T.C. Summary Opinion 2012-79

T.C. Summary Opinion 2012-79

UNITED STATES TAX COURT

KENNETH MICHAEL FRANCIS AND SEDEF TARLAN FRANCIS, Petitioners

v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 19986-10S.

Filed August 8, 2012.

Kenneth Michael Francis, pro se.

Mistala G. Merchant and Maggie Stehn (student), for respondent.

SUMMARY OPINION

ARMEN, Special Trial Judge: This case was heard pursuant to the

provisions of section 7463 of the Internal Revenue Code in effect when the

SEaVED AUG -8 2012

-2petition was filed.i Pursuant to section 7463(b), the decision to be entered is not

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

for any other case.

Respondent determined a deficiency in petitioners' 2008 joint Federal

income tax of $6,491 and an accuracy-related penalty under section 6662(a) of

$1,287.2 After a concession by petitioners,3 the issues for decision are: (1)

Whether petitioners must include an award of backpay in their gross income for

2008; and (2) whether they are liable for the accuracy-related penalty under

section 6662(a).

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 California when the petition was filed.

i Unless otherwise indicated, all subsequent 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.

2 All dollar amounts are rounded to the nearest dollar.

3 Petitioners concede that they received but failed to report a taxable

retirement distribution of $290 on their 2008 joint Federal income tax return.

-3In 2005 Kenneth Michael'Francis (petitionef) was granted an award of

backpay by the U.S. Air Force Board for the Correction-öf Military Records ~

(BCMR). The BCMR held, inter alia, that petitioner was wrongfully denied a

promotion to the rank of lieutenant colonel in the IJ.S. Air Force (promotion

denial).

In December 2008 petitioners received a payment òf $24,566 (promotion

backpay) from the Defense Finance and Accounting Service (DFAS).4 The

promotion backpay represented the difference between the military pay and

allowances petitioner received as an Air Force major and the militarÿ pay ánd

allowances he would lîave received as an Air Foròe lieutenant colonel while he

served on active duty from October 1998 to April 2002.

In February 2009 petitioner self-prepared and filed petitioners' 2008 joint

Federal income tax return (joint return). Petitioners, however, did not report the

promotion backpay on their joint return.

DFAS mailed petitioner a letter dated September 6, 2008 (DFAS letter), that

states: "The following are enclosed for your use and information * * * Treasury

Department Form W-2, Wage and Tax Statement, indicating taxable income that

4 The record is not clear as,to why the payment was not made until

December 2008.

must be reported on your next tax return". Attached to the DFAS letter was a

Form W-2, Wage and Tax Statement, for 2008 reporting the promotion backpay as

wages. At trial petitioner testified that petitioners did not receive the DFAS letter

and Form W-2 until approximately April 2009 because DFAS had mailed the letter

to his mother's address in Illinois (Illinois address). Petitioners were aware,

however, that DFAS typically sent tax correspondence to the Illinois address and

that the Illinois address was petitioner's "permanent home of record" on file with

DFAS.

In or around April 2009 petitioner began treatment for melanoma and

remained in treatment for approximately a year thereafter. Petitioners never filed

an amended joint return for 2008 including the promotion backpay in.their gross

income or otherwise reported the promotion backpay on any other tax return.

Discussion

I.

Burden ofProof

In general, the Commissioner's determinations set forth in a notice of

deficiency are presumed to be correct, and the taxpayer bears the burden of

proving that those determinations are in error. Rule 142(a); Welch v. Helvering,

290 U.S. 111, 115 (1933). Pursuant to section 7491(a), the burden of proof as to

factual matters shifts to the Commissioner under certain circumstances.

-5Petitioners have neither alleged that section 7491(a) applies, nor have they

established their compliance with its requirements. Accordingly, petitioners bear

the burden of proof. See Rule 142(a); Welch v. Hélvering, 290 U.S. at 115; cf.

sec. 6201(d).

