T.C. Memo. 2007-19
UNITED STATES TAX COURT
BIDYUT K. BHATTACHARYYA AND DIANA T. BHATTACHARYYA, Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15024-04. Filed January 30, 2007.
Bidyut K. Bhattacharyya and Diana T. Bhattacharyya, pro
sese.
Wesley F. McNamara, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: Respondent determined a deficiency in
petitioners’ 2000 Federal income tax of $314,372 and an addition
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to tax under section 6651(a)(1) of $38,837.1 After concessions,2
the issues for decision are: (1) Whether respondent’s and
petitioners’ motions to conform pleadings to the evidence should
be granted; (2) whether petitioners received but failed to report
certain items of income; (3) whether petitioners are liable for a
10-percent additional tax under section 72(t) on early
distributions from qualified retirement plans; (4) whether
petitioners are entitled to certain itemized deductions; (5)
whether petitioners are liable for any alternative minimum tax;
and (6) whether petitioners are liable for an addition to tax
under section 6651(a)(1).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts, supplemental stipulation of facts, and
the second supplemental stipulation of facts and attached
exhibits are incorporated herein by this reference. At the time
they filed their petition, petitioners resided in Beaverton,
Oregon.
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended, and all Rule references
are to the Tax Court Rules of Practice and Procedure. All
amounts are rounded to the nearest dollar.
2
The parties have agreed to certain issues, either in the
stipulation of facts, at trial, or on brief, and respondent has
conceded other issues. The parties’ agreements and concessions
are discussed herein.
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Bidyut K. Bhattacharyya (petitioner) was born on October 8,
1955, and Diana T. Bhattacharyya (Mrs. Bhattacharyya) was born on
January 19, 1960. From July 16, 1984, until October 21, 2000,
petitioner was employed by Intel Corporation (Intel).
A. Income From Salary, Bonuses, Stock Options, and Other
Sources
During 2000, petitioner received compensation from Intel in
the form of a salary, bonuses, and through the exercise of
nonqualified stock options. On January 11, 2000, petitioner
exercised a nonqualified stock option granted by Intel to
purchase 800 shares of stock at $8.391 per share. The market
price on January 11, 2000, was $92.00 per share, resulting in a
realized gain of $66,887. On April 17, 2000, petitioner
exercised a nonqualified stock option granted by Intel to
purchase 5,000 shares of stock at $8.391 per share. The market
price on April 17, 2000, was $116.4062 per share, resulting in a
realized gain of $540,076. Petitioner exercised the nonqualified
stock options through an investment brokerage account with
Merrill Lynch (Merrill Lynch brokerage account).
Intel issued petitioner a Form W-2, Wage and Tax Statement,
for 2000 (the Intel Form W-2), which reported total wages, tips,
and other compensation of $746,191. Of that amount, $606,963
represented the gain realized by petitioner on the exercise of
the nonqualified stock options.
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During 2000, petitioners received a State income tax refund
of $34,500 for State income taxes paid with respect to their 1999
tax year.
B. Petitioner’s Intel Retirement Plans
At the time he terminated his employment, petitioner
maintained three Intel retirement plans, Plan 15104, Plan 15105,
and Plan 15106.
Plan 15104 was a nonqualified deferred compensation plan
called the Sheltered Employee Retirement Plan Plus (or SERP+) and
was administered by Fidelity Investments Institutional Operations
Company (Fidelity Institutional) on behalf of Intel. On December
22, 2000, petitioner received $285,603 from Intel, representing
the full distribution of Plan 15104 in the gross amount of
$372,850 less Federal and State withholding taxes. Fidelity
Institutional issued petitioner a Form W-2 with respect to Plan
15104 for 2000 (the Plan 15104 Form W-2). The parties stipulated
that the Plan 15104 Form W-2 accurately reflected the
distribution amount, withholding taxes paid, that petitioner made
no employee contributions, and that no portion of the
distribution was rolled over into another account.
Plan 15105 was a qualified retirement plan called the Intel
Corporation 401(k) Savings Plan and was administered by Fidelity
Institutional on behalf of Intel. Petitioner borrowed money from
Plan 15105 and made payments through payroll withholding.
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Petitioner ceased making payments after he terminated his
employment, and the loan was considered in default. The loan was
repaid in 2000 by an offsetting distribution from Plan 15105 of
$15,552. During October or November of 2000, petitioner made a
direct rollover of $286,390 from Plan 15105 into his Fidelity
Investments IRA Rollover Account (Fidelity IRA). Fidelity
Institutional issued petitioner a Form 1099-R, Distributions From
Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs,
Insurance Contracts, etc., with respect to Plan 15105 for 2000
(the Plan 15105 Form 1099-R). The parties stipulated that the
Plan 15105 Form 1099-R accurately reflected the offsetting
distribution made in satisfaction of the loan and the direct
rollover into the Fidelity IRA, indicated that petitioner made
employee contributions of $1,108, and reported a taxable amount
of $14,443.
Plan 15106 was a qualified retirement plan called the Intel
Corporation Profit Sharing Retirement Plan and was administered
by Fidelity Institutional on behalf of Intel. Petitioner
borrowed money from Plan 15106 and made payments through payroll
withholding. Petitioner ceased making payments after he
terminated his employment, and the loan was considered in
default. The loan was repaid in 2000 by an offsetting
distribution from Plan 15106 of $30,623. On November 6, 2000,
petitioner made a direct rollover of $463,930 from Plan 15106
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into his Fidelity IRA. Fidelity Institutional issued petitioner
a Form 1099-R with respect to Plan 15106 for 2000 (the Plan 15106
Form 1099-R). The parties stipulated that the Plan 15106 Form
1099-R accurately reflected the offsetting distribution made in
satisfaction of the loan and the direct rollover into the
Fidelity IRA, indicated that petitioner made no employee
contributions, and reported a taxable amount of $30,623.
