T.C. Summary Opinion 2016-52
UNITED STATES TAX COURT
BRUCE W. PETERSON AND LISA A. PETERSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 30229-13S. Filed September 1, 2016.
Bruce W. Peterson and Lisa A. Peterson, pro se.
Luke D. Ortner, for respondent.
SUMMARY OPINION
PARIS, 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
1
Unless otherwise indicated, all section references are to the Internal
Revenue Code of 1986, as amended and 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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Pursuant to section 7463(b), the decision to be entered in not reviewable by any
other court, and this opinion shall not be treated as precedent for any other case.
Respondent determined a deficiency of $26,405 in, and a section 6662(a)
accuracy-related penalty of $5,281 in relation to, petitioners’ 2011 Federal income
tax. After concessions, the issues for decision are whether petitioners are liable
for: (1) tax with respect to taxable retirement income in excess of the amount they
reported, and (2) an accuracy-related penalty for an underpayment due to a
substantial understatement of Federal income tax for 2011.2
Background
Some of the facts have been stipulated and are so found. The stipulated
facts and facts drawn from stipulated exhibits are incorporated herein by this
reference. Petitioners resided in Colorado when they filed their petition.
Petitioner began his career of advising individuals on insurance and
financial investments as an employee of Allstate Insurance Co. (Allstate) in 1975.
2
Mr. Peterson (petitioner) conceded at trial that a distribution of $7,220
from a Roth IRA managed by Aviva Life & Annuity Co. (Aviva) was subject to
the sec. 72(t) additional tax for an early distribution because his wife had not
reached the age of 59-1/2 before the distribution. An adjustment was also made to
petitioners’ claimed medical expense deduction because of changes to petitioners’
adjusted gross income. That adjustment was computational and will not be
discussed further. Petitioners filed a joint Federal income tax return, and a notice
of deficiency was issued to both of them. Mrs. Peterson neither appeared at nor
participated in the trial, but she will be bound by the Court’s decision.
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As he continued through his career and legislation created new investment tools,
petitioner included those tools in his financial advising. His financial advice
included advice on retirement investments, including annuities, individual
retirement accounts (IRAs), and Roth IRAs.3 Before embarking on his insurance
and financial planning career, petitioner completed 3-1/2 years of college, where
he studied finance and business administration.
In 2000 Allstate terminated petitioner and all its other employee-agents and
offered to rehire them as independent contractors.4 Petitioner accepted Allstate’s
offer and rolled his Allstate pension benefits into a simplified employee pension
plan (SEP-IRA) to maintain their tax deferred status.5 His deferred compensation
3
IRAs were created by the Employee Retirement Income Security Act of
1974, Pub. L. No. 93-406, 88 Stat. 829. Roth IRAs were created by the Taxpayer
Relief Act of 1997, Pub. L. No. 105-34, 111 Stat. 788.
4
The Court takes judicial notice, see Fed. R. Evid. 201, of the following: (1)
in 2000 Allstate terminated over 6,000 of its employee-agents and offered to rehire
them as independent contractors under its “Preparing for the Future
Reorganization Program”; (2) a class action lawsuit was filed on behalf of the
terminated employees, but petitioner was not one of the named plaintiffs, and there
is no evidence in the record that he participated in the lawsuit; and (3) the U.S.
Equal Employment Opportunity Commission (EEOC) filed an age discrimination
lawsuit against Allstate on behalf of approximately 90 former Allstate employees.
Allstate agreed to pay $4.5 million to settle the lawsuit in 2009. There is no
evidence in the record that petitioner was involved in the EEOC litigation.
5
A self-employed individual can establish a SEP-IRA, which follows the
(continued...)
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package from Allstate consisted solely of Allstate stock. In 2009 petitioner
purchased an annuity contract from Forethought Life Insurance Co. (Forethought)
and rolled over his SEP-IRA to pay the single-payment premium. Petitioner
believed he had a basis of $169,297.88, the amount of the single-payment
premium, in the contract. The annuity contract was a qualified individual
retirement annuity under section 408(b). Petitioner relied on Internal Revenue
Service (IRS) Publication 590, Individual Retirement Arrangements (IRAs), when
he decided to purchase the annuity contract and when he subsequently canceled
the contract. Petitioner did not seek advice from his accountant regarding his
purchase or cancellation of the annuity contract.
In 2011 petitioner’s health declined, and he required a medical procedure
for which he had to pay $11,000 out of pocket. To cover his medical costs,
petitioner canceled his Forethought annuity contract and received the cash
surrender value of the contract.6 Forethought mailed petitioner a letter dated July
28, 2011, confirming that petitioner had canceled the annuity contract, had
received the contract’s cash surrender value of $140,088.84, and had paid a
5
(...continued)
same investment, distribution, and rollover rules as a traditional IRA.
6
Petitioner gave no explanation for why he canceled the entire annuity
contract to cover medical expenses of $11,000.
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surrender fee of $20,618.04. No Federal tax was withheld from the distribution,
and petitioner was 60 years old at the time of the distribution.