II.

Unreported Income

Section 61(a)(1) provides the general-rule that gross income includes

income from whatever source derived, including dompensation for services.

Section 451(a) generally provides that taxpayers, such as petitioners, who use the

cash receipts and disbursements method of accoupting, must:include any item of

gross income in their gross income for the taxablé year in which the item is

actually.or constructively received. See sec. 1.451-1(a), Income Tax Regs.

Petitioners generally argue that the promotion backpay received in 2008

should be included in their gross income for the years 1998 through 2002 because

the promotion backpay is attributable to the.services petitioner provided in those .

years. Petitioners further contend that the promotion backpay should have been

allocated to the years 1998 through 2002 because their taxable income was subject

to a lower tax bracket during those years when compared to 2008. In this regard,

5 We note that petitioners do not allege that sec. 6201(d) applies and do not

dispute that they received all $24,566 of the promotion backpay in December 2008

reported on the 2008 Form W-2, Wage and Tax Statement, issued by DFAS.

-6petitioners believe that by reporting the promotion backpay as taxable wages for

2008 on Form W-2, DFAS has placed an artificial tax burden on them that is

contrary to the purpose of the BCMR decision, i.e., to place petitioner in the same

position that he would be in if the promotion denial had never occurred.6

The parties do not dispute that DFAS paid, and petitioners actually received,

the promotion backpay in 2008. Petitioners have failed to show, and the record

does not suggest, that the promotion backpay was constructively received by

petitioners in any prior year. Therefore, the promotion backpay is properly

includible in petitioners' gross income for 2008. See sec. 451(a); Prewitt v.

Commissioner, T.C. Memo. 1995-24; sec. 1.451-1(a), Income Tax Regs.

Petitioners' argument that they should be entitled to retroactively allocate

the promotion backpay to their gross income for the years 1998 through 2002

because their tax bracket for that period was lower than their tax bracket for 2008

has been rejected by this Court in the past. See Prewitt v. Commissioner, T.C.

Memo. 1995-24. We acknowledge that the purpose of the BCMR decision was to

6 petitiOners alsO argue that DFAS should have reduced the promotion

backpay by the amount of civilian pay petitioner earned during the period from

April 1, 2002, through April 5, 2005 (civilian pay offset). The civilian pay offset

does not apply to petitioner's promotion backpay, however, because the promotion

backpay relates to a period when petitioner was not engaged in civilian

employment. See Groves v. United States, 47 F.3d 1140, 1147-1148 (Fed. Cir.

1995); see also Montiel v. United States, 40 Fed. Cl. 67, 69-74 (1998).

-7place petitioner in the same situation he would have been in if the promotion

denial had never occurred. Although not clear from the record, it may very well

be that petitioners would have.paid.less tax with respect to the promotion backpay

if the promotion denial had never occurred. Under the circumstances we can

appreciate petitioners' dismay. Nevertheless, we are constrained to apply the law

as written by Congress to the facts as they occurred and not as they might have

occurred. See,Commissioner v. Nat'l Alfalfa Deliydrating & Milling Co., 417

U.S. 134, 148-149 (1974). We cannot reallocate the promotion backpay petitioner

received in 2008 to prior years simply because doing so might provide favorable

tax treatment for petitioners. Therefore, we sustain respondent's deficiency

determination.

III.

Accuracy-Related Penalty

..

Respondent determined that petitioners arè liable for the accuracy-related

penalty under section 6662(a) for a substantial understatement of income tax for

the taxable year 2008.

Section 6662(a) and (b)(2) imposes a penalty equal to 20% of the amount of

any underpayment that is due to a substantial understatement of income tax. An 042

individual substantially understates his or her income tax when the reported tax is

-8understated by the greater of 10% of the tax required to be shown on the return or

$5,000. Sec. 6662(d)(1)(A).

