LEONARD v. COMMISSIONER

T.C. Summary Opinion 2005-114

UNITED STATES TAX COURT

FRANCIS N. AND PATRICIA A. LEONARD, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 7893-03S. Filed August 4, 2005.

Francis N. and Patricia A. Leonard, pro sese.

Michael F. O’Donnell, for respondent.

CARLUZZO, 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 2000. Rule references are to the Tax

Court Rules of Practice and Procedure. The decision to be

entered is not reviewable by any other court, and this opinion

should not be cited as authority.
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Respondent determined a deficiency of $25,746, and a section

6662(a) accuracy-related penalty of $2,412, with respect to

petitioners’ 2000 Federal income tax.

The issues for decision are: (1) Whether petitioners are

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

with respect to a distribution from a qualified retirement plan,

(2) whether petitioners are entitled to a casualty loss deduction

not claimed on their 2000 joint Federal income tax return, and

(3) whether petitioners are liable for an accuracy-related

penalty under section 6662(a).

Background

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

Petitioners are, and were at all times relevant, married to each

other. At the time the petition was filed, they resided in

Midlothian, Illinois. References to petitioner are to Francis N.

Leonard.

In 1978, petitioners purchased a house which had been built

about 1905. Petitioners had a deck built on the back of the

house in 1995 at a cost of approximately $7,000. The deck was

attached, in part, to the siding on the backside of petitioners’

house. The deck was insured by petitioners’ homeowner’s policy

with Illinois Farmers Insurance Company (Farmers Insurance) at a

value of $9,000.
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In August 2000, the deck collapsed during a graduation party

for petitioners’ son. In addition to the damage to the deck,

some siding on the back of petitioners’ house was damaged.

Petitioners submitted a claim of $18,035 with Farmers

Insurance for the damage caused by the collapsed deck. The

insurance claim included the replacement cost of $6,500 for a

smaller deck and the replacement cost of $3,500 for siding on

petitioners’ house. After inspection, Farmers Insurance

determined that the damage to the deck and the siding on

petitioners’ house was due to “wear and tear and deterioration,

wet rot and dry rot.” Petitioners’ insurance claim was denied

because their insurance policy specifically denied coverage for

losses due to “wear and tear, marring, deterioration”, as well as

“rust, mold, wet or dry rot”.

After the denial of petitioners’ claim, petitioners filed a

claim with the State of Illinois Department of Insurance

(Department of Insurance). In a letter from the Department of

Insurance, petitioners were likewise notified:

All insurance policies contain language that excludes
any kind of rot or deterioration. For your policy to
provide coverage for the collapse of your deck, you
will need to provide some type of proof or evidence
that it was not rot whether it be wet or dry rot that
caused the collapse. Also be advised that if it was
improper construction, that also is not covered by an
insurance policy.

During 2000, petitioners rebuilt a smaller deck and made

major repairs to their house, including repairs to the siding on
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the back of the house, the foundation, the kitchen, various

windows and doors, a portion of the roof, and the electrical

components under the house. Petitioners estimated the total

expenditures to be approximately $30,000.

About 1985, petitioner began working as a heavy equipment

operator. He suffers from chronic back problems, and in 1988 he

was diagnosed with osteoporosis. Over the years, despite his

back problems, petitioner continued to work as a heavy equipment

operator.

In 2000, petitioner informed his employer that he wanted to

be placed on disability due to the continued problems with his

back. Petitioner’s employer denied his disability request, and

as a result, petitioner resigned from his employment. Petitioner

also applied for, and was denied, Social Security disability

benefits. After being denied disability benefits, petitioner

continued to work as a heavy equipment operator for several

different employers during 2001 and 2002. As of the date of

trial, petitioner continued to hold a special operator’s license

to operate heavy equipment.

During 2000, petitioner received a distribution of $68,444

from his qualified retirement plan (the distribution). As of the

close of 2000, petitioner had not attained the age of 59-1/2.

Federal income tax withholdings of $13,688 were withheld from the
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distribution. The distribution was used, in part, to pay for

building the above-mentioned deck and repairs to the house.

Petitioners filed a timely 2000 joint Federal income tax

return that was prepared by H&R Block. The distribution is not

included in the income reported on that return, and no part of

the tax liability reported on the return is attributable to

section 72(t). Petitioners elected to itemize deductions but did

not claim a casualty loss deduction on their 2000 return.

In the notice of deficiency, respondent determined that the

entire amount of the distribution is includable in petitioners’

2000 income. Respondent further determined that the entire

distribution was subject to the additional tax imposed by section

72(t) and imposed a section 6662(a) accuracy-related penalty.

Other adjustments made in the notice of deficiency are

computational and need not be addressed.

