CROW v. COMMISSIONER

T.C. Memo. 2002-178

UNITED STATES TAX COURT

RICHARD B. CROW, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 2651-01. Filed July 30, 2002.

Bruce C. O’Neill, for petitioner.

Frederic J. Fernandez, for respondent.

MEMORANDUM OPINION

RUWE, Judge: Respondent determined a deficiency in

petitioner’s 1998 Federal income tax of $10,000 and an

accuracy-related penalty under section 6662(a)1 of $2,000. The

1
Unless otherwise indicated, all 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 -

issues for decision are: (1) Whether a distribution of

$39,295.08 from an individual retirement account is includable in

petitioner’s gross income for 1998; and (2) whether petitioner is

liable for the accuracy-related penalty pursuant to section

6662(a) due to a substantial understatement of income tax.

Background

The parties submitted this case fully stipulated pursuant to

Rule 122.2 The stipulation of facts, the supplemental

stipulation of facts, and the attached exhibits are incorporated

herein by this reference. Petitioner resided in Kenosha,

Wisconsin, at the time he filed his petition.

Petitioner has maintained individual retirement accounts

(IRAs) at TCF National Bank (the bank), formerly known as

Republic Savings. On July 23, 1976, petitioner established an

IRA, account number 0400014416, with the bank. During the period

July 23, 1976, through August 28, 1998, periodic payments were

made to this IRA. Petitioner received annual statements

indicating the value of all his IRAs.

On August 28, 1998, petitioner met with Maria Koble (Ms.

Koble), a representative from the bank, to discuss petitioner’s

2
We note that although this case was submitted fully
stipulated, that does not alter the burden of proof, or the
requirements otherwise applicable with respect to adducing proof,
or the effect of failure of proof. Rule 122(b); Kitch v.
Commissioner, 104 T.C. 1, 5 (1995), affd. 103 F.3d 104 (10th Cir.
1996).
 - 3 -

IRA, account number 0400014416, which was invested in a

certificate of deposit that was earning 1.75 percent. On that

same day, petitioner withdrew the entire amount, $39,295.08, from

the IRA and closed the account. The amount withdrawn from the

IRA was transferred into a nonqualified annuity through American

Express Life Insurance Company (AEL).3 The nonqualified annuity

consisted of the funds from the closed IRA and additional funds

added by petitioner.

In 1999, petitioner received a 1998 Form 1099-R,

Distributions From Pensions, Annuities, Retirement or Profit-

Sharing Plans, IRAs, Insurance Contracts, Etc., from the bank

relating to his IRA, account number 0400014416. The Form 1099-R

reported a gross distribution of $39,295.08 and a taxable amount

of $39,295.08.

Petitioner did not include the $39,295.08 reported on the

Form 1099-R on his 1998 Form 1040, U.S. Individual Income Tax

3
On the “Annuity Contract Data and Application”, completed
in connection with the transfer of funds from petitioner’s
individual retirement account (IRA) to the nonqualified annuity,
there is a section entitled “Annuity Plan” and an instruction to
check one of three boxes indicating different annuity plans. The
box for “Nonqualified Annuity” is checked. The boxes for
“Individual Retirement Annuity” and “Other” are not checked.
Below the heading “Annuity Plan” appears the words “If IRA:”, and
three choices are given. The choices are “Regular”, “Rollover
IRA”, and “Trustee to Trustee Transfer”. None of the boxes next
to these choices are checked.
 - 4 -

Return.4 In August 2000, respondent contacted petitioner

regarding the withdrawal from the IRA and transfer of funds to

the nonqualified annuity. In response to respondent’s inquiry,

petitioner began to investigate the tax implications of the 1998

withdrawal and closing of the IRA.

Petitioner contacted the bank to discuss the withdrawal from

the IRA and transfer of funds to the nonqualified annuity. The

bank and Ms. Koble subsequently took steps to recharacterize the

August 28, 1998, transactions. On February 1, 2001, Ms. Koble

prepared and signed a “Traditional IRA Withdrawal Statement”.

