T.C. Memo. 2010-20
UNITED STATES TAX COURT
GREGORY A. AND CAROLYN S. PROUGH, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11114-07. Filed February 3, 2010.
Edith F. Moates, for petitioners.
Huong T. Bailie, for respondent.
MEMORANDUM OPINION
KROUPA, Judge: Respondent determined an $8,700 deficiency
in petitioners’ Federal income tax and a $1,740 accuracy-related
penalty under section 66621 for 2004. We are asked to decide
whether distributions petitioner husband (petitioner) received
1
All section references are to the Internal Revenue Code in
effect for 2004, and all Rule references are to the Tax Court
Rules of Practice and Procedure, unless otherwise indicated.
-2-
from his retirement accounts are subject to the 10-percent
additional tax on early distributions if they fail to qualify for
the exception for substantially equal periodic payments under
section 72(t)(2)(A)(iv). We find that they are subject to the
additional tax. We are also asked to decide whether petitioners
are liable for the accuracy-related penalty under section
6662(a). We hold that they are.
Background
This case was submitted fully stipulated under Rule 122.
The stipulation of facts and the accompanying exhibits are
incorporated by this reference. The facts are so found.
Petitioners resided in Nevada at the time they filed the
petition.
Petitioner was born in 1951. He retired from Southwestern
Bell Telephone in 2003 when he was 52 and received almost $1
million of lump-sum distributions from qualified retirement
plans. The lump-sum distributions consisted of $37,025,2
$13,296, $669,665, and $187,857. He rolled over the
distributions tax free to qualified individual retirement
annuities from Jefferson National Life Insurance (Jefferson
National annuity) and Nationwide Life Insurance Company
(Nationwide annuity) in 2003. Petitioner had a life expectancy
2
All monetary amounts are rounded to the nearest dollar.
-3-
of 32.3 years at that time. See sec. 1.401(a)(9)-9, Q&A-1,
Income Tax Regs.
The Jefferson National Life Insurance Annuity
Petitioner rolled over the $669,665 distribution to the
Jefferson National annuity. The annuity contract contained an
individual retirement annuity (IRA) endorsement (IRA endorsement)
providing that the contract is governed by section 408(b). An
IRA endorsement meant that early distributions would be subject
to the 10-percent additional tax under section 72(t).
Petitioner signed a One-Time or Systematic Partial
Withdrawal Request Form (withdrawal form) approximately one week
after entering into the Jefferson National annuity contract. The
withdrawal form, prepared by Aspen Retirement Planning Services
(Aspen Retirement), authorized monthly distributions of $5,600
from the Jefferson National annuity. The record does not
indicate how the $5,600 monthly distribution amount was
determined. The withdrawal form indicates, however, that the
distributions qualify for section 72(t). Jefferson National
started making the $5,600 monthly distributions to petitioner on
August 17, 2003. The Jefferson National annuity had a fair
market value of $716,676 as of the end of 2003.
Petitioner signed another withdrawal form on February 4,
2004, authorizing a one-time “hardship withdrawal” of $45,000
from the Jefferson National annuity. Petitioners concede that
-4-
the $45,000 hardship withdrawal distribution is subject to the
10-percent additional tax for early distributions even though
they failed to report the additional tax on the return for 2004.
Jefferson National issued to petitioners a Form 1099-R,
Distributions from Pensions, Annuities, Retirement or Profit-
Sharing Plans, IRAs, Insurance Contracts, etc. (1099-R), for 2004
reporting a gross distribution of $112,200 from the annuity. The
gross distribution amount for 2004 included the $45,000 hardship
withdrawal and $67,200 of systematic partial withdrawal payments
(the $5,600 monthly amount times 12 months). The 1099-R
indicated that the distribution was from an “IRA/SEP/SIMPLE” and
listed a distribution code of “1” indicating that it was an early
distribution for which there was no known exception to the
additional tax. See IRS Announcement 2004-3, 2004-1 C.B. 294.
Petitioners reported the total distribution on the return for
2004 but failed to report that any portion was subject to the
additional tax.
Nationwide Life Insurance Company
Petitioner rolled over $170,000 of the distributions to the
Nationwide annuity. The Nationwide annuity contract contained an
IRA endorsement providing that the contract is governed by
section 408(b). The Nationwide annuity contract also contained a
separate IRA Disclosure Statement advising that early
distributions would be subject to the 10-percent additional tax.
