T.C. Summary Opinion 2005-39

T.C. Summary Opinion 2005-39

UNITED STATES TAX COURT

MARK A. FILER AND JULIE J. FILER, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 4014-04S.

Filed April 12, 2005.

Mark A. Filer and Julie J. Filer, pro sese.

Margaret A. Martin, for respondent.

ARMEN, Special Trial Judge:

This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time that the petition was filed.1

1

The decision to

Unless otherwise indicated, all subsequent section

references are to the Internal Revenue Code in effect for 2001,

the taxable year in issue, and all Rule references are to the Tax

Court Rules of Practice and Procedure. All monetary amounts are

rounded to the nearest dollar.

- 2 be entered is not reviewable by any other court, and this opinion

should not be cited as authority.

Respondent determined a deficiency in petitioners’ Federal

income tax for the taxable year 2001 of $7,052 and an accuracyrelated penalty under section 6662(a) of $1,410.

After concessions, the issues for decision are:2

(1)

Whether a distribution received by petitioner Julie J. Filer as

the successor owner of her deceased mother-in-law’s annuity

contract is includable in petitioners’ gross income.

that it is to the extent provided herein.

(2)

We hold

Whether

petitioners are liable under section 6662(a) for an accuracyrelated penalty for substantial understatement of income tax.

We

hold that they are not.

Background

Some of the facts have been stipulated, and they are so

found.

We incorporate by reference the parties’ stipulation of

facts, supplemental stipulation of facts, and accompanying

exhibits.

At the time that the petition was filed, petitioners resided

in Orangevale, California.

(References to petitioners

individually are to Mark or Julie.)

2

Petitioners concede: (1) They received unreported

interest income of $28, and (2) they are not entitled to an IRA

deduction. Respondent concedes that petitioners are not liable

under sec. 72(t) for the additional tax on an early distribution

from a qualified retirement plan.

- 3 On November 17, 2000, Mark’s mother, Phyllis D. Filer

(Phyllis), died.

She was survived by her three children:

Mark,

Paul Filer (Paul), and Heidi Higdon (Heidi) (hereinafter referred

to collectively as the children).

At the time of her death, Phyllis owned a flexible premium

deferred annuity (annuity) with Anchor National Life Insurance

Co. (Anchor).

Phyllis applied for the annuity on October 29,

1985. On the application form, Phyllis named herself both as the

owner and primary beneficiary, she designated Julie both as the

annuitant and as the successor owner, and she designated Mark and

Paul as the contingent beneficiaries to share equally.3

Phyllis

paid the initial annual premium of $11,704, and Anchor issued the

annuity to Phyllis on November 5, 1985, with a retirement date of

November 5, 2036.4

The annuity contract provided that Phyllis could change the

successor owner or beneficiaries at any time by filing a written

request.

In addition, the annuity contract contained the

following provisions:

3

The annuitant is the person on whose life the contract is

issued.

The successor owner is the “person named by the owner to

receive all ownership rights upon the death of the owner.” The

contract further stated that the naming of a successor owner is

not an assignment, nor is the successor owner an assignee.

4

The retirement date is the date on which annuity payments

would begin.

- 4 (1)

If Julie is alive on the retirement date, Phyllis will

begin receiving annuity payments.

If Phyllis subsequently dies,

any remaining payments will be paid to the contingent

beneficiaries.

(2)

If Phyllis predeceases Julie before the retirement

date, Julie will become the successor owner, and she must

terminate the contract within 1 year after Phyllis’s death by

either:

(1) Surrendering the contract as described in the

contract’s nonforfeiture provisions; or (2) electing an annuity

as described in the contract’s settlement options provisions.

The nonforfeiture provisions provide that Julie could take free

annual withdrawals or surrender all or part of the contract.

The

settlement options provide that Julie could take partial

surrenders of the cash value, fixed amount installments, fixed

period installments, life annuity with a period certain,

installment refund annuity, or a joint and survivor annuity.

(3)

If Julie predeceases Phyllis before the retirement

date, Phyllis will receive the death benefit of the total cash

value of the contract less any unpaid loans.

A few years after the annuity was issued, Phyllis told Julie

that she placed Julie’s name on the annuity as the annuitant and

successor owner because Mark was busy, Paul’s lifestyle was

different, and Heidi lived in Florida and that Phyllis knew that

“if anything ever happened to me [Phyllis], that you [Julie]

- 5 would be fair and you would make sure that everyone got their

fair share.”

Phyllis was a big part of petitioners’ family’s

lives, and Phyllis and Julie had a very close relationship.

Because of their close personal relationship, Julie understood

Phyllis intended the “retirement plan or whatever you call it” to

benefit Phyllis’s children.

At that time, Julie told Mark about

Phyllis’s intent with respect to the annuity.

At the time of her death, Phyllis also had a last will and

testament, which she executed on November 19, 1991.