Petitioner’s original plan was to roll over the remaining funds from the
annuity contract into another IRA. Approximately three weeks after the medical
procedure, petitioner began experiencing complications, and he was concerned
that a second procedure would be necessary. Petitioner retained the remaining
funds from the annuity contract.
Petitioners reported $158,419 of IRA distributions on line 15a of their 2011
Form 1040, U.S. Individual Income Tax Return.7 This amount included the
distributions from Forethought and Aviva. Petitioners also reported $16,199 as
the taxable amount of those distributions on line 15b. “ROLLOVER” is typed
next to line 15b. Petitioners’ accountant prepared their return.
Respondent issued petitioners a notice of deficiency determining that they
had failed to report an additional $135,000 of taxable retirement income and
determining a section 6662(a) accuracy-related penalty against them for an
7
Forethought issued petitioner a Form 1099-R, Distributions From Pensions,
Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.,
reporting a gross distribution and taxable amount of $151,199.01. Petitioner could
not explain the discrepancy between the amount reported on the Form 1099-R and
the amount stated as the cash surrender amount in Forethought’s letter dated July
28, 2011.
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underpayment attributable to a substantial understatement of income tax.
Respondent calculated the unreported taxable retirement income by subtracting the
reported taxable amount of distributions on line 15b and the Aviva Roth IRA
distribution from the total IRA distributions reported on line 15a ($158,419 !
$16,199 ! $7,220 ' $135,000). Petitioners timely filed a petition with the Court
for redetermination.
Discussion
I. Burden of Proof
Ordinarily, the Commissioner’s determinations in a notice of deficiency are
presumed correct, and the taxpayer bears the burden of proving that the
determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111,
115 (1933). Under certain circumstances the burden of proof as to factual matters
may shift to the Commissioner pursuant to section 7491(a). Petitioners did not
argue for a burden shift under section 7491(a), and the record does not establish
that the prerequisites for a burden shift have been met; therefore, the burden of
proof remains theirs.
II. The Forethought Annuity Contract Distribution
Section 408(d)(1) provides that any amount paid or distributed out of an
IRA is includible in the gross income of the payee or distributee as provided under
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section 72. Section 72(e) is applicable, inter alia, to amounts received under an
annuity contract but not received as an annuity. Petitioner’s distribution from
Forethought was an amount received under an annuity contract but not received as
an annuity.
Amounts received before the annuity starting date shall be includible in
gross income to the extent allocable to income on the contract and shall not be
includible in gross income to the extent allocable to the investment in the contract.
Sec. 72(e)(2)(B); sec. 1.72-11(d), Income Tax Regs. This effectively gives a
taxpayer a basis in his IRA to the extent of his investment in the contract. A
taxpayer’s “investment in the contract” is defined as the aggregate amount of
premiums or other consideration paid for the contract reduced by the amount
received that was previously excludable from gross income. Sec. 72(e)(6). If the
taxpayer’s investment in the contract is zero, all amounts received under the
annuity contract will be includible in gross income. Sec. 1.72-4(d)(1), Income Tax
Regs.; see also sec. 1.408-4(a)(2), Income Tax Regs.
Petitioner’s single-payment premium for the annuity contract was
$169,297.88. He rolled over his SEP-IRA to pay the annuity contract premium.
Petitioner testified that he had a basis of around $169,000 in the annuity contract.
He also testified multiple times that the entire amount of his SEP-IRA was funded
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with pretax or nontaxed amounts. During his direct testimony, petitioner stated:
“[T]he deductions were put in my IRA before I paid my income tax”. He also
stated: “[W]hen I invaded the IRA, I invaded non-taxed moneys”. Additionally,
petitioner stated that putting after-tax dollars into the rolled over SEP-IRA would
be “a violation of everything I stand for.” When the Court verified that petitioner
stipulated that he had purchased the annuity contract with a rolled-over, nontaxed
IRA for the single-payment premium, he responded: “[Y]ou’re right”.
Petitioner’s single-payment premium was funded entirely with amounts that were
previously excluded from gross income and tax deferred; therefore, petitioner’s
basis in the annuity contract was zero. See Patrick v. Commissioner, T.C. Memo.
1998-30, aff’d without published opinion, 181 F.3d 103 (6th Cir. 1999); Vorwald
v. Commissioner, T.C. Memo. 1997-15; sec. 1.72(d)(1), Income Tax Regs.
Petitioner offered into evidence at trial the Form 1099-R that Forethought
had issued to him, reporting a distribution and taxable amount of $151,199. The
parties also offered into evidence a letter from Forethought to petitioner that states
the cash surrender value of the annuity contract was $140,088.84. Petitioner could
not explain the discrepancy between the amounts on the Form 1099-R and the
Forethought letter, and he testified that he had not contacted Forethought about the
discrepancy. It is clear from the total amount of IRA distributions petitioners
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reported on their return that they had included the amount reported on the Form
1099-R, not the amount stated in Forethought’s letter, in that sum.
