Ross v. Commissioner

T.C. Memo. 1995-599

UNITED STATES TAX COURT

RHETT B. ROSS AND SANDRA L. ROSS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 4985-93. Filed December 19, 1995.

Paula M. Junghans, for petitioners.

Alan R. Peregoy, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

DAWSON, Judge: This case was assigned to Special Trial

Judge Robert N. Armen, Jr., pursuant to the provisions of section

7443A(b)(4) of the Internal Revenue Code of 1986, as amended, and

Rules 180, 181, and 183.1 The Court agrees with and adopts the

Opinion of the Special Trial Judge, which is set forth below.

1
Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for 1989, the taxable year in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
 - 2 -

OPINION OF THE SPECIAL TRIAL JUDGE

ARMEN, Special Trial Judge: For the taxable year 1989,

respondent determined a deficiency in petitioners' Federal income

tax, as well as deficiencies in petitioners' Federal excise taxes

under sections 4973 and 4980A,2 in the total amount of

$34,974.34. The deficiency in income tax includes the 10-percent

additional tax imposed by section 72(t) on early distributions

from qualified retirement plans.

The pivotal issue for decision is whether the distribution

received by petitioner Rhett B. Ross in 1989 from the Maryland

State Teachers' Retirement System qualifies for tax-free rollover

treatment under section 402(a)(5). The resolution of this issue

turns on whether the distribution constitutes a "qualified total

distribution" as defined by section 402(a)(5)(E)(i). If we

conclude that the distribution in question does not qualify for

tax-free rollover treatment, then we must also decide whether

petitioners are liable for the 10-percent additional tax under

section 72(t).3

2
Sec. 4973 imposes a 6-percent excise tax on excess contributions to
individual retirement accounts. Sec. 4980A imposes a 15-percent excise tax on
excess distributions from qualified retirement plans. Both of these taxes are
included within ch. 43 of the I.R.C. They are therefore subject to the
deficiency procedures set forth in subch. B of ch. 63 of the I.R.C. See sec.
6211(a).
3
At trial, respondent conceded that the notice of deficiency overstates
the amount of the deficiency in excise tax under sec. 4973 and that the
correct amount of such deficiency is $4,080 rather than $4,200. On brief,
respondent conceded that petitioner Sandra L. Ross is not liable for any
deficiency in excise tax under either sec. 4973 or 4980A. At trial,
petitioner Rhett B. Ross conceded liability for the 15-percent excise tax
under section 4980A, and on brief he effectively conceded liability for the 6-
percent excise tax under section 4973 by abandoning the issue. See Money v.
 - 3 -

FINDINGS OF FACT

Petitioners resided in Ijamsville, Maryland, at the time

that their petition was filed with the Court.

At the time of trial, petitioner Rhett B. Ross (petitioner)

was employed, and had been so employed for some 32 years, as a

teacher in the public schools of the State of Maryland. During

1989, the year in issue, as well as at the time of trial,

petitioner was employed by Montgomery County Public Schools,

where he taught physical education and coached varsity basketball

and baseball.

For most of petitioner's career as a teacher in the Maryland

public schools, petitioner was a member of the Teachers'

Retirement System of the State of Maryland (the Retirement

System). On October 22, 1989, however, petitioner voluntarily

elected to transfer from the Retirement System to the Teachers'

Pension System of the State of Maryland (the Pension System).4

Petitioner's transfer became effective November 1, 1989.

The Retirement System is a qualified defined benefit plan

under section 401(a). The Retirement System requires mandatory

Commissioner, 89 T.C. 46, 48 (1987); Atlee v. Commissioner, 67 T.C. 395, 396
n.2 (1976); Hedrick v. Commissioner, 63 T.C. 395, 396-397 (1974); Alexander v.
Commissioner, 61 T.C. 278, 288 n.6 (1973); Stengel v. Commissioner, T.C. Memo.
1992-570, affd. without published opinion 996 F.2d 1227 (9th Cir. 1993);
Cotter v. Commissioner, T.C. Memo. 1991-316.
4
For a discussion of the Retirement System and the Pension System, see
generally Hylton v. Commissioner, T.C. Memo. 1995-27; Hoppe v. Commissioner,
T.C. Memo. 1994-635; Hamilton v. Commissioner, T.C. Memo. 1994-633; Maryland
State Teachers Association v. Hughes, 594 F. Supp. 1353, 1357-1358 (D. Md.
1984); Conway v. United States, 76 AFTR 2d 95-6918 (D. Md. 1995).
 - 4 -