The document directs “the Trustee or Custodian to make a

distribution from the IRA” as a transfer to the new trustee, “AEL

Annuity”. The document states that the IRA, account number

0400014416, was “closed out as reg CD / should have been done as

trustee transfer”. Just below this statement are the words “Bank

Error”. The document is backdated to August 28, 1998, the date

the funds from the IRA were withdrawn and transferred to the

nonqualified annuity.

In 2001, the bank prepared a corrected 1998 Form 1099-R.

The corrected Form 1099-R reported a gross distribution of $0 and

a taxable amount of $0. On a “Retirement Account Correction

Worksheet”, the bank explained that it issued the corrected Form

4
Petitioner’s 1998 Form 1040, U.S. Individual Income Tax
Return, listed his occupation as truck driver.
 - 5 -

1099-R because “This was to have been a trustee transfer to AEL

IRA Annuity, not a distribution for $39,295.08”. The bank also

changed the distribution code to “Trustee Transfer”. The parties

agree that Ms. Koble would have testified that the corrected Form

1099-R was sent to petitioner in April 2001 and should have been,

but apparently was not, sent to respondent in April 2001. The

parties also agree that Ms. Koble would have further testified

that the bank sent the corrected Form 1099-R to respondent on

February 7, 2002. Respondent has been unable to verify through

his record-keeping system that the corrected Form 1099-R was sent

by Ms. Koble on February 7, 2002.

As of March 12, 2002, the transferred funds from

petitioner’s IRA remained in the AEL nonqualified annuity. On

March 18, 2002, the Court granted the parties’ joint motion to

submit this case fully stipulated under Rule 122. The record

does not contain evidence demonstrating that the funds withdrawn

from the IRA on August 28, 1998, and transferred to the

nonqualified annuity that same day, have been transferred to an

IRA or other qualified plan.
 - 6 -

Discussion5

Generally, any amount paid or distributed out of an

individual retirement plan is includable in the payee’s or

distributee’s gross income as provided in section 72. Sec.

408(d)(1); Arnold v. Commissioner, 111 T.C. 250, 253 (1998).

However, “rollover contributions” are not includable in gross

income. Sec. 408(d)(3); Lemishow v. Commissioner, 110 T.C. 110,

112 (1998), supplemented 110 T.C. 346 (1998). To qualify as a

rollover contribution, a payment or distribution from an

individual retirement plan must be rolled over into an IRA or

other qualified plan within 60 days of the payment or

distribution. Sec. 408(d)(3); Schoof v. Commissioner, 110 T.C.

1, 7 (1998); Metcalf v. Commissioner, T.C. Memo. 2002-123; sec.

1.408-4(b)(1) and (2), Income Tax Regs.

5
In certain circumstances, if the taxpayer introduces
credible evidence with respect to any factual issue relevant to
ascertaining the proper tax liability, sec. 7491 places the
burden of proof on the Secretary. Sec. 7491(a). Sec. 7491(c)
operates to place the burden of production on the Secretary in
any court proceeding with respect to the liability of the
taxpayer for penalties and additions to tax. Sec. 7491 is
effective with respect to court proceedings arising in connection
with examinations commencing after July 22, 1998. Internal
Revenue Service Restructuring and Reform Act of 1998, Pub. L.
105-206, sec. 3001(c), 112 Stat. 727. The examination in the
instant case commenced after July 22, 1998. However, for
purposes of deciding whether the $39,295.08 attributable to the
IRA is includable in petitioner’s gross income for 1998, we need
not base our decision on the burden of proof because the record
contains sufficient evidence with which to decide the issue.
With respect to respondent’s burden of production under sec.
7491(c) for the accuracy-related penalty, see infra page 11.
 - 7 -

Rev. Rul. 78-406, 1978-2 C.B. 157, states that the direct

transfer of funds from one IRA trustee to a new IRA trustee which

involves no payment or distribution of funds to the IRA

participant is not a rollover contribution because the funds are

not within the direct control or use of the participant.6 See

also Martin v. Commissioner, T.C. Memo. 1992-331, affd. without

published opinion 987 F.2d 770 (5th Cir. 1993). The revenue

ruling further states that this conclusion would apply whether

the bank trustee initiates, or the IRA participant directs, the

transfer of funds. Rev. Rul. 78-406, 1978-2 C.B. at 157-158.