-5-
Petitioner signed a withdrawal form approximately one week
after entering into the annuity contract with Nationwide. The
withdrawal form, prepared by Aspen Retirement, authorized monthly
distributions of $1,400 from the Nationwide annuity. The record
does not indicate how the $1,400 monthly amount was calculated.
Nationwide determined that a maximum of $757 could be withdrawn
per month if the distributions were to qualify for an exception
to section 72(t). Nationwide started making the $1,400 monthly
distributions to petitioner on August 17, 2003. The Nationwide
annuity had a fair market value of $172,820 at the end of 2003.
Nationwide issued to petitioners a 1099-R for 2004 reporting
a gross distribution of $16,800 (the $1,400 monthly amount times
12 months). The 1099-R indicated that the distribution was from
an “IRA/SEP/SIMPLE” and listed a distribution code of “1”
indicating that it was an early distribution for which there was
no known exception to the additional tax. See IRS Announcement
2004-3, supra. Petitioners reported the distribution on the
return for 2004 but failed to report that it was subject to the
additional tax.
-6-
The Return for 2004
Petitioners reported taxable pensions and annuities totaling
$136,000 on the return for 2004.3 Petitioners reported that only
$49,000 of the $136,000 constituted an early distribution and
reported additional tax of $4,900. The record does not indicate
how petitioners determined the taxable amount. Respondent issued
petitioners a deficiency notice determining that the entire
distribution constituted an early distribution and therefore
determined an $8,700 deficiency. The deficiency notice also
determined the accuracy-related penalty based on substantial
understatement of income tax. Petitioners timely filed a
petition to contest the determinations in the deficiency notice.
Discussion
We are asked to determine the taxability of distributions
petitioner received in 2004 when he was 52 years old. Section
72(t) imposes a 10-percent additional tax on early distributions
from a retirement plan because they “frustrate the intention of
saving for retirement, and * * * [the additional tax] discourages
this from happening.” Dwyer v. Commissioner, 106 T.C. 337, 340
(1996) (citing S. Rept. 93-383, at 134 (1973), 1974-3 C.B.
(Supp.) 80, 213). We are asked to decide whether the
distributions petitioner received qualify for an exception to the
3
Petitioners also received a $7,000 distribution from a
Fiserv Securities, Inc. account for which they concede they are
liable for the 10-percent additional tax on early distributions.
-7-
10-percent additional tax on early distributions under section
72(t) and whether petitioners are liable for the section 6662(a)
accuracy-related penalty. We address each of these issues in
turn.
I. 10-Percent Additional Tax for Early Distribution
Respondent argues that petitioner is liable for the 10-
percent additional tax on early distributions because petitioner
was under 59-1/2 years of age at the time he received the
distributions and the distributions do not qualify for an
exception under section 72(t)(2). Petitioners argue that section
72(q), rather than section 72(t), applies to the distributions
because the distributions were from annuities. Petitioners fail
to distinguish between nonqualified and qualified annuity
contracts, however, which are treated under different sections of
the Code.4 The distinction is irrelevant here, though, because
4
Sec. 72(q) provides for a 10-percent additional tax on
early distributions from nonqualified annuity contracts while
sec. 72(t) provides for the additional tax on early distributions
from qualified retirement plans described in sec. 4974(c).
Individual retirement annuities described in sec. 408(b)
constitute qualified retirement plans under sec. 4974(c), and are
thus subject to the additional tax for early distribution under
sec. 72(t). Sec. 72(t) applies here because the Jefferson
National and Nationwide annuities were qualified individual
retirement annuities under sec. 408(b). Furthermore, petitioners
are estopped under the duty of consistency from arguing that the
annuities were nonqualified. See Estate of Ashman v.
Commissioner, T.C. Memo. 1998-145, affd. 31 F.3d 41 (9th Cir.
2000). Accordingly, we will apply sec. 72(t), rather than sec.
72(q), to determine whether the distributions qualify for an
exception to the additional tax.
-8-
the section 72(q) exception claimed by petitioners also appears
in section 72(t). See IRS Notice 2004-15, 2004-1 C.B. 526.
A 10-percent additional tax is generally imposed on a
distribution from a qualified retirement plan to a taxpayer who
has not reached the age of 59-1/2. Sec. 72(t)(1), (2)(A)(i).
