CRONK v. COMMISSIONER

T.C. Summary Opinion 2005-174

UNITED STATES TAX COURT

RICHARD ALAN CRONK, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 4544-04S. Filed November 29, 2005.

Richard Alan Cronk, pro se.

Aimee R. Lobo-Berg, for respondent.

COUVILLION, Special Trial Judge: This case was heard

pursuant to section 7463 of the Internal Revenue Code in effect

at the time the petition was filed.1 The decision to be entered

1
Unless otherwise indicated, subsequent section references
are to the Internal Revenue Code in effect for the year at issue,
and all Rule references are to the Tax Court Rules of Practice
and Procedure. The Court decides this case without regard to the
burden of proof, except that, with respect to the addition to tax
and the penalty, the burden of proof is on respondent. Sec.
7491.
 - 2 -

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

be cited as authority.

Respondent determined a deficiency of $8,579 in petitioner’s

Federal income tax for the year 2001, an addition to tax under

section 6651(a)(1) in the amount of $410, and an accuracy-related

penalty under section 6662(a) in the amount of $1,716.

The issues for decision are: (1) Whether petitioner

realized interest income from the redemption during 2001 of

series E U.S. savings bonds inherited from his mother; (2)

whether petitioner is liable for the addition to tax under

section 6651(a)(1); and (3) whether petitioner is liable for the

accuracy-related penalty under section 6662(a).

Some of the facts were stipulated, and those facts, with the

annexed exhibits, are so found and are incorporated herein by

reference. At the time the petition was filed, petitioner’s

legal residence was Lake Oswego, Oregon.

Petitioner is an accountant and was employed as finance

manager for the County Housing Authority at Lake Oswego, Oregon.

His work generally consisted of maintaining the books and records

of his employer as well as handling financial transactions such

as grants, loans, and the like between his employer and the U.S.

Department of Housing and Urban Development.

The facts in this case are not in dispute. Petitioner’s

mother, Esther G. Cronk, died on June 3, 1999. She left a last
 - 3 -

will and testament and, under the terms of that will, bequeathed

her entire estate to petitioner. The will was duly probated,

petitioner was recognized as his mother’s sole heir and legatee,

and he was placed in possession of her estate. The record does

not indicate what properties, other than the savings bonds,

constituted the mother’s estate. It appears that the

probate/succession proceedings were concluded in early 2001.

Although the record is not entirely clear as to when the

following events occurred, it appears that, at some point in

2001, petitioner received a notice from the bank where his mother

did business, which stated that the annual fee for her safe

deposit box was due. Petitioner was not aware that his mother

had a safe deposit box, and he, accordingly, went through the

necessary procedures to have the box opened. When the box was

opened in 2001, petitioner discovered that his mother owned

several series E U.S. savings bonds, which she had purchased over

the years. The bonds totaled $30,000, and petitioner was the

named beneficiary on the bonds. Petitioner then proceeded to

redeem the bonds. Petitioner was paid the principal of the bonds

and the interest that had accrued on the bonds. The interest

totaled $31,980. For the year 2001, petitioner received from the

payer bank two Forms 1099-INT, Interest Income, which totaled

$31,980 for the interest. Petitioner did not include the

interest as income on his 2001 Federal income tax return. The
 - 4 -

notice of deficiency, which petitioner thereafter received,

attributed the $31,980 in interest as income to him. That income

is the principal issue in this case.

The parties agree that, for the years in which petitioner’s

mother held the bonds, her income was minimal, and she did not

file Federal income tax returns. Thus, income tax on the bond

interest was never paid.

Shortly after petitioner received the notice of deficiency,

he prepared, for the 2001 tax year, a Federal income tax return

in the name of his mother, on which he reported the $31,980 as

interest income. The tax shown on that return was $11,598, which

included tax on the $31,980 in interest on the bonds. He mailed

the return to the IRS and included a check of $11,598. The

return was not accepted by the IRS for the reason that

petitioner’s mother died in 1999 and, therefore, was not a

taxpayer in 2001. The $11,598 check petitioner sent with the

return was not returned to him, nor was petitioner refunded that
 - 5 -

amount.2 Petitioner, in the meantime, filed a timely petition

with the Court.

