Michael G. Bunney v. Commissioner

114 T.C. No. 17
UNITED STATES TAX COURT
MICHAEL G. BUNNEY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 20713-97. Filed April 10, 2000.
Petitioner (H) and his former wife (W) were
divorced in 1992. H and W were residents of
California, a community property State. The judgment
dissolving the marriage ordered that H’s IRA’s, which
were funded with contributions that were community
property, be divided equally between H and W. In 1993,
H withdrew $125,000 from his IRA’s and transferred
$111,600 to W. Held: sec. 408(g), I.R.C., precludes
characterization of W as a 50-percent “distributee” of
H’s IRA’s under sec. 408(d)(1), I.R.C.; accordingly, H,
not W, is taxable on the distributions. Held, further,
no portion of the $111,600 paid to W is excludable from
H’s income under sec. 408(d)(6), I.R.C. Held, further,
H is liable for the sec. 72(t), I.R.C., additional tax
on the IRA distributions. Held, further, petitioner
had a reasonable basis for his position, and thus the
accuracy-related penalty for negligence under sec.
6662(a), I.R.C., applies only with respect to the
adjustments conceded by H.
- 2 -
Lawrence J. Kaplan, for petitioner.
Christine V. Olsen, for respondent.
OPINION
LARO, Judge: This case is before the Court fully
stipulated. See Rule 122. Petitioner petitioned the Court to
redetermine respondent’s determination of an $84,080 deficiency
in Federal income tax for 1993 and a $16,816 accuracy-related
penalty for negligence under section 6662(a).
After concessions,1 we must decide the following issues with
respect to 1993:
1. Whether petitioner’s gross income includes the entire
$125,000 in distributions he received from his individual
retirement accounts (IRA’s). We hold it does.
1
Petitioner concedes the following: (1) His gross income
includes a $64,054 gain on the sale of his home; (2) he may
deduct only $1,476 of the $11,735 claimed for legal and
professional fees paid; (3) he may not deduct the $11,000 claimed
with respect to the purchase of a horse, but may take a Schedule
F, Profit or Loss From Farming, depreciation deduction in the
amount of $393; and (4) he may not deduct the $5,178 claimed for
repair expenses paid. Petitioner also concedes that he should be
taxed on one-half of the $125,000 in IRA distributions he
received in 1993, but he challenges whether he is liable for tax
on the other half.
- 3 -
2. Whether petitioner is subject to the 10-percent
additional tax for early distributions under section 72(t). We
hold he is.
3. Whether petitioner is liable for the negligence
accuracy-related penalty. We hold he is, but only as to the
conceded items.
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the year in issue. Rule
references are to the Tax Court Rules of Practice and Procedure.
Dollar amounts are rounded to the nearest dollar.
Background
The stipulation of facts and the exhibits submitted
therewith are incorporated herein by this reference. Petitioner
was born on August 23, 1944. He resided in California when the
petition in this case was filed.
Petitioner was formerly married. He and his former spouse
were granted a Judgment of Dissolution of Marriage (dissolution
judgment) on August 17, 1992. The dissolution judgment stated:
“IT IS FOUND that all of MICHAEL BUNNEY’S retirement valued at
approximately $120,000 was accumulated by the parties prior to
their separation and ordered to be divided equally between the
parties.”
