Robert C. and Nancy L. Arnold v. Commissioner , 111 T.C. No. 12 ( 1998 )

111 T.C. No. 12UNITED STATES TAX COURT
ROBERT C. AND NANCY L. ARNOLD, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 16855-97. Filed September 28, 1998.
In December 1989, following P's retirement, P began
receiving annual distributions from his individual
retirement account (IRA). At that time, P was 55 years
old. The distributions were intended to constitute a
series of substantially equal periodic payments within
the purview of sec. 72(t)(2)(A)(iv), I.R.C., so as to
avoid P's having to pay the 10-percent tax pursuant to
sec. 72(t)(1), I.R.C. In November 1993, after five
distributions of $44,000 each had been made, and when P
attained age 59-1/2, P received $6,776 from his IRA. In
the notice of deficiency, R determined that the November
1993 distribution impermissibly modified the series of
substantially equal periodic payments within the 5-year
period beginning on the date of the first distribution,
and therefore the 10-percent recapture tax under sec.
72(t)(4), I.R.C., should be imposed on all distributions
P received prior to attaining age 59-1/2. P contends
that the series of substantially equal periodic payments
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was completed with the fifth distribution in January
1993, or in the alternative, that the November 1993
distribution represented a cost-of-living adjustment.
Held: P modified the series of substantially equal
periodic payments by receiving the $6,776 from his IRA in
November 1993 prior to the close of the 5-year period
beginning on the date of the first distribution in
December 1989, and is therefore subject to the 10-percent
recapture tax on all distributions received prior to
attaining age 59-1/2, as provided in sec. 72(t)(4),
I.R.C. Held, further: P failed to prove that the
November 1993 distribution constituted a permissible
cost-of-living adjustment.
Robert C. and Nancy L. Arnold, pro sese.
Michael F. O'Donnell and George W. Bezold, for respondent.
JACOBS, Judge: Respondent determined a $21,221 deficiency in
petitioners' Federal income tax for 1993. The deficiency arises
due to the imposition of the 10-percent recapture tax under section
72(t)(4), which was triggered by a November 1993 distribution to
Robert C. Arnold (hereinafter petitioner) from his individual
retirement account. The sole issue for decision is whether the
November 1993 distribution impermissibly modified a series of
substantially equal periodic payments.
All 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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Some of the facts have been stipulated and are so found. The
stipulated facts are incorporated in our findings by this
reference.
FINDINGS OF FACT
At the time petitioners filed their petition, they resided in
Delafield, Wisconsin.
Background
From approximately 1956 until 1987, petitioner was a 50-
percent shareholder and vice president of ARCO Industries (ARCO),
a Wisconsin corporation that manufactured chemicals for the
swimming pool industry. Carl Ulrich, who served as president of
ARCO, owned the remaining 50-percent interest in ARCO.
In 1987, petitioner and Mr. Ulrich sold their interests in
ARCO to Sowhite Chemical Corp. (Sowhite Chemical), another
Wisconsin corporation in the same business as ARCO, and petitioner
then retired. Sowhite Chemical agreed to pay the purchase price
for petitioner's and Mr. Ulrich's interests in ARCO through monthly
installments over an 11-year period. The amount of petitioner's
monthly installment was approximately $7,488. In October 1993,
Sowhite Chemical filed for bankruptcy protection and stopped making
payments to petitioner.
IRA Distributions
When petitioner sold ARCO, he rolled his qualified pension
plan into an individual retirement account (IRA). In 1989,
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petitioner retained EMJAY Corp. (EMJAY), an actuary, to calculate
the needed series of substantially equal periodic payments from his
IRA (pursuant to section 72(t)(2)(A)(iv)) to avoid the imposition
of the 10-percent tax on premature distributions under section
72(t)(1). In a December 5, 1989, letter, an executive vice
president of EMJAY advised petitioner of the different calculation
methods petitioner could employ.1 Petitioner elected the
calculation method that allowed him to receive annual distributions
of approximately $44,000.