C. Petitioner’s Individual Retirement Accounts (IRAs)
As described above, petitioner made direct rollovers from
Plan 15105 and Plan 15106 to his Fidelity IRA totaling $750,320
in 2000. Petitioner received the following distributions from
his Fidelity IRA:
Date Amount
Nov. 2, 2000 $100,000
Nov. 9, 2000 10,000
Nov. 9, 2000 20,000
Nov. 16, 2000 30,000
Total 160,000
On November 9 and 16, 2000, petitioner made direct rollovers
of $500,000 and $62,930, respectively, from his Fidelity IRA into
another IRA administered by US Bancorp Piper Jaffray (US Bancorp
IRA). On November 10 and 17, 2000, petitioner received
distributions of $500,000 and $62,930, respectively, from his US
Bancorp IRA.
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On December 11, 2000, petitioner transferred 815 shares of
Intel stock from his Fidelity IRA into his US Bancorp IRA. On
December 22, 2000, the Intel stock was sold, and petitioner was
issued a check for $27,000.
US Bancorp issued petitioner a Form 1099-R with respect to
his US Bancorp IRA for 2000. The Form 1099-R reflected the
distributions of $500,000 and $62,930, and the check for $27,000,
for total distributions of $589,930.
D. Petitioners’ 1999 Federal Income Tax Return
Petitioners filed a joint Federal income tax return for 1999
on June 18, 2003.3 Petitioners reported adjusted gross income of
$564,156, itemized deductions of $427,211, a total tax of
$33,735, an overpayment of tax of $116,498. Petitioners
requested a refund of $105,228 and that $11,270 be applied to
their estimated tax for 2000. Petitioners’ 1999 tax return did
not include a Form 6251, Alternative Minimum Tax--Individuals.
Respondent examined petitioners’ 1999 tax year and
determined that petitioners were not entitled to a refund or
estimated tax credit and were liable for alternative minimum tax
of $105,616. On November 17, 2003, respondent assessed
additional tax of $105,616 and interest of $33,935. The
Certificate of Official Record for petitioners’ 1999 tax year
3
Petitioners’ 1999 tax year is not at issue.
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reflects that this assessment of additional tax and interest was
“abated” on November 8, 2004.
On October 27, 2004, petitioners filed a refund suit in U.S.
District Court for the District of Oregon, at docket No. CV-04-
01563-KI. By opinion and order dated March 16, 2005, the
District Court dismissed petitioners’ suit for lack of subject
matter jurisdiction. On May 22, 2006, the Court of Appeals for
the Ninth Circuit affirmed the District Court’s dismissal for
lack of subject matter jurisdiction. Bhattacharyya v.
Commissioner, 180 Fed. Appx. 763 (9th Cir. 2006).
E. Petitioners’ 2000 Federal Income Tax Return
Petitioners filed a joint Federal income tax return for 2000
on May 19, 2003. Petitioners reported wages, salaries, tips,
etc., of $746,191, the amount reported by Intel on the Form W-2.
On an attached “Exhibit II”, petitioners summarized their IRA and
retirement plan distributions and rollovers as follows:
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Plan Amt. withdrawn Rollover amt. Notes
Fidelity IRA $100,000 --
Fidelity IRA 10,000 $10,000 “Direct
rollover
correction”
Fidelity IRA 20,000 10,000 “Direct
rollover
correction”
Fidelity IRA 500,000 500,000 Direct
rollover to US
Bancorp IRA
Fidelity IRA 30,000 --
US Bancorp IRA 500,000 285,603
US Bancorp IRA 62,931 --
US Bancorp IRA 27,000 --
Total 1,249,931 805,603
Based on Exhibit II, petitioners reported total taxable IRA
distributions of $444,327. Petitioners also reported total
pension distributions of $372,850, reflecting the distribution
from Plan 15104, but they determined that only $192,850 was
taxable. After including interest income, dividend income, other
income, and a capital loss of $3,000, petitioners reported
adjusted gross income of $1,402,076. Petitioners’ reported
adjusted gross income did not include: (1) The State income tax
refund of $34,500;4 (2) $180,000 of the distribution from Plan
4
The parties agree that petitioners are liable for Federal
income tax in 2000 on the State income tax refund received in
(continued...)
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15104; (3) the offsetting distributions made in satisfaction of
the loans from Plan 15105 and Plan 15106 of $15,552 and $30,623,
respectively; and (4) $305,603 of the IRA distributions.
On an attached Schedule A, Itemized Deductions, petitioners
reported itemized deductions of $1,118,870, summarized by
petitioners as follows:
Type of Expense Amount Notes
Option Int $37,738 US Bank Corp.
Option Int 186,370 Merrill Lynch
MLF 71,657 Merrill Lynch
Fees
US Bank Fees 26,000 US Bank Fees
Opt.int 20,164 Merrill Lynch
Cash Pay 330,979 Merrill Lynch,
to protect
Taxable income
Cash Pay 123,000 Merrill Lynch,
to protect
Taxable income
Other 322,962 Merrill Lynch,
to protect
Taxable income
Total 1,118,870
Petitioners reported taxable income of $213,977, tax of $60,080,
tax on IRAs and other retirement plans of $63,717, and total tax
4
(...continued)
2000.