Petitioner’s retirement savings consisted of several IRA
accounts. The money used to fund petitioner’s IRA’s had been
- 4 -
community property. During 1993, petitioner withdrew $125,000
from his IRA’s and deposited the proceeds in his money market
savings account. During the same year, petitioner transferred
$111,600 to his former spouse in a transaction in which he
acquired her interest in the family residence. Petitioner
reported only the remaining $13,400 of the distributions on his
1993 Federal income tax returns.
Discussion
Issue 1. Taxability of IRA Distributions
A. Allocation of Tax Liability
We pass for the first time on the question of whether one-
half of community funds contributed to an IRA account established
by an IRA participant are, upon distribution, taxable to the
participant’s former spouse by virtue of the fact that the former
spouse has a 50-percent ownership interest in the IRA under
applicable community property law. Section 408(g), as discussed
below, provides explicitly that section 408 (the statutory
provision governing IRA requirements and the taxability of IRA
distributions) “shall be applied without regard to any community
property laws”. Thus, at first blush, it appears that the answer
to our question is that the husband is taxable on 100-percent of
the distribution notwithstanding the fact that his former wife
owned and was entitled to receive 50 percent of the distributed
proceeds. As petitioner observes, however, the Commissioner
- 5 -
administratively has recognized that section 408(g) does not
preclude taking community property rights into account in
allocating the tax consequences of IRA distributions. See Priv.
Ltr. Rul. 80-401-01 (Jul. 15, 1980) (distribution of decedent’s
community property interest in surviving spouse’s IRA is taxable
to decedent’s legatees). But see Priv. Ltr. Rul. 93-440-27 (Aug.
9, 1993) (distribution of wife’s community property interest in
husband’s IRA under a separation agreement is taxable to
husband).2 Additionally, the courts of at least two community
property States have concluded that section 408(g) does not
preempt recognition of community property rights in an IRA for
State law purposes.3 See In re Mundell, 857 P.2d 631, 633 (Idaho
1993) (community property interest in wife’s IRA is includable in
2
We recognize that private letter rulings have no
precedential value but merely represent the Commissioner’s
position as to a specific set of facts. See sec. 6110(j)(3)
(redesignated sec. 6110(k)(3) under the IRS Restructuring and
Reform Act of 1998, Pub. L. 105-206, sec. 3509(b), 112 Stat. 743,
772); Lucky Stores, Inc. v. Commissioner, 153 F.3d 964, 966 n.5
(9th Cir. 1998), affg. 107 T.C. 1 (1996); Fowler v. Commissioner,
98 T.C. 503, 506 n.5 (1992); Estate of Jalkut v. Commissioner, 96
T.C. 675, 684 (1991); First Chicago Corp. v. Commissioner, 96
T.C. 421, 443 (1991), affd. 135 F.3d 457 (7th Cir. 1998). We
mention these rulings merely to set forth the Commissioner’s
administrative practice as to sec. 408(g). See Rowan Cos. v.
United States, 452 U.S. 247, 261 n.17 (1981); First Chicago Corp.
v. Commissioner, 96 T.C. 421, 443 (1991).
3
We address a somewhat narrower issue, i.e., whether for
Federal income tax purposes petitioner is the sole “distributee”
and thus taxable on the distributions he received from his IRA’s.
We do not address, as did these State cases, whether sec. 408(g)
preempts community property interests in IRA’s altogether.
- 6 -
husband’s estate); Succession of McVay v. McVay, 476 So. 2d 1070,
1073-1074 (La. Ct. App. 1985) (IRA to be accounted for in
division of community property at divorce).
Our analysis of this issue begins with section 408(d)(1).
Pursuant to that section, “any amount paid or distributed out of
an individual retirement plan shall be included in gross income
by the payee or distributee, as the case may be, in the manner
provided under section 72.” Neither the Code nor applicable
regulations define the terms “distributee” or “payee” as used in
section 408(d)(1). In construing a parallel provision governing
the taxation of distributions from pension plans under section
402,4 we have held that a distributee is generally “the
participant or beneficiary who, under the plan, is entitled to
receive the distribution”. Darby v. Commissioner, 97 T.C. 51, 58
(1991); see also Estate of Machat v. Commissioner, T.C. Memo.
1998-154. Under this definition, petitioner would be the
distributee and the payee because he was the IRA participant and
received the distributions according to the terms of his IRA’s.
Similarly, petitioner’s former spouse would not be a distributee
because she was not the IRA participant and did not receive the
funds as a designated beneficiary. Thus, unless the community
4
Sec. 402(b)(2) provides that “The amount actually
distributed or made available to any distributee by * * * [an
employee’s trust] shall be taxable to the distributee, in the
taxable year in which so distributed or made available, under
section 72”.
- 7 -
property interest of petitioner’s former spouse is recognizable
for Federal income tax purposes, the distributions are taxable to
petitioner.