In December 1989 when petitioner was 55 years old,2 he began
receiving annual distributions from his IRA. The distributions
from petitioner's IRA were as follows:
December 1989 $44,000
January 1990 44,000
January 1991 44,000
January 1992 44,000
January 1993 44,000
November 1993 6,776
Petitioner received the $6,776 distribution in November 1993 to
compensate for the lack of payment by Sowhite Chemical after it
filed for bankruptcy. In November 1993, petitioner was over the
age of 59-1/2.
1
The three permissible methods for calculating the
series of substantially equal periodic payments under sec.
72(t)(2)(A)(iv) are provided in Notice 89-25, Q&A-12, 1989-1 C.B.
662, 666. The parties agree that the method selected by
petitioner satisfies the requirements of Notice 89-25.
2
Petitioner was born on Mar. 3, 1934.
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Notice of Deficiency
In the notice of deficiency, respondent determined that the
November 1993 distribution to petitioner was an impermissible
modification of a series of substantially equal periodic payments.
As a result, respondent determined that the 10-percent recapture
tax under section 72(t)(4) should be imposed on all distributions
made prior to the date petitioner attained age 59-1/2.
OPINION
The sole issue for decision is whether the November 1993
distribution from petitioner's IRA impermissibly modified a series
of substantially equal periodic payments so as to trigger the
imposition of the 10-percent recapture tax under section 72(t)(4).
Generally, amounts distributed from an IRA are includable in
gross income as provided in section 72. Sec. 408(d)(1).
Additionally, a 10-percent tax is imposed under section 72(t)(1) on
any distribution that fails to satisfy one of the exceptions for
premature distributions as provided in section 72(t)(2). Section
72(t)(2) states in pertinent part:
(2) Subsection not to apply to certain distributions.
--Except as provided in paragraphs (3) and (4),
paragraph (1) shall not apply to any of the following
distributions:
(A) In general.--Distributions which are--
* * * * * * *
(iv) part of a series of
substantially equal periodic
payments (not less frequently than
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annually) made for the life (or
life expectancy) of the employee or
the joint lives (or joint life
expectancies) of such employee and
his designated beneficiary * * *
Section 72(t)(4)3 dictates, however, that if the series of
substantially equal periodic payments (which otherwise is excepted
from the 10-percent tax) is subsequently modified (other than by
reason of death or disability) within a 5-year period beginning on
the date of the first distribution, then the 10-percent tax under
3
Sec. 72(t)(4) states in part:
(4) Change in substantially equal payments.--
(A) In general.--If--
(i) paragraph (1) does not apply
to a distribution by reason of
paragraph (2)(A)(iv), and
(ii) the series of payments under
such paragraph are subsequently
modified (other than by reason of
death or disability)--
(I) before the close of
the 5-year period
beginning with the date
of the first payment and
after the employee
attains age 59-1/2, or
(II) before the employee
attains age 59-1/2,
the taxpayer's tax for the 1st taxable year in which
such modification occurs shall be increased by an
amount, determined under regulations, equal to the tax
which (but for paragraph (2)(A)(iv)) would have been
imposed, plus interest for the deferral period.
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section 72(t)(1) will be imposed retroactively on prior
distributions made before the taxpayer attains age 59-1/2, plus
interest. This retroactive application of the 10-percent tax under
section 72(t)(4) is known generally as a recapture tax. See infra.
Petitioners contend that the November 1993 distribution of
$6,776 did not impermissibly modify a series of substantially equal
periodic payments. Petitioners make two principal arguments in
support of this claim.
First, petitioners contend that the November 1993 distribution
occurred after the series of substantially equal periodic payments
was completed in January 1993, and thus no modification occurred.
Respondent asserts that petitioners' contention contradicts the
plain language of section 72(t)(4) which requires no modifications
within a 5-year period. Respondent notes that in this case the 5-
year period beginning with the date of the first distribution ran
from 1989 through 1994. Thus, respondent argues, the November 1993
distribution was premature and hence impermissibly modified the
series of substantially equal periodic payments.
