T.C. Summary Opinion 2011-16
UNITED STATES TAX COURT
PAULETTE A. AND MATTHEW D. MALENA, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 29211-09S. Filed February 24, 2011.
Paulette A. Malena, pro se.
Christopher A. Pavilonis, for respondent.
ARMEN, Special Trial 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
1
Unless otherwise indicated, all subsequent 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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other court, and this opinion shall not be treated as precedent
for any other case.
Respondent determined a deficiency in petitioners’ 2007
Federal income tax of $15,743, as well as a section 6662(a)
accuracy-related penalty of $3,132.
After the dismissal of petitioner Matthew D. Malena,2 the
issues for decision are:
(1) Whether petitioner Paulette A. Malena (petitioner)
received unreported income, principally in the form of a taxable
distribution under section 72(p) related to a defaulted loan;
(2) whether petitioner is entitled to a mortgage interest
deduction on Schedule A, Itemized Deductions, greater than that
allowed by respondent in the notice of deficiency;
(3) whether petitioner is entitled to a medical expense
deduction greater than that claimed by her on her return as
filed;
(4) whether petitioner is liable for a 10-percent additional
tax under section 72(t) by virtue of a taxable distribution under
section 72(p); and
2
Petitioner Matthew D. Malena, a resident of the State of
Florida at the time that the petition was filed, did not execute
the stipulation, nor did he appear at trial. Accordingly, the
Court granted respondent’s motion to dismiss this case as to him
for lack of prosecution. See Rule 123(b). However, the decision
to be entered against petitioner Matthew D. Malena will be
consistent with the decision to be entered against petitioner
Paulette A. Malena as to the deficiency in tax and the accuracy-
related penalty. See Rule 123(d).
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(5) whether petitioner is liable for a section 6662(a)
accuracy-related penalty.
Background
Some of the facts have been stipulated, and they are so
found. We incorporate by reference the parties’ stipulation of
facts and accompanying exhibits. Petitioner resided in the State
of Florida when the petition was filed.
Petitioner and Mr. Malena (husband) fell on hard times in
2007 caused by the combination of petitioner’s poor health and
her husband’s losing his job.
Petitioner suffered from several maladies. She saw multiple
medical specialists and took costly prescription drugs. To ease
the financial burden of petitioner’s medical issues, petitioner’s
husband borrowed $32,075 from his section 401(k) plan (401(k)) in
March 2007. Later that year, petitioner’s husband was let go
from his job, and he defaulted on the loan, at which time the
outstanding balance was $29,143.
Petitioner and her husband filed a joint Federal income tax
return for 2007. On the return, petitioner did not report the
defaulted loan of $29,143 from her husband’s 401(k).
Petitioner attached to her joint return for 2007 a Schedule
A. On the Schedule A, petitioner claimed deductions for, inter
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alia, home mortgage interest of $54,356 and medical expenses of
$27,008.3
Relying on various Forms 1099 from third-party payors,
including petitioner’s husband’s former employer, respondent
determined in the notice of deficiency that petitioner failed to
report the aforementioned defaulted loan, as well as a class
action lawsuit recovery of $883, unemployment compensation of
$825, dividends of $13, and interest income of $10.
Relying on various Forms 1098, Mortgage Interest Statement,
from third-party lenders, respondent also determined in the
notice of deficiency that petitioner paid mortgage interest of
$36,829 and therefore disallowed $17,527 of the amount claimed on
Schedule A, $54,356. In contrast, respondent did not disallow
any part of petitioner’s deduction for medical expenses other
than to adjust the amount of the deduction in order to reflect
the increase in petitioner’s adjusted gross income. See sec.
213(a).
Finally, respondent determined in the notice of deficiency
that petitioner was liable for (1) a 10-percent additional tax
under section 72(t) in respect of the defaulted loan from her
husband’s 401(k) and (2) an accuracy-related penalty under
section 6662(a).
3
As required by sec. 213(a), petitioner reduced the
$27,008 amount by 7.5 percent of adjusted gross income.
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Discussion
A. Burden of Proof
In general, the Commissioner’s determinations in a notice of
deficiency are presumed correct, and the taxpayer bears the
burden of showing that those determinations are erroneous. Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Pursuant to section 7491(a)(1), the burden of proof as to
factual matters may shift from the taxpayer to the Commissioner
under certain circumstances. Petitioner did not allege that
section 7491 applies, nor did she introduce the requisite
evidence to invoke that section. See sec. 7491(a)(2)(A) and (B).
Therefore, petitioner bears the burden of proof.4 See Rule
142(a).
B. Unreported Income
Gross income includes all “‘accessions to wealth, clearly
realized, and over which the taxpayers have complete dominion.’”
James v. United States, 366 U.S. 213, 219 (1961) (quoting
Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).