Petitioner acknowledges that section 408(g) requires that
section 408 be applied without regard to community property laws,
but he contends that his former spouse’s community property
interest in his IRA’s arose ab initio and thus may be taken into
account to determine the taxability of the distributions.
Respondent takes no position in this case on the effect of
section 408(g). Instead, respondent contends that petitioner is
the sole taxable distributee because he was the sole recipient of
the distributions.
We disagree with respondent’s assertion that the recipient
of an IRA distribution is automatically the taxable distributee.
We have held that in the context of a distribution from a pension
plan the term “distributee” is not necessarily synonymous with
“recipient”. Estate of Machat v. Commissioner, T.C. Memo. 1998-
154 (citing Darby v. Commissioner, 97 T.C. 51, 64-66 (1991)). We
nevertheless find that petitioner was the sole distributee in
this case. The IRA’s were established by petitioner in his name,
and, by reason of section 408(g), his wife is not treated as a
distributee of any portion of the IRA for Federal income tax
purposes despite her community property interest therein.
- 8 -
Recognition of community property interests in an IRA for
Federal income tax purposes would conflict with the application
of section 408 in several ways. As an initial matter, an account
imbued with a community property characterization would have
difficulty meeting the IRA qualifications. Section 408(a)
defines an IRA as a trust created or organized “for the exclusive
benefit of an individual or his beneficiaries”. (Emphasis
added.) An account maintained jointly for a husband and wife
would be created for the benefit of two individuals and would not
meet this definition. See Rodoni v. Commissioner, 105 T.C. 29,
33 (1995) (“as its name suggests, the essence of an IRA is that
it is a retirement account created to provide retirement benefits
to ‘an individual’”).
Secondly, recognition of community property interests would
jeopardize the participant’s ability to roll over the IRA funds
into a new IRA. Section 408(d)(3)(A)(i) provides that
distributions out of an IRA “to the individual for whose benefit
the account * * * is maintained” are not taxable under section
408(d)(1) if the entire amount received is paid into an IRA “for
the benefit of such individual” within 60 days. (Emphasis
added.) The rollover of a community-owned IRA would doubly fail
because both the distribution and contribution would involve two
persons.
- 9 -
Thirdly, recognition of community property interests would
affect the minimum distribution requirements for IRA’s. Section
408(a)(6) requires that distributions from an IRA account meet
the requirements of section 401(a)(9). Among those requirements
is that the individual for whom an IRA is maintained withdraw the
balance in the IRA or start receiving distributions from the IRA
by April 1 of the year following the year in which such
individual reaches 70-1/2. See sec. 401(a)(9)(c). Recognition
of a nonparticipant spouse’s community property interest in the
IRA might require the age of the nonparticipant spouse to be
taken into account in determining the commencement date for the
required distributions.
In addition, treating a nonparticipant spouse as a 50-
percent distributee would create an asymmetry. Section 219(f)(2)
provides that the deductibility of a contribution to an IRA is to
be determined without regard to any community property laws. See
Medlock v. Commissioner, T.C. Memo. 1978-464. Section 408(g)
appropriately balances that provision by disregarding community
property laws when the IRA funds are later distributed. These
sections work in tandem to insure that an IRA participant who
lives in a community property State is treated as both the sole
contributor and the sole distributee of IRA funds.
In Powell v. Commissioner, 101 T.C. 489, 496 (1993), we
indicated that the distribution of a community property interest
- 10 -
in a retirement plan is taxed one-half to each spouse except
where Congress has specified otherwise; e.g., in sections
219(f)(2), 402(e)(4)(G), and 408(g). In Karem v. Commissioner,
100 T.C. 521, 529 (1993), we held that a pension distribution
subject to section 402(e)(4)(G) was taxable entirely to the
participant even though his former spouse was considered a one-
half owner under State community property law. Unlike the
taxpayer in Powell, the taxpayer in Karem had elected the multi-
year averaging method then available under former section 402(e)
for computing the tax due on lump-sum distributions. As a
result, the distributions were subject to former section
402(e)(4)(G), which provided that “the provisions of this
subsection * * * shall be applied without regard to community
property laws.” Consistent with these opinions, we hold that
section 402(g) precludes taxation of petitioner’s former spouse
as a distributee in recognition of her State community property
interest in petitioner’s IRA’s. Accordingly, the distributions
from petitioner’s IRA’s are wholly taxable to petitioner.