nondeductible employee contributions. The Pension System is also

a qualified defined benefit plan under section 401(a) but

generally does not require mandatory nondeductible employee

contributions. The State of Maryland contributes to both the

Retirement System and the Pension System on behalf of the members

of those systems. The trusts maintained as part of the

Retirement System and the Pension System are both exempt from

taxation under section 501(a).

Within a few weeks after the effective date of petitioner's

transfer from the Retirement System to the Pension System, the

Retirement System issued a check to petitioner in the amount of

$172,559.14 (the Transfer Refund). The Transfer Refund consisted

of $18,112.25 in previously taxed contributions made by

petitioner during his employment tenure as a teacher and

$154,446.89 of earnings. The earnings constitute the taxable

portion of the Transfer Refund.

At the time that he received the Transfer Refund, petitioner

was 47 years old and was not disabled.

If petitioner had not transferred to the Pension System but

rather had remained a member of the Retirement System, he would

have been entitled to retire at an appropriate age and receive a

normal service retirement benefit, including a regular monthly

annuity. He would not, however, have been entitled to receive a

transfer refund because a transfer refund is only payable to
 - 5 -

those who elect to transfer from the Retirement System to the

Pension System.

As a member of the Pension System, petitioner will

eventually receive a retirement benefit based upon his salary and

his creditable years of service, specifically including those

years of creditable service recognized under the Retirement

System. However, because of petitioner's receipt of the Transfer

Refund, petitioner's monthly annuity, upon retirement, will be

less than the monthly annuity that he would have received if he

had not transferred to the Pension System but had ultimately

retired under the Retirement System.

Petitioner received the Transfer Refund in the form of a

check dated November 30, 1989. On January 30, 1990, within 60

days of receiving the Transfer Refund, petitioner deposited

$70,000 of the Transfer Refund in an individual retirement

account (IRA) with T. Rowe Price, Inc., a family of mutual funds

in Baltimore, Maryland. Petitioner used the balance of the

Transfer Refund to help finance a new home and to help pay his

tax liability as reported on his 1989 Federal income tax return.

Petitioner received a Form 1099-R (Total Distributions From

Profit-Sharing, Retirement Plans, Individual Retirement

Arrangements, Insurance Contracts, Etc.) for 1989 from the

Maryland State Retirement Agency. The Form 1099-R reported

petitioner's Transfer Refund and reflected a gross distribution

of $172,559.14, petitioner's contributions in the amount of
 - 6 -

$18,112.25, and the taxable amount as the difference or

$154,446.89.

On their Federal income tax return for 1989, petitioners

disclosed the receipt of the Transfer Refund. Specifically, on

line 17a of Form 1040, petitioners entered $154,447 as the amount

of "Total pensions and annuities". On line 17b they reported

$84,447 as the taxable amount thereof, and immediately below such

entry they disclosed that the balance, or $70,000, was rolled

over. Petitioners included the $84,447 amount in taxable income

and paid regular income tax thereon. See sec. 1(a).

Petitioners also attached to their 1989 income tax return

Form 5329 (Return for Individual Retirement Arrangement and

Qualified Retirement Plans Taxes). In Part II of such form,

petitioners reported liability for the 10-percent additional tax

imposed by section 72(t) on early distributions from qualified

retirement plans. Petitioners computed the additional tax as

follows:

Total distribution received $172,559
Taxable amount 154,447
Less: amount rolled over -70,000
Balance 84,447
10 percent rate of tax x .10
Sec. 72(t) additional tax 8,445

Petitioners combined their liability for the section 72(t)

additional tax with their liability for the regular income tax in

reporting their total tax liability on page 2 of their Form 1040

for 1989.
 - 7 -

In December 1991, petitioner closed his IRA with T. Rowe

Price, Inc., and received a distribution in the amount of

$69,089. On their Federal income tax return for 1991,

petitioners disclosed the receipt of this amount. Specifically,

on line 16b of Form 1040, petitioners entered $69,089 as the

taxable amount of "Total IRA distributions". They included this

amount in taxable income and paid regular income tax thereon.

