Harrell v. Comm'r

T.C. Memo. 2017-76

UNITED STATES TAX COURT

CHRISTOPHER S. HARRELL, SR. AND INGRID T. HARRELL, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 29383-14. Filed May 8, 2017.

Christopher S. Harrell, Sr., and Ingrid T. Harrell, pro sese.

Peter N. Scharff, for respondent.

MEMORANDUM OPINION

THORNTON, Judge: Respondent determined deficiencies in petitioners’

income tax of $9,881 for 2009 and $9,356 for 2010.1 Respondent also determined

1

Unless otherwise indicated, all section references are to the Internal

Revenue Code (Code) in effect for the relevant years, and all Rule references are

to the Tax Court Rules of Practice and Procedure. All monetary amounts are

(continued...)

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[*2] that petitioners are liable for accuracy-related penalties under section 6662 of

$1,976 for 2009 and $1,871 for 2010.

After the parties’ concessions, the remaining issues for decision are:

(1) whether any portion of the annuity received by petitioner Ingrid T. Harrell

from the New York City Employees’ Retirement System is excludable from

petitioners’ gross income for 2009 and 2010; and (2) whether petitioners are

entitled to deduct any expenses paid or incurred for the funeral or in the

administration of the estate of Howard Wilkerson.

Background

The parties submitted this case fully stipulated pursuant to Rule 122. The

stipulated facts are found accordingly. When the petition was filed petitioners

resided in New York.

During taxable years 2009 and 2010 Mrs. Harrell received gross

distributions of $28,937 from the New York City Employees’ Retirement System

(NYCERS). Mrs. Harrell received the distributions from NYCERS as the

beneficiary of Howard Wilkerson, her father, who died on November 2, 1994. On

the date of her father’s death, Mrs. Harrell was 24 years old.

1

(...continued)

rounded to the nearest dollar.

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[*3] Mr. Wilkerson was a tier 1 member of NYCERS. The summary plan

description (SPD) for tier 1 members of NYCERS states that NYCERS is a

defined benefit plan that consists of both employer and employee contributions.

The SPD states that “[t]ier 1 Members are required to contribute a portion of their

salary each pay period through payroll deductions”; these deductions are “‘basic’

employee contributions”. The basic employee contributions “are not subject to

* * * Federal income taxation” in the year contributed, but “those contributions

will be subject to Federal taxation” upon distribution. The SPD further states that

members may make additional employee contributions beyond the required basic

employee contributions up to 50% of the basic employee contribution rate; these

additional employee contributions are “subject to income tax in the year the

contributions are made.”

Mrs. Harrell received a letter from NYCERS dated February 9, 1995, titled

“Information Concerning Death Benefit”. This document indicates a total benefit

payable of $403,829, comprising a member’s share of $11,245 and an employer’s

share of $392,584. The letter does not designate what amount, if any, of the

member’s share of $11,245 is an additional employee contribution as opposed to

the required basic employee contribution. According to a letter from NYCERS

dated March 20, 1997, Mrs. Harrell elected to receive the benefit as an annual

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[*4] annuity of $28,937 payable for life in equal monthly installments effective

November 3, 1994.

During 1994 and 1996 Mrs. Harrell paid various expenses related to her

father’s death and the administration of his estate. These expenses included,

among other things, funeral expenses, attorney’s fees, and certified public

accountant (C.P.A.) fees. Petitioners provided an unsigned copy of a Form ET-90,

New York State Estate Tax Return, for Mr. Wilkerson’s estate listing Mrs. Harrell

as the executor and reporting an annuity of $298,099 at line 31 and New York

estate tax of $8,428. On the Form ET-90 Mrs. Harrell claimed a deduction of

$27,400 for, among other things, funeral expenses, estate administration expenses,

and debts of decedent and marked the box for “No” with regard to whether a

Federal estate tax return was required. A memorandum from the C.P.A. who

allegedly prepared the Form ET-90 states that the amount of New York estate tax

owed is $13,321. An incomplete copy of a notice of assessment resolution

(notice) from the New York State Department of Taxation and Finance dated

September 16, 1996, with regard to Mr. Wilkerson’s estate, indicates a total

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[*5] amount of estate tax due of $15,464. The notice states that the Form ET-90

reported an annuity at line 31 of $403,828,2 but that

[t]o determine the proper amount * * * [of the annuity], you should

consult the Life Expectancy Table. Using the beneficiary’s age and

the information from the table it will result in the life expectancy.

That amount multiplied by the annual payment is the figure that

should be reported * * * [as the annuity amount]. We are unable to

change tax until an amended return is filed.

The record does not include a copy of an amended Form ET-90.

