T.C. Summary Opinion 2001-60
UNITED STATES TAX COURT
BLANEY H. HOWLE III AND POLLY T. HOWLE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 6702-00S. Filed April 23, 2001.
Blaney H. Howle III and Polly T. Howle, pro sese.
Amy Dyar Seals, for respondent.
DEAN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in
effect at the time the petition was filed. Unless otherwise
indicated, subsequent section references are to the Internal
Revenue Code in effect for the years in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
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The decision to be entered is not reviewable by any other court,
and this opinion should not be cited as authority.
Respondent determined a deficiency of $5,000 in petitioners’
1997 Federal income tax. The issues for decision are:
(1) Whether respondent subjected petitioners to multiple audits
for their 1997 taxable year in violation of section 7605(b); and
(2) whether respondent determined petitioners’ 1997 Federal
income tax correctly.
Background
The stipulation of facts and the accompanying exhibits are
incorporated herein by reference. Petitioners resided in
Florence, South Carolina, at the time their petition was filed
with the Court.
Petitioners are husband and wife. Petitioner Blaney H.
Howle III (Mr. Howle) turned 62 on October 31, 1997, and
petitioner Polly T. Howle (Mrs. Howle) turned 62 on March 1,
1997. Mr. Howle has been retired on disability from railroad
employment since the age of 57.
In 1997, Mr. Howle received Tier 1 railroad retirement
benefits of $1,186, and Mrs. Howle received Tier 1 railroad
retirement benefits of $284. Mr. Howle also received $23,083.28
in Tier 2 railroad retirement benefits and $516 in supplemental
annuity benefits. Mr. Howle’s employee contributions toward
Tier 2 benefits total $20,365.56. In 1997, Mrs. Howle received
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$5,387.40 in Tier 2 railroad retirement benefits. Mrs. Howle has
no employee contributions to recover.
Petitioners reported their $28,986.68 of Tier 2 railroad
retirement benefits and supplemental annuity benefits as “Social
Security benefits” and the $1,470 of Tier 1 railroad retirement
benefits as the “Taxable amount” on their joint 1997 Form 1040,
U.S. Individual Income Tax Return (return). Petitioners made a
$3,000 math error in adding their itemized deductions on their
Schedule A, Itemized Deductions. The Internal Revenue Service
(IRS) corrected this math error, and as a result, petitioners
received a refund of $684.63 for 1997 rather than the $2,221.93
they claimed for a refund on their return.
By letter dated April 21, 1998, Mr. Howle asked the IRS to
explain how social security and railroad retirement benefits are
taxed. The IRS responded by letter dated May 9, 1998, with
“corrected” copies of petitioners’ 1997 Form 1040, Schedule D,
Capital Gains and Losses, and Social Security Benefits Worksheet.
The IRS determined petitioners’ tax liability based on $1,470 of
Tier 1 railroad retirement benefits received and adjustments to
petitioners’ tax computations using maximum capital gains rates.
As a result, petitioners received an additional refund for 1997
of $1,395.30. However, the IRS did not account for the Tier 2
railroad retirement and supplemental annuity benefits received by
petitioners.
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By notice dated September 20, 1999 (September notice), the
IRS proposed to change petitioners’ 1997 return to include
unreported pension income. The proposed changes appear to have
been brought about by review of petitioners’ return and the
information returns submitted to the IRS by the Railroad
Retirement Board. Petitioners disagreed with the proposed
changes set forth, and the IRS realized that the proposed changes
failed to include $515 of the taxable Tier 1 railroad retirement
benefits.
By letter dated December 2, 1999, the IRS acknowledged that
the changes proposed in its September notice were incorrect and
proposed revised changes to petitioners’ 1997 return (December
proposed changes). The December proposed changes are the basis
for the statutory notice of deficiency issued petitioners on
April 7, 2000.