There are some exceptions to the additional tax, however, and
taxpayers bear the burden of proving that a particular exception
applies. Bunney v. Commissioner, 114 T.C. 259, 265 (2000).
There is an exception for distributions that are part of a series
of substantially equal periodic payments made for the life or
life expectancy of the taxpayer or the joint lives or joint life
expectancies of the taxpayer and his designated beneficiary.
Sec. 72(t)(2)(A)(iv). Petitioners argue that the monthly
distributions from the Jefferson National and Nationwide
annuities qualify for this exception. We disagree.
The Internal Revenue Service has issued guidance that
amounts calculated under one of three methods (the IRS Notice 89-
25 methods) may qualify for the exception. IRS Notice 89-25,
Q&A-12, 1989-1 C.B. 662, 666. Additionally, this Court has held
that conforming to one of the IRS Notice 89-25 methods may
relieve a taxpayer of the 10-percent additional tax. See Arnold
v. Commissioner, 111 T.C. 250, 252 n.1 (1998). The IRS Notice
89-25 methods include: (1) the required minimum distribution
method, (2) the fixed amortization method, or (3) the fixed
-9-
annuitization method.5 See IRS Notice 89-25, Q&A-12, supra; Rev.
Rul. 2002-62, 2002-2 C.B. 710. Each of these three methods takes
into account the taxpayer’s life expectancy. See IRS Notice 89-
25, Q&A-12, supra.
Petitioners have failed to prove that the distribution
amounts were based on any of the IRS Notice 89-25 methods. The
record does not identify which, if any, method Aspen Retirement
used in calculating the amount of distributions. In fact, the
monthly distributions petitioner received were more than double
the maximum amounts determined by respondent under the fixed
amortization and fixed annuitization methods.6 Petitioners
5
Maximum payments under the fixed amortization method are
determined by amortizing the account balance over the taxpayer’s
life expectancy at a reasonable interest rate. Rev. Rul. 2002-
62, sec. 2.01(b), 2002-2 C.B. at 710. Maximum payments under the
fixed annuitization method are determined by dividing the account
balance by an annuity factor based on the taxpayer’s life
expectancy and a reasonable interest rate. Id. sec. 2.01(c),
2002-2 C.B. at 710. A reasonable interest rate for each method
is not more than 120 percent of the Federal midterm rate
determined in accordance with sec. 1274(d) for either of the two
months preceding the month in which the distribution begins. Id.
sec. 2.02(c), 2002-2 C.B. at 711.
6
Respondent applied interest rates of 3.68 percent and 3.06
percent, reflecting 120 percent of the Federal midterm rates for
June 2003 and July 2003. See Rev. Rul. 2003-60, 2003-1 C.B. 987,
988; Rev. Rul. 2003-71, 2003-2 C.B. 1, 2. Respondent determined
the maximum monthly distribution amount from the Jefferson
National annuity under the fixed amortization method was $2,981
per month and the maximum monthly amount under the fixed
annuitization method was $2,963. Respondent determined the
maximum monthly distribution amount from the Nationwide annuity
under the fixed amortization amount was $757 per month, and the
maximum monthly amount under the fixed annuitization method was
(continued...)
-10-
assert that Aspen Retirement based the monthly distributions on a
10-percent annual rate of return for variable annuities but have
not established that a 10-percent rate of return is reasonable.
In comparison, a reasonable rate of return for annuity
distributions beginning in August 2003 under either the fixed
amortization or fixed annuitization methods would be 3.06 percent
or 3.68 percent. See Rev. Rul. 2002-62, sec. 2.02(c), 2002-2
C.B. at 711; Rev. Rul. 2003-60, 2003-1 C.B. 987, 988; Rev. Rul.
2003-71, 2003-2 C.B. 1, 2. Petitioners also claim that the
distributions were calculated so as to continue over petitioner’s
lifetime without depleting the account. Petitioners have not
provided any documentation or testimony from Aspen Retirement
explaining what factors they considered in determining the
distribution amount for either annuity.
Furthermore, it is unclear how the distributions could have
been substantially equal periodic payments made for petitioner’s
life expectancy, given the annuity account balances and
petitioner’s age and life expectancy in 2003. Petitioner was 52
years of age and had a life expectancy of 32.3 years at the time
the distributions commenced in 2003. See sec. 1.401(a)(9)-9,
Q&A-1, Income Tax Regs.7 The Jefferson National annuity had a
6
(...continued)
$752.