See sec. 1(a).

Petitioners also attached to their 1991 income tax return

Form 5329 (Additional Taxes Attributable to Qualified Retirement

Plans (Including IRA's), Annuities, and Modified Endowment

Contracts). In Part II of such form, petitioners reported

liability for the 10-percent additional tax imposed by section

72(t) in the amount of $6,909. Petitioners computed the

additional tax by multiplying the statutory rate (10 percent) by

the reported distribution ($69,089).

On December 14, 1992, respondent sent petitioners a notice

of deficiency. In the notice, respondent determined the

deficiencies for 1989 that are in issue in the present case.

Specifically, respondent determined that the Transfer Refund was

not eligible for tax-free rollover treatment under section

402(a)(5). Therefore, respondent determined that, under sections

402(a)(1) and 72, the taxable portion of the Transfer Refund

($154,446.89) was includable in petitioners' gross income for

1989 and not merely the portion thereof reported by petitioners
 - 8 -

($84,447). As a consequence, respondent increased petitioners'

income by $70,000. As corollaries to this determination,

respondent also determined that petitioners are liable for: (1)

The 10-percent additional tax under section 72(t), (2) the excise

tax under section 4973 on excess contributions to individual

retirement accounts, and (3) the excise tax under section 4980A

for excess distributions from qualified retirement plans.5

In February 1993, petitioners filed Form 1040X (Amended U.S.

Individual Income Tax Return), seeking to amend their 1991 income

tax return. On the amended return for 1991, petitioners sought

to reduce taxable income by the previously reported IRA

distribution in the amount of $69,089. Also on the amended

return for 1991, petitioners sought to eliminate the previously

reported additional tax under section 72(t) in the amount of

$6,909.

In July 1993, the Commissioner sent petitioners a notice of

claim disallowance in respect of their claim for refund for 1991.

In July 1995, petitioners commenced a suit for refund against the

United States in the U.S. District Court for the District of

Maryland in respect of said claim for refund. Such refund action

is presently pending at docket No. Y952024.

5
See supra note 3 regarding the parties' concessions of these corollary
determinations.
 - 9 -

OPINION
I. Rollover Issue

The pivotal issue in this case is whether petitioner's

Transfer Refund qualifies for tax-free rollover treatment under

section 402(a)(5). The resolution of this issue turns on whether

the Transfer Refund constitutes either a "qualified total

distribution", as defined by section 402(a)(5)(E)(i), or a

"partial distribution", as defined by section 402(a)(5)(D)(i).

Petitioners concede that the Transfer Refund does not

qualify as a partial distribution under section 402(a)(5)(D). In

view of the fact that the Transfer Refund was not received on

account of death, disability, or separation from the service, but

rather on account of petitioner's election to transfer from the

Retirement System to the Pension System, petitioners' concession

is required by both statutory and case law. See sec.

402(a)(5)(D)(i)(I), (e)(4)(A); Wittstadt v. Commissioner, T.C.

Memo. 1995-492, and cases cited therein; Conway v. United States,

76 AFTR 2d 95-6918 (D. Md. 1995).

On the other hand, petitioners do not concede that the

Transfer Refund does not constitute a qualified total

distribution. However, they have not actively argued this issue,

but rather have essentially reserved the right to pursue it on

appeal. In this regard, petitioners recognize that the existing

case law of this Court, as well as the U.S. District Court for

the District of Maryland, supports the conclusion that the
 - 10 -

Transfer Refund does not constitute a qualified total

distribution. See Wittstadt v. Commissioner, T.C. Memo. 1995-

492; Humberson v. Commissioner, T.C. Memo. 1995-470; Pumphrey v.

Commissioner, T.C. Memo. 1995-469; Adler v. Commissioner, T.C.

Memo. 1995-148; Dorsey v. Commissioner, T.C. Memo. 1995-97; Brown

v. Commissioner, T.C. Memo. 1995-93; Hylton v. Commissioner, T.C.

