T.C. Memo. 2010-186
UNITED STATES TAX COURT
KWAME OWUSU, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5389-08. Filed August 23, 2010.
Kwame Owusu, pro se.
Wendy D. Gardner, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GALE, Judge: Respondent determined a deficiency of $962 and
an addition to tax under section 6651(a)(1) of $145 in
petitioner’s 2005 Federal income tax.1 Petitioner subsequently
1
All section references are to the Internal Revenue Code of
1986, as 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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averred in an amended petition that he erroneously reported as
gross income on his 2005 Federal income tax return a $9,627
distribution from a qualified pension plan. After a concession,2
the issues for decision are: (1) Whether petitioner must include
in income the $9,627 balance of certain loans from a qualified
plan as a deemed distribution under section 72(p); (2) whether
petitioner is liable for the 10-percent additional tax under
section 72(t) on a deemed distribution arising from the foregoing
loan balance; and (3) whether petitioner is liable for an
addition to tax under section 6651(a)(1) for failure to timely
file his 2005 return.
FINDINGS OF FACT
Some of the facts have been stipulated and are incorporated
by this reference. At the time he filed the petition, petitioner
resided in New Jersey.
Before 2005 petitioner was employed as a senior actuary with
the New York State Department of Insurance. In 1993 petitioner
commenced participation in the New York State and Local
Retirement System (NYSLRS), and by March 1998 his contribution
balance had reached $4,482. At that time petitioner requested a
loan from the NYSLRS. Under NYSLRS rules petitioner was allowed
to borrow up to 75 percent of his contribution balance.
2
Respondent conceded that $567 of wages reported on a Form
W-2, Wage and Tax Statement, do not constitute income to
petitioner.
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Petitioner requested a loan in the maximum allowable amount, and
after reduction by a $15 service charge he was granted a loan of
$3,346. The NYSLRS required repayment within 5 years.
Petitioner obtained additional loans from the NYSLRS in each
subsequent year, through 2004. The amounts of the NYSLRS loans
to petitioner were as follows:
Date of Loan Amount
Mar. 31, 1998 $3,361
Mar. 31, 1999 1,581
Apr. 6, 2000 2,207
Apr. 6, 2001 2,402
Apr. 8, 2002 2,755
Apr. 8, 2003 3,162
Nov. 29, 2004 2,941
Before 2004 the NYSLRS did not permit a participant to hold
multiple loans from the plan. Therefore, each time petitioner
requested a new loan, the balance of his previous loans was
consolidated with his new loan. As a result, until 2004
petitioner had only one loan from the NYSLRS at any one time,
though the balance of the loan increased with each additional
amount petitioner requested. Each time he took out a new loan
and refinanced the old loan, the consolidated loan extended the
repayment period to 5 years from the inception of the new loan.
The NYSLRS changed its policy with respect to multiple loans at
some point after petitioner obtained the 2003 loan. As a result,
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the loan made to petitioner in 2004 was not consolidated with his
previous loans.
Petitioner elected to repay his loans through payroll
deductions. After taking into account the payroll deduction
payments, the outstanding loan balances on his consolidated loan
after each new loan were as follows:
Date Outstanding Loan Balance
Mar. 31, 1998 $3,361
Mar. 31, 1999 4,683
Apr. 6, 2000 5,793
Apr. 6, 2001 7,146
Apr. 8, 2002 8,613
1
Apr. 8, 2003 10,228
1
The $3,162 loan by the plan to petitioner on Apr. 8, 2003,
caused his outstanding loan balance to reach $10,228. The NYSLRS
took the position that the $228 excess over $10,000 was a taxable
distribution. The NYSLRS consequently issued to petitioner a
Form 1099-R, Distributions From Pensions, Annuities, Retirement
or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.,
reflecting a $228 taxable distribution in 2003.
At the time petitioner took out the 2004 loan his balance on
the 1998-2003 borrowings was $7,058. Taking into account the
2004 loan, petitioner’s outstanding loan balance in November 2004
was $9,999.
