. Tilley a
letter,2 notifying her that she had a deemed distribution from
the plan equal to the then-unpaid loan balance of $31,176.99.
The letter also identified this distribution as being fully
taxable and without any applicable statutory exception.3
On April 19, 2004, Fidelity sent Ms. Tilley a check for
$61,479.94, which represented the $76,849.93 balance of her plan
account less $15,369.99 in Federal tax withholding. Petitioners
2
Although Fidelity Investments sent the letter to Ms.
Tilley, Fidelity Management Trust Co. is listed as the plan’s
administrator. We use the name Fidelity to refer to these
entities interchangeably.
3
Ms. Tilley, born in 1954, was not 59½ at the time of the
distribution.
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deposited the entire $61,479.94 into their checking account
rather than depositing it into the individual retirement account
(IRA) they had established with Fidelity for Ms. Tilley.
Fidelity issued a Form 1099-R, Distributions From Pensions,
Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance
Contracts, etc., for 2004 reporting a gross distribution to Ms.
Tilley of $108,026.92. The distribution amount reflected the
gross distribution from the remainder of Ms. Tilley’s 401(k) plan
as well as the unpaid balance on the loan. Although petitioners
included two other Form 1099-R distributions in their income on
their 2004 Federal income tax return, petitioners did not include
this distribution. Respondent determined in the notice of
deficiency that petitioners were required to include Ms. Tilley’s
distribution in income. Respondent also determined that the
distribution was subject to the 10-percent additional tax under
section 72(t) on early distributions from qualified retirement
plans. Further, respondent determined that petitioners were
subject to a penalty under section 6662(a).
Discussion
A. Taxable Distributions
1. Burden of Proof
Generally, the Commissioner’s determinations are presumed
correct, and the taxpayer bears the burden of proving those
determinations wrong. Rule 142(a); INDOPCO, Inc. v.
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Commissioner, 503 U.S. 79, 84 (1992); Welch v. Helvering, 290
U.S. 111, 115 (1933). Under section 7491 the burden of proof may
shift from the taxpayer to the Commissioner if the taxpayer
produces credible evidence with respect to any factual issue
relevant to ascertaining the taxpayer’s tax liability. Sec.
7491(a)(1). In this case there is no such shift because
petitioners did not allege that section 7491 was applicable, nor
did they establish that they fully complied with the requirements
of section 7491(a)(2). The burden of proof remains on
petitioners.
2. Balance of the 401(k) Plan Account
Generally, a distribution from a qualified plan such as Ms.
Tilley’s 401(k) plan is includable in the distributee’s gross
income in the year of distribution. See secs. 61(a)(11), 72,
401(a), 402(a), 408(d), 4974(c)(1). Therefore, the balance of
Ms. Tilley’s 401(k) plan account, $76,849.93, was disbursed in a
taxable distribution to Ms. Tilley in April 2004. Accordingly,
$15,369.99 in Federal taxes was withheld by Fidelity.
Petitioners testified that they had intended to roll over
the money into Ms. Tilley’s IRA. Amounts moved from one
qualified plan to another may be treated as a rollover
contribution if the transaction is completed within 60 days and
meets certain other requirements. Sec. 408(d)(3). Partial
rollovers are permitted. Sec. 408(d)(3)(D). Petitioners did not
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take advantage of the rollover provisions. Regardless of their
original intentions, petitioners cashed the check and spent the
money.
Four years later, petitioners urge the Court to grant them a
waiver of the 60-day requirement. See sec. 408(d)(3)(I). They
argue that Fidelity made a mistake sending them the check and
that they would now be willing to put the money into Ms. Tilley’s
IRA. On these facts we decline to grant the waiver, and we do so
without offense to equity or good conscience.
3. Loan Balance
Section 72(p)(1)(A) treats loans from qualified plans as
taxable distributions. See sec. 72(p)(1)(A), (4)(A)(i)(I);
Plotkin v. Commissioner, T.C. Memo. 2001-71; Patrick v.
Commissioner, T.C. Memo. 1998-30, affd. per curiam without
published opinion 181 F.3d 103 (6th Cir. 1999); Prince v.
Commissioner, T.C. Memo. 1997-324. However, section 72(p)(2)(A)
provides an exception for certain loans; the mere making of a
loan that does not exceed one-half of the nonforteitable accrued
benefit of the employee under the plan, that is repayable within
5 years, and that provides for substantially level amortization
does not give rise to a deemed distribution. See sec. 72(p)(2);
see also sec. 72(p)(1)(B)(ii) (providing an exception to the 5-
year repayment requirement for loan proceeds used to purchase a
primary residence).
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Although a loan may initially satisfy the requirements of
section 72(p)(2)(A) at the time that it is made, a deemed
distribution may nevertheless occur subsequently because of the
failure to repay the loan in accordance with the loan agreement.
