T.C. Summary Opinion 2006-152
UNITED STATES TAX COURT
ROBERT G. AND LANA L. GALE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 2088-06S. Filed September 14, 2006.
Robert G. and Lana L. Gale, pro sese.
R. Craig Schneider, for respondent.
DAWSON, Judge: This case was heard pursuant to section 7463
of the Internal Revenue Code in effect when the petition was
filed.1 The decision to be entered is not reviewable by any
other court, and this opinion should not be cited as authority.
1
Unless otherwise indicated, subsequent section references
are to the Internal Revenue Code in effect for the year at issue.
Rule references are to the Tax Court Rules of Practice and
Procedure.
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Respondent determined a $6,860 deficiency in petitioners’
Federal income tax and a $1,372 accuracy-related penalty under
section 6662(a) for 2003. The primary issue for decision is
whether petitioners were insolvent within the meaning of section
108(a)(1)(B) when the $39,274.90 second mortgage on their home
was canceled following the sale of the home in 2003 caused by the
default on the first mortgage.2
Background
Some of the facts were stipulated and are so found. The
stipulation of facts and the accompanying exhibits are
incorporated herein by this reference. Petitioners resided in
Layton, Utah, when they filed the petition in this case.
Mrs. Gale is a homemaker and earns no income. Mr. Gale is
employed by the Bureau of Land Management.
In 2003, Mr. Gale had back surgery and was out of work for
several weeks. He did not receive a pay check for some weeks.
Consequently, petitioners were unable to make the payments on two
loans secured by mortgages on their home, a first mortgage held
by First National Mortgage (First National) and a second mortgage
held by Citibank. First National notified petitioners that it
2
In the notice of deficiency, respondent also made
adjustments to deductions for medical and dental expenses
petitioners reported on Schedule A, Itemized Deductions, that are
computed on the basis of the increase in petitioners’ adjusted
gross income.
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intended to foreclose on the loan and suggested that they contact
a real estate broker to arrange a short sale.3
On June 23, 2003, petitioners sold the house for $68,500.
They incurred and paid settlement costs and taxes totaling
$1,954.50, paid the total $61,615.50 balance outstanding on the
first mortgage, and paid $1,500 of the total $40,775 balance
outstanding on the second mortgage. Citibank forgave the
remaining $39,275 outstanding on the second mortgage.
Petitioners’ records show that petitioners’ assets and
liabilities before the sale of the house were as follows:
Assets Totals
House $68,500
Blazer 25,000
Cash accounts 1,068
Investments -0-
Jewelry 1,500
Computer 400
Furniture/appliances 2,000
CSRS pension NA
Thrift savings account NA
3
A short sale in real estate occurs when the outstanding
loans against a property are greater than what the property is
worth and the lender agrees to accept less than it is owed to
permit a sale of the property which secures its note.
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Liabilities Totals
1st mortgage 61,616
2nd mortgage 40,774
RC Willey 1,300
Providian 2,250
Chase Mastercard 5,000
AmeriCredit 32,465
Medical 550
Medicine 900
Discover card 2,500
Texaco 1,500
Mrs. Gale’s student loan 6,000
Dentist 1,100
Petitioners purchased the 2001 Blazer in January 2001 for
$32,000. Mr. Gale estimated that the Blazer was worth $25,000
when the second mortgage was canceled. He did not consult any
publication showing used car values.
Petitioners’ records do not show the value of Mr. Gale’s
CSRS pension benefit or thrift savings account at the time the
second mortgage was canceled. Mr. Gale believed that had he
retired in 2003, his CSRS pension benefit would have been
approximately $858 per month. Mr. Gale contributed to a thrift
savings account from about 1984 to 1990. He did not make any
contributions to his thrift savings account after 1990. In 1998,
Mr. Gale borrowed from his thrift savings account to make the
downpayment on the house.
Petitioners employed Julie K. Young of JKY Tax Service to
prepare their 2003 Form 1040, U.S. Individual Income Tax Return.
Petitioners jointly filed the return prepared by Ms. Young.
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Petitioners did not report the $39,275 discharge of indebtedness
as income on the return.
Citibank sent petitioners a Form 1099-C, Cancellation of
Debt, reporting the $39,275 discharge of indebtedness. After
petitioners received the Form 1099-C, Ms. Young prepared and
petitioners filed an amended return that reported the $39,275 as
gain on the sale of their residence that was excludable from
income.
Discussion
A. Deficiency
In general, the Commissioner’s determinations set forth in a
notice of deficiency are presumed correct, and the taxpayer bears
the burden of showing that such determinations are in error.
Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Section 7491(a)(1) provides that the burden of proof as to
factual matters shifts to the Commissioner under certain limited
circumstances. Petitioners do not fall within these limited
circumstances, and therefore the burden of proof remains with
them.
Generally, discharge of indebtedness gives rise to gross
income to the obligor. Sec. 61(a)(12); see Gitlitz v.
Commissioner, 531 U.S. 206, 213 (2001). Section 108 provides
certain exceptions to this general rule. Pursuant to one of
these exceptions, income from discharge of indebtedness is
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excluded from gross income if the discharge occurs when the
taxpayer is insolvent. The amount of income from discharge of
indebtedness excluded under section 108(a)(1)(B) is not to exceed
the amount by which the taxpayer is insolvent. Sec. 108(a)(3).