At that

time, Phyllis and Mark met with an attorney to draft her will.

In the will, Phyllis appointed Mark as the executor, and she

bequeathed her estate equally among her children.

In addition to her will, Phyllis executed a declaration of

trust for the Phyllis D. Filer Revocable 1991 Trust (1991 Trust)

on November 19, 1991.

In the 1991 Trust, Phyllis directed that

upon her death, the trust corpus be distributed equally among the

children.

After Phyllis’s death and under the terms of the annuity,

Julie became the successor owner of the annuity effective

November 30, 2000.

Around January 2001, Mark, on Julie’s behalf, contacted

Anchor about the annuity.

After Mark sent Anchor the death

certificate, Anchor sent a certified check for $27,641 payable to

Julie, individually, representing the lump-sum cash surrender

- 6 value of the annuity.

Julie immediately endorsed the check and

distributed one-third of such amount each to Mark, Paul, and

Heidi.

For the taxable year 2001, Anchor issued a Form 1099-R,

Distributions From Pensions, Annuities, Retirement or ProfitSharing Plans, IRAs, Insurance Contracts, etc., reporting that

Julie received a gross distribution of $27,641 and a taxable

distribution of $15,936.

On their 2001 Federal income tax return, petitioners did not

report any part of the $27,641 distribution.

Respondent

determined that petitioners received gross income of $15,936 from

the surrender of the annuity.

Respondent further determined that

petitioners are liable for the accuracy-related penalty under

section 6662(a) for a substantial understatement of income tax.

Petitioners timely filed with the Court a petition

disputing the determined deficiency as well as the accuracyrelated penalty.

Discussion

Generally, the Commissioner’s determinations are presumed

correct, and the taxpayer bears the burden of proving that those

determinations are erroneous.

290 U.S. 111, 115 (1933).

Rule 142(a); Welch v. Helvering,

The burden of proof may shift to the

Commissioner under section 7491 in certain circumstances.

Petitioners do not contend that section 7491(a) applies in this

- 7 case.

Consequently, we hold that petitioners have the burden of

proof as to any disputed factual issue.

See Rule 142(a).

With

respect to a taxpayer’s liability for any penalty, however,

section 7491(c) places on the Commissioner the burden of

production.

A.

Anchor Distribution

Petitioners do not dispute that Julie received from Anchor a

check payable to her in the amount of $27,641, which check

represented the lump-sum cash surrender value of the annuity.

Petitioners contend that Phyllis listed Julie as the successor

owner subject to an oral trust, with the intent and instruction

that Julie distribute the funds to the children upon Phyllis’s

death.

Moreover, petitioners assert that Phyllis’s instruction

to Julie is consistent with the directives in her 1991 Trust and

will that her estate be distributed equally among the children.

Petitioners further assert that when Julie received the

distribution, she did not take any part of the distribution, but

complied with Phyllis’s directive and divided the distribution

equally among the children.

Petitioners therefore contend that

the distribution should not be included in their gross income.

Respondent, on the other hand, does not dispute that Julie

distributed the proceeds one-third each to Mark, Paul, and Heidi,

but contends that petitioners must include the distribution in

their gross income because Julie was entitled to the entire

- 8 distribution under the terms of the annuity.

On brief,

respondent further contends that Phyllis’s oral statement to

Julie did not create a trust.

Clearly, Phyllis’s naming of Julie as the successor owner of

the annuity constituted a nonprobate transfer of the annuity to

Julie.

See Cal. Prob. Code sec. 5000 (West 1991).

The question

thus presented is whether Julie received the distribution subject

to an oral trust to distribute the annuity proceeds to the

children upon Phyllis’s death.

Under California law, it is well settled that a trust over

personal property may be created orally and established by parol

evidence.

Cal. Prob. Code sec. 15207 (West 1991);5 see Fahrney

v. Wilson, 4 Cal. Rept. 670, 672-673 (Dist. Ct. App. 1960).

The

essential elements of a trust, whether oral or written, under

California law are:

(1) A manifestation of an intention by the

settlor to create a trust; (2) a proper trust purpose; (3) trust

property;

and (4) an identifiable beneficiary.

secs. 15201-15205 (West 1991).

Cal. Prob. Code

A trust may be created by the

“transfer of property by the owner, by will or by other

instrument taking effect upon the death of the owner, to another

5

As relevant herein, Cal. Prob. Code sec. 15207 (West

1991) provides: (a) An oral trust of property may be

established only by clear and convincing evidence; and (b) the

oral declaration of the settlor, standing alone, is not

sufficient evidence of the creation of a trust of personal

property.

- 9 person as trustee.”

Cal. Prob. Code sec. 15200(c) (West 1991).

Our findings in this case are based in part on the testimony

of petitioners.

Here, we found petitioners to be honest,

sincere, and credible witnesses.

In the instant case, Phyllis designated Julie as the

successor owner of the annuity contract.