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of $123,797.5 After deducting total payments of $282,821,
petitioners requested a refund of $131,024 and that $28,000 be
applied to their 2001 estimated tax. Petitioners’ 2000 tax
return did not include a Form 6251 or any other calculation of
their alternative minimum tax liability.
In response to a letter from respondent inquiring about the
absence of an alternative minimum tax computation, petitioners
sent respondent a letter on September 15, 2003, and attached a
Form 1040X, Amended U.S. Individual Income Tax Return
(petitioners’ first Form 1040X). On petitioners’ first Form
1040X, petitioners included a Form 6251, determined an
alternative minimum tax liability of $56,827, but reduced their
income by more than $630,000 and claimed a refund of $9,270.
Respondent did not file petitioners’ first Form 1040X.
On May 25, 2004, respondent issued petitioners a notice of
deficiency. Respondent determined a deficiency in petitioners’
2000 Federal income tax of $314,372, based on respondent’s
determination that petitioners were liable for alternative
minimum tax of $314,371.6 Respondent also determined that
5
It is unclear how petitioners calculated the tax on IRAs
and other retirement plans, but $63,717 is apparently
petitioners’ calculation of a 10-percent additional tax under
sec. 72(t).
6
Respondent also increased petitioners’ itemized
deductions by $1 to correct a rounding error made by petitioners.
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petitioners were liable for an addition to tax under section
6651(a)(1) of $38,837.
On June 26, 2004, petitioners sent respondent a letter and
attached another Form 1040X (petitioners’ second Form 1040X).
Petitioners’ second Form 1040X was identical to petitioners’
first Form 1040X, but the letter included an additional
explanation of the changes made by petitioners to their original
Federal income tax return. Respondent did not file petitioners’
second Form 1040X.
Petitioners filed their petition with this Court on August
20, 2004. Petitioners requested the Court to determine that they
are due a refund “$9000 (Back Approx.)”. Respondent filed an
answer on September 29, 2004, but did not seek an increased
deficiency or addition to tax.
This case was called during the Court’s regular trial
session in Portland, Oregon, beginning December 5, 2005. On
February 21, 2006, respondent filed a Motion for Leave to Amend
Answer to Conform to Evidence Presented at Trial and to Claim an
Increased Deficiency and Addition to Tax, with Accompanying
Proposed Amendment to Answer (respondent’s motion to conform the
pleadings to the evidence) under Rule 41(b). In the amendment to
answer, which was lodged with the Court on February 21, 2006,
respondent asserted that petitioners were liable for an increased
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deficiency of $561,309, and an increased section 6651(a)(1)
addition to tax of $100,571.
On November 3, 2006, petitioners filed a Motion for Amended
Petition Consistent with the Evidences Presented at Trial, and to
Claim a Refund by Petitioners for $76,890.00, with Accompanying
Proposed Amended Petition (petitioners’ motion to conform
pleadings to the evidence) under Rule 41(b).
OPINION
I. Respondent’s and Petitioners’ Motions To Conform Pleadings
to the Evidence
As a preliminary matter, we must determine whether
respondent’s and petitioners’ motions to conform pleadings to the
evidence should be granted. Section 6214(a) requires a claim for
increased deficiency to be asserted at or before the hearing or
rehearing. It is well established that the word “hearing” used
in section 6214(a) includes all Tax Court proceedings in a case
through entry of decision. Henningsen v. Commissioner, 243 F.2d
954, 959 (4th Cir. 1957), affg. 26 T.C. 528 (1956); Law v.
Commissioner, 84 T.C. 985, 989 (1985). Rule 41(b) allows the
parties to amend their pleadings to conform with the evidence
presented at trial.7 Whether a motion seeking an amendment to
7
Rule 41(b) provides in part:
(1) Issues Tried by Consent: When issues not raised by
the pleadings are tried by express or implied consent
of the parties, they shall be treated in all respects
(continued...)
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the pleadings to conform to the evidence should be allowed is
within the sound discretion of the Court. Commissioner v. Estate
of Long, 304 F.2d 136, 143-145 (9th Cir. 1962). If granting the
motion would result in unfair surprise or prejudice to the
nonmoving party, the motion should be denied. Church of
Scientology v. Commissioner, 83 T.C. 381, 469 (1984), affd. 823
F.2d 1310 (9th Cir. 1987).
In respondent’s motion to conform pleadings to the evidence
and in the lodged amendment to answer, respondent asserts an
increased deficiency of $561,309, and an increased addition to
tax under section 6651(a)(1) of $100,571. The increased
deficiency is not based on petitioners’ liability for alternative
minimum tax, as was the deficiency asserted in the notice of
deficiency. Instead, the increased deficiency results from the
7
(...continued)
as if they had been raised in the pleadings. The
Court, upon motion of any party at any time, may allow
such amendment of the pleadings as may be necessary to
cause them to conform to the evidence and to raise
these issues, but failure to amend does not affect the
result of the trial of these issues.
(2) Other Evidence: If evidence is objected to at the
trial on the ground that it is not within the issues
raised by the pleadings, then the Court may receive the
evidence and at any time allow the pleadings to be
amended to conform to the proof, and shall do so freely
when justice so requires and the objecting party fails
to satisfy the Court that the admission of such
evidence would prejudice such party in maintaining such
party’s position on the merits.
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increase in income and the disallowance of many of petitioners’
itemized deductions.