B. Nonrecognition Under Section 408(d)(6)
Petitioner alternatively contends that the distribution and
transfer of his IRA proceeds pursuant to the dissolution judgment
- 11 -
was a nonrecognition event for him under section 408(d)(6).5 We
disagree.
There are two requirements that must be met for the
exception of section 408(d)(6) to apply: (1) There must be a
transfer of the IRA participant’s “interest” in the IRA to his
spouse or former spouse, and (2) such transfer must have been
made under a section 71(b)(2) divorce or separation instrument.
The transaction at issue does not meet the first
requirement. Petitioner did not transfer any of his interest in
his IRA’s to his former spouse. Rather, he cashed out his IRA’s
and paid her some of the proceeds.6 The distribution itself was
5
Sec. 408(d)(6) provides:
Transfer of account incident to divorce.--The
transfer of an individual’s interest in an
individual retirement account or an individual
retirement annuity to his spouse or former spouse
under a divorce or separation instrument described
in subparagraph (A) of section 71(b)(2) is not to
be considered a taxable transfer made by such
individual notwithstanding any other provision of
this subtitle, and such interest at the time of
the transfer is to be treated as an individual
retirement account of such spouse, and not of such
individual. Thereafter such account or annuity for
purposes of this subtitle is to be treated as
maintained for the benefit of such spouse.
6
IRS Publication 590 describes two commonly used methods of
transferring an interest in an IRA: (1) Changing the name on the
IRA to that of the nonparticipant spouse or (2) directing the
trustee of the IRA to transfer the IRA assets to the trustee of
an IRA owned by the nonparticipant spouse.
- 12 -
a taxable event for petitioner that was not covered by section
408(d)(6).7 See Czepiel v. Commissioner, T.C. Memo. 1999-289.
Issue 2. Section 72(t)(1) Additional Tax
Respondent determined that the distributions made to
petitioner out of his IRA’s were subject to the 10-percent
additional tax on early withdrawals from an IRA imposed by
section 72(t).8 Section 72(t)(1) imposes a 10-percent additional
tax on early distributions from qualified retirement plans. A
qualified retirement plan includes an IRA. Secs. 408(a),
4974(c)(4).
Section 72(t)(2)(A) lists the types of distributions to
which the additional tax does not apply. Petitioner has the
burden of proving his entitlement to any of these exceptions.
See Matthews v. Commissioner, 92 T.C. 351, 361-362 (1989), affd.
907 F.2d 1173 (D.C. Cir. 1990). Petitioner has not produced any
7
Sec. 408(d)(6) governs the transfer of an “individual’s
interest” in an IRA. It does not address distributions. In
contrast, distributions from a qualified pension plan pursuant to
a qualified domestic relations order may be reallocated to a
spouse (designated as the “alternate payee” and considered a plan
“beneficiary”). See sec. 402(e)(1)(A); 29 U.S.C. sec.
1056(d)(3)(J) (1993).
8
Sec. 72(t)(1) provides:
Imposition of additional tax.--If any taxpayer receives
any amount from a qualified retirement plan (as defined
in section 4974(c)), the taxpayer’s tax under this
chapter for the taxable year in which such amount is
received shall be increased by an amount equal to 10
percent of the portion of such amount which is
includible in gross income.
- 13 -
evidence that any exception applies in this case. Accordingly,
we sustain respondent’s determination as to the section 72(t)
additional tax.
Issue 3. Addition to Tax for Negligence.