Memo. 1995-27; Hoppe v. Commissioner, T.C. Memo. 1994-635;

Hamilton v. Commissioner, T.C. Memo. 1994-633; Sites v. United

States, 75 AFTR 2d 95-2503 at 95-2504, 95-1 USTC par. 50,280 (D.

Md. 1995); see also Conway v. United States, supra; cf. Wheeler

v. Commissioner, T.C. Memo. 1993-561.6 We observe that the

definition of "qualified total distribution" set forth in section

402(a)(5)(E)(i)(II) incorporates the definition of "lump sum

distribution" set forth in section 402(e)(4)(A) and that the

latter definition includes concepts such as "balance to the

credit" and "on account of the employee's separation from the

service", which the foregoing cases address and resolve in the

Commissioner's favor.

6
We note that certain of the foregoing cases involve transfer refunds
arising from the taxpayer's transfer from the Maryland State Employees'
Retirement System to the Maryland State Employees' Pension System. The plan
provisions of the Maryland State Employees' Retirement System and the Maryland
State Employees' Pension System are set forth in secs. 1 through 80 and secs.
111 through 129, respectively, of Art. 73B of the Ann. Code of Md. The plan
provisions of the Maryland State Teachers' Retirement System and the Maryland
State Teachers' Pension System are set forth in secs. 81 through 104 and secs.
140 through 155, respectively, of Art. 73B of the Ann. Code of Md. The secs.
governing the foregoing two Retirement Systems contain virtually identical
provisions authorizing distributions to employees and teachers who choose to
transfer from a retirement system to a pension system. See Md. Ann. Code,
art. 73B, secs. 11B(5), 14(1)(g) (1988), regarding the Maryland State
Employees' Retirement System; Md. Ann. Code, art. 73B, sec. 89(1)(e) (1988),
regarding the Maryland State Teachers' Retirement System.
 - 11 -

Based on existing case law, we hold that the Transfer Refund

does not qualify for tax-free rollover treatment under section

402(a)(5) because it does not constitute a qualified total

distribution.

II. Section 72(t) Additional Tax Issue

We turn next to respondent's determination that petitioners

are liable for the 10-percent additional tax imposed by section

72(t).

Section 72(t) provides for a 10-percent additional tax on

early distributions from qualified retirement plans. Paragraph

(1), which imposes the tax, provides in relevant part as follows:

(1) Imposition of Additional Tax.--If any taxpayer
receives any amount from a qualified retirement plan
* * * the taxpayer's tax under this chapter for the
taxable year in which such amount is received shall be
increased by an amount equal to 10 percent of the
portion of such amount which is includible in gross
income.

We have already sustained respondent's determination that

the taxable portion of the Transfer Refund is includable in

petitioners' gross income in the year of receipt. Because none

of the exceptions of section 72(t)(2) apply to relieve

petitioners of this additional tax, we can see no alternative but

to sustain respondent's determination that petitioners are liable

for the 10-percent additional tax imposed by section 72(t).

Petitioners argue, however, that there is an alternative.

First, petitioners contend that they have already paid the

additional tax under section 72(t) on the taxable portion of the
 - 12 -

Transfer Refund. In this regard petitioners point to the fact

that they reported liability for additional tax under section

72(t) on their 1989 income tax return in the amount of $8,445

based on a reported taxable distribution in the amount of $84,447

and on their 1991 income tax return in the amount of $6,909 based

on a reported taxable distribution in the amount of $69,089.7

There are at least two fundamental weaknesses to

petitioners' contention. First, petitioners overlook the fact

that they have commenced a suit for refund against the United

States in the U.S. District Court for the District of Maryland.

Such action involves petitioners' claim for refund relating to

the payment of additional tax under section 72(t) in 1991. In

other words, petitioners are currently seeking the recovery of

taxes allegedly overpaid relating to the reporting of the IRA

distribution in December 1991 and the additional tax under

section 72(t) paid in respect thereof.

Second, petitioners overlook the fact that only 1 taxable

year is pending before this Court and that such year is 1989.

