T. C. Summary Opinion 2011-129

T. C. Summary Opinion 2011-129

UNITED STATES TAX COURT

TIMOTHY JOHN KARLEN AND JENNIFER KARLEN, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 22614-10S.

Filed November 10, 2011.

Timothy John Karlen and Jennifer Ka len, p o sese.

Christina L. Cook, for respondent.

ARMEN, Special Trial Judge:

This case was heard pursuant to

the provisions of section 7463 of the In ernal Revenue Code in

effect when the petition was filed.1

Pufsuant t!o 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 C de in f fect for the

year in 1ssue, and all Rule references are to the Tax Court Rules

of Practice and Procedure.

sgøto nov i o zon

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other court, and this opinion shall not be treated as precedent

for any other case.

Respondent determined a deficiency of $1,318 in petitioners'

Federal income tax for 2008.

After a concession by petitioners,2

the issues for decision are as follows:

(1) Whether distributions from petitioners'

section 529 plan

accounts are includable in gross income; and if so,

(2) whether petitioners are liable for a 10-percent

additional tax under section 529(c) (6) regarding distributions

not used for educational expenses.

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 the

State of Minnesota when the petition was filed.

All references

to petitioner in the singular are to petitioner Timothy John

Karlen.

-

, In 2008, petitioners maintained an investment account with

the North Carolina 529.Plan (NC 529 Plan)

children.

for each of their three

The NC 529 Plan is a qualified tuition program (QTP)

as defined by section 529(b) and.is administered by the College

Foundation of North Carolina.

2 Petitioners concede that they received a taxable refund

of overpaid mortgage interest in the amount of $47 in 2008.

- 3 Petitioner works as a recruiter with his salary based

entirely on commissions.

Beginning in 2008, petitioner started

to experience financial difficulty when his incode decreased

because of the downturn in the national economy:.

On September 4, 2008, petitioner requested distributions of

$3,500 from each of his children's investment acÔounts in order

to obtain additional cash to pay household and other living

expenses.

On the application forms, petitioner:selected "Non-

Qualified Withdrawal" rather than "Withdrawal fo

his reason for requesting the distributions.

Rollover" as

The NC 529 Plan

issued the distributions to petitioner, mailing

hree checks,

each dated September 9, 2008.

e

After receiving all three checks, pétitione

confer with his wife regardíng the distributions.

decided to

She disagreed

with petitioner's decision to withdraw the funds from their 1

children's investment accounts.

In light of this disagreement,

petitioner changed his mindiand informed the NC 529 Plan that he'

no longer wished to take the requested distribut ons.

A

representative for the NC 529 Plan informed petkitioner that

because no error had been made by the NC 529 Pla

in processing

his applications for distributions, the transactions could not be

voided.

The representative instructed petitione

to endorse the

three checks and return them if he wished to redeposit the

amounts,

Petitioner did so immediately, enclosing with the

checks a note requesting that the NC 529 Plan redeposit the

distributions.

On September.19, 2008, the NC 529 Plan received the three

checks and redeposited each one as a new, current-day

contribution into the same.account from :which it had been

withdrawn.

Thereafter,. petitioner received a Form 1099-Q,

Payments From Qualified Education Programs

(Under Sections 529

and 530), from the NC 529 Plan for each of the three

distributions that he had received.

Discussion3

A.

·

.

Distributions and Rollovers Under Section 529

Generally, distributions from a section 529 QTP are

includable in the^ distributee's gross income in the year of

distribution and are taxed under the provisions of section 72

dealing with annuity payments.

Sec. 529(c) (3) (A).

Any portion

of a distribution,, however, that is rolled over under section

529(c) (3) (C) (i) is excluded from the general rule on inclusion.

To constitute a valid rollover, a distribution_ must be

transferred within 60 days either to a different QTP for the

benefit of the original beneficiary or transferred to the credit

3 We decide the issues in this case without regard to the

burden of proof or the burden of production.

See sec. 7491(a),

(c); Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933);

cf. H. Conf. Rept. 105-599, at 241 (1998), 1998-3 C.B. 747, 995.

of a different beneficiary who is a member of the original

beneficiary's family.

Sec. 529(c) (3) (C) (i).

Petitioner does not deny that he requested·the three

distributions or that he received a check for each distribution

in the mail.

Nevertheless, petitioner anserts that because he

did not cash or deposit the checks with his bank, he never

received the distributions. 4 Petitioner's assertion, however, is

misplaced.

For taxpayers who use the cash receipts and

disbursements method of accounting, such as petitioners, an item

is includable in gross income in the year in which the item is

actually or constructively received.

1(a), Income Tax Regs.