As of the end of December 2004, petitioner was treated by
his employer as being in “suspended without pay” status.
Petitioner ceased receiving paychecks from the New York State
Department of Insurance, and as a result, no further payroll
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deductions were made with respect to petitioner’s loans and no
repayments in any form were made after December 2004. However,
the NYSLRS’ records erroneously reflected that petitioner made
three further payroll deduction payments during January and
February 2005. When no payment had been received by May 31,
2005, the NYSLRS sent petitioner a letter giving him until June
30, 2005, to make a payment. The letter stated that if no
payment were received by June 30, 2005, the NYSLRS would consider
petitioner’s loans in default and the entire amount of the
outstanding loans, less any amount previously reported, would be
reported to the Internal Revenue Service as a distribution from a
qualified plan. Petitioner did not make any payment in response
to the letter.
When petitioner made no payments by June 30, 2005, the
NYSLRS treated the loans as deemed distributions and issued to
petitioner two Forms 1099-R, Distributions From Pensions,
Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance
Contracts, etc., for 2005, one for the 1998-2003 consolidated
loan and one for the 2004 loan. The former reported a gross
distribution amount of $6,792, consisting of a taxable amount of
$6,693 and a nontaxable amount of $99. The latter reported a
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gross distribution of $2,977, consisting of a taxable amount of
$2,933 and a nontaxable amount of $43.3
Petitioner was under the age of 55 during 2005.
In December 2005 the NYSLRS discovered that petitioner’s
loans had been credited with three payments through payroll
deductions in January and February 2005 even though no paychecks
had been issued to petitioner during those periods. The NYSLRS
reversed these payments in its records but did not issue
petitioner corrected Forms 1099-R for 2005 reflecting deemed
distributions of the higher loan balance that resulted.4
Petitioner filed his 2005 return on July 6, 2006.
Petitioner did not request an extension of time to file his 2005
return. Petitioner reported gross pension income of $9,769 and
taxable pension income of $9,627 but did not report a 10-percent
additional tax under section 72(t). On December 3, 2007,
respondent issued petitioner a notice of deficiency which
determined a deficiency of $962 as a result of petitioner’s
failure to report the 10-percent additional tax under section
3
The nontaxable amounts presumably reflect that a portion of
the 1998-2003 consolidated loan had been treated as taxable in
2003. See supra p. 4, table note 1.
4
Because the Forms 1099-R issued by the NYSLRS erroneously
reflected loan payments that had not occurred, the Forms 1099-R
understated the gross and taxable deemed distributions to
petitioner in 2005. Respondent has not sought to amend his
answer to assert that petitioner had larger deemed distributions
than those reflected in the Forms 1099-R.
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72(t) and an addition to tax under section 6651(a)(1) for failure
to timely file the return.5 Petitioner filed a timely petition
with this Court. The Court allowed petitioner to amend his
petition to include the claim that the $9,627 petitioner reported
as a taxable distribution on his 2005 return was not taxable.
OPINION
Respondent argues that petitioner bears the burden of proof
and that the burden has not shifted under section 7491(a). Since
we decide this case on the preponderance of the evidence, the
allocation of the burden of proof does not affect the outcome and
need not be decided. See Knudsen v. Commissioner, 131 T.C. 185,
189 (2008); see also Blodgett v. Commissioner, 394 F.3d 1030 (8th
Cir. 2005), affg. T.C. Memo. 2003-212.
1. Treatment of Petitioner’s Loans as Distributions
A distribution from a qualified plan such as petitioner’s
pension plan is generally includable in income of the distributee
in the year of distribution.6 Sec. 402(a). If a participant or
beneficiary of a qualified plan receives a loan from the plan,
that amount is treated as a distribution in the year received,
unless: (1) The loan is evidenced by a legally enforceable
5
Respondent assessed the $2,054 tax reported as due on the
return on July 31, 2006, and erroneously assessed the $962
deficiency on Aug. 4, 2008. Respondent abated the premature
assessment on Jan. 5, 2009.