Petitioners object to respondent’s motion to conform
pleadings to the evidence, arguing: (1) An evidentiary ruling
made by the Court during trial prevents respondent from seeking
an increased deficiency; and (2) an amendment to answer would
result in unfair surprise and would prejudice petitioners because
the amendment is based on grounds different from those asserted
in the notice of deficiency.
Petitioners also filed a motion to conform pleadings to the
evidence. Petitioners assert that, based on the evidence and
testimony presented at trial, they are entitled to a refund in
the amount of $76,890, instead of the approximately $9,000
asserted in the petition. Respondent does not object to the
granting of petitioners’ motion to conform pleadings to the
evidence.
Petitioners’ objection notwithstanding, we find that
granting respondent’s or petitioners’ motions to conform
pleadings to the evidence would not result in unfair surprise or
prejudice to either party. Petitioners’ argument that an
evidentiary ruling made by the Court prevents respondent from
seeking an increased deficiency is based on a misunderstanding of
the Court’s evidentiary ruling. Petitioners focus on Exhibit 42-
R, which was a Form 4549, Income Tax Examination Changes,
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prepared by respondent and shown to petitioners on the morning of
trial. Essentially, Exhibit 42-R summarized respondent’s
interpretation of the impact the exhibits attached to the
parties’ joint stipulations of fact had on petitioners’ tax
liability. The Court did not admit Exhibit 42-R into evidence.
Petitioners appear to argue that, because the Court did not admit
Exhibit 42-R into evidence, the Court rejected the arguments
contained therein. The Court’s ruling was limited to the
admissibility of Exhibit 42-R and was not a ruling on the merits
of respondent’s arguments contained therein. The increased
deficiency and addition to tax sought by respondent are not based
on Exhibit 42-R, but instead are based on the exhibits admitted
into evidence as part of the parties’ joint stipulations of fact.
The Court’s ruling on Exhibit 42-R does not affect respondent’s
ability to rely on the exhibits admitted into evidence in seeking
an increased deficiency and addition to tax.
Petitioners’ argument that an amendment to answer would
result in unfair surprise or prejudice is not persuasive. The
amendment to answer would change the issue in this case from
whether petitioners are liable for alternative minimum tax to
whether petitioners received and did not report certain items of
income and whether they are entitled to certain itemized
deductions. As stated above, in seeking an increased deficiency
and addition to tax, respondent relies on exhibits attached to
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the parties’ joint stipulations of fact. Petitioners rely on
these same exhibits in seeking an increased refund. Petitioners
cannot expect to use this evidence to seek an increased refund
and at the same time shield themselves from an increased
deficiency or addition to tax based on the same evidence.
Additionally, respondent informed petitioners at various times
before trial, including in respondent’s pretrial memorandum, that
respondent intended to raise the issues asserted in the amendment
to answer. Petitioner’s testimony also demonstrated his
knowledge of respondent’s intention.
Accordingly, we shall grant respondent’s and petitioners’
motions to conform pleadings to the evidence.
II. Items of Income
Generally, taxpayers bear the burden of proving that the
Commissioner’s determinations are incorrect. Rule 142(a); Welch
v. Helvering, 290 U.S. 111, 115 (1933). However, the
Commissioner bears the burden of proof with respect to any new
matter or increases in deficiency. Rule 142(a). Once the
Commissioner produces evidence sufficient to establish a prima
facie case, the burden shifts to the taxpayers of coming forward
with evidence sufficient to rebut the Commissioner’s proof. See
King v. Commissioner, T.C. Memo. 1995-524; Cally v. Commissioner,
T.C. Memo. 1983-203 (citing Papineau v. Commissioner, 28 T.C. 54
(1957)).
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Respondent asserts that petitioners received unreported or
underreported taxable income from the following sources: (1)
$372,850 from the distribution from Plan 15104, of which only
$192,850 was reported; (2) $14,443 and $30,623 from the
offsetting distributions made in satisfaction of the loans from
Plan 15105 and Plan 15106, respectively, none of which was
reported; and (3) $749,930 on the distributions from the Fidelity
IRA and the US Bancorp IRA, of which only $444,327 was reported
as being taxable.8 Respondent raised these matters in the
amendment to answer, not in the notice of deficiency, and now
seeks an increased deficiency based in part on these new matters.
Therefore, respondent bears the burden of proof with respect to
these new matters. See Rule 142(a).
Petitioners dispute respondent’s assertions and argue that,
of the $746,191 reported as taxable income on the Intel W-2,
$606,963 is not included in gross income.9
8
Petitioners also received but did not report a State
income tax refund of $34,500. As noted above, the parties agree
that petitioners are liable for Federal income tax in 2000 on
that refund. See supra note 4.
9
On petitioners’ first and second Forms 1040X, petitioners
assert that their taxable income should be reduced by $632,639.
In their amended petition and on brief, petitioners argue that
their taxable income should be reduced by $606,963. The origin
of this discrepancy is unclear.
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A. Distribution From Plan 15104
Gross income means all income from whatever source derived,
including income from pensions. Sec. 61(a)(11). However,
distributions of after-tax employee contributions from a pension
plan constitute a nontaxable return of capital. See Lange v.
Commissioner, T.C. Memo. 2005-176.
The Plan 15104 Form W-2 reflects a gross distribution to
petitioner from Plan 15104 of $372,850 and that petitioner made
no employee contributions to Plan 15104. The parties stipulated
the accuracy of the Plan 15104 Form W-2, and no evidence in the
record contradicts the Plan 15104 Form W-2. This evidence, if
not rebutted, is sufficient for respondent to meet his burden of
proving that petitioner received a distribution of $372,850 from
Plan 15104 and that no employee contributions were made to Plan
15104. The burden shifts to petitioners to come forward with
evidence that all or a portion of that distribution is not
included in their gross income.