With respect to a taxpayer's liability for any penalty, section 7491(c) places

on the Commissioner the burden of production, thereby requiring the

Commissioner to come forward with sufficient evidence indicating that it is

appropriate to impose the penalty. Higbee v. Commissioner, 116 T.C. 438, 446447 (2001). Once the Commissioner meets his burden of production, the taxpayer

must come forward with persuasive evidence that the Commissioner's

determination is incorrect. See Rule 142(a); Welch v. Helvering, 290 U.S. at 115.

Respondent has satisfied his burden of production because the record shows

that petitioners understated their income tax for 2008 by $6,491, which constitutes

a substantial understatement within the meaning of section 6662(d)(1)(A). See

Higbee v. Commissioner, 116 T.C. at 446.

The accuracy-related penalty does not apply to any portion of an

underpayment, however, if the taxpayer proves that the taxpayer had reasonable

cause for that portion of the underpayment and that the taxpayer acted in good

faith with respect to such portion. Sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax

Regs. Petitioners bear the burden of proving that the accuracy-related penalty

-9should not be imposed. See sec. 6664(c)(1); Higbée v. Commissioner, 116 T.C. at

446.

The decision as to whether the taxpayer acted with reasonable cause and in

good faith is made on a case-by-case basis, taking into account the pertinent facts

and circumstances. See Neely v. Commissioner, 85 T.C. 934, 947-950 (1985).

Most important in this decision "is the extent of tl e taxpayer's effort to assess the

taxpayer's proper tax liability." Sec. 1.6664-4(b) 1), Income Tax Regs. A

taxpayer must take reasonable steps to determine and apply the law. Niedringhaus

v. Commissioner, 99 T.C. 202, 222 (1992); Campbell v. Commissioner, T.C.

Memo. 2001-118.

Petitioners contend that they should not be liable for the accuracy-related

penalty with respect to the portion of the underp yment attributable to the

promotion backpay.7 Although petitioners admit that they received the promotion

backpay in December 2008, they did not report the promotion backpay on their

joint return because they believed that the payment was nontaxable. Petitioners,

however, presented no evidence that they consulted a tax professional or took any

7 As for the portion of the underpayment attributable to the unreported

retirement distribution, petitioners make no argument regarding the penalty and

are therefore deemed to have conceded that matter.

- 10 other reasonable steps to ascertain the proper tax treatment of the promotion

backpay they received.

Moreover, although petitioners allege that hey did not receive the DFAS

letter or the Form W-2 until April 2009, they still did not file an amended joint

return or contact a tax professional thereafter.8 I etitioners admitted at trial that

they should have filed an amended return once they received the DFAS letter and

Form W-2. Petitioners, however, point to petiti ner's yearlong treatment for

melanoma beginning in April 2009 as reasonable cause for not filing an amended

joint return. Petitioners provided no explanatio as to why they did not file an

amended joint return once petitioner's treatmen for melanoma ended or why

petitioner Sedef Tarlan Francis could not have repared an amended return for

petitioner to sign.

Although the record might support a finding of good faith on petitioners'

part, the standard we are obliged to apply also r quires the existence of reasonable

cause. See sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. Thus, petitioners

might have had a good faith belief that the pron otion backpay was nontaxable.

8 Petitioner was aware that DFAS frequ ntly sent tax correspondence to his

mother's address in Illinois. Petitioner, howev r, presented no evidence that he

inquired whether his mother received the DFAS letter or Form W-2 before he filed

petitioners' joint return in February 2009.

- 11 However, they have failed to prove that they acted with reasonable cause under the

relevant facts and circumstances. Therefore, we sustain respondent's

determination with respect to the accuracy-related penalty.

Conclusion

We have considered all of the arguments advanced by petitioners, and, to

the extent not expressly addressed, we conclude that those arguments do not

support a result contrary to our decision herein.

To give effect to our disposition of the disputed issues as well as

petitioners' concession,

Decision will be entered

for respondent.