CIPRIANO v. COMMISSIONER

T.C. Memo. 2001-157

UNITED STATES TAX COURT

ANDREA CIPRIANO, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 20699-98. Filed June 28, 2001.

Andrea Cipriano, pro se.

Leon St. Laurent, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

SWIFT, Judge: For 1994 and 1996, respondent determined

deficiencies in petitioner’s Federal income taxes and accuracy-

related penalties as follows:

Accuracy-Related Penalty
Year Deficiency Sec. 6662(a)
1994 $3,046 $ 608
1996 9,754 1,951
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After settlement of some issues, the primary issue for

decision is whether certain amounts petitioner received in

connection with a division of marital property constitute taxable

interest income.

Unless otherwise indicated, all 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.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

At the time the petition was filed, petitioner resided in

Basking Ridge, New Jersey.

Petitioner is well educated. In 1964, petitioner received a

bachelor of arts degree in teaching from William Paterson

College. In 1984, petitioner received a masters degree in

business administration from Fairleigh Dickenson University.

Since 1987, petitioner has been employed as a revenue agent

for respondent.

Petitioner also is a certified public accountant and teaches

accounting and tax courses part time at Ramapo College.

Petitioner’s ex-spouse is an attorney and maintains a law

practice in New Jersey.

On March 17, 1993, petitioner and her ex-spouse divorced and

entered into a property settlement agreement (the agreement).
 - 3 -

Under the terms of the agreement, petitioner was entitled to

receive $385,000, representing the value of her share of the

marital assets. Under the agreement, of the total $385,000,

petitioner was to receive $235,000 in cash immediately after the

divorce, and petitioner was to receive the remaining $150,000

through a series of 5 annual installments of $30,000, plus

interest of 5.5 percent per year on the unpaid balance.

To secure payment of the installment payments that were due,

petitioner received a mortgage on real estate owned by

petitioner’s ex-spouse. The language from the agreement relating

to the mortgage stated as follows:

A mortgage in the amount of $150,000 shall be
recorded against the real estate * * * which
mortgage shall bear interest at the rate of
5.5% and shall be paid in annual installments
of $30,000 plus all accrued interest over a
period of five (5) years, each payment
falling due on the anniversary date of this
Agreement.

Under the agreement, petitioner’s ex-spouse was also liable

for all attorney’s fees incurred by petitioner in enforcing

payment of amounts due under the agreement.

As part of the property settlement agreement, petitioner and

her ex-spouse each agreed to relinquish any rights they then

owned in property held by the other spouse.
 - 4 -

In late March of 1993, shortly after the divorce, petitioner

received the $235,000 cash payment that was due under the

agreement.

In March of 1994, however, petitioner did not receive the

first $30,000 installment payment due from her ex-spouse.

Petitioner then requested the Superior Court of New Jersey

Chancery Division of Monmouth County to issue an order compelling

petitioner’s ex-spouse to pay petitioner this delinquent $30,000

installment payment plus interest and attorney’s fees. Pursuant

to a June 24, 1994, court order, petitioner received from her ex-

spouse $41,649, of which $30,000 was denominated as principal,

$1,015 was denominated as attorney’s fees, and the remaining

$10,634 was denominated as accrued interest.

The $30,000 installment payments due from petitioner’s ex-

spouse in each of 1995 and 1996, plus amounts denominated as

accrued interest, were received by petitioner as due.

In summary, petitioner received the following payments from

her ex-spouse under the property settlement:1

Amounts Denominated Amounts Denominated
Year As Principal As Interest
1993 $235,000 $ -0-
1994 30,000 10,634
1995 30,000 6,000
1996 30,000 4,950

1
Not shown in the schedule is the $1,015 that was denominated
as attorney’s fees that petitioner received in 1994.
 - 5 -

The record does not reflect whether or when petitioner received

the installment payments that were due from her ex-spouse under

the agreement in 1997 and 1998.

On her 1994, 1995, and 1996 timely filed Federal income tax

returns, petitioner did not report as interest income any of the

above payments received from her ex-spouse.