4
Insofar as the sec. 72(t) issue (discussed infra in the
text) is concerned, we note that regardless of whether the
additional tax under that section is a penalty or an additional
amount to which sec. 7491(c) applies, and regardless of whether
the burden of production with respect to this additional tax
would be on respondent, respondent has satisfied any burden of
production with respect to the distribution. See H. Conf. Rept.
105-599, at 241 (1998), 1998-3 C.B. 747, 995.
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We begin with the loan from petitioner’s husband’s 401(k),
as that loan gives rise to the most significant of respondent’s
income determinations.
Section 402(a) provides generally that distributions from a
qualified plan are taxable to the distributee in the taxable year
in which the distribution occurs, pursuant to the provisions of
section 72. A plan such as petitioner’s husband’s 401(k)
constitutes a qualified plan. We turn therefore to section 72.
Under the general rule of section 72(p)(1)(A), the making of
a loan from a qualified plan gives rise to a deemed distribution
that is taxable in the year in which the loan is received. See
sec. 72(p)(4)(A)(i)(I). See generally Owusu v. Commissioner,
T.C. Memo. 2010-186; Plotkin v. Commissioner, T.C. Memo. 2001-71.
However, section 72(p)(2)(A) provides an exception to the general
rule for certain loans.
Although a loan may initially satisfy the requirements of
section 72(p)(2)(A) at the time that it is made and thus be
excepted from the general rule of section 72(p)(1)(A), a deemed
distribution may nevertheless occur subsequently because of the
failure to repay the loan consistent with the loan agreement,
e.g., because of the failure to amortize the loan on a
substantially level basis. Sec. 72(p)(2)(C). Accordingly, if a
default occurs, a distribution is deemed to occur at that time in
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the amount of the then outstanding balance of the loan. Owusu v.
Commissioner, supra; Plotkin v. Commissioner, supra.
In the present case, there is no dispute that petitioner’s
husband defaulted on the 401(k) loan in 2007. The record
demonstrates that the balance due at the time of the default was
$29,143. Thus, pursuant to section 72(p)(1)(A), a distribution
is deemed to have been made at such time and in such amount, and,
pursuant to section 402(a), the distribution is taxable.
Regarding the more modest items of income that respondent
determined were not reported, petitioner essentially conceded
their inclusion in income, as she did not address the issue at
trial.5
In view of the foregoing, respondent’s income determinations
are sustained.
C. Deduction for Home Mortgage Interest
Deductions are allowed solely as a matter of legislative
grace, and the taxpayer bears the burden of proving his or her
entitlement to them. Rule 142(a); INDOPCO, Inc. v. Commissioner,
503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292
U.S. 435, 440 (1934). The taxpayer also bears the burden of
substantiating claimed deductions. Sec. 6001; Hradesky v.
5
Indeed, petitioner expressly conceded in the petition
that unemployment compensation of $825 and interest income of $10
were “owed”.
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Commissioner, 65 T.C. 87, 89 (1975), affd. per curiam 540 F.2d
821 (5th Cir. 1976).
A deduction is allowed for any qualified residence interest.
Sec. 163(h)(2)(D). Deductible interest includes interest from
both acquisition and home equity indebtedness. Sec. 163(h)(3).
Petitioner claimed a mortgage interest deduction of $54,356
on her return. At trial, petitioner made no argument and
provided no substantiation for the portion thereof that
respondent disallowed ($17,527).
In view of the foregoing, we sustain respondent’s
determination that petitioner is entitled to a mortgage interest
deduction of only $36,829.
D. Deduction for Medical Expenses
On her return, petitioner claimed a deduction for medical
expenses of $27,008 (prior to application of the 7.5 percent
floor prescribed by section 213(a)). In the notice of
deficiency, respondent did not disallow any part of this
deduction other than to adjust it in order to reflect the
increase in petitioner’s adjusted gross income. See sec. 213(a).
At trial, petitioner argued that she incurred additional
medical expenses in 2007 and that those additional expenses would
offset her unreported income, thereby reducing, if not
eliminating, the deficiency in tax. However, petitioner’s
testimony, even in concert with the modest documentary evidence
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that she introduced, is insufficient to demonstrate that she
incurred medical expenses in an amount greater than $27,008, as
originally claimed by her and allowed by respondent. On this
issue we therefore hold against petitioner.
E. Additional Tax Under Section 72(t)
Section 72(t)(1) imposes an additional tax on an early
distribution from a qualified retirement plan equal to 10 percent
of the portion of such distribution that is includable in gross
income.6 As previously discussed, failure to make an installment
payment when due in accordance with the terms of a loan from a
qualified retirement plan may result in a taxable distribution.