Discussion

Petitioners now agree that the distribution is includable in

their 2000 income but argue that they are not liable for the

section 72(t) additional tax because the retirement distribution

was attributable to petitioner’s disability. Petitioners also

claim that they are entitled to a casualty loss deduction for the

collapsed deck. Finally, petitioners argue that they are not

liable for the accuracy-related penalty under section 6662(a).
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1. The Casualty Loss Deduction

In general and in addition to other types of losses, an

individual is entitled to a deduction for the loss of property if

the loss arises from fire, storm, shipwreck, or other casualty

and is not compensated for by insurance or otherwise. Sec.

165(a), (c)(3). “Other casualty” is defined as a loss

proximately caused by a sudden, unexpected, or unusual event,

excluding the progressive deterioration of property through a

steadily operating cause or by normal depreciation. Maher v.

Commissioner, 680 F.2d 91, 92 (11th Cir. 1982), affg. 76 T.C. 593

(1981); Coleman v. Commissioner, 76 T.C. 580, 589 (1981). There

must be a causal connection between the alleged casualty and the

loss claimed by the taxpayer. Kemper v. Commissioner, 30 T.C.

546, 549-550 (1958), affd. 269 F.2d 184 (8th Cir. 1959).

Whether damage qualifies as a casualty typically turns on whether

the damage satisfies the suddenness requirement, which denotes an

accident, a mishap, or some sudden invasion by hostile agency

rather than progressive deterioration of property through

steadily operating cause. Fay v. Helvering, 120 F.2d 253 (2d

Cir. 1941), affg. 42 B.T.A. 206 (1940). In considering whether

wood rot damage qualified as a casualty, we have held that the

“suddenness” of the loss itself (the lapse of time between the

precipitating event and the loss proximately caused by that

event) is a determining factor. Hoppe v. Commissioner, 42 T.C.
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820, 823 (1964), affd. 354 F.2d 988 (9th Cir. 1965). We have

also held that wood rot damage may qualify as a casualty loss if

it was of “comparatively recent origin so as to qualify for the

requisite degree of ‘suddenness’.” Id. at 823-824; see also

Kilroe v. Commissioner, 32 T.C. 1304 (1959). In this regard, the

burden is on petitioners to prove their entitlement to a casualty

loss deduction. Rule 142(a); Welch v. Helvering, 290 U.S. 111

(1933).

Respondent contends that the collapsed deck and related

damage to the house do not give rise to a casualty loss deduction

because the loss is attributable to deterioration that occurred

during an extended period of time. Petitioners contend that if

wood rot was the cause of the collapse of the deck, it was

“hidden” and they “were not aware of it.”

After inspection by Farmers Insurance, it was determined

that the cause of the collapse of the deck was wood rot and

deterioration. Although concealed, after the collapse of the

deck, the wood rot became obvious, even to petitioners. Nothing

in the record suggests that the wood rot was a “sudden”

occurrence, or that it did not progress, as it usually does, over

an extended period of time. Hoppe v. Commissioner, supra.

The collapse of petitioners’ deck was the result of wood rot

and deterioration. The damages and losses resulting from the

collapse of the deck were not caused by a “sudden” event, and
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therefore the collapse of the deck was not a casualty within the

meaning of section 165. Petitioners are not entitled to a

casualty loss deduction.

2. Section 72(t)

Section 72(t)(1) imposes an additional tax on early

distributions from qualified retirement plans “equal to 10

percent of the portion of such amount which is includable in

gross income.” Petitioners now concede that the entire amount of

the distribution is includable in their 2000 income but take the

position that the section 72(t) additional tax is not applicable

because petitioner was disabled at the time the distribution was

made.

Among other exceptions, none of which apply here, section

72(t)(2)(A)(iii) provides an exception for distributions

“attributable to the employee’s being disabled within the meaning

of subsection (m)(7)”. Section 72(m)(7) defines the term

“disabled” as follows:

(7) Meaning of disabled.--For purposes of this
section, an individual shall be considered to be
disabled if he is unable to engage in any substantial
gainful activity by reason of any medically
determinable physical or mental impairment which can be
expected to result in death or to be of long-continued
and indefinite duration. An individual shall not be
considered to be disabled unless he furnishes proof of
the existence thereof in such form and manner as the
Secretary may require.

The determination of whether a taxpayer is disabled is made

on the basis of all the facts. Sec. 1.72-17A(f)(2), Income Tax
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Regs. The regulations emphasize that the “substantial gainful

activity” to which section 72(m)(7) refers is the activity, or a

comparable activity, in which the individual customarily engaged

prior to the disability. Sec. 1.72-17A(f)(1), Income Tax Regs.

The regulations also provide that the nature and severity of the

impairment are the primary consideration in determining whether

an individual is able to engage in any substantial gainful

activity. Id. Other factors to consider in the evaluation of

the impairment include the taxpayer’s education, training, and

work experience. Id. Therefore, the impairment must be

evaluated in terms of whether it does, in fact, prevent the

individual from engaging in his customary, or any comparable,

substantial gainful activity. Sec. 1.72-17A(f)(2), Income Tax

Regs.