Even though petitioners' litigation expenses relating to their

refund action would be minimized, if not obviated, by our

resolving the issues pertaining to 1991, we simply have no

7
The sum of the two reported distributions, i.e., $84,447 + $69,089 or
$153,536, is slightly less than the taxable portion of petitioner's Transfer
Refund, i.e., $154,447. Accordingly, the sum of the additional taxes under
sec. 72(t) reported by petitioners on their 1989 and 1991 income tax returns
($15,354) is slightly less than the additional tax on the taxable portion of
petitioner's Transfer Refund ($15,448). This difference is unimportant to our
decision.
 - 13 -

jurisdiction over that year. See Commissioner v. Gooch Milling &

Elevator Co., 320 U.S. 418 (1943). Moreover, in deciding

petitioners' liability for additional tax under section 72(t) for

1989, we fail to appreciate the relevance of petitioners'

original reporting position for 1991. Cf. sec. 6214(b). Apart

from the fact that the District Court might rule in petitioners'

favor in their refund action, we are aware of the annual

accounting principle, which holds that taxable income is

determined on an annual, rather than on a transactional, basis.

Burnet v. Sanford & Brooks Co., 282 U.S. 359, 365-366 (1931). We

have therefore approached the issue of petitioners' liability for

additional tax under section 72(t) for 1989 with regard only for

the facts and law pertaining to that year.

Alternatively, petitioners contend that even if petitioner

Rhett B. Ross is liable for the additional tax under section

72(t), petitioner Sandra L. Ross is not so liable. In this

regard, petitioners contend that the joint and several liability

provision of section 6013(d)(3) applies only to income taxes, and

that the additional tax under section 72(t) is a penalty and not

a tax. We think that petitioners' contention is without merit

for the following reasons.

First, section 72(t) denominates the exaction that it

imposes as a "tax" and not as a "penalty". Other sections of the

Internal Revenue Code denominate the exactions that they impose

as "penalties" or "additions to tax". See, e.g., section 6651(a)
 - 14 -

(additions to tax for failure to file return or to pay tax),

section 6654(a) (addition to tax for failure to pay estimated

income tax), section 6662(a) (accuracy-related penalty), and

section 6663(a) (fraud penalty).

Second, structurally, section 72(t) is part of chapter 1 of

subtitle A of the Internal Revenue Code. Subtitle A is

denominated "Income Taxes" and chapter 1 is denominated "Normal

Taxes and Surtaxes". The penalties and additions to tax noted

above are found in chapter 68 (Additions to the Tax, Additional

Amounts, and Assessable Penalties) of subtitle F (Procedure and

Administration).

Third, chapter 1 of subtitle A of the Internal Revenue Code

includes a number of income taxes. Insofar as individuals are

concerned, there is, of course, the regular income tax imposed by

section 1 and the alternative minimum tax imposed by section 55.

Additional income taxes are found in other chapters of subtitle

A, most notably the self-employment tax in chapter 2. It is

apparent, therefore, that there is not a single income tax, but

rather a number of separate taxes that compose what is commonly

referred to as "the income tax".

Fourth, the foregoing point is underscored by section

6013(a), which authorizes a husband and wife to make "a single

return jointly of income taxes under subtitle A". (Emphasis

added.) Indeed, line 52 of Form 1040, the basic individual
 - 15 -

income tax return, is dedicated to the reporting of liability for

the additional tax under section 72(t).

Fifth, a useful analogy is furnished by section 1.6017-

1(b)(2), Income Tax Regs. That section provides that, as a

general rule, each spouse is jointly and severally liable for any

self-employment tax that is reported on a joint return. As

previously noted, the self-employment tax is imposed by chapter 2

of the Internal Revenue Code and is distinct from the regular

income tax imposed by section 1.

Petitioners rely heavily on In re Cassidy, 983 F.2d 161

(10th Cir. 1992), wherein the additional tax under section 72(t)

was viewed as a penalty. That case, however, is not controlling

because the Court of Appeals' holding was based on the

application of bankruptcy policy and was limited to determining

priority of claims in bankruptcy proceedings.

In view of the foregoing, we hold that petitioners are

liable for the 10-percent additional tax imposed by section

72(t). See Wittstadt v. Commissioner, T.C. Memo. 1995-492, and

cases cited therein.

III. Conclusion

In order to give effect to our disposition of the disputed

issues, as well as the parties' concessions,

Decision will be entered

under Rule 155.