T.C. Summary Opinion 2009-122
UNITED STATES TAX COURT
JANET S. SMILEY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8049-08S. Filed August 4, 2009.
Janet S. Smiley, pro se.
Matthew A. Mendizabal, for respondent.
GERBER, Judge: This case was heard pursuant to the
provisions of section 7463 of the Internal Revenue Code in effect
when the petition was filed.1 Pursuant to section 7463(b), the
decision to be entered is not reviewable by any other court, and
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
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this opinion shall not be treated as precedent for any other
case.
Respondent determined a $5,400 income tax deficiency for
petitioner’s 2005 tax year and a section 6662(a) penalty of
$1,080. The income tax deficiency was based on petitioner’s
failure to report two items of income. Petitioner now agrees
that the items should have been reported, but she contends that
her actions were reasonable and that no section 6662(a) penalty
should apply to the portion of the underpayment attributable to
either income adjustment. That penalty is the only issue
remaining for the Court’s consideration.
Background
Petitioner resided in California at the time her petition
was filed. She was employed before 2005 as a legal assistant and
performed both clerical and paralegal work. Although petitioner
was licensed to practice law, she never practiced. Petitioner
had no background in tax law and did little or no legal research
in performing her employment duties. Before 2005 petitioner
became severely depressed and was unable to continue working. At
the onset of her depression petitioner took several prescription
medicines for her condition. The medication coupled with her
condition affected her judgment and thought processes throughout
the period under consideration.
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Before 2005 petitioner applied for State of California
disability benefits and private group disability benefits from
her employer’s health plan. She was granted benefits from both
the State and her employer’s plan. For income tax purposes
petitioner reported only her employer’s plan benefits because it
was her understanding that, unlike the private benefits,
Government disability benefits were not taxable.
During 2005 petitioner applied for Social Security
Administration (SSA) disability benefits. She maintained
correspondence with the SSA in a separate folder. Petitioner
maintained other folders, including a folder for information and
documents that she used in preparing her income tax return.
During 2005 petitioner received notice that she had been awarded
Social Security benefits. She filed that notification in the
Social Security folder.
During 2005 petitioner was paid $19,021 in Social Security
benefits, including retroactive 2004 benefits and 2005 benefits.
She also received a Form SSA-1099, Social Security Benefit
Statement, from the SSA, which she placed in her Social Security
folder. The Form SSA-1099 contains several statements indicating
that a portion of Social Security benefits may be taxable.
Petitioner did not report any of the Social Security disability
benefits because of her understanding and belief that Federal
benefits for disability, like her State benefit, were not
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taxable. Petitioner reported her private disability benefits for
2005, but she did not report either the State or Federal
disability benefits received in that year.
For 2005 petitioner received a “1099 Consolidated Tax
Statement” (1099 statement) from her stockbroker. The document
consisted of eight pages and contained petitioner’s income tax
information, including interest, tax-exempt municipal interest,
ordinary dividends, qualifying dividends, stock transactions, and
related materials. The face or first page of the statement
listed amounts for ordinary dividends, qualified dividends,
investment expenses, and interest income. Interest income of
$3,908.68 was listed. The line showing the interest income
contained the following explanation: “INTEREST INCOME NOT
INCLUDED IN IRS BOX 3”. On that same page were three places that
were labeled “BOX 3”. They were denominated “NONTAXABLE
DISTRIBUTIONS”; “INTEREST INCOME ON U.S. TREASURY OBLIGATIONS”;
and “OTHER INCOME.”
Petitioner found the “INTEREST INCOME NOT INCLUDED IN IRS
BOX 3” language to be ambiguous and confusing, and she
interpreted it to mean that her interest income was not taxable.
Petitioner, however, did extract information from other parts of
the 1099 statement, including tax-exempt municipal interest,
which she reported on the correct part of her Form 1040, U.S.
Individual Income Tax Return. The fifth page of the 1099
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statement made clear that the $3,908.68 in interest had been
received on petitioner’s behalf from various corporate
securities.
Respondent’s computer matching capability revealed that
petitioner had not reported the Social Security disability
benefits and interest income, and she was notified by mail.
Shortly after petitioner received the notification from
respondent, she filed an amended 2005 income tax return, along
with payment, that reported the $3,908.68 of interest income and
the 2005 portion of her Social Security benefits. Petitioner’s
failure to report the 2004 Social Security benefits was based on
her lack of understanding about tax accounting principles and,
more specifically, on the fact that she was a cash basis
taxpayer.