Sec. 72(p)(2). Accordingly, if a default occurs, a distribution
is deemed to occur at that time in the amount of the then-
outstanding balance of the loan. It is clear that Ms. Tilley
defaulted on her loan and thus had a deemed distribution from her
401(k) plan account; the issue here is the date on which the
default-–and thus the deemed distribution--occurred.
Petitioners argue that because the entire loan balance
became due and payable upon Ms. Tilley’s termination of
employment pursuant to an acceleration clause in the plan
documents (“Upon * * * termination of employment, the entire
outstanding principal and accrued interest shall be immediately
due and payable”.), the missed installment payment took place in
October 2003. Petitioners argue that any distribution,
therefore, took place in 2003.
It is true that it was in October 2003 when Ms. Tilley first
missed her payment. However, the plan documentation provided to
us by petitioners shows that the plan had a 90-day grace, or
cure, period. The plan documents explain that “The Plan
Administrator shall treat a loan in default if any scheduled
repayment remains unpaid more than 90 days”. Therefore, Ms.
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Tilley’s default under the plan did not occur until the
expiration of the cure period in 2004.
Under the current regulations, when a participant fails to
make payments in accordance with the terms of a loan, the loan is
treated as no longer meeting the requirements of section
72(p)(2)(C) and a deemed distribution results. Sec. 1.72(p)-1,
Q&A-4, Income Tax Regs. The deemed distribution occurs at the
time the installment payment was due but not made. Sec. 1.72(p)-
1, Q&A-10, Income Tax Regs. The current regulations also provide
that the deemed distribution will not occur if the installment
payment due is made before the end of any cure period permitted
by the plan administrator. Sec. 1.72(p)-1, Q&A-10, Income Tax
Regs. In other words, under the current regulations, the deemed
distribution would clearly not occur until the close of any cure
period provided under the plan. However, Ms. Tilley’s loan was
made in 1999, before the effective date of the current
regulations. See sec. 1.72(p)-1, Q&A-22, Income Tax Regs.
Accordingly, the final regulation is not applicable to the case
at bar.
Before the promulgation of the final regulation, a proposed
regulation had been issued containing the same provisions. See
sec. 1.72(p)-1, Q&A-4, Q&A-10, Proposed Income Tax Regs., 60 Fed.
Reg. 66235, 66236 (Dec. 21, 1995). The proposed regulation,
however, was to apply only to loans made after a certain period
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after the final regulation had been published. Sec. 1.72(p)-1,
Q&A-19, Proposed Income Tax Regs., 60 Fed. Reg. 66237 (Dec. 21,
1995). Further, a proposed regulation is given no more weight
than a position advanced by the Commissioner on brief. KTA-
Tator, Inc. v. Commissioner, 108 T.C. 100, 102-103 (1997); F.W.
Woolworth Co. v. Commissioner, 54 T.C. 1233, 1265-1266 (1970).
Given that the regulations do not shed light on this
dispute, the only logical way to reach a conclusion is to examine
the facts before us and, in particular, the plan documents. The
materials provided to us at trial suggest that the plan’s
administrator defines date of default as being 90 days following
an outstanding payment’s due date. Although petitioners point to
the plan’s loan acceleration clause and urge us to adopt their
argument that the default occurred immediately upon Ms. Tilley’s
termination of employment, a far more reasonable interpretation
is that the acceleration clause merely controls the amount due at
termination (i.e., the entire balance of the loan becomes due and
payable) and does not negate the 90-day cure period. Further,
petitioners’ own actions belie their argument that they believed
the deemed distribution occurred in 2003, as they did not report
the deemed distribution on their 2003 Federal income tax return.
The record demonstrates that the balance due at the time of
the default–-the date at which cure was no longer possible–-was
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$31,176.99. Thus, pursuant to section 72(p)(1)(A), a $31,176.99
distribution is deemed to have been made in 2004.
Section 402(a) provides generally that distributions from a
qualified plan are taxable to the distributee in the taxable year
in which the distribution occurs, pursuant to the provisions of
section 72, and thus the $31,176.99 deemed distribution was
taxable in 2004.
B. 10-Percent Additional Tax
Section 72(t) imposes an additional tax on a distribution
from a qualified retirement plan made prior to a taxpayer’s
attaining the age of 59½ unless an enumerated exception applies.
For example, the additional tax does not apply to distributions
that are made to a beneficiary on or after the death of the
employee or that are attributable to the employee’s being
disabled. See sec. 72(t)(2). The additional tax equals 10
percent of the portion of such distribution that is includable in
gross income. The additional tax is intended to discourage
premature distributions from retirement plans. 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.
Petitioners had a deemed distribution of $31,176.99 from the
balance of Ms. Tilley’s loan and an actual distribution of
$76,849.93 (from which taxes were withheld) from the closure of
her 401(k) plan account. Ms. Tilley had not yet attained the age
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of 59½ at the time of the distributions, nor did any of the other
statutory exceptions to the additional tax apply. See sec.