By letter dated July 2, 1998, respondent notified petitioner

that respondent wished to examine petitioner’s 1995 and 1996

Federal income tax returns. In the letter, respondent proposed a

meeting for July 30, 1998, between respondent’s audit

representative and petitioner relating to petitioner’s 1995 and

1996 Federal income taxes. At petitioner’s request, the meeting

was held on July 30, 1998, in Parsippany, New Jersey, the

location of petitioner’s employment.

Petitioner and respondent’s audit representative met again

in August of 1998 to discuss petitioner’s 1995 and 1996 Federal

income taxes. During that meeting, petitioner and respondent’s

representative failed to reach an agreement on various

adjustments that had been raised. After this meeting, in August

of 1998 or thereafter, petitioner’s 1994 Federal income tax

return was opened for examination by respondent. Another meeting

was scheduled for September 16, 1998, between petitioner and

respondent’s audit representative to discuss further petitioner’s

1995 and 1996 Federal income taxes and to discuss petitioner’s
 - 6 -

1994 Federal income tax. Petitioner, however, failed to attend

this meeting.

On October 6, 1998, respondent mailed to petitioner a notice

of deficiency regarding petitioner’s 1994 and 1996 Federal income

taxes. In the notice of deficiency sent to petitioner for 1994

and 1996, respondent determined that petitioner failed to report

as taxable income on her respective Federal income tax returns

the above $10,6642 and $4,950 payments that petitioner received

from her ex-spouse in 1994 and 1996 that were denominated as

interest.3

In the petition filed with this Court, petitioner raised as

a new issue a claimed ordinary deduction in the amount of $79,688

for expenses relating to attorney, accountant, and appraiser fees

allegedly incurred in connection with her divorce, the division

of marital property, and the installment payments. Petitioner

does not indicate whether the $79,688 should be deducted in 1994

or in 1996 or how the expenses should be allocated between 1994

and 1996.

2
The record does not explain the $30 variance in amounts
denominated as interest by the Superior Court of New Jersey
Chancery Division of Monmouth County and by respondent in the
notice of deficiency.
3
The record does not reflect whether respondent mailed to
petitioner a statutory notice of deficiency regarding
petitioner’s 1995 Federal income tax.
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OPINION

Generally, the burden of proof is on the taxpayer. See

Rule 142(a). In 1998, however, Congress enacted section 7491,

effective July 22, 1998, under which the burden of proof will be

placed on respondent if a taxpayer meets certain requirements.

See Internal Revenue Service Restructuring and Reform Act of 1998

(RRA 1998), Pub. L. 105-206, sec. 3001, 112 Stat. 685, 726.

Under section 7491(a), the burden of proof with regard to

any fact issue will be placed on respondent if the taxpayer

maintained adequate records, satisfied applicable substantiation

requirements, cooperated with respondent, and introduced during

the court proceeding credible evidence with regard to the fact

issue.

The specific relevant language of section 7491 provides as

follows:

SEC. 7491. BURDEN OF PROOF.

(a) Burden Shifts Where Taxpayer Produces Credible
Evidence.--

(1) General rule.--If, in any court proceeding, a
taxpayer introduces credible evidence with respect to
any factual issue relevant to ascertaining the
liability of the taxpayer for any tax imposed by
subtitle A or B, the Secretary shall have the burden of
proof with respect to such issue.

(2) Limitations.--Paragraph (1) shall apply with
respect to an issue only if–-
 - 8 -

(A) the taxpayer has complied with the
requirements under this title to substantiate any
item;

(B) the taxpayer has maintained all records
required under this title and has cooperated with
reasonable requests by the Secretary for
witnesses, information, documents, meetings, and
interviews; * * *

The legislative history of section 7491(a) makes it clear

that before the burden of proof will be placed on respondent,

taxpayers have the burden of proving that they satisfied each of

the above requirements of section 7491. The legislative history

states as follows:

The taxpayer has the burden of proving that
it meets each of these conditions, because
they are necessary prerequisites to
establishing that the burden of proof is on
the Secretary. [H. Conf. Rept. 105-599, at
239 (1998), 1998-3 C.B. 747, 993.]