Additionally, the impairment must be expected either to

continue for a long and indefinite period or to result in death.

Sec. 1.72-17A(f)(3), Income Tax Regs. In this context, the term

“indefinite” means that it cannot reasonably be anticipated that

the impairment will, in the foreseeable future, be so diminished

as no longer to prevent substantial gainful activity. Id. More

specifically, the regulations provide that “An individual will

not be deemed disabled if, with reasonable effort and safety to

himself, the impairment can be diminished to the extent that the

individual will not be prevented by the impairment from engaging
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in his customary or any comparable substantial gainful activity.”

Sec. 1.72-17A(f)(4), Income Tax Regs.

According to respondent, petitioner was not disabled within

the meaning of section 72(m)(7). We agree.

Although petitioner suffered from chronic back problems over

the years, he continued to work as a heavy equipment operator

until 2002. In fact, after receiving the distribution,

petitioner worked “six days a week, 12 hours a day.”

We find that petitioner’s chronic back problems did not

prevent him from returning, and, in fact, petitioner did return,

to comparable substantial gainful activity as a heavy equipment

operator. Therefore, we find that petitioner was not disabled

within the meaning of section 72(m)(7) at the time of the

distribution. Accordingly, petitioners are liable for the 10-

percent additional tax pursuant to section 72(t).

3. The Section 6662(a) Penalty

Section 6662(a) imposes an accuracy-related penalty of 20

percent of any portion of an underpayment of tax that is

attributable to a substantial understatement of income tax.

Sec. 6662(b)(2), (d). An understatement of income tax is a

substantial understatement of income tax if it exceeds the

greater of $5,000 or 10 percent of the tax required to be

shown on the taxpayer’s return. Sec. 6662(d)(1). Ignoring

conditions not relevant here, for purposes of section 6662, an
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understatement is defined as the excess of the amount of the tax

required to be shown on the taxpayer’s return over the amount of

the tax which is shown on the return. Sec. 6662(d)(2)(A).

Under section 7491(c), respondent has the burden of

production with respect to the accuracy-related penalty under

section 6662(a). To meet that burden, respondent must come

forward with sufficient evidence to show that imposition of the

penalty is appropriate. Higbee v. Commissioner, 116 T.C. 438,

446 (2001). We have sustained, or petitioners have conceded, the

determinations in the notice that give rise to the deficiency

that respondent determined. In addition, we have rejected

petitioners’ position that they are entitled to a casualty loss

deduction. Respondent has satisfied his burden of production

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

penalty under section 6662(a) determined in the notice.

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

an underpayment of tax if it is shown the taxpayer acted with

reasonable cause and in good faith. Sec. 6664(c)(1). The

determination of whether a taxpayer acted in 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.

Petitioners bear the burden of proof that they had reasonable

cause and acted in good faith with respect to the understatement.

Higbee v. Commissioner, supra at 449.
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Petitioners dispute the imposition of the penalty.

According to petitioners, the penalty should not apply because

they relied on the advice of a paid income tax preparer.

The general rule is that taxpayers have a duty to file

complete and accurate tax returns and cannot avoid the duty by

placing responsibility with an agent. United States v. Boyle,

469 U.S. 241, 252 (1985); Metra Chem Corp. v. Commissioner, 88

T.C. 654, 662 (1987). In limited situations, the good faith

reliance on the advice of an independent, competent professional

in the preparation of the tax return can satisfy the reasonable

cause and good faith exception. United States v. Boyle, supra at

250-251; Weis v. Commissioner, 94 T.C. 473, 487 (1990). However,

reliance on the advice of a professional tax adviser does not

necessarily demonstrate reasonable cause and good faith. See

sec. 1.6664-4(b)(1), Income Tax Regs. All facts and

circumstances must be taken into account. Sec. 1.6664-4(c)(1),

Income Tax Regs. The advice must be based upon all pertinent

facts and the applicable law. Sec. 1.6664-4(c)(1)(i), Income Tax

Regs. The taxpayer cannot establish reasonable reliance if he

fails to disclose facts that the taxpayer knows, or should know,

are relevant to the proper tax treatment of an item. Id. The

advice must not be based on unreasonable factual or legal

assumptions. See sec. 1.6664-4(c)(1)(ii), Income Tax Regs.
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Apart from passing references to the tax return preparer in

petitioner’s testimony, the record is devoid of evidence to

support petitioners’ claim that the position taken on their 2000

return was consistent with the tax return preparer’s advice.

Petitioners did not call their tax return preparer as a witness.

There is no evidence establishing the qualifications of

petitioners’ tax return preparer or that petitioners provided

their tax return preparer with all relevant information.

Respondent’s imposition of the section 6662(a) accuracy-

related penalty is sustained.

Reviewed and adopted as the report of the Small Tax Case

Division.

To reflect the foregoing,

Decision will be entered

for respondent.