With respect to series E U.S. savings bonds, section 454(a)

allows a cash-basis taxpayer/owner of such bonds for whom the

entire interest is includable in income at the maturity of the

bonds to elect to treat the annual interest as income. An

“election” is effected simply by including the interest as income

on a tax return, and that election is binding for all subsequent

years. If no election is made, the interest accumulates, and,

when the bonds mature, the accumulated interest is taxable in the

year the bonds mature or are redeemed. In this case, because

petitioner’s mother did not file income tax returns, no election

was made under section 454(a); therefore, when petitioner

redeemed the bonds in 2001, the accrued interest was includable

in income for that year. Petitioner does not dispute that the

interest is includable in income.

Petitioner’s motive in having the interest taxable to his

mother’s estate is obvious. If the interest is taxed as her

2
A copy of the return was not offered into evidence.
Petitioner did not explain how he arrived at the $11,598 tax
liability shown on the return; however, it appears that the check
tracks the deficiency determined in the notice of deficiency as
well as the addition to tax and penalty plus an additional amount
the Court assumes was interest. Counsel for respondent agreed
that petitioner had sent a check for that amount but did not
explain why the payment was not returned to petitioner. The
decision in this case will presumably determine the disposition
of those funds by respondent.
 - 6 -

income, the tax amounts to approximately $3,300; whereas, if the

interest is lumped with petitioner’s salary and other income, the

tax on the interest approximates $8,570. Respondent was not

caught off guard by this strategy.

With respect to the first issue, whether petitioner realized

interest income during 2001, the Court sustains respondent. The

accrued interest on the bonds, as the Court held in a parallel

situation in Apkin v. Commissioner, 86 T.C. 692, 695 (1986),

constituted “income in respect of a decedent” under section 691,

which provides in pertinent part:

SEC. 691(a). Inclusion in Gross Income.--

(1) General rule.--The amount of all items of gross
income in respect of a decedent which are not properly
includible in respect of the taxable period in which falls
the date of his death or a prior period * * * shall be
included in the gross income, for the taxable year when
received, of:

* * * * * * *

(B) the person who, by reason of the death of the
decedent, acquires the right to receive the amount, * *
*

Petitioner inherited the bonds when his mother died in 1999.

Petitioner was not only her sole heir but was the sole legatee in

her will. Additionally, petitioner was the named beneficiary on

the bonds. No election had previously been made under section

454(a) by petitioner’s mother to have the annual interest on the
 - 7 -

bonds made taxable. The interest on the bonds, therefore,

“accrued” or accumulated and, when the bonds were redeemed by

petitioner, that accumulated or “accrued” interest was includable

in his income.

Respondent agrees that, following his mother’s death,

petitioner, as her personal representative, could have filed a

final return on her behalf for the year 1999, in which petitioner

could have elected, on behalf of her estate, under section 454,

to have the interest included as income for that year on his

deceased mother’s final 1999 return. Petitioner did not do that

and instead attempted to file a return on behalf of his mother’s

estate for the year 2001, which was rejected by the IRS. Since

petitioner did not have knowledge of his mother’s ownership of

the bonds until 2001, respondent agrees that petitioner could

have, under section 301.9100-1, Proced. & Admin. Regs., applied

for an extension to file a return for her estate for 1999 to make

the election under section 454(a); however, no such application

was ever made. Moreover, as respondent points out, requests for

such extensions are conditioned upon the taxpayer’s providing

evidence satisfying the Commissioner that the taxpayer acted

reasonably and in good faith, and the granting of relief does not

prejudice the interests of the Government. A taxpayer is deemed

to have acted reasonably and in good faith if he failed to make

the election because, after exercising reasonable diligence,
 - 8 -

taking into account the taxpayer’s experience, he was unaware of

the necessity for the election. Sec. 301.9100-3(b)(1)(iii),

Proced. & Admin. Regs. In this case, although petitioner was not

aware of the bonds until 2001, he did not act until he received

the notice of deficiency on December 15, 2003, almost 3 years

later. Petitioner is an accountant employed as a finance manager

who could reasonably be expected to know of the necessity for the

election. Consequently, petitioner would not have been entitled

to an extension to make the election under section 454(a). The

Court holds, therefore, that the interest on the redeemed bonds

constituted income to petitioner, as owner of the bonds, and

petitioner is not entitled to the election under section 454(a).

