T.C. Memo. 2013-152
UNITED STATES TAX COURT
WILLIAM K. MCGRAW, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12029-12. Filed June 17, 2013.
Frederick J. O’Laughlin, for petitioner.
Moenika Coleman, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LAUBER, Judge: Respondent determined a deficiency in petitioner’s 2009
Federal income tax of $23,659 and an accuracy-related penalty under section
6662(a) of $4,732.1 Petitioner resided in Texas when he petitioned this Court.
1
All statutory references are to the Internal Revenue Code, as amended and
in effect for the tax year at issue. All references to Rules are to the Tax Court
(continued...)
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[*2] At the start of trial petitioner conceded that he had failed to include in his
gross income for 2009 a taxable distribution of $67,440 from a qualified
retirement plan.2 Two issues remain for decision: (1) whether petitioner is liable
for the 10% additional tax imposed by section 72(t) on early distributions from
qualified retirement plans; and (2) whether petitioner is liable for the accuracy-
related penalty imposed by section 6662. In seeking shelter from the section 72(t)
additional tax, petitioner relies on the exception for “medical expenses” in section
72(t)(2)(B).
FINDINGS OF FACT
At the outset of 2009 petitioner maintained a retirement annuity account
with ING USA Annuity & Life Insurance Co. (ING). An acquaintance offered to
assist petitioner in rolling over the balance of this annuity into what was purported
to be a better performing annuity. Petitioner acquiesced in this plan. However,
instead of implementing a rollover, the acquaintance in April 2009 presented
petitioner with a check for $67,440, representing the gross proceeds of liquidating
petitioner’s ING annuity account. This caused petitioner distress, not only
1
(...continued)
Rules of Practice and Procedure. All dollar amounts are rounded to the nearest
dollar.
2
Petitioner also conceded that he had failed to include in his 2009 gross
income $52 of rental income and $183 from a State income tax refund.
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[*3] because he expected a rollover rather than a cashout, but also because the
proceeds were substantially less than what he had assumed the account was worth.
Petitioner, whose testimony revealed some familiarity with investment
matters, realized that no rollover had occurred. Although he could have preserved
the tax-deferred status of the funds by rolling over the money into a new
retirement vehicle himself, he instead deposited the $67,440 check into his regular
bank account. While initially shocked by the failure of a trusted acquaintance to
implement the agreed-upon rollover strategy, petitioner came to regard this turn of
events as fortuitous when he learned that his wife was pregnant. Because her first
pregnancy had been difficult, he believed that he might need the funds to defray
pregnancy-related expenses and determined to deposit the check.
Petitioner’s wife encountered some complications with her high-risk
pregnancy, though she was not hospitalized until her delivery date, December 4,
2009. The delivery was accomplished by Caesarean section. His wife did not
return to her outside employment until mid-2010. Her delayed return to work was
due in part to the longer recovery period necessitated by a Caesarean section, but
also to her desire “to stay home and take care of the kids.”
Petitioner provided no documentation to substantiate the amount of his 2009
medical expenses to the Internal Revenue Service (IRS) before trial. He itemized
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[*4] deductions on his 2009 Form 1040, U.S. Individual Income Tax Return, and
claimed three categories of itemized deductions, but he did not report any medical
expenses on line 1 of Schedule A, Itemized Deductions. On the morning of the
trial, his wife discovered a document allegedly substantiating pregnancy-related
expenses of approximately $5,700. However, this document was neither produced
at trial nor admitted into evidence. Petitioner’s best recollection was that the total
out-of-pocket expenses of his wife’s pregnancy were in the range of $5,000 to
$6,000. When asked how he had employed the balance of the $67,440 retirement
distribution, petitioner mentioned getting a room ready for the baby and using the
funds “for all the baby things that you do.”
United Healthcare provided medical insurance coverage to petitioner’s
family at the time, though petitioner offered no specific details about the scope of
the coverage.
OPINION
A. The Section 72(t) Additional Tax
The Commissioner’s determination of a deficiency is generally presumed
correct, though this presumption can be rebutted by the taxpayer. See Sec.
7491(a); Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Petitioner
does not contend that the burden of proof should shift to respondent under section
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[*5] 7491(a) and, if he had advanced this contention, it would lack merit. As
explained below, petitioner has not complied “with the requirements under this
title to substantiate” his claimed medical expenses. See sec. 7491(a)(2)(A).
Petitioner therefore bears the burden of proof on this issue.
Section 72(t)(1) generally provides that, if a taxpayer receives a distribution
from a qualified retirement plan, the taxpayer’s income tax shall be increased “by
an amount equal to 10 percent of the portion of such amount which is includible in
gross income.” Petitioner conceded that the entirety of his $67,440 distribution
from ING is includible in gross income. Thus, the tentative additional tax
imposed by section 72(t) is $6,744.
Section 72(t)(2)(A) provides several exceptions to this general rule, e.g.,
where the taxpayer receiving the distribution has attained the age of 59½ or is
disabled. See sec. 72(t)(2)(A)(i), (iii). A further exception appears in section
72(t)(2)(B), captioned “[m]edical expenses.” It provides, with exceptions not
relevant here, that an early distribution from a qualified retirement plan is not
subject to the 10% additional tax to the extent it does not exceed “the amount
allowable as a deduction under section 213 * * * for amounts paid during the
taxable year for medical care (determined without regard to whether the * * *
[taxpayer] itemizes deductions for such taxable year).” Section 213(a) in turn
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[*6] allows as a deduction “the expenses paid during the taxable year, not
compensated for by insurance or otherwise, for medical care of the taxpayer, his
spouse, or a dependent * * * to the extent that such expenses exceed 7.5 percent of
adjusted gross income.”