7
The single life expectancy table found at sec. 1.401(a)(9)-
(continued...)
-11-
value of $716,676 and the Nationwide annuity had a value of
$172,820 at the end of 2003. Petitioner could receive
distributions of only $1,849 per month from the Jefferson
National annuity, rather than $5,600, to avoid depleting the
account during his lifetime.8 Similarly, petitioner could
receive monthly distributions of only $425, rather than $1,400,
from the Nationwide annuity.
Accordingly, we conclude that petitioners have not shown
that the distributions from the Jefferson National and Nationwide
annuities were substantially equal periodic payments exempt from
the additional tax under section 72(t).
II. Accuracy-Related Penalty
We next consider whether petitioners are liable for the
accuracy-related penalty under section 6662(a). A taxpayer is
liable for an accuracy-related penalty of 20 percent of any
portion of an underpayment attributable to, among other things, a
substantial understatement of income tax under section 6662(b)(2)
if the amount of the understatement exceeds the greater of either
10 percent of the tax required to be shown on the return, or
7
(...continued)
9, Q&A-1, Income Tax Regs., is used for determining the life
expectancy of an individual for purposes of these calculations.
8
We reach this conclusion without taking into account any
rate of return on the annuity. We have not applied the 10-
percent rate of return used by Aspen Retirement because
petitioners have not established that it was reasonable.
-12-
$5,000. Sec. 6662(a), (b)(2), (d)(1)(A); sec. 1.6662-4(a) and
(b)(i) and (2), Income Tax Regs. Petitioners reported that they
owed $12,956 of tax for 2004 and respondent determined upon
examination that petitioners owed $21,656. Petitioners therefore
understated the tax on the return by $8,700, which is greater
than 10 percent of the tax required to be shown on the return, or
$5,000.
The accuracy-related penalty under section 6662(a) does not
apply to any portion of an underpayment, however, 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); sec. 1.6664-4(a), Income Tax Regs.
The determination of whether a taxpayer acted with reasonable
cause and in good faith is made on a case-by-case basis, taking
into account all the pertinent facts and circumstances, including
the taxpayer’s efforts to assess his or her proper tax liability
and the knowledge and experience of the taxpayer. Sec. 1.6664-
4(b)(1), Income Tax Regs. The taxpayer bears the burden of proof
with respect to reasonable cause. Higbee v. Commissioner, 116
T.C. 438, 446 (2001).
Petitioners argue that they should be absolved from the
penalty because they had reasonable cause for failing to report
-13-
the entire amount as taxable.9 We disagree. Nationwide informed
petitioners that the distributions did not qualify as
substantially equal periodic payments exempt from the section
72(t) additional tax and the Jefferson National withdrawal
request specifically indicated that the distribution was subject
to section 72(t). Moreover, the 1099-Rs issued by Jefferson
National and Nationwide indicated that all the distributions were
early distributions for which no exception to the additional tax
applied. We find that petitioners have not shown reasonable
cause for failing to report the entire amount as taxable.
Petitioners also claim that they relied on Aspen
Retirement’s computations to argue that they were eligible for
the substantially equal periodic payments exception. Good faith
reliance on the advice of an independent, competent professional
as to the tax treatment of an item may fulfill the reasonable
cause requirement. See Neonatology Associates, P.A. v.
Commissioner, 115 T.C. 43, 98 (2000), affd. 299 F.3d 221 (3d Cir.
2002). Petitioners have not shown, however, how Aspen Retirement
calculated the distributions, nor have they shown how they could
9
Petitioners also seek relief on the grounds that they
disclosed the distributions on the return. See sec.
6662(d)(2)(B)(ii). Disclosure is adequate with respect to an
item or a position on a return only if it was made on a Form
8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure
Statement, attached to the return or on a qualified amended
return for the taxable year. See Kelly v. Commissioner, T.C.
Memo. 1996-529; sec. 1.6662-4(f)(1), Income Tax Regs. We find
that petitioners failed to adequately disclose the distributions.
-14-
have relied upon any such calculations given the other
documentary evidence that no exception applied. Accordingly, we
sustain respondent’s determination that petitioners are liable
for the accuracy-related penalty under section 6662(a) for 2004.
We have considered all remaining arguments the parties made
and, to the extent not addressed, we conclude they are
irrelevant, moot, or meritless.
To reflect the foregoing,
Decision will be entered
for respondent.