Thus, Rev. Rul. 78-406, supra, indicates that a trustee-to-

trustee transfer which otherwise meets the requirements of the

revenue ruling is not a taxable transaction because no amount is

treated as paid or distributed out of an IRA.

In the instant case, petitioner appears to argue that the

funds withdrawn from the IRA on August 28, 1998, are not

includable in gross income because either (1) the bank mistakenly

rolled over the funds into a nonqualified annuity instead of

correctly rolling over the funds into an IRA or other qualified

plan or (2) the bank mistakenly rolled over the funds instead of

correctly making a trustee-to-trustee transfer to an IRA or other

qualified plan. The parties dispute whether the bank made a

6
We note that, although entitled to consideration, revenue
rulings are not precedent. Dixon v. United States, 381 U.S. 68,
73 (1965).
 - 8 -

mistake and, assuming a mistake was made, whether petitioner took

the necessary steps to correct the mistake and transfer the funds

to an IRA or other qualified plan.7

In Wood v. Commissioner, 93 T.C. 114 (1989), we discussed

the effect of a bookkeeping error committed by a financial

institution during the process of rolling over funds into an IRA.

In that case, the taxpayer received a distribution of cash and

stock from a profit-sharing plan and then established an IRA.

The taxpayer was aware that his distribution was required to be

rolled over into an IRA within 60 days of receipt. Acting with

this knowledge, the taxpayer did everything he could reasonably

be expected to do in order to roll over his lump-sum distribution

as required by law. For example, the taxpayer met with an IRA

trustee, instructed the IRA trustee to open the IRA, and

transferred the entire distribution to the IRA trustee for

deposit in his IRA. The IRA trustee assured the taxpayer that

the taxpayer’s request would be carried out.

However, because of a bookkeeping error by the IRA trustee,

certain of the trustee’s records indicated that part of the

distribution had not been transferred to the IRA within the

requisite 60-day period. Approximately 4 months after the

7
Respondent states that he did not assert the 10-percent
additional tax on amounts received from a qualified retirement
plan under sec. 72(t) because petitioner was over the age of 59
1/2 at the time his IRA was closed.
 - 9 -

expiration of the 60-day period, the trustee corrected its

records to reflect that all of the distribution had been

transferred to the taxpayer’s IRA rollover account. The parties

stipulated that the taxpayer’s IRA rollover account was

established and satisfied the requirements of the Internal

Revenue Code. The taxpayer did not become aware of the error

until after the Commissioner questioned his failure to report the

lump-sum distribution on his tax return. We held that the

financial institution’s bookkeeping error did not preclude

rollover treatment because, in substance, the taxpayer had

satisfied the statutory requirements.

In Schoof v. Commissioner, supra at 11, we held that the

failure of a fundamental element of the statutory requirements

for an IRA rollover contribution, namely, the qualification of an

IRA trustee, required distributions from an IRA to be includable

in the taxpayers’ gross income. We relied on the following

passage to support our holding:

“Where the requirements of a statute relate to the
substance or essence of the statute, they must be
rigidly observed. On the other hand, if the
requirements are procedural or directory in that they
do not go to the essence of the thing to be done, but
rather are given with a view to the orderly conduct of
business, they may be fulfilled by substantial
compliance.” [Schoof v. Commissioner, supra at 11
(quoting Rodoni v. Commissioner, 105 T.C. 29, 38-39
(1955)); citations omitted.]
 - 10 -

We distinguished Wood v. Commissioner, supra, on the ground that

it involved procedural defects in the execution of a rollover.