For three related reasons, petitioner is not eligible for the “medical expense”
exception of section 72(t)(2)(B). First, while it seems clear that his family did
incur pregnancy-related expenses during 2009, he did not substantiate any
particular amount of medical expenses. Although he itemized deductions, he
reported no medical expenses on his Form 1040 Schedule A. He provided no
documentation of medical expenses to the IRS during the examination, at the
Appeals conference, or during the pretrial process. He introduced no documentary
evidence at trial. Although he testified that he incurred total pregnancy-related
medical expenses in the range of $5,000 to $6,000, his testimony on this point
lacked certainty. Moreover, his recollection appeared to have been refreshed by the
contents of an unidentified document that was not produced at trial.
Second, even if petitioner did have qualifying medical expenses, he failed to
prove that the expenses were unreimbursed. Section 72(t)(2)(B) requires that in
order to qualify for the exception, medical expenses must be “allowable as a
deduction under section 213.” Section 213(a) allows a deduction for medical
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[*7] expenses only if they have not been “compensated for by insurance or
otherwise.” Petitioner testified that he had insurance provided by United
Healthcare during 2009, but he acknowledged that he did not know the extent to
which the costs of his wife’s pregnancy were covered by their insurance. In the
absence of any testimony or documentary evidence concerning the details of
petitioner’s insurance coverage and insurance claims experience, it is impossible to
determine the extent, if any, to which his claimed medical expenses were “not
compensated for by insurance.”
Third, even if petitioner had documented some unreimbursed medical
expenses for 2009, the amount would not exceed the statutory floor. Section 213
would allow a medical expense deduction only to the extent petitioner’s
unreimbursed medical expenses exceeded 7.5% of his corrected adjusted gross
income (AGI). His 2009 tax return reported AGI of $54,351. Adding the $67,440
retirement plan distribution and other conceded adjustments to this sum produces
corrected AGI in excess of $122,000, creating a statutory floor in excess of $9,150.
The maximum amount of medical expenses that his testimony could support would
be $6,000. Because petitioner has not proven unreimbursed medical expenses in
excess of $9,150, he is ineligible for the section 72(t)(2)(B) “medical expense”
exception.
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[*8] B. The Accuracy-Related Penalty
Section 6662 imposes a 20% penalty upon the portion of any underpayment
of tax that is attributable (among other things) to “[a]ny substantial understatement
of income tax.” Sec. 6662(a), (b)(2). An understatement of income tax is
“substantial” if it exceeds the greater of $5,000 or 10% of the tax required be
shown on the return. Sec. 6662(d)(1)(A). Respondent’s notice of deficiency,
whose determinations have been sustained by us or conceded by petitioner,
determined an understatement of income tax in excess of $23,000. This amount
comfortably exceeds $5,000 and 10% of the total tax required to be shown on
petitioner’s 2009 return. Respondent has thus carried his burden of production by
demonstrating a “substantial understatement of income tax.” See sec. 7491(c).
Section 6664(c)(1) provides that the accuracy-related penalty shall not be
imposed with respect to any portion of an underpayment “if it is shown that there
was a reasonable cause for such portion and that the taxpayer acted in good faith
with respect to * * * [it].” Once the Commissioner has carried his burden of
production, the taxpayer bears the burden of proving reasonable cause and good
faith. Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001).
The decision as to whether the taxpayer acted with reasonable cause and in
good faith is made on a case-by-case basis, taking into account all pertinent facts
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[*9] and circumstances. See sec. 1.6664-4(b)(1), Income Tax Regs. Circumstances
that may signal reasonable cause and good faith “include an honest
misunderstanding of fact or law that is reasonable in light of all of the facts and
circumstances, including the experience, knowledge, and education of the
taxpayer.” Id. “Reasonable cause” may also be shown by demonstrating reliance
on the advice of a competent tax professional. Sec. 1.6664-4(c), Income Tax Regs.
“Advice” must take the form of a “communication” that sets forth the adviser’s
“analysis or conclusion.” Sec. 1.6664-4(c)(2), Income Tax Regs.
Petitioner’s 2009 tax return was prepared by a professional return preparer
who is both an accountant and a lawyer. However, petitioner did not testify to
having received specific advice, from his return preparer or anyone else, that an
early distribution from a retirement plan can properly be excluded altogether from
gross income. Petitioner recognized, at the time he received the $67,440 check,
that a tax-free rollover had not occurred. Rather than implementing a rollover
himself by investing the funds in a substitute retirement vehicle, he deposited the
money in the bank and used it for general living expenses. His failure to report the
$67,440 as gross income was not due to reasonable cause and did not reflect a
good-faith effort to comply with the tax laws.
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[*10] The “reasonable cause” exception is similarly unavailable with respect to
petitioner’s failure to report, on line 58 of his Form 1040, the additional tax
imposed by section 72(t). That failure was clearly attributable to his antecedent
failure to report the $67,440 retirement distribution as gross income, which itself
was unsupported by reasonable cause. In any event, his claimed reliance on the
“medical expense” exception of section 72(t)(2)(B) lacked reasonable cause and
good faith. He reported no medical expenses as allowable deductions under
section 213 on his Form 1040 Schedule A, even though he itemized deductions
generally, and he could not substantiate any medical expenses during the IRS
examination or at trial.
Decision will be entered
for respondent.