On their tax return, petitioners reported the distribution
of $372,850 from Plan 15104, but they asserted that only $192,850
of that amount was taxable. In the information accompanying
petitioners’ second Form 1040X, petitioners further reduced the
amount they reported as taxable to $132,674. Petitioners’ theory
is that the distribution contained after-tax employee
contributions, and thus only a portion of the distribution was
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taxable. Petitioners explain their theory on brief:
[In] 2000 [the] bonus received was $79568.00. * * *
The federal tax withheld on that money was $10,582.54.
* * * [the] remaining * * * bonus amount went in SERP+
account for the tax year 2000. * * * Petitioners
estimated about 1/2 of the SERP money [came] from
depositing bonus money after paying tax and remaining
is the growth of the money due to investment by
Fidelity. Thus $186425.25, which is exactly 1/2 of the
total distribution, was assumed growth and inserted in
* * * the form 1040.
Petitioners’ estimation that approximately half of the Plan
15104 distribution consisted of after-tax employee contributions
is contrary to the Plan 15104 Form W-2, on which Fidelity
Institutional reported that no employee contributions were made.
No evidence in the record supports petitioners’ claim.10
Petitioners have not met their burden of coming forward with
evidence that all or a portion of that distribution is not
included in their gross income.
Therefore, we find that the distribution of $372,850 from
Plan 15104 is included in petitioners’ gross income.
10
Petitioners cite Exhibit 21-J as evidence that half of
the Plan 15104 distribution was comprised of employee
contributions. Exhibit 21-J, a pay statement from Intel dated
Oct. 31, 2000, indicates that a total “SERP deferral” of $39,784
had been made between Jan. 1 and Oct. 31, 2000. Petitioner
maintained several accounts that were at various times referred
to as “SERP” accounts. Exhibit 21-J does not indicate that the
“SERP deferral” was made with respect to Plan 15104 and does not
otherwise contradict the Form W-2 issued by Fidelity
Institutional.
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B. Distributions From Plan 15105 and Plan 15106
Petitioners did not report any distributions made from Plan
15105 or Plan 15106 on their Federal income tax return. However,
petitioners received Forms 1099-R from Fidelity Institutional,
which reflected: (1) An offsetting distribution of $15,552 was
made from Plan 15105 in satisfaction of petitioner’s loan from
Plan 15105; (2) petitioner made employee contributions to Plan
15105 totaling $1,109; (3) due to the employee contributions, the
taxable amount of the offsetting distribution from Plan 15105 was
$14,443; (4) an offsetting distribution of $30,623 was made from
Plan 15106 in satisfaction of petitioner’s loan from Plan 15106;
and (5) petitioner made no employee contributions to Plan 15106.
The parties stipulated the accuracy of the Forms 1099-R, and no
evidence in the record contradicts the Forms 1099-R. This
evidence is sufficient for respondent to meet his burden of
proof. Therefore, we find that $14,443 and $30,623 of the
offsetting distributions from Plan 15105 and Plan 15106,
respectively, are included in petitioners’ gross income.11
C. IRA Rollovers and Distributions
In general, distributions from an IRA are included gross
income in the year received. Sec. 408(d)(1). A distribution to
11
Petitioners did not introduce evidence to contradict the
Forms 1099-R, nor did they address the distributions on brief.
We find that petitioners abandoned any argument that the
offsetting distributions are not included in their gross income.
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the individual for whose benefit an IRA is maintained is excluded
from gross income, however, if the entire amount is paid into an
IRA for the benefit of the same individual within 60 days. Sec.
408(d)(3)(A). Exclusion of a rollover from one IRA to another
can only be made by an individual once during any 1-year period.
Sec. 408(d)(3)(B). However, the transfer of a taxpayer’s funds
directly from the trustee of one IRA to the trustee of another
IRA, in a fashion that does not involve any payment directly to
the taxpayer, is not a “rollover” for purposes of section
408(d)(3) and therefore does not trigger or violate the 1-year
limitation. Rev. Rul. 78-406, 1978-2 C.B. 157; see also Crow v.
Commissioner, T.C. Memo. 2002-178; Martin v. Commissioner, T.C.
Memo. 1992-331, affd. without published opinion 987 F.2d 770 (5th
Cir. 1993).
On their Federal income tax return, petitioners reported the
rollovers of $286,390 from Plan 15105 and $463,930 from Plan
15106 to the Fidelity IRA, the subsequent direct rollovers of
$500,000 and $62,390 from the Fidelity IRA to the US Bancorp IRA,
and the distributions from the Fidelity IRA and the US Bancorp
IRA to petitioners totaling $749,930. The parties agree that the
rollovers from Plan 15105 and Plan 15106 to the Fidelity IRA and
the direct rollovers of $500,000 and $62,930 from Fidelity IRA to
the US Bancorp IRA are excluded from income. See sec. 402(c);
Rev. Rul. 78-406, 1978-2 C.B. 157. The parties also agree that
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petitioners received distributions totaling $749,930 from the
Fidelity IRA and the US Bancorp IRA. However, the parties
disagree as to what extent the distributions totaling $749,930
are included in petitioners’ gross income.
Respondent argues that $749,930 is included in petitioners’
gross income.12 The record establishes, and petitioners do not
dispute, that during November and December 2000, petitioners
received distributions from the Fidelity IRA totaling $160,000
and from the US Bancorp IRA totaling $589,930. Respondent has
met his burden of establishing a prima facie case that
petitioners received IRA distributions totaling $749,930.