A shift in the burden of proof under section 7491 is

available only in court proceedings arising in connection with

examinations by respondent that commenced after July 22, 1998,

the effective date of section 7491. See RRA 1998 sec.

3001(c)(2), 112 Stat. 727.

For 1994, because respondent’s examination of petitioner’s

1994 Federal income tax commenced in August of 1998, or

thereafter, it is clear that section 7491 generally applies to

petitioner. Petitioner contends that for 1994 she has met the
 - 9 -

requirements of section 7491(a) and that the burden of proof is

on respondent on the issue as to the treatment of the $10,664

denominated as interest.

For 1994, respondent contends that petitioner did not meet

the requirements of section 7491(a) and therefore that the burden

of proof remains with petitioner. Among other things, respondent

notes that during the examination petitioner failed to attend the

scheduled September 16, 1998, meeting, the only scheduled meeting

regarding petitioner’s 1994 Federal income tax.

For 1996, petitioner contends that respondent’s July 2,

1998, letter was inadequate and defective to commence on July 2,

1998, respondent’s examination of petitioner’s 1996 tax.

Petitioner therefore argues that respondent’s examination for

1996 did not commence before July 30, 1998, the date of the

actual meeting between petitioner and respondent’s

representative. Petitioner also claims that respondent has not

provided evidence to prove when respondent’s July 2, 1998, letter

was actually mailed to petitioner. Petitioner does not

specifically claim to have received that letter after July 22,

1998, the effective date of section 7491.

Based on the above, petitioner argues that respondent’s

examination of petitioner for 1996 commenced after July 22, 1998,

that section 7491(a) is therefore generally applicable, and that
 - 10 -

thereunder the burden of proof is on respondent as to the

treatment of the $4,950 denominated as interest.

Respondent argues that the letter to petitioner dated

July 2, 1998, was mailed on that date, that the letter

effectively commenced on that date the examination of

petitioner’s 1996 Federal income tax, 20 days prior to the

effective date of section 7491, and therefore that for 1996 the

burden of proof is on petitioner.

Neither the Code nor the regulations define when an

examination will be regarded as having commenced for purposes of

section 7491. Respondent points us to the legislative history of

section 7491 and to Rev. Proc. 97-27, 1997-1 C.B. 680. The

legislative history explains the following with regard to what

constitutes an examination for purposes of section 7491:

An audit is not the only event that would be
considered an examination for purposes of
this provision. For example, the matching of
an information return against amounts
reported on a tax return is intended to be an
examination for purposes of this provision.
Similarly, the review of a claim for refund
prior to issuing that refund is also intended
to be an examination for purposes of this
provision. [H. Conf. Rept. 105-599, supra
at 242, 1998-3 C.B. at 996.]

In Rev. Proc. 97-27, 1997-1 C.B. at 683, for purposes of a

change in accounting method under section 481, respondent takes

the position that any contact by respondent to schedule an
 - 11 -

examination is sufficient to commence an examination. Rev. Proc.

97-27, supra, states as follows:

an examination of a taxpayer with respect to
a federal income tax return begins on the
date the taxpayer is contacted in any manner
by a representative of the Service for the
purpose of scheduling any type of examination
of the return. * * * [Id.; emphasis added.]

Respondent argues that the above examples suggest that an

examination may occur without a personal meeting between

respondent’s representative and the taxpayer or the taxpayer’s

representative.