Petitioners reported the full annuity distributions of $28,937 from NYCERS

on their Forms 1040, U.S. Individual Income Tax Return, for 2009 and 2010.

Petitioners now assert that $16,245 of each of the $28,937 distributions is

excludable from gross income. On their original 2009 Form 1040 petitioners did

not deduct the expenses incurred in 1994 and 1996 related to the death of, and

administration of the estate of, Mr. Wilkerson, but they now claim entitlement to

them as an estate tax deduction on Schedule A, Itemized Deductions, as a net

operating loss carryforward to their 2009 taxable year.

2

The $1 difference in this amount and the amount we find as the annuity

amount is due to rounding. Additionally, the annuity amount as reported on the

Form ET-90 provided by petitioners and the annuity amount as recounted in the

notice from the New York State Department of Taxation in Finance do not

correspond. This discrepancy does not affect the outcome of this case.

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[*6] Discussion

In general, the Commissioner’s determination set forth in a notice of

deficiency is presumed correct. Welch v. Helvering, 290 U.S. 111, 115 (1933). In

pertinent part, Rule 142(a)(1) provides the general rule that “[t]he burden of proof

shall be upon the petitioner”. The submission of this case under Rule 122 does not

change or otherwise lessen petitioners’ burden of proof. See Rule 122(b); Weaver

v. Commissioner, 121 T.C. 273, 275 (2003). Under section 7491(a) if the taxpayer

introduces credible evidence with respect to any factual issue relevant to

ascertaining the proper income tax liability, and if certain conditions are met, the

burden of proof shifts to the Commissioner. See also Rule 142(a). Petitioners do

not contend that the burden of proof should shift pursuant to section 7491(a), and

we conclude that the burden of proof has not shifted to respondent.

1. Annuity Payments

Section 61(a) defines “gross income” broadly as “all income from whatever

source derived”. It is well established that “gross income” is to be broadly

construed, while exclusions from income are to be narrowly construed.

Commissioner v. Schleier, 515 U.S. 323, 328 (1995); Taggi v. United States, 35

F.3d 93, 95 (2d Cir. 1994). Taxpayers seeking an exclusion from gross income

must demonstrate that they are eligible for the exclusion and bring themselves

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[*7] “within the clear scope of the exclusion”. Dobra v. Commissioner, 111 T.C.

339, 349 n.16 (1998).

Section 61(a)(9) and (11) provides that annuities and pensions are among

the forms of income within the purview of section 61(a). Section 72 sets forth the

specific rules applicable to taxation of, among other things, annuities and

distributions from qualified employer retirement plans. See also sec. 403(a).

Section 72(a) reiterates the general rule of inclusion in gross income unless

otherwise provided. Section 72(b), however, provides that portions of annuity

payments may be excludable from income. The excludable portion of a payment

generally is that portion which bears the same ratio to the payment as the

“investment in the contract” bears to the expected return under the contract

determined at the time the annuity payments begin (exclusion ratio). Sec.

72(b)(1).

The term “investment in the contract” is defined by reference to “the

aggregate amount of premiums or other consideration paid for the contract”. Sec.

72(c)(1)(A). A taxpayer’s investment in the contract includes his or her

nondeductible contributions. See Campbell v. Commissioner, 108 T.C. 54, 65-66

(1997); Hall v. Commissioner, T.C. Memo. 1998-336, 1998 Tax Ct. Memo LEXIS

334, at *12. For this purpose, an employee’s investment in the contract also

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[*8] includes amounts contributed by the employer, “but only to the extent that

* * * such amounts were includable in the gross income of the employee”. Sec.

72(f). Consequently, employee or employer contributions that were not includable

in the employee’s gross income for the contribution year are not included in the

employee’s investment in the contract.

Additionally, for decedents dying before August 21, 1996, former section

101(b)(1) provided that “[g]ross income does not include amounts received * * *

by the beneficiaries or the estate of an employee, if such amounts are paid by or on

behalf of an employer and are paid by reason of the death of the employee.” See

Small Business Job Protection Act of 1996 (SBJPA), Pub. L. No. 104-188, sec.

1402(a), 110 Stat. at 1789. The exclusion amount is limited to $5,000 and is

treated as additional investment in the contract. Sec. 101(b)(2)(A) and (D),

repealed by SBJPA sec. 1402(a); sec. 1.72-8(b), Income Tax Regs.

Section 72(c)(3)(A) provides that if the expected return under the contract

for an annuity depends on the life expectancy of one or more individuals, the

expected return is computed with reference to actuarial tables prescribed by the

Secretary. Table V of section 1.72-9, Income Tax Regs., is generally used in

determining the expected return when the investment in the contract includes a

post-June 1986 investment and the annuity is based upon a single life expectancy.