Respondent's position is supported by the legislative history
of section 72(t). The conference report accompanying the Tax
Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, supports the
proposition that the period described in section 72(t)(4)(A)(ii)
must be completed before further distributions can be received to
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avoid imposition of the 10-percent recapture tax under section
72(t)(4):
In addition, the recapture tax will apply if an
individual does not receive payments under a method that
qualifies for the exception for at least 5 years, even if
the method of distribution is modified after the
individual attains age 59-1/2. Thus, for example, if an
individual begins receiving payments in substantially
equal installments at age 56, and alters the distribution
method to a form that does not qualify for the exception
prior to attainment of age 61, the additional tax will be
imposed on amounts distributed prior to age 59-1/2 as if
the exception had not applied. The additional tax will
not be imposed on amounts distributed after attainment of
age 59-1/2. This 5-year minimum payout rule is waived
upon the death or disability of the employee.
H. Conf. Rept. 99-841, at II-457 (1986), 1986-3 C.B. (Vol. 4) 1,
457. It is evident that the 5-year period in section 72(t)(4)
closes at the end of 5 years from the date of the first
distribution; it does not end on the date of the fifth annual
distribution pursuant to a series of substantially equal periodic
annual payments.
In the case herein, petitioner received the fifth distribution
from his IRA in January 1993, slightly more than 3 years from the
date of the first distribution. Under section 72(t)(4), petitioner
was required to wait until sometime in December 1994 before he
could receive additional distributions that would avoid modifying
the prior series of substantially equal periodic payments. He did
not meet the required waiting period. Instead, petitioner received
his distribution in November 1993, prior to the close of the 5-year
period as provided in section 72(t)(4).
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Next, petitioners argue that the November 1993 distribution
was part of a cost-of-living adjustment which respondent concedes
would be a permissible modification to the series of substantially
equal periodic payments during the applicable 5-year period. See
Staff of Joint Comm. on Taxation, General Explanation of the Tax
Reform Act of 1986, at 717 (J. Comm. Print 1987). In this regard,
petitioners note that the $6,776 distribution, spread over the
latter 4 years of distributions, was only a 3.65-percent increase
over the prior $44,000 distributions and "was well within the
limits of a reasonable cost of living adjustment (CLA), and thus
not a modification."
Respondent claims, and we agree, that petitioners have failed
to prove that the purpose of the November 1993 distribution was to
serve as a cost-of-living adjustment. Rule 142(a); Welch v.
Helvering, 290 U.S. 111 (1933). Petitioners did not put forth any
evidence of the appropriate cost-of-living adjustment for the
relevant time period, nor did they explain how they arrived at the
figure calculated or why the adjustment was made in the form of a
lump-sum payment in November 1993 (rather than allocated over each
of the years).
Petitioner testified that the November 1993 distribution was
received after Sowhite Chemical filed for bankruptcy protection in
October 1993 and ceased making its monthly installment payments to
him. Thus, it is evident that petitioner received the distribution
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as a result of a financial hardship when his monthly cash flow was
suddenly reduced. However, no exception exists under section 72(t)
for financial hardship. See Duffy v. Commissioner, T.C. Memo.
1996-556; Pulliam v. Commissioner, T.C. Memo. 1996-354.
The legislative purpose underlying the section 72(t) tax is
that "premature distributions from IRA's frustrate the intention of
saving for retirement, and section 72(t) discourages this from
happening." Dwyer v. Commissioner, 106 T.C. 337, 340 (1996); see
also S. Rept. 93-383, at 134 (1973), 1974-3 C.B. (Supp.) 80, 213.
In order to avoid the section 72(t) tax, petitioners must show that
the November 1993 distribution falls within one of the exceptions
provided under section 72(t)(2)(A). They have not done so.
Consequently, we hold that the November 1993 distribution
impermissibly modified a series of substantially equal periodic
payments. Thus, the 10-percent recapture tax under section
72(t)(4) is applicable to all distributions petitioner received
prior to the date he attained 59-1/2.
To reflect the foregoing,
Decision will be entered
for respondent.