72(t)(2).
Petitioners do not, in fact, argue that any statutory
exception applies. Their only argument as to why they should not
be subject to the additional tax is that “they didn’t cause the
withdrawal” and that Fidelity made a mistake in failing to roll
over the money into Ms. Tilley’s IRA. But petitioners did
receive a distribution, and they did use the money distributed.
Further, alleged mistakes of the sort claimed here are not among
the enumerated exceptions to the additional tax. Petitioners are
therefore liable for it.4 See Arnold v. Commissioner, 111 T.C.
250, 255 (1998); Schoof v. Commissioner, 110 T.C. 1, 11 (1998);
Clark v. Commissioner, 101 T.C. 215, 224-225 (1993); Swihart v.
Commissioner, T.C. Memo. 1998-407.
C. Negligence Penalty
Section 6662(a) imposes a penalty equal to 20 percent of any
underpayment that is attributable to either negligence or
disregard of rules or regulations. See sec. 6662(a) and (b)(1).
The term “negligence” includes any failure to make a reasonable
attempt to comply with the provisions of the internal revenue
4
Regardless of whether the sec. 72(t) additional tax is a
penalty or an additional amount under sec. 7491(c), respondent
has satisfied his burden of production with respect to the
distribution. See Milner v. Commissioner, T.C. Memo. 2004-111
n.2.
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laws. Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. The
term “disregard” includes any careless, reckless, or intentional
disregard. Sec. 6662(c); sec. 1.6662-3(b)(2), Income Tax Regs.
Respondent determined that petitioners are liable for this
penalty.
By virtue of section 7491(c), the Commissioner has the
burden of production with respect to a taxpayer’s liability for
any penalty. To meet this burden, the Commissioner must produce
sufficient evidence indicating that it is appropriate to impose
the relevant penalty. Higbee v. Commissioner, 116 T.C. 438, 446
(2001). Once the Commissioner meets the burden of production,
the taxpayer must come forward with persuasive evidence that the
Commissioner’s determination is incorrect. Id.
Respondent satisfied his burden of production under section
7491(a)(1) because the record clearly demonstrates that
petitioners failed to include Ms. Tilley’s 401(k) plan
distributions in their gross income despite being required to do
so. Accordingly, we hold that respondent satisfied his burden.
Section 6664 provides an exception to the imposition of an
accuracy-related penalty if the taxpayer establishes that there
was reasonable cause for the understatement and that the taxpayer
acted in good faith with respect to that portion. Sec.
6664(c)(1); sec. 1.6664-4(b), Income Tax Regs. The taxpayer
bears the burden of proving that he or she acted with reasonable
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cause and in good faith. See sec. 6664(c)(1); see also Higbee v.
Commissioner, supra at 446; sec. 1.6664-4(b)(1), Income Tax Regs.
The determination of whether a taxpayer acted with reasonable
cause and good faith is made on a case-by-case basis. Sec.
1.6664-4(b)(1), Income Tax Regs. Generally, the most important
factor is the extent of the taxpayer’s effort to assess the
proper tax liability for such year. Id.
Petitioners claim that they relied on the Fidelity
representative’s assertion that the distribution was not taxable
and thus should not be held responsible for the penalty. Good
faith reliance on professional advice concerning tax laws may be
a defense to the negligence penalty. Neonatology Assocs., P.A.
v. Commissioner, 115 T.C. 43, 99 (2000), affd. 299 F.3d 221 (3d
Cir. 2002); see also United States v. Boyle, 469 U.S. 241, 250-
251 (1985); sec. 1.6664-4(b)(1), Income Tax Regs. However,
“Reliance on professional advice, standing alone, is not an
absolute defense to negligence, but rather a factor to be
considered.” Freytag v. Commissioner, 89 T.C. 849, 888 (1987),
affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868 (1991);
see also sec. 1.6664-4(b)(1), Income Tax Regs. In order to be
considered as such, the reliance must be reasonable. See Freytag
v. Commissioner, supra at 888; sec. 1.6664-4(b)(1), Income Tax
Regs.
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Petitioners did not have reasonable cause to believe that
the $108,026.92 distribution they received from Ms. Tilley’s plan
account was not taxable. In fact, they received three Forms
1099-R that year, and we are not persuaded by petitioners’
allegation that they believed this distribution alone was not
taxable. Further, it was not reasonable for petitioners to rely
on a Fidelity call-center representative for tax advice.
Accordingly, we sustain respondent’s determination on this issue.
D. Conclusion
We have considered all of petitioners’ arguments and, to the
extent we did not specifically address them, we conclude they are
without merit.
Any remaining adjustments listed in the notice of deficiency
are mechanical in nature, and their resolution flows from this
decision. To reflect our disposition of the disputed issues,
Decision will be entered
for respondent.