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[*9] See sec. 1.72-6(d)(7), Income Tax Regs. If the contract provides that one

annuitant is to receive a fixed monthly income for life, the expected return is

determined by multiplying the total of the annuity payments to be received

annually by the multiple shown in the applicable table. Sec. 1.72-5(a)(1), Income

Tax Regs.

Section 72(c)(4) provides that the annuity starting date is “the first day of

the first period for which an amount is received as an annuity under the contract.”

In determining the amounts of the annuity payments excludable from

petitioners’ gross income, the analysis must begin with a determination of the

investment in the contract. The letter from NYCERS regarding the “Information

Concerning Death Benefit” states that Mrs. Harrell is entitled to a benefit payable

of $403,829 comprising a member’s share of $11,245 and an employer’s share of

$392,584. Petitioners have not produced evidence showing that the member’s

share of $11,245 was Mr. Wilkerson’s investment in the contract. The evidence

strongly suggests that the member’s share of $11,245 was Mr. Wilkerson’s

required basic employee contribution to NYCERS that was not previously

includable in his gross income. Contrary to petitioners’ assertion that the entire

amount of the member’s share of $11,245 was made with after-tax dollars, the

SPD provides that any additional employee contribution is in addition to the basic

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[*10] employee contribution. Nothing in the record establishes what portion, if

any, of the member’s share is an additional employee contribution as opposed to

the required basic employee contribution. Additionally, nothing in the record

evidences that any of the employer’s share of $392,584 was previously includable

in Mr. Wilkerson’s gross income. Therefore, we conclude that none of the

NYCERS death benefit of $403,829 is investment in the contract. However,

because Mr. Wilkerson died before August 21, 1996, petitioners are entitled under

former section 101(b) to exclude from gross income death benefits of $5,000.

Accordingly, we conclude that petitioners’ investment in the contract for the

NYCERS death benefit is $5,000.

The expected return on the NYCERS contract is determined by multiplying

the total of the annuity payments to be received annually of $28,937 by the

multiple shown in the applicable table of section 1.72-9, Income Tax Regs. The

$5,000 NYCERS death benefit was payable as a result of Mr. Wilkerson’s death

on November 2, 1994. Thus, the $5,000 death benefit is a post-1986 investment in

the NYCERS annuity, and Table V of section 1.72-9, Income Tax Regs., applies.

Mrs. Harrell was 24 years old on November 3, 1994, the date the annuity became

effective. Table V of section 1.72-9, Income Tax Regs., provides that for a single

life annuity that begins when the annuitant is 24 years old the multiple is 58.0. As

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[*11] a result the expected return of the NYCERS annuity is the total annual

annuity payment of $28,937 multiplied by the multiple shown in Table V of 58.0,

or $1,678,346 ($28,937 × 58.0 = $1,678,346).

The exclusion ratio is computed by dividing the investment in the contract

of $5,000 by the expected return of $1,678,346, or 0.002979 ($5,000 ÷ $1,678,346

= 0.002979). See sec. 72(b)(1). As a result of applying the exclusion ratio to the

NYCERS annual annuity payment of $28,937, the excludable amount is $86

($28,937 × 0.002979 = $86). See id.

Accordingly, we hold that petitioners are entitled to exclude from gross

income $86 of the $28,937 NYCERS annuity payment for each of the taxable

years 2009 and 2010.

2. Expenses Related to Mr. Wilkerson’s Death and Estate Administration

Deductions are a matter of legislative grace, and the taxpayer bears the

burden of proving entitlement to them. Interstate Transit Lines v. Commissioner,

319 U.S. 590, 593 (1943); Segel v. Commissioner, 89 T.C. 816, 842 (1987). “It is

axiomatic that income is taxed to the person who earns it, and * * * deductions are

thus generally not transferable between taxpayers.” Vichich v. Commissioner, 146

T.C. 186, 193 (2016) (holding that a surviving spouse was not entitled to inherit or

otherwise retain a tax benefit that was originally conferred on the deceased spouse

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[*12] (citing United States v. Basye, 410 U.S. 441, 447 (1973); Commissioner v.

Culbertson, 337 U.S. 733, 739-740 (1949); New Colonial Ice Co. v. Helvering,

292 U.S. 435 (1934); and Lucas v. Earl, 281 U.S. 111, 114-115 (1930))). “[A]

taxpayer seeking a deduction must be able to point to an applicable statute and

show that he comes within its terms.” New Colonial Ice Co. v. Helvering, 292

U.S. at 440.