Petitioner argued that the amount of the IRA distributions reported as
taxable was the correct amount because the funds from the annuity contract were
used to pay medical expenses. He relied on IRS Publication 590 to support his
argument.8 Petitioner relied on a section of Publication 590, chapter 1, about early
distributions to support his argument that no additional amount of his IRA
distributions was taxable. The section on which petitioner relies discusses
distributions made before the taxpayer is age 59-1/2 and several exceptions where
distributions can be made before one reaches that age that will not incur a 10%
additional tax. One such exception is for a distribution used to pay unreimbursed
medical expenses.
The flaw in petitioner’s argument is that the section on early distributions
on which he relies concerns the 10% additional tax assessed on early distributions
8
The Court notes that IRS publications are not authoritative sources of tax
law. See Dixon v. United States, 381 U.S. 68, 73 (1965) (“Congress, not the
Commissioner, prescribes the tax laws[.]”); see also Zimmerman v. Commissioner,
71 T.C. 367, 371 (1978), aff’d without published opinion, 614 F.2d 1294 (2d Cir.
1979); Green v. Commissioner, 59 T.C. 456, 458 (1972).
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under section 72(t).9 Petitioner was 60 years old when he received the
Forethought distribution; therefore, the additional tax under section 72(t) does not
apply.
Petitioner has confused an exception to the additional tax for an early
distribution for unreimbursed medical expenses with the general rule that any
distribution from an annuity contract will be includible in gross income. The fact
that petitioner used a portion of the distribution to pay medical expenses does not
shield the distribution from taxation. Petitioner has failed to prove that an
additional $135,000 of his IRA distributions was not a taxable distribution.
III. Accuracy-Related Penalty
Respondent determined an accuracy-related penalty of $5,281 for a
substantial understatement of Federal income tax. Section 6662(a) and (b)(2)
authorizes a 20% penalty on the portion of an underpayment of income tax
attributable to a substantial understatement of income tax. Under section 7491(c),
the Commissioner bears the burden of production with regard to penalties. Higbee
v. Commissioner, 116 T.C. 438, 446 (2001). Once the Commissioner has met the
burden of production, the taxpayer has the burden of proving that the penalties are
9
Petitioner’s annuity contract was a qualified individual retirement annuity
under sec. 408(b); thus it constituted a qualified retirement plan under sec.
4974(c). Therefore, the provisions of sec. 72(t) rather than subsec. (q) apply.
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inappropriate because of reasonable cause or substantial authority. See Rule
142(a); Hall v. Commissioner, 729 F.2d 632, 635 (9th Cir. 1984), aff’g T.C.
Memo. 1982-337; Higbee v. Commissioner, 116 T.C. at 446-447.
There is a “substantial understatement” of income tax for any year if the
amount of the understatement for the taxable year exceeds the greater of 10% of
the tax required to be shown on the tax return or $5,000. Sec. 6662(d)(1)(A);
Higbee v. Commissioner, 116 T.C. at 448.
The understatement of income tax is $26,405, which is greater than $5,000,
which in turn is greater than 10% of the tax required to be shown on the return.
Thus, the understatement of income tax for 2011 is substantial for purposes of the
section 6662(a) accuracy-related penalty.
Pursuant to section 6664(c)(1), no penalty shall be imposed under section
6662 with regard to any portion of an underpayment if it can be shown that there
was reasonable cause for such portion and that the taxpayer acted in good faith
with respect to such portion. Whether a taxpayer acted with reasonable cause and
in good faith is decided on a case-by-case basis, taking into account all 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 his proper tax
liability. Id.; see also Remy v. Commissioner, T.C. Memo. 1997-72.
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Petitioner testified that he gave all of the pertinent documents to his
accountant and that “it takes about 15 minutes to do his taxes”. Petitioner did not
review the return after his accountant prepared it and did not ask his accountant
about the discrepancy between the amount on the Form 1099-R, which was
attached to his return, and the amount in the Forethought letter. Taxpayers have a
duty to review their tax returns before signing and filing them. Magill v.
Commissioner, 70 T.C. 465, 479-480 (1978), aff’d, 651 F.2d 1233 (6th Cir. 1981).
“Reliance on a tax return preparer cannot absolve a taxpayer from the
responsibility to file an accurate return.” Devy v. Commissioner, T.C. Memo.
2015-110, at *4 (citing Metra Chem Corp. v. Commissioner, 88 T.C. 654, 662
(1987) (“As a general rule, the duty of filing accurate returns cannot be avoided by
placing responsibility on a tax return preparer.”)). Additionally, petitioner did not
discuss with his accountant his opinion that he had a basis from rolling his SEP-
IRA into an annuity contract or the subsequent cancellation of the contract and the
coinciding distribution. Neither did he seek any advice when he received contrary
reporting information from Forethought before filing his return.
Because of petitioner’s experience as a financial and retirement investment
adviser, his failure to seek his accountant’s advice about his annuity contract and
the cancellation of the contract and the distribution from Forethought, and his
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failure to review his 2011 return, the Court finds that he failed to prove that he
acted with reasonable cause and in good faith in his effort to assess his proper tax
liability. Therefore the Court will sustain respondent’s determination of an
accuracy-related penalty for an underpayment due to a substantial understatement
of income tax for 2011.
The Court has considered all of the arguments made by the parties, and to
the extent they are not addressed herein, they are considered unnecessary, moot,
irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
for respondent.