Phyllis had a very

close relationship with Julie, which evidently reassured Phyllis

that, by naming Julie as the successor owner, Julie would ensure

that the annuity proceeds were distributed for the benefit of the

children consistent with Phyllis’s intent.

At the time that

Julie learned about Phyllis’s intent, Julie clearly understood

that the funds were for the benefit of the children.

Indeed,

upon Phyllis’s death, Julie immediately cashed the check from

Anchor and distributed the proceeds equally to the children.

On

the basis of the record before us, we conclude that Phyllis

designated Julie as the successor owner pursuant to an oral trust

wherein Julie would distribute the annuity proceeds for the

benefit of the children.

Respondent contends, however, that Phyllis’s oral statement

to Julie is not sufficient evidence of the creation of a trust.

We disagree.

The California Law Revision Commission Comment to

California Probate Code section 15207(b) states that for purposes

of this section:

[the] delivery of personal property to another person

accompanied by an oral declaration by the transferor that

- 10 the transferee holds it in trust for a beneficiary creates a

valid oral trust. Constructive delivery, such as by

earmarking property or recording it in the name of the

transferee, is also sufficient to comply with * * *

[California Probate Code section 15207(b)].

Here, Phyllis essentially “delivered” the trust property to Julie

when she named Julie as the successor owner.

Moreover, Phyllis

made an oral declaration to Julie instructing her to distribute

the annuity to the children upon Phyllis’s death. Indeed, Julie

immediately complied with Phyllis’s directive upon Phyllis’s

death.

Based on our conclusion that Julie received the distribution

in trust for the benefit of the children, we hold that Julie did

not receive the distribution in her personal capacity, and,

therefore, the distribution is not income to her.

See Healy v.

Commissioner, 345 U.S. 278, 282 (1953) (“[R]eceipts by a trustee

expressly for the benefit of another are not income to the

trustee in his individual capacity, for he ‘has received nothing

* * * for his separate use and benefit’”.), quoting Eisner v.

Macomber, 252 U.S. 189, 211 (1920).

We now turn to whether any part of the distribution

constitutes income to Mark.

For tax purposes, amounts required

to be distributed to a beneficiary from a trust corpus are

includable in the gross income of the beneficiary.

Sec. 662(a).

Indeed, the beneficiaries of the oral trust were the three

children.

As one of those beneficiaries, Mark received in his

- 11 personal capacity one-third of the distribution.

Thus,

petitioners, having filed a joint return, must include one-third

of the distribution in their gross income.

662(a).

See secs. 61(a)(9),

Therefore, such amount, less one-third of the

consideration paid for the contract, is includable in

petitioners’ gross income.

B.

Section 6662(a) Substantial Understatement of Income Tax

The last issue for decision is whether petitioners are

liable for an accuracy-related penalty pursuant to section

6662(a) for the year in issue.

As previously mentioned, section

7491(c) places on the Commissioner the burden of production with

respect to a taxpayer’s liability for any penalty.

Section 6662(a) imposes a penalty equal to 20 percent of any

underpayment of tax that is due to a substantial understatement

of income tax.

See sec. 6662(a) and (b)(2).

An individual

substantially understates his or her income tax when the reported

tax is understated by the greater of 10 percent of the tax

required to be shown on the return or $5,000.

6662(d)(1)(A).

Sec.

Tax is not understated to the extent that the

treatment of the item is (1) based on substantial authority, or

(2) relevant facts are adequately disclosed in the return or in a

statement attached to the return, and there is a reasonable basis

for the tax treatment of such item by the taxpayer.

6662(d)(2)(B).

Sec.

- 12 Moreover, the accuracy-related penalty does not apply with

respect to any portion of an underpayment if it is shown that

there was reasonable cause for the underpayment and the taxpayer

acted in good faith with respect to the underpayment.

Sec.

6664(c); sec. 1.6664-4(b), Income Tax Regs.; see United States v.

Boyle, 469 U.S. 241, 242 (1985).

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.

Sec. 1.6664-4(b)(1), Income Tax Regs.

The

most important factor is the extent of a taxpayer’s effort to

assess the taxpayer’s proper tax liability for such year.

Id.

Based on our holding on the first issue as well as

respondent’s concession, see supra note 2, we hold that

respondent did not satisfy the burden of production under section

7491(c) because petitioners did not substantially understate the

income tax on their return.

Sec. 6662(d)(1)(A); Higbee v.

Commissioner, 116 T.C. 438, 442 (2001).

Accordingly, we hold for

petitioners on this issue.

Conclusion

We have considered all of the other arguments made by the

parties, and, to the extent that we have not specifically

addressed them, we conclude that they are without merit.

Reviewed and adopted as the report of the Small Tax Case

Division.

- 13 To reflect our disposition of the disputed issues, as well

as the parties’ concessions,

Decision will be entered

under Rule 155.