Discussion2
Petitioner has conceded that the interest income and Social
Security benefits are taxable. She contends, however, that her
failure to report these amounts was reasonable and that the
section 6662(a) penalty should not apply to her underpayment.
Section 6662(a) and (b)(1) and (2) provides that a taxpayer
is liable for a 20-percent accuracy-related penalty on any
2
The parties did not raise any question about the burden of
proof or sec. 7491. Under that statute, respondent bears a
burden of production with respect to the accuracy-related
penalties determined under sec. 6662(a). See sec. 7491(c).
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portion of an underpayment of tax required to be shown on a
return attributable to, inter alia, (1) negligence or disregard
of the rules or regulations or (2) a substantial understatement
of income tax. Negligence is defined as any failure to make a
reasonable attempt to comply with the provisions of the Internal
Revenue Code, and the term “disregard” includes any careless,
reckless, or intentional disregard. Sec. 6662(c). Section
6664(c)(1) provides that the penalty under section 6662(a) shall
not apply to any portion of an underpayment if it is shown that
there was reasonable cause for the taxpayer’s position with
respect to that portion and that the taxpayer acted in good faith
with respect to that portion. Higbee v. Commissioner, 116 T.C.
438, 448 (2001). The determination of whether a taxpayer acted
with reasonable cause and in good faith within the meaning of
section 6664(c)(1) is made on a case-by-case basis, taking into
account all the pertinent facts and circumstances. Id.; sec.
1.6664-4(b)(1), Income Tax Regs. The most important factor is
the extent of the taxpayer’s effort to assess her proper tax
liability for the year. Sec. 1.6664-4(b)(1), Income Tax Regs.
“Circumstances that may indicate reasonable cause and good faith
include * * * the experience, knowledge, and education of the
taxpayer.” Id.
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We consider the two adjustments separately concerning whether
the accuracy-related penalty applies to the resulting
underpayment caused by each.
With respect to petitioner’s failure to report $3,908.68 of
interest income, her explanation is that the language preceding
the amount shown on the 1099 statement was “ambiguous”. We are
unable to find that petitioner’s explanation is reasonable under
the circumstances. Petitioner, who prepared her own return,
sorted through this 1099 statement to find various amounts of
income, both taxable and tax exempt, and she placed the amounts
on various parts of her income tax return. Petitioner’s
interpretation of the phrase “INTEREST INCOME NOT INCLUDED IN IRS
BOX 3" as meaning that the interest income was not reportable or
taxable is more wishful thinking than anything else. Moreover,
we are unconvinced that the face of the 1099 statement was
ambiguous. Accordingly, and considering all of the
circumstances, we hold that petitioner’s failure to report the
interest income was not reasonable, and petitioner is subject to
the section 6662(a) penalty on the resulting underpayment.
With respect to petitioner’s failure to report $19,021 of
disability benefits, her explanation is that it was her
understanding and belief that, like State disability payments,
Federal disability payments were not subject to the income tax.
We are cognizant of the fact that before 2005 petitioner had
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received disability payments and correctly reported them; i.e.,
payments from employer’s health plan as taxable and payments from
the State of California as not taxable. In addition, petitioner
was being treated by a doctor for a serious mental condition and
was taking various medicines that affected her judgment and
thinking processes. She was involved in pursuing disability
claims with three different sources and had received various
correspondence from each, including the SSA. It is clear that
she believed the disability payments from the SSA were not
taxable. She filed correspondence and documents from the SSA in
a special folder on that subject, and she did not include any of
those documents in her separately maintained folder for tax-
related documents.
When her failure to report was brought to her attention by
respondent, petitioner promptly filed an amended return including
interest and benefits, along with payment of the additional tax.
We note that petitioner did not understand tax accounting
principles; and in spite of the fact that respondent had
determined that she failed to report the $19,021, petitioner
included only the payments for 2005 on her amended return,
although all of the $19,021 had been received during 2005.
Petitioner’s testimony, actions, and the circumstances of this
case are persuasive and reflect that she made a reasonable and
good faith attempt to report her tax liability as it related to
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her disability payments. Accordingly, we hold that petitioner is
not liable for a section 6662(a) penalty on the underpayment
caused by her failure to report Social Security benefits.
To reflect the foregoing,
Decision will be entered
under Rule 155.