Petitioners bear the burden of coming forward with evidence that
all or a portion of the IRA distributions are not included in
their gross income.
Petitioners argue that $285,603 of the $500,000 distribution
from the US Bancorp IRA was rolled over into another IRA and is
12
Petitioners argue that the numbers proposed by
respondent “should be discarded due to inconsistency and
generation of various random numbers generated by respondent in
[sic] various times.” At various times during preparation for
trial, respondent changed his position regarding what amount of
the rollovers and distributions were includable in petitioners’
gross income. It is worth noting that, on each occasion,
respondent reduced the amount included in petitioners’ gross
income as petitioners substantiated the various rollovers. Our
ultimate conclusion on this issue is not based on the changes in
respondent’s position, but instead is based on the record.
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thus not included in their gross income.13 Petitioners provided
no evidence that such a rollover took place, or that the rollover
took place within 60 days of the distribution. Petitioners were
in a superior position with respect to access to information that
would prove the amount and date of the alleged rollover. By
failing to produce such information, petitioners have failed to
meet their burden of coming forward with evidence that $285,603
of the IRA distributions is not included in their gross income.
Therefore, we find that the distributions from the Fidelity
IRA and the US Bancorp IRA totaling $749,930 are included in
petitioners’ gross income.
D. Income From the Exercise of Intel Stock Options
Gross income includes compensation for services, “including
fees, commissions, fringe benefits, and similar items”. Sec.
61(a)(1). Section 83(a) provides in pertinent part that if
property is transferred to a taxpayer in connection with the
performance of services (e.g., stock transferred to a taxpayer
13
On their Federal income tax return, petitioners reported
that only $444,327 of the $749,930 in distributions from the
Fidelity IRA and the US Bancorp IRA was included in their gross
income. Petitioners’ position was based on their assertion that
$20,000 of the $160,000 in distributions from the Fidelity IRA
and $285,603 of the $500,000 distribution from the US Bancorp IRA
were rolled over into another IRA. On brief, petitioners claimed
that only $285,603 of the $500,000 distribution from the US
Bancorp IRA was rolled over into another IRA and conceded that
$469,091 was includable in their gross income. Thus, we find
that petitioners have abandoned their argument that $20,000 of
the $160,000 in distributions from the Fidelity IRA was rolled
over into another IRA.
- 25 -
upon the exercise of a stock option), the excess of the fair
market value of the property (stock) over the amount, if any,
paid for the property (the exercise price) shall be included in
the taxpayer’s gross income in the first year in which the
taxpayer’s rights in the property are not subject to a
substantial risk of forfeiture. See Montgomery v. Commissioner,
127 T.C. 43, 53-54 (2006).
Petitioners assert that, of the $746,191 in taxable income
reported on the Intel W-2, $606,963 is not included in gross
income. Petitioners do not address this assertion in detail.
However, it appears that petitioners are arguing that the
$606,963 should be treated as long-term capital gain, which could
be offset by long-term capital losses realized in 2000, and thus
would not be included in their gross income. Petitioners’
position is without merit.
Petitioner exercised on January 11 and April 17, 2000,
nonqualified stock options granted to him by Intel, resulting in
realized gains of $66,887 and $540,076, respectively (the spread
between the exercise price and the market price of the stock on
the dates of exercise). This gain is not recognized as long-term
capital gain. Instead, section 83(a) and section 1.83-1(a)(1),
Income Tax Regs., establish that such gain is ordinary income
included in petitioners’ gross income as compensation in 2000,
- 26 -
the year of exercise.14 Therefore, we find that the $746,191 in
taxable income reported on the Intel W-2, including the $606,963
attributable to the exercise of nonqualified stock options, is
included in petitioners’ gross income as ordinary income.
III. Additional Tax on Early Distributions From Qualified
Retirement Plans and IRAs
Section 72(t)(1) imposes a 10-percent additional tax on
early distributions from qualified retirement plans. Qualified
retirement plans are defined to include IRAs as defined in
section 408(a) and (b). Secs. 72(t)(1), 4974(c). The 10-percent
additional tax does not apply to certain distributions, including
distributions made after an employee attains age 59-1/2 and
distributions attributable to the employee’s disability. Sec.
72(t)(2)(A)(i), (iii). Respondent alleges that petitioners are
liable for the 10-percent additional tax on the taxable
distributions from Plan 15105 and Plan 15106 (both qualified
retirement plans) of $14,443 and $30,623, respectively, and on
the taxable distributions totaling $749,930 from the Fidelity IRA
and the US Bancorp IRA.
Petitioners were born in 1955 and 1960, respectively. The
qualified retirement plan distributions and the IRA distributions
14
Petitioners do not argue that the stock was subject to a
substantial risk of forfeiture. Thus, the gain was recognized at
the time petitioner acquired beneficial ownership of the stock
(the time of exercise). See sec. 83(a); Walter v. Commissioner,
T.C. Memo. 2007-2.
- 27 -
were made in 2000, before petitioner or Mrs. Bhattacharyya
attained age 59-1/2.15 Petitioners do not allege and the record
does not reflect that the distributions were attributable to
disability, or that the distributions otherwise qualify for an
exception to the 10-percent additional tax. In fact, petitioners
state on brief that “Petitioners do understand that petitioners
have to pay 10% penalty tax on the amount stated above * * * This
is consistent with IRC section 72(t)(1).” Therefore, we find
that petitioners are liable for the 10-percent additional tax on
the early distributions from Plan 15105 and Plan 15106 of $14,443
and $30,623, respectively, and on the early distributions
totaling $749,930 from the Fidelity IRA and the US Bancorp IRA.