Focusing on the facts before us in this case, we do not

believe that the character of the amounts in dispute for both

1994 and 1996 need be resolved on the basis of the burden of

proof. In spite of the extensive arguments of the parties in

their briefs regarding the burden of proof in this case for both

1994 and 1996, as set forth below, we conclude that the evidence

establishes that the amounts petitioner received that were

denominated as interest in fact constituted interest income for

Federal income tax purposes. We so hold, and we decline to

resolve the parties’ many arguments regarding the commencement of

respondent’s 1996 examination, regarding the applicability of

section 7491(a), and regarding petitioner’s qualification under

the various requirements of section 7491(a).
 - 12 -

Gross income includes all income from whatever source

derived. See sec. 61(a). Interest received is specifically

included within the definition of gross income. See sec.

61(a)(4). Generally, any portion of a judgment that compensates

taxpayers for delay in receipt of money constitutes interest

income and is taxable as such. See Kieselbach v. Commissioner,

317 U.S. 399, 403 (1943).

Petitioner contends that the portions of the installment

payments received from her ex-spouse in 1994 and 1996 that were

denominated as interest (namely, $10,664 and $4,950,

respectively) represented postdivorce appreciation in the value

of her ex-spouse’s law practice and that these amounts should be

treated as nontaxable transfers under section 1041. To the

contrary, it is clear that the above amounts compensated

petitioner for delay in the receipt of the marital assets to

which petitioner was entitled as of the day of the divorce. The

amounts received are consistent with the 5.5-percent interest

rate specified in the agreement.4 The $10,664 and the $4,950

that petitioner received in 1994 and 1996 constitute interest

income.

4
Assuming that the installment payments were paid on time each
year, the approximate interest to be received each year by
petitioner on $150,000 payable in 5 annual installments of
$30,000 would be $8,250 in year 1, $6,600 in year 2, $4,950 in
year 3, $3,300 in year 4, and $1,650 in year 5.
 - 13 -

We now turn to petitioner’s claim that she is entitled to an

additional $79,688 deduction, or some part thereof, for fees paid

to attorneys, accountants, and appraisers. The parties herein

make no argument as to the placement of the burden of proof nor

as to how section 7491(a) applies, if at all, to a new issue.

In general, attorney’s fees and other expenses relating to a

divorce represent personal expenses and are nondeductible to

either spouse. See United States v. Gilmore, 372 U.S. 39, 49

(1963). A deduction under section 212, however, may be allowed

for expenses incurred for the production or collection of income,

such as expenses relating to the right to receive interest

income.

The evidence in support of the $79,688 paid to attorneys,

accountants, and appraisers does not indicate the date the fees

were actually paid by petitioner. From the invoices provided by

petitioner, it appears that most of the bills were paid by

petitioner before the years in dispute. Furthermore, the

invoices that do relate to 1994 and 1996 fail to differentiate

between amounts paid in connection with petitioner’s divorce and

amounts paid, if any, to obtain the receipt of interest income.

For 1994 and 1996, no part of the claimed $79,688 is

deductible by petitioner.

Section 6662(a) imposes a penalty of 20 percent on the

portion of an underpayment of tax attributable to negligence or
 - 14 -

to disregard of rules and regulations. For purposes of section

6662(a), negligence consists of a failure to make a reasonable

attempt to comply with the Code. See sec. 6662(c).

Accuracy-related penalties under section 6662(a) do not

apply to any part of an underpayment if the taxpayer shows

reasonable cause and if the taxpayer acted in good faith. See

sec. 6664(c). Whether a taxpayer acted with reasonable cause and

in good faith is ascertained on a case-by-case basis, taking into

account all of the pertinent facts and circumstances. See sec.

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

Circumstances that may establish reasonable cause and good

faith include an honest misunderstanding of fact or law that is

reasonable in light of the experience, knowledge, and education

of the taxpayer. See id.

With regard to the penalties under section 6662(a) for 1994

and 1996, the parties make no argument regarding the burden of

proof or the burden of production. See sec. 7491(c).

Because of petitioner’s education and professional

experience, and because the agreement adequately identified the

payments in question as interest, petitioner knew or should have

known that the payments constituted interest income and were

includable in her Federal income tax returns.

We conclude that petitioner is liable for the accuracy-

related penalties.
 - 15 -

To reflect the foregoing,

Decision will be entered

under Rule 155.