Sec. 72(p)(1). Accordingly, a loan balance that constitutes a
taxable distribution is subject to the 10-percent additional tax
under section 72(t) on early distributions. See Owusu v.
Commissioner, supra; Plotkin v. Commissioner, supra.
The additional tax under section 72(t) does not apply to
certain distributions from qualified retirement plans. The only
exception relevant herein is found in section 72(t)(2)(B), which
excepts from the additional tax such distributions that do not
exceed the amount allowable as a deduction under section 213 for
amounts paid during the taxable year for medical care.
6
Petitioner’s husband’s 401(k) account constitutes a
qualified retirement plan for purposes of sec. 72(t). See sec.
4974(c)(1).
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In the present case, petitioner paid medical expenses of
$27,008, but under section 213(a) a deduction is allowed only to
the extent that the amount paid for medical care exceeds 7.5
percent of the taxpayer’s adjusted gross income. Therefore,
under the clear language of section 72(t)(2)(B), we hold that the
portion of the defaulted loan that equals the amount of the
deduction allowed for medical expenses under section 213 is
excepted from the 10-percent additional tax under section 72(t);
regrettably for petitioner, the balance of such loan is subject
to the additional tax. See Duncan v. Commissioner, T.C. Memo.
2005-171.
In view of the foregoing, respondent’s determination on this
case is sustained only in part.
F. Accuracy-Related Penalty
Section 6662(a) and (b)(2) imposes a penalty equal to 20
percent of the amount of any underpayment attributable to a
substantial understatement of income tax. An understatement is
“substantial” if the understatement exceeds the greater of 10
percent of the tax required to be shown on the return or $5,000.
Sec. 6662(d)(1)(A). The term “understatement” means the excess
of the tax required to be shown on the return over the tax
actually shown on the return. Sec. 6662(d)(2)(A).
Section 6664(c)(1) provides an exception to the imposition
of the accuracy-related penalty with respect to any portion of an
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underpayment if the taxpayer establishes that there was
reasonable cause for the underpayment and that the taxpayer acted
in good faith with respect to that portion. See sec. 1.6664-
4(a), Income Tax Regs. The determination of whether the taxpayer
acted with reasonable cause and in good faith is made on a case-
by-case basis, taking into account the pertinent facts and
circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. Generally,
the most important factor is the extent of the taxpayer’s effort
to assess the proper tax liability for such year. Id.
With respect to a taxpayer’s liability for any penalty,
section 7491(c) places on the Commissioner the burden of
production, thereby requiring the Commissioner to come forward
with sufficient evidence indicating that it is appropriate to
impose the penalty. Higbee v. Commissioner, 116 T.C. 438, 446-
447 (2001). Once the Commissioner meets his burden of
production, the taxpayer musts come forward with persuasive
evidence that the Commissioner’s determination is incorrect. See
id. at 447; see also Rule 142(a); Welch v. Helvering, 290 U.S. at
115.
The Commissioner may satisfy his burden of production for
the accuracy-related penalty on the basis of a substantial
understatement of income tax by showing that the understatement
on the taxpayer’s return satisfies the definition of
“substantial”. E.g., Graves v. Commissioner, T.C. Memo. 2004-
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140, affd. 220 Fed. Appx. 601 (9th Cir. 2007); Janis v.
Commissioner, T.C. Memo. 2004-117, affd. 461 F.3d 1080 (9th Cir.
2006), affd. 469 F.3d 256 (2d Cir. 2006).
In the instant case, respondent has satisfied his burden of
production because the record demonstrates the presence of a
substantial understatement of income tax attributable to, inter
alia, unreported income. See sec. 6662(d)(1)(A); Higbee v.
Commissioner, supra at 447-449. Accordingly, petitioner bears
the burden of proving that the accuracy-related penalty should
not be imposed. See sec. 6664(c)(1); Higbee v. Commissioner,
supra at 446.
Insofar as the understatement of income tax is attributable
to the taxable distribution under section 72(p), we conclude that
there was reasonable cause for the underpayment and that
petitioner acted in good faith. See sec. 6664(c)(1). The
provisions of section 72(p) are highly technical and not
intuitive, particularly to a taxpayer such as petitioner who,
given her education and experience, did not (and could not
reasonably be expected to) comprehend the tax consequences of her
husband’s defaulted loan. To that extent we hold that petitioner
should be absolved from liability for the accuracy-related
penalty. Otherwise, however, we are unpersuaded by petitioner
and we therefore sustain the penalty insofar as the
understatement of income tax is attributable to the other items
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of unreported income and to the disallowance of the mortgage
interest deduction.
Conclusion
We have considered all of the arguments made by the parties,
and, to the extent that we have not specifically addressed those
arguments, we conclude that they do not support results contrary
to those reached herein.
To reflect the foregoing,
Decision will be entered
under Rule 155.