For purposes of section 108, the term “insolvent” means the
excess of liabilities over the fair market value of assets. Sec.
108(d)(3). Whether the taxpayer is insolvent, and the amount by
which the taxpayer is insolvent, is determined on the basis of
the taxpayer’s assets and liabilities immediately before the
discharge.
Petitioners did not submit to respondent or to the Court any
contemporaneous records or documents to establish the value of
their assets or liabilities at the time the second mortgage was
canceled. The night before the trial petitioners created a list
of their assets and liabilities from information stored on their
computer. Petitioners relied upon that list and Mr. Gale’s oral
testimony as evidence of the value of assets owned and
liabilities owed in 2001 immediately before the discharge.
Having observed Mr. Gale’s appearance and demeanor at trial, we
find his testimony to be honest, forthright, and credible.
Immediately before the discharge of indebtedness, without regard
to Mr. Gale’s CSRS pension benefit and thrift savings account,
petitioners had liabilities of $92,839 which exceeded the $29,968
value of their assets by $62,871, shown as follows:
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Assets
Blazer $25,000
Cash accounts 1,068
Investments -0-
Jewelry 1,500
Computer 400
Furniture/appliances 2,000
Total assets $29,968
Liabilities
2nd mortgage 39,274
RC Willey 1,300
Providian 2,250
Chase Mastercard 5,000
AmeriCredit 32,465
Medical 550
Medicine 900
Discover card 2,500
Texaco 1,500
Mrs. Gale’s stud. 6,000
Dentist 1,100
Total liabilities (92,839)
Net liabilities (62,871)
Although Mr. Gale believes that his CSRS pension benefit
would have been about $858 per month had he retired in 2003, he
did not provide any statements related to the value of that
pension or his thrift savings account on the date the second
mortgage was canceled. We have no way to accurately estimate the
value of those assets on the date the second mortgage was
canceled, and petitioners have not established that the combined
value of Mr. Gale’s thrift savings account and CSRS pension
benefit was less than $62,871 on that date. Consequently,
petitioners have failed to establish that they were insolvent
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when the debt was canceled and that the insolvency exception of
section 108(a)(1)(B) applies.
We hold that petitioners’ income for 2003 includes $39,274
from the discharge of indebtedness that was not reported on their
2003 return.
B. Accuracy-Related Penalty
Section 7491(c) places the burden of production on the
Commissioner with respect to the liability of any individual for
any penalty, addition to tax, or additional amount.
Respondent contends that petitioners are liable for an
accuracy-related penalty under section 6662(a). Respondent has
the burden of production under section 7491(c) and must come
forward with evidence sufficient for us to sustain the section
6662(a) penalty. See Higbee v. Commissioner, 116 T.C. 438,
446-447 (2001). As pertinent here, section 6662(a) imposes a
20-percent penalty on the portion of an underpayment attributable
to negligence or disregard of rules or regulations, sec.
6662(b)(1), or a substantial understatement of tax, sec.
6662(b)(2). Negligence includes any failure to make a reasonable
attempt to comply with the provisions of the Internal Revenue
Code, including any failure to keep adequate books and records or
to substantiate items properly. Sec. 6662(c); sec.
1.6662-3(b)(1), Income Tax Regs. An “understatement” is the
excess of the amount of tax required to be shown on the tax
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return over the amount of tax shown on the tax return, sec.
6662(d)(2)(A), and is “substantial” in the case of an individual
if the understatement exceeds the greater of 10 percent of the
tax required to be shown or $5,000, sec. 6662(d)(1)(A).
The penalty under section 6662(a) does not apply to any
portion of an understatement of tax if it is shown that there was
reasonable cause for the taxpayer’s position and that the
taxpayer acted in good faith with respect to that portion. Sec.
6664(c)(1). Reasonable cause requires that the taxpayer exercise
ordinary business care and prudence as to the disputed item. See
United States v. Boyle, 469 U.S. 241 (1985). The good faith
reliance on the advice of an independent, competent professional
as to the tax treatment of an item may meet this requirement.
Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 98
(2000), affd. 299 F.3d 221 (3d Cir. 2002); sec. 1.6664-4(b),
Income Tax Regs. To show good faith reliance, the taxpayer must
show that the return preparer was supplied with all the necessary
information and the incorrect return was a result of the
preparer’s mistakes. Neonatology Associates, P.A. v.
Commissioner, supra at 99; Pessin v. Commissioner, 59 T.C. 473,
489 (1972); sec. 1.6664-4(c)(1)(i), Income Tax Regs.
We are convinced that petitioners provided Ms. Young with
all the necessary information concerning the sale of their home
and the cancellation of the second mortgage by Citibank.
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Petitioners reasonably relied on Ms. Young. Consequently, we
hold that petitioners are not liable for the section 6662(a)
accuracy-related penalty.
To reflect the foregoing,
Decision will be entered
for respondent with respect to
the deficiency and for
petitioners with respect to
the section 6662(a) accuracy-
related penalty.