IV. Itemized Deductions
Deductions are a matter of legislative grace and are
allowable only as specifically provided by statute.16 See
INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); Joseph v.
Commissioner, T.C. Memo. 2005-169. Itemized deductions allowed
15
Nor had petitioner attained age 55 so as to be eligible
for an exception based on his separation from service. See sec.
72(t)(2)(A)(v).
16
Generally, taxpayers also bear the burden of proving
they are entitled to deductions. INDOPCO, Inc. v. Commissioner,
503 U.S. 79, 84 (1992); Joseph v. Commissioner, T.C. Memo. 2005-
169. However, the resolution of this issue does not depend on
which party bears the burden of proof, and we resolve this issue
based on the preponderance of the evidence in the record.
- 28 -
for individual taxpayers are set forth in part VI and part VII of
subchapter B, chapter 1, subtitle A of the Internal Revenue Code.
See secs. 161-222.
Petitioners assert that they are entitled to itemized
deductions totaling $1,118,870, as originally set forth in their
Federal income tax return. Respondent concedes that petitioners
are entitled to deduct the following expenses totaling $243,363
as itemized deductions: (1) $37,738, identified by petitioners
as “Option Int” for “US Bank Corp.”, as investment interest
expenses under section 163; (2) $186,370, identified by
petitioners as “Option Int” for “Merrill Lynch”, as investment
interest expenses under section 163; and (3) $19,255 of the
$20,164 identified by petitioners as “Opt.int” for “Merrill
Lynch”, as investment interest expenses under section 163.
Respondent also concedes that petitioners are entitled to deduct
the following expenses as miscellaneous itemized deductions,
totaling $84,581: (1) $71,657, identified by petitioners as
“MLF” or “Merrill Lynch Fees”, as expenses for the production of
income under section 212; and (2) $12,924 of the $26,000
identified by petitioners as “US Bank Fees”, as expenses for the
production of income under section 212.”17 However, respondent
17
Petitioners have not objected to respondents’
characterization of these expenses as miscellaneous itemized
deductions. An impact of this characterization is that such
deductions are subject to sec. 67(a), which states: “In the case
(continued...)
- 29 -
argues that petitioners are not entitled to deduct the remaining
expenses, including: (1) $909 of the $20,164 identified by
petitioners as “Opt.int” for “Merrill Lynch”; (2) $13,076 of the
$26,000 identified by petitioners as “US Bank Fees”; (3) $330,979
and $123,000, identified by petitioners as “Cash Pay” and
described as “Merrill Lynch, to protect Taxable income”; and (4)
$322,962, identified by petitioners as “Other” and described as
“Merrill Lynch, to protect Taxable Income”. Respondent raised
these matters in the amendment to answer, not in the notice of
deficiency, and now seeks an increased deficiency based in part
on these new matters. Therefore, respondent bears the burden of
proof with respect to these new matters. See Rule 142(a).
The “Opt.int” expense of $20,164 represents interest
petitioners purportedly paid on margin loans issued by Merrill
Lynch. Respondent concedes that petitioners are entitled to
deduct this type of expense as an itemized deduction. However,
respondent argues that a monthly account statement for
petitioner’s Merrill Lynch brokerage account shows that only
$19,255 was paid. The monthly account statement cited by
respondent shows that petitioner paid $19,255 in interest on
margin loans issued by Merrill Lynch during the month of August.
17
(...continued)
of an individual, the miscellaneous itemized deductions for any
taxable year shall be allowed only to the extent that the
aggregate of such deductions exceeds 2 percent of adjusted gross
income.”
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A yearend account statement shows that petitioners paid a total
of $186,370 in interest on margin loans during 2000. The $19,255
appears to be a portion of the $186,370, which respondent already
conceded petitioners were entitled to deduct. The record
establishes that petitioners paid only $186,370 in interest to
Merrill Lynch and did not pay an additional $20,164 as claimed on
their return. Nevertheless, based on respondent’s concession, we
find that petitioners are entitled to an additional itemized
deduction of $19,255.
The “US Bank Fees” expense of $26,000 represents bank fees
petitioners purportedly paid to US Bancorp. Respondent concedes
that petitioners are entitled to deduct this type of expense as a
miscellaneous itemized deduction. However, respondent argues
that petitioners are entitled to deduct only $12,924 in bank
fees. The US Bancorp statements of account show that petitioners
paid $12,924 in bank fees to US Bancorp in 2000. There is no
evidence of a greater payment. The statements of account are
sufficient for respondent to meet his burden of proof.
Therefore, we find that petitioners are entitled to a
miscellaneous itemized deduction of only $12,924 with respect to
the US Bancorp fees.
The “Cash Pay” expenses of $330,979 and $123,000, and the
“Other” expenses of $322,962, represent deposits made by
petitioner into his Merrill Lynch brokerage account to exercise
- 31 -
his nonqualified stock options and to acquire other stock. The
costs of acquiring stock, a capital asset, are capital in nature
and are not currently deductible but instead are included in the
stock’s tax basis. See Woodward v. Commissioner, 397 U.S. 572,
575 (1970); Lychuk v. Commissioner, 116 T.C. 374, 388-389 (2001);
Pappas v. Commissioner, T.C. Memo. 2002-127; see also secs. 1012,
1221(a). Therefore, we find that petitioners are not entitled to
deduct the “Cash Pay” and “Other” expenses.