6
Respondent concedes that petitioner’s pension plan is a
qualified plan within the meaning of secs. 401(a) and 402(a).
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agreement, sec. 1.72(p)-1, Q&A-3, Income Tax Regs.; (2) the
amount does not exceed a specified maximum amount, sec.
72(p)(2)(A); (3) the loan is to be repaid within 5 years, unless
it is a home loan, sec. 72(p)(2)(B); and (4) except as provided
in regulations, the loan has substantially level amortization
over the term of the loan with payments not less frequently than
quarterly, sec. 72(p)(2)(C). If a plan fails to satisfy these
requirements, a deemed distribution will occur at the first time
those requirements are not satisfied, either in form or in
operation. Sec. 1.72(p)-1, Q&A-4(a), Income Tax. Regs.
Respondent concedes that the loans to petitioner from the
NYSLRS plan satisfied the foregoing requirements when they were
made and through the end of 2004, but he contends that the loans
failed to meet the level amortization requirement when petitioner
ceased making repayments in 2005.
If a loan initially satisfies all four requirements, but one
or more installment payments is not made when due in accordance
with the terms of the loan, the failure to make such payments
violates the level amortization requirement. Therefore, a deemed
distribution occurs at the time of the failure. Sec. 1.72(p)-1,
Q&A-10(a), Income Tax Regs. The amount of the deemed
distribution equals the entire outstanding balance of the loan at
the time of the failure to make the required payment. Sec.
1.72(p)-1, Q&A-10(b), Income Tax Regs. However, the plan
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administrator may grant the participant a cure period. If the
administrator does so, section 72(p)(2)(C) is not considered
violated until the last day of the cure period. Sec. 1.72(p)-1,
Q&A-10(a), Income Tax Regs. The cure period may not extend past
the last day of the calendar quarter following the calendar
quarter in which the required installment payment was due. Id.
When petitioner failed to make payments on his loans during
the first quarter of 2005, the loans ceased to satisfy the level
amortization requirement. As permitted by the regulations, the
NYSLRS gave petitioner a cure period through June 30, 2005; i.e.,
the last day of the quarter following the quarter in which
petitioner defaulted. Petitioner concedes that he made no
payments with respect to his loans after he was placed in
suspended without pay status by his employer in December 2004.7
7
Petitioner argues that taxation in his case is
unconstitutional because sec. 72(p) permits respondent to tax an
individual on notional or perceived income rather than actual
income. Petitioner is mistaken. The amounts contributed to
petitioner’s qualified plan were compensation for services and
would have been taxable when earned if not for the congressional
decision to defer taxation on contributions to retirement plans
in order to encourage retirement savings. Congress may
constitutionally impose a tax on loans from retirement plans in
furtherance of the goal of encouraging retirement savings. See
Furlong v. Commissioner, 36 F.3d 25, 28 (7th Cir. 1994), affg.
T.C. Memo. 1993-191.
Petitioner’s second argument is that he was wrongfully
terminated from his employment, causing his payments on his loans
through payroll deductions to cease, and that his former employer
must therefore be liable for any tax attributable to a deemed
distribution from petitioner’s qualified plan. This argument is
without merit.
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We accordingly hold that petitioner’s failure to comply with
the repayment terms for his loans in 2005 caused a deemed
distribution from the plan under section 72(p). Consequently, we
reject petitioner’s contention that he erroneously reported a
$9,627 pension plan distribution in gross income for 2005.