Discussion
Since 1983, railroad retirees have been taxed on two
categories of benefits. See Railroad Retirement Solvency Act of
1983, Pub. L. 98-76, 97 Stat. 411. “Tier 1” benefits are taxed
in the same manner as Social Security benefits under the
provisions of section 86. See sec. 86(d)(1)(B). “Tier 2”
benefits are taxed in the same manner as pension benefits
provided under an employer plan that meets the requirements of
section 401(a). See sec. 72(r).
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Petitioners challenge the validity of respondent’s notice of
deficiency claiming that they have been subjected to multiple
audits for their 1997 tax year. Although they concede that their
railroad retirement benefits are taxable, they challenge
respondent’s calculations.
There is no express limit on the number of examinations that
may be pursued by the IRS for the same taxable year. See Digby
v. Commissioner, 103 T.C. 441, 447 (1994). Section 7605(b),
however, protects taxpayers from repetitive investigations
undertaken by the IRS as a means of harassment. See Curtis v.
Commissioner, 84 T.C. 1349, 1352 (1985); Collins v. Commissioner,
61 T.C. 693, 698-699 (1974). It provides:
No taxpayer shall be subjected to unnecessary
examination or investigations, and only one inspection
of a taxpayer’s books of account shall be made for each
taxable year unless the taxpayer requests otherwise or
unless the Secretary, after investigation, notifies the
taxpayer in writing that an additional inspection is
necessary. [Sec. 7605(b).]
In petitioners’ case, respondent has not violated either of
the two prohibitions contained in section 7605(b). Petitioners
have not been subjected to an unnecessary examination or
investigation, nor have their books and records been reexamined
without written notice thereof.
Nothing in the record suggests that petitioners were
subjected to an unnecessary examination. Section 7605(b) was not
meant to restrict the scope of respondent's legitimate effort to
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protect the revenue. See United States v. Powell, 379 U.S. 48,
54-56 (1964); Collins v. Commissioner, supra. It is not to be
read so liberally as to defeat the powers granted to the IRS to
examine the correctness of taxpayers’ returns. See De Masters v.
Arend, 313 F.2d 79, 86-87 (9th Cir. 1963).
Petitioners did not include any of their Tier 2 railroad
retirement benefits in the gross income reported on their 1997
return, and they incorrectly included all of their Tier 1
benefits. They now acknowledge that 85 percent of their Tier 1
benefits are includable in gross income, and they do not dispute
that their Tier 2 benefits are taxable in the same manner as
pension benefits. Petitioners do not suggest that the IRS
properly accounted for these items in its previous adjustments to
their return. Therefore, respondent did not subject petitioners
to an unnecessary examination.
Further, nothing in the record suggests that respondent ever
examined or inspected petitioners’ books of account. The IRS
first corrected a mathematical error made by petitioners on their
return. In response to petitioners’ request for assistance, the
IRS then attempted to provide petitioners with a completed Form
1040 calculating their income tax liability. It appears that the
IRS realized that the return it had completed was incorrect when
it matched petitioners’ return with information returns received
from the Railroad Retirement Board. Based on this review, the
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IRS sent a notice proposing changes to petitioners’ return.
After petitioners objected to the proposed changes, the IRS
recognized it had failed to include $515 of the $1,250
petitioners now acknowledge is the portion of their Tier 1
benefit which is includable in their gross income. The IRS
corrected this error and sent petitioners a new notice of
proposed changes.
The IRS’ reconsideration of petitioners’ tax return and
accompanying schedules does not constitute an inspection of their
books of account. See Curtis v. Commissioner, supra at 1351;
Benjamin v. Commissioner, 66 T.C. 1084, 1097 (1976), affd. 592
F.2d 1259 (5th Cir. 1979). Likewise, respondent’s comparison of
petitioners’ return with the information returns of a third party
does not constitute an inspection of petitioners’ books of
account. See Digby v. Commissioner, supra at 447-448.