As described above, respondent met his burden of proving
that petitioners are entitled to itemized deductions of only
$243,363 and miscellaneous itemized deductions of only $84,581.
However, petitioners argue that they are entitled to deduct the
claimed expenses in full in 2000 because respondent allowed them
to deduct similar expenses in 1999.18 Petitioners’ argument is
without merit. Each taxable year stands alone, and respondent
may challenge in a succeeding year what was condoned or agreed to
in a former year. Rose v. Commissioner, 55 T.C. 28, 31-32
(1970); Jeanmarie v. Commissioner, T.C. Memo. 2003-337; Boatner
18
Petitioners also argue that respondent cannot challenge
their itemized deductions because the Court admitted into
evidence Exhibit 38-P. Exhibit 38-P was offered by petitioners
as a summary of their arguments. Similar to their argument
regarding Exhibit 42-R, discussed supra pp. 15-16, petitioners’
argument is based on a misunderstanding of the Court’s
evidentiary ruling. The admission of Exhibit 38-P into evidence
does not establish the truth of petitioners’ assertions made in
that exhibit, nor does it preclude respondent from contesting
those assertions.
- 32 -
v. Commissioner, T.C. Memo. 1997-379, affd. 164 F.3d 629 (9th
Cir. 1998). Respondent’s allowance of certain itemized
deductions in 1999 does not establish petitioners’ entitlement to
similar deductions in 2000.
For the above-stated reasons and to reflect respondent’s
concessions, we find that petitioners are entitled to itemized
deductions of $243,363 and miscellaneous itemized deductions of
$84,581.
V. Alternative Minimum Tax
In the notice of deficiency, respondent determined that
petitioners were liable for alternative minimum tax of $314,371.
Petitioners’ alternative minimum tax liability was triggered in
part by the itemized deductions claimed on their Federal income
tax return. Respondent concedes that, if petitioners are
entitled to itemized deductions and miscellaneous itemized
deductions only to the extent conceded by respondent, the
alternative minimum tax will not apply. As found above,
petitioners are entitled to itemized deductions and miscellaneous
itemized deductions only to the extent conceded by respondent.
Therefore, a determination regarding petitioners’ alternative
minimum tax liability is unnecessary.
VI. Section 6651(a)(1) Addition to Tax
Section 6651(a)(1) imposes an addition to tax for failure to
file a return on the date prescribed (in this case, April 16,
- 33 -
2001), unless the taxpayer can establish that such failure is due
to reasonable cause and not willful neglect. In the notice of
deficiency, respondent asserted that petitioners were liable for
a section 6651(a)(1) addition to tax of $38,837. In the
amendment to answer, respondent asserted an increased section
6651(a)(1) addition to tax of $100,571, based on the asserted
increased deficiency.
Respondent bears the burden of production with respect to
petitioners’ liability for the section 6651(a)(1) addition to
tax. See sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438,
446-447 (2001). To meet his burden of production, respondent
must come forward with sufficient evidence indicating that it is
appropriate to impose the addition to tax. See Higbee v.
Commissioner, supra at 446-447. Respondent has met his burden of
production because the parties stipulated that petitioners’ 2000
Federal income tax return was filed on May 19, 2003, more than 25
months after it was due.
Once respondent meets his burden of production, petitioners
bear the burden of proving that their failure to timely file was
due to reasonable cause and not willful neglect.19 To show
19
Respondent bears the burden of proof with regard to any
increased deficiency. See Rule 142(a). However, the amount of
the sec. 6651(a)(1) addition to tax is a computational matter
based on the amount of tax due. To the extent respondent bears
the burden of proving an increased sec. 6651(a)(1) addition to
tax, respondent has met this burden because, as discussed supra,
(continued...)
- 34 -
reasonable cause, petitioners must show that they “exercised
ordinary business care and prudence and [were] nevertheless
unable to file the return within the prescribed time”. Sec.
301.6651-1(c)(1), Proced. & Admin. Regs. For illness or
incapacity to constitute reasonable cause, petitioners must show
that they were incapacitated to a degree that they could not file
their returns. Williams v. Commissioner, 16 T.C. 893, 905-906
(1951); see, e.g., Joseph v. Commissioner, T.C. Memo. 2003-19
(“Illness or incapacity may constitute reasonable cause if the
taxpayer establishes that he was so ill that he was unable to
file.”).
Petitioners argue that their failure to file was due to
reasonable cause because petitioner was sick and because their
return preparer had a brain tumor. Petitioners have not
introduced any evidence to corroborate these allegations, nor
have they explained how long petitioner was sick, how serious his
illness was, why Mrs. Bhattacharyya was unable to fulfill
petitioners’ filing obligations, or why they were unable to find
another return preparer. We find that petitioners did not have
reasonable cause for their failure to file timely. Therefore, we
19
(...continued)
the record shows that petitioners are liable for an increased
deficiency. See Howard v. Commissioner, T.C. Memo. 2005-144.
- 35 -
hold that petitioners are liable for a section 6651(a)(1)
addition to tax.20
VII. Conclusion
Based on the above, petitioners are liable for an increased
deficiency in income tax, an increased addition to tax under
section 6651(a)(1), and are not entitled to a refund.
In reaching our holdings, we have considered all arguments
made, and, to the extent not mentioned, we conclude that they are
moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.
20
Because petitioners filed their return more than 25
months after it was due, the addition to tax under sec.
6651(a)(1) will be 25 percent of the amount required to be shown
as a tax on the return. See sec. 6651(a)(1). The amount of the
addition to tax should be determined by the parties as part of
their Rule 155 computations.