In support of their claimed entitlement to a deduction for 2009 for funeral

and estate administration expenses for Mr. Wilkerson, petitioners point to various

Internal Revenue Service (IRS) publications.3 Petitioners’ reliance on these

publications is misplaced.

The publications that petitioners rely upon discuss deductions allowable

under section 691(b) and (c), relating to income in respect of decedents, and net

operating losses allowable under section 172. Section 691(b) is not pertinent

because funeral and estate administration expenses are not specified therein as a

3

Petitioners’ seriatim answering brief in support of the deduction for funeral

and estate administration expenses references the following IRS publications:

Instructions for Form 706, United States Estate (and Generation-Skipping

Transfer) Tax Return (Rev. November 2016); Publication 559, Survivors,

Executors and Administrators (2009); Publication 575, Pension and Annuity

Income (2010); Publication 590, Individual Retirement Arrangements (IRAs)

(2009); and Publication 536, Net Operating Losses (NOLs) for Individuals,

Estates and Trusts (2009).

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[*13] type of expense for which a deduction may be claimed; section 691(b) is

limited to deductions or credits authorized by sections 162 (trade or business

expenses), 163 (interest), 164 (taxes), 212 (expenses for production of income), or

611 (depletion). Section 262 provides that except as otherwise expressly provided

in the Code no deduction shall be allowed for personal, living, or family expenses.

Funeral expenses are clearly personal or family expenses. See Beck v.

Commissioner, T.C. Memo. 2001-270, 2001 Tax Ct. Memo LEXIS 309, at *43

(holding that income tax deduction claimed for wife’s funeral expenses was a

nondeductible personal expense); Carr v. Commissioner, T.C. Memo. 1979-400,

1979 Tax Ct. Memo LEXIS 120, at *17-*18 (holding that taxpayer failed to show

that funeral expenses for brother-in-law “was a business [expense] as

distinguished from a personal expense”); see also Estate of Yetter v.

Commissioner, 35 T.C. 737 (1961) (finding that funeral expenses were not

properly claimed on estate’s fiduciary income tax return but were allowable only

as a deduction to the estate under section 2053). Therefore, petitioners are not

entitled to a deduction under section 691(b) as the funeral and estate

administration expenses are nondeductible personal or family expenses. See sec.

262.

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[*14] Section 691(c) allows a recipient of income in respect of a decedent an

income tax deduction equal to the Federal estate tax attributable to that item.

Petitioners have not produced evidence that a Federal estate tax return was filed or

that Federal estate tax was paid for Mr. Wilkerson’s estate. Therefore petitioners

are not entitled to a deduction under section 691(c).

In any event, section 461(a) requires a taxpayer to deduct expenses for the

year required under his or her method of accounting. A cash basis taxpayer

generally must deduct his or her expenses for the year that payment of those

expenses takes place. Tippin v. Commissioner, 104 T.C. 518, 531 (1995);

Reynolds v. Commissioner, T.C. Memo. 2000-20, aff’d, 296 F.3d 607 (7th Cir.

2002); sec. 1.461-1(a), Income Tax Regs. For this additional reason, petitioners

are not entitled to deductions for their taxable year 2009 for expenses paid in 1994

and 1996.

Finally, petitioners are not entitled to deduct any net operating loss

carryforward with respect to the disputed funeral and estate administration

expenses. Because, as previously discussed, these expenses are nondeductible

personal or family expenses, they are not allowable expenses in computing any net

operating loss. See sec. 172(c) (defining “net operating loss” as the excess of

deductions “allowed” in chapter 1 of the Code over gross income). And perhaps

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[*15] more fundamentally section 172(d)(4) “preclude[s] from the computation of

the net operating loss of an individual taxpayer, any deduction which is not

attributable to a trade or business, Weill v. Commissioner, 17 T.C. 318 (1951);

Townend v. Commissioner, 27 T.C. 99 (1956), unless it be a section 165(c)(3)

casualty loss.” Rodriguez-Torres v. Commissioner, T.C. Memo. 1970-76, 1970

Tax Ct. Memo LEXIS 281, at *14 n.6.

In sum, petitioners are not entitled to a deduction for 2009 for funeral or

estate administration expenses.4

The Court has considered all of petitioners’ arguments, contentions, and

statements. To the extent not discussed herein, the Court concludes that they are

moot, meritless, or irrelevant.

To reflect the foregoing,

Decision will be entered under

Rule 155.

4

The deductions that petitioners claimed might have been allowable on a

Federal estate tax return under sec. 2053(a), which provides that the value of the

taxable estate shall be determined by reducing the value of the gross estate for,

among other things, funeral and estate administration expenses. The evidence

does not show, however, that any Federal estate tax return was filed for Mr.

Wilkerson’s estate.