There is no evidence that petitioners’ books of account were
ever examined much less that they were examined for a second time
without the notice required by section 7605(b). Thus, respondent
has not violated section 7605(b).
We now turn to respondent’s computation of petitioners’
income tax liability. Petitioners have conceded that $1,250
(85 percent) of their Tier 1 railroad retirement benefit is
includable in their 1997 gross income. Petitioners do not
dispute that their Tier 2 and supplemental annuity benefits are
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taxable; however, they have challenged the amount of the
deficiency determined by respondent. Therefore, an examination
of the taxable amount of petitioners’ Tier 2 and supplemental
annuity benefits is necessary.
Tier 2 railroad retirement benefits are treated for tax
purposes as provided under an employer plan that meets the
requirements of section 401(a). See sec. 72(r)(1). Section
402(a) provides that such benefits are subject to tax to the
extent provided in section 72, which relates to annuities.
Section 72(a) generally requires any amount received as an
annuity to be included in gross income. Section 72(d), however,
allows taxpayers to exclude the benefits which represent a return
of their own investment in their employer’s plan. The method for
recovery of investment provided for in section 72(d)(1)(B)
excludes from gross income the amount of any monthly annuity
payment that does not exceed the amount obtained by dividing the
taxpayer’s contribution to the plan by the number of anticipated
payments.
Section 1.72-15(b), Income Tax Regs., provides that section
72 does not apply to any amount received as an accident or health
benefit. The pension benefits petitioners received as a result
of petitioner’s disability are accident or health benefits within
the meaning of section 1.72-15, Income Tax Regs. See sec. 1.72-
15(a), Income Tax Regs. If a plan provides that any portion of
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an accident or health benefit is attributable to the
contributions of the employee, then that portion of the benefit
is excludable from gross income under section 104(a)(3). See
sec. 1.72-15(c)(1), Income Tax Regs. If, however, the plan does
not expressly provide that the accident or health benefits are to
be provided with employee contributions and the portion of
employee contributions to be used for such purpose, it will be
presumed that none of the employee contributions is used to
provide such benefits. See sec. 1.72-15(c)(2), Income Tax Regs.
Absent disability, no railroad retirement benefits are paid
until the employee reaches age 62 or is at least 60 years old and
has completed 30 years of service. See Railroad Retirement Act
of 1974, Pub. L. 93-445, sec. 2(a)(10), 88 Stat. 1312, currently
codified at 45 U.S.C. sec. 231(a)(1) (1994). Petitioners have
not presented any evidence regarding Mr. Howle’s length of
service. We thus conclude that Mr. Howle was not eligible for
retirement until he turned 62 on October 31, 1997, and that the
railroad retirement benefits petitioners received in 1997 were on
account of disability until such date.
We have found no provision in the Railroad Retirement Act
expressly stating that disability benefits are to be provided
with employee contributions. See 45 U.S.C. 231. Therefore, all
of the Tier 2 benefits received by petitioners through
October 31, 1997, are to be included in gross income.
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Petitioners, however, are entitled to exclude from gross
income the portion of Mr. Howle’s benefits received in November
and December that is attributable to his contributions.
Mr. Howle’s total employee contributions are $20,365.56. The
number of anticipated monthly payments is 260. See sec.
72(d)(1)(B). Thus, petitioners may exclude $156.66 ($20,365.56
divided by 260 and multiplied by 2) of their Tier 2 benefits.
See id. Because Mrs. Howle had no employee contributions, all of
her Tier 2 benefits are taxable.
No part of an employee’s contribution is allocable to a
supplemental annuity. See sec. 72(r)(2)(C). Thus, the $516
Mr. Howle received as a supplemental annuity benefit is fully
includable in petitioners’ gross income.
In view of the discrepancies among respondent’s computations
of petitioners’ income for 1997, we direct that a computation
under Rule 155 be made.
Reviewed and adopted as the report of the Small Tax Case
Division.
Decision will be entered
under Rule 155.