2. Section 72(t)
When a distribution is made from a qualified retirement plan
before the distributee is 59-1/2 years old, section 72(t) imposes
an additional 10-percent tax on the distribution. The 10-percent
tax applies when the distribution is a deemed distribution under
section 72(p). Sec. 1.72(p)-1, Q&A-11(b), Income Tax Regs. The
10-percent additional tax does not apply to distributions from
plans other than individual retirement plans if one of several
exceptions are met, including: (1) Distributions made on the
death or disability of the participant, sec. 72(t)(2)(A)(ii) and
(iii); (2) distributions that are part of a series of
substantially equal periodic payments over the life of the
participant or the joint lives of the participant and the
beneficiary, sec. 72(t)(2)(A)(iv); (3) distributions after
separation from service, if the separation occurred during or
after the calendar year in which the participant reached age 55,
sec. 72(t)(2)(A)(v); (4) certain distributions by employee stock
ownership plans of dividends on employer’s securities, sec.
72(t)(2)(A)(vi); (5) payments made on account of a levy under
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section 6331, sec. 72(t)(2)(A)(vii); (6) distributions not
exceeding deductible medical expenses, sec. 72(t)(2)(B); (7)
distributions to a nonparticipant under a qualified domestic
relations order, sec. 72(t)(2)(C); and (8) certain distributions
to individuals called to active duty, sec. 72(t)(2)(G).
Petitioner has not claimed that any of these exceptions
applies to him, and the preponderance of the evidence shows that
none does. The evidence establishes that the distribution was a
deemed distribution as a result of petitioner’s default on loans
from his pension plan. It was therefore not prompted by
petitioner’s death or disability, was not made under a qualified
domestic relations order, was not made on account of a levy under
section 6331, was not made to an individual called to active
duty, and was not a distribution of dividends on an employer’s
securities by an employee stock ownership plan. Further, the
deemed distribution occurred only once; it was therefore not part
of a series of substantially equal periodic payments over the
life of petitioner. There is also no evidence in the record that
petitioner had any deductible medical expenses in 2005. Finally,
the exception exempting a taxpayer from the 10-percent additional
tax if the distribution occurred after separation from service if
the separation occurred during or after the calendar year in
which the taxpayer reached age 55 does not apply because the
parties stipulated that petitioner was younger than 55 in 2005.
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Accordingly, petitioner is liable for the 10-percent additional
tax under section 72(t).
3. Section 6651(a)(1) Addition to Tax
Under section 7491(c), respondent has the burden of
production with respect to petitioner’s liability for the section
6651(a)(1) addition to tax. In order to meet that burden,
respondent must offer sufficient evidence to indicate that it is
appropriate to impose the addition. See Higbee v. Commissioner,
116 T.C. 438, 446 (2001). Once respondent meets his burden of
production, petitioner bears the burden of proving error in the
determination, including evidence of reasonable cause or other
exculpatory factors. See id. at 446-447.
Section 6651(a)(1) provides for an addition to tax for a
taxpayer’s failure to file a required return on or before the due
date, including extensions. Because petitioner admits that his
2005 return was due on April 15, 2006, that he did not request an
extension, and that he filed his return on July 6, 2006,
respondent has met his burden of production under section
7491(c).
Petitioner testified at trial that he had instructed his
accountant to request an extension of time to file his 2005
return. Petitioner stated he had done so instead of filing his
return by April 15, 2006, because he had received an erroneous
Form W-2, Wage and Tax Statement, and was attempting to get the
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error corrected before filing. Petitioner stated that when he
discovered that his accountant had not requested an extension,
petitioner filed his 2005 return as soon as he could. Even if
petitioner believed that his accountant had requested an
extension on his behalf, his reliance on the accountant would not
constitute reasonable cause so as to avoid a section 6651(a)(1)
addition. Reliance on an agent is not reasonable cause for late
filing of a tax return. United States v. Boyle, 469 U.S. 241,
252 (1985). The duty to timely file a return is not delegable to
an accountant, and reliance on an accountant does not provide
reasonable cause for petitioner’s failure to timely file his
return. See id. Accordingly, petitioner is liable for the
addition to tax under section 6651(a)(1).
To reflect the foregoing,
Decision will be entered
under Rule 155.