Respondent is sustained on this issue. Apkin v. Commissioner,

supra.

Respondent determined that petitioner’s Federal income tax

return for 2001 was not filed timely, and that he is liable for

the addition to tax under section 6651(a)(1). The parties

stipulated that petitioner’s 2001 return was mailed on April 17,

2002, and was received by the IRS on April 23, 2002. The

addition to tax under section 6651(a)(1) is imposed where there

is failure to file a timely tax return, unless it is shown that

the failure to timely file is due to reasonable cause and not due

to willful neglect. Under section 6072(a), calendar year

taxpayers, such as petitioner, are required to file their income
 - 9 -

tax returns by April 15, following the close of the calendar

year. Petitioner’s 2001 return, due April 15, 2002, was not

filed with the IRS until April 23, 2002. The return, therefore,

was filed late. Petitioner presented no evidence to establish

reasonable cause for the delinquent filing of his return.

Respondent, therefore, is sustained on this issue.

The final issue is respondent’s determination that

petitioner is liable for the penalty under section 6662(a).

Section 6662(a) imposes an accuracy-related penalty in the

amount of 20 percent of any portion of an underpayment of tax

that is attributable to causes set forth in subsection (b).

However, under section 6664(c), no penalty shall be imposed under

section 6662(a) with respect to any portion of an underpayment if

it is shown that there was a reasonable cause for the

underpayment and that the taxpayer acted in good faith with

respect to the underpayment.

Section 6662(b)(2) provides that the penalty is applicable

where there is a substantial understatement of tax.

A substantial understatement exists where the amount of the

understatement 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). The understatement is reduced by the

portion of the understatement attributable to an item for which

there was either substantial authority for its treatment or
 - 10 -

adequate disclosure of the relevant facts and a reasonable basis

for its treatment. Sec. 6662(d)(2)(B). There is no dispute that

the understatement of tax in this case meets this threshold. The

issue, however, is whether petitioner had reasonable cause for

the understatement and acted in good faith with respect to the

understatement.

The determination of whether a taxpayer acted with

reasonable cause and in good faith is made on a case-by-case

basis. Sec. 1.6664-4(b), Income Tax Regs. The most important

factor is the extent of the taxpayer’s effort to assess the

taxpayer’s proper tax liability. An honest misunderstanding of

fact or law that is reasonable in light of the experience,

knowledge, and education of the taxpayer may indicate reasonable

cause and good faith. Remy v. Commissioner, T.C. Memo. 1997-72.

Further, reliance by the taxpayer on the advice of a qualified

adviser constitutes reasonable cause and good faith, if, under

all of the facts and circumstances, the reliance by the taxpayer

was reasonable and the taxpayer acted in good faith. Sec.

1.6664-4(b), Income Tax Regs. Petitioner here did not consult

with a tax adviser.

Petitioner is an accountant. His position is that, because

he acquired the bonds by inheritance, he, therefore, had a

“stepped-up” basis for the bonds, which basis would include the

accrued interest. That rationale, however, has no bearing or
 - 11 -

relevance to the income tax liability for the accrued interest on

the bonds. The Court, therefore, rejects that argument.

Petitioner also contends he relied on the representation of

an Appeals officer of the IRS in the form of a letter he received

in connection with the 2001 income tax return he prepared for his

mother that was rejected by the IRS. It is apparent from the

letter that the Appeals officer who signed the letter was not

knowledgeable about the facts surrounding the bonds. Moreover,

even if the letter is authoritative, the information in that

letter clearly does not account for and take into consideration

all the facts of this case. The law is well settled that the IRS

is not bound by erroneous advice of its agents or employees.

Bornstein v. United States, 170 Ct. Cl. 576, 345 F.2d 558 (1965).

Respondent, therefore, is sustained on this issue.

Reviewed and adopted as the report of the Small Tax Case

Division. To account for treatment of petitioner’s payment of

$11,598 that accompanied the 2001 income tax return on behalf of

petitioner’s mother that was not returned to petitioner,

Decision will be entered

under Rule 155.