Schoof v. Commissioner, 110 T.C. at 11.

The evidence in the record indicates that Ms. Koble and the

bank felt that they had mistakenly characterized the transactions

and that they were attempting to correct their mistake. This was

not the only mistake or defect in the rollover or transfer, nor

was this defect corrected in a timely manner. The parties

stipulated that, as of March 12, 2002, the funds withdrawn from

the IRA on August 28, 1998, remained in the AEL nonqualified

annuity. A fundamental requirement for a rollover contribution

under section 408(d)(3) or a trustee-to-trustee transfer under

Rev. Rul. 78-406, supra, is that funds actually be rolled over or

transferred into an IRA or other qualified plan. We believe that

failure of this fundamental requirement extends beyond the

procedural error in Wood v. Commissioner, supra, which was cured

by substantial compliance and the fulfilment of the remaining

requirements of the statue. Thus, like the situation in Schoof

v. Commissioner, supra, we find that the failure to roll over or

transfer the funds to an IRA or other qualified plan is fatal to

petitioner’s case.8 Accordingly, we hold that the $39,295.08 is

includable in petitioner’s 1998 gross income.

8
Again, we note that the parties stipulated that at the time
this case was submitted the funds remained in the nonqualified
annuity.
 - 11 -

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

portion of an underpayment of tax attributable to a taxpayer’s

negligence, disregard of rules or regulations, or substantial

understatement of income tax. Sec. 6662(a), (b)(1) and (2). An

understatement is “substantial” if it exceeds the greater of 10

percent of the tax required to be shown on the return for the

taxable year, or $5,000. Sec. 6662(d)(1) and (2).

Respondent concedes that he bears the burden of production

under section 7491(c) with respect to the accuracy-related

penalty. Petitioner reported tax liability of $1,020.01 on his

1998 return. We have sustained respondent’s determination that

petitioner has a deficiency of $10,000 for 1998. Thus, there was

an understatement of tax because the deficiency exceeds the

greater of 10 percent of the tax required to be shown on

petitioner’s 1998 return, or $5,000.

The accuracy-related penalty does not apply to any part of

an underpayment if the taxpayer shows that there was reasonable

cause for that part of the underpayment and that he acted in good

faith in view of the facts and circumstances. Sec. 6664(c). The

determination of whether a taxpayer acted with reasonable cause

and 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 taxpayer bears the burden of
 - 12 -

proving that he acted with reasonable cause and in good faith.

Higbee v. Commissioner, 116 T.C. 438, 446-448 (2001).

The facts and circumstances of this case do not support

imposition of the accuracy-related penalty. In response to

petitioner’s inquiry, the bank issued a corrected Form 1099-R

reporting a gross distribution of $0 and a taxable distribution

of $0. The bank prepared a “Retirement Account Correction

Worksheet”, explaining that it issued the corrected Form 1099-R

because the transaction should have been a trustee transfer to an

AEL IRA. Ms. Koble prepared and signed a new “Traditional IRA

Withdrawal Statement” which was intended to be retroactive to

August 1998, and it indicated that there should have been a

trustee-to-trustee transfer of funds from petitioner’s IRA to an

AEL annuity. The documents indicate that Ms. Koble and the bank

felt that they had mistakenly characterized the transactions and

that they were attempting to correct their mistake.

Additionally, the parties agree that Ms. Koble would have

testified that the bank should have sent a corrected Form 1099-R

to respondent after it prepared the corrected form and that the

bank did send a corrected Form 1099-R to respondent in February

2002. Although the evidence in the record indicates that the

funds are still in the nonqualified annuity, we believe that

petitioner had reasonable cause and acted in good faith in not

reporting the distribution on his 1998 return on the basis of his
 - 13 -

dealings with the bank and Ms. Koble and their subsequent

attempts to correct the situation. Accordingly, we hold that

petitioner is not liable for the accuracy-related penalty for

1998.

Decision will be entered for

respondent as to the deficiency.