Seå. 451(a); sec. 1.451-

Undqr the doctrise of cbnstructive

receipt, a check generally donstitutes iäcome when received, even

though not cashed or deposited.

F.3d 1027,

1029-1030

See Walter v. United States, 148

(8th Cir. vl998); Kahler v.·Commissioner, -18

T.C. 31, 34-35 (1952).

Accordingly, petitioners received the

funds even though they did not cash or deposit the distribution

checks.

Petitioner also assert

that the di

over and were therefore not taxable.

541tributions

were rolled

In*this regard, petitioner

points out that after speaking with his wife, he decided that he

no longer wanted to retain the funds from his children's accounts

and that all three checks were returned to the NC 529 Plan with

instructions to redeposit them.

Petitio er ca didly admits,

however, that he requested the distributions because he needed

cash to pay household expenses and that he never contemplated any

rollover of.the distributions.

Indeed, on petitioner's.request

forms he selected "Non-Qualified Withdrawal" rather than

"Withdrawal for Rollover" as his reason for taking the

distributions.

Taxpayers are "bound by the consequences of * * *

[their]

transaction as structured, even if; hindsight reveals a more

favorable tax treatment."

F.3d 553,

557

248 F.3d 572,

(8th Cir.

576

Estate of Bean v. Commissioner, 268

2001)

(7th Cir.

(citing Gro1ean v.

2001)),

Commissioner,

affg. T.C. Memo.

2000-355.

Although we may be sympathetic- to the circumstances surrounding

petitioner's decision to request the distributions, we may not

restructure the transaction as a rollover simply to produce a

favorable result to petitioners.

Because no distribution was

transferred either to a different QTP for the benefit of the

original beneficiary or to theicredit of a different beneficiary

who is a member of the original beneficiary's family, there was

no rollover under section 529(c) (3) (C) (i).

In view of the foregoing, we hold that the distributions in

1ssue are includable in petitioners' gross income.'

We note that the redeposited distributions will increase

the basis in each account.

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B.

Additional Tax Under Section 529 (c) (6)

Taxpayers who receive distributions from a QTP may be

subject to an additional tax applied in the same imanner as the

additional tax on distribátions from Coverdell education savings

accounts .

Secs .

529 (c) (6) ,

530 (d) (4) .

Under section 530 (d) (4) ,

entitled "Additional Tax For DistributioÀs Not Used For

Educational Expenses", a 10-percent additional tax is imposed on

an includable distribution that was not used fo

expenses.

Sec. 530 (d) (4)^(A) .

the distributions at all.

educhtional

Petitioner, howe er, never "used"

Instead, when petitioner received the

distribution checks in the nail he immediately returned them for

redeposit into his childrens' education investment accounts.

Congress granted tax-e:Éempt status to education investment

accounts "To encourage families and students to save for future

education expenses".

(Vol.

2)

1067,

(Vol. 1) 319,

S. Rept.

1096; H. Rept.

645.

105-33, at 16

(1997),

1997-4 C.B.

105-148,

(1997),

1997-4 C.B.

at 323

To impose a 10-percent additional tax upon

petitioners given the unique facts in this case "would be like

throwing salt into a wound."

287, 292

(1987) .

Larotonda v. Commissioner, 89 T.C.

Although the distributions received are

includable in petitioners' gross income,

mind as to whether the * *

"doubt exists in our

[additional tax]

cover the situation involve$ herein."

Id.

s designed to

We are mindful that

"A particular construction Titust not produce inequality and

injustice if another and more reasonable interpretation is

possible."

Grier v. Kennan, 64 F.2d 605, 607 (8th.Cir. 1933)

(citing Knowlton v. Moore, 178 U.S. 41 (1900)).

Because

petitioners never used the.distributions and instead immediately

returned the distribution checks to the NC 529 Plan to save for

their childrens' future educational expenses,

"we think it

judicious to resolve this issue in favor of" petitioners given

their.unique situation.

292.

See Larotonda v. Commissioner, supra at

Consequently, we hold that the 10-percent additional tax

does not apply.5

.

.

Conclusion

We have considered all of the arguments made by.the parties

and, to the extent that we have not specifically addressed those

arguments, we conclude that they are without merit.

To reflect the foregoing,

Decision will be entered

for respondent in the amount

of thè determined deficiency

less the additional tax.

s We also note that "'All laws should receive a sensible

construction. General terms should be. so limited in their

application as not to lead to injustice, oppression, or an absurd

consequence, and it will always be presumed that the legislature

intended exceptions to its language, which would avoid results of

this character.'"

Grier v. Kennan,. 64 F.2d 605, 607 (8th Cir.

1933) (quoting United States v. Kirby, 74 U.S. 482, 483 (1868)).