Respondent determined that petitioner is liable for the
negligence accuracy-related penalty under section 6662(a). That
section imposes an accuracy-related penalty equal to 20 percent
of the portion of an underpayment that is attributable to
negligence. Petitioner will avoid this penalty if the record
shows that he made a reasonable attempt to comply with the
provisions of the Internal Revenue Code, and that he was not
careless, reckless, or in intentional disregard of rules or
regulations. See sec. 6662(c); Accardo v. Commissioner, 942 F.2d
444, 452 (7th Cir. 1991), affg. 94 T.C. 96 (1990); Drum v.
Commissioner, T.C. Memo. 1994-433, affd. without published
opinion 61 F.3d 910 (9th Cir. 1995).
Negligence connotes a lack of due care or a failure to do
what a reasonable and prudent person would do under the
circumstances. See Allen v. Commissioner, 92 T.C. 1 (1989),
affd. 925 F.2d 348 (9th Cir. 1991); Neely v. Commissioner, 85
T.C. 934, 947 (1985). The negligence accuracy-related penalty is
inapplicable to any portion of an underpayment to the extent that
an individual has reasonable cause for that portion and acts in
good faith with respect thereto. See sec. 6664(c)(1). Such
- 14 -
penalty is also inapplicable where a taxpayer has a “reasonable
basis” for the return position taken. See sec. 1.6662-3(b),
Income Tax Regs. A return position that is “arguable, but fairly
unlikely to prevail in court” satisfies the reasonable basis
standard. Sec. 1.6662-4(d)(2), Income Tax Regs. The negligence
accuracy-related penalty is inappropriate where an issue to be
resolved by the Court is one of first impression involving
unclear statutory language. See Everson v. United States, 108
F.3d 234 (9th Cir. 1997); Lemishow v. Commissioner, 110 T.C. 110
(1998).
With respect to petitioner’s conceded items, petitioner
claimed deductions to which he was not entitled, duplicated
deductions, and omitted taxable gain from the sale of property.
Petitioner also failed to report income from more than half of
his IRA distributions and failed to pay the 10-percent premature
distribution penalty. Petitioner contends that he is not liable
for an accuracy-related penalty with respect to these items
because Form 1040 is a “complicated return”, and he utilized a
tax software program to prepare his return.
On this stipulated record, we conclude petitioner is liable
for the negligence accuracy-related penalty with respect to the
conceded items. There is no evidence that reasonable cause
existed for these errors or that petitioner was not negligent.
Tax preparation software is only as good as the information one
- 15 -
inputs into it. Petitioner has not shown that any of the
conceded issues were anything but the result of his own
negligence or disregard of regulations.9
As to the contested adjustment, this Court has not
previously addressed the issue of whether section 408(g)
precludes recognition of a spouse’s community property interest
in allocating the taxability of an IRA distribution. While we
find the text of section 408(g) to be clear and unambiguous on
its face, we bear in mind that the Commissioner has interpreted
section 408(g) administratively in a manner that is inconsistent
with our holding herein. Under these circumstances, we conclude
that petitioner had a reasonable basis for his return position
that one-half of his IRA distributions were allocable to his
former spouse.10 Accordingly, we hold the negligence accuracy-
9
Petitioner has claimed entitlement to an NOL carryback that
may eliminate some or all of the deficiency determined in this
case. The parties have agreed to address this issue in the
context of their Rule 155 computations. Petitioner is liable for
the negligence accuracy-related penalty regardless of whether the
claimed NOL carryback eliminates the deficiency for the year. A
loss in a later year does not reduce the underpayment for
purposes of imposing the penalty. See C.V.L. Corp. v.
Commissioner, 17 T.C. 812, 816 (1951); McCauley v. Commissioner,
T.C. Memo. 1988-431; sec. 1.6664-2(f), Income Tax Regs.; see also
Estate of Trompeter v. Commissioner, 111 T.C. 57, 59-60 (1998),
and the cases cited therein.
10
We note that for returns filed on or after Dec. 2, 1998,
respondent’s view is that a return position “reasonably based on
one or more of the authorities set forth in §1.6662-4(d)(3)(iii)
(taking into account the relevance and persuasiveness of the
authorities, and subsequent developments)” will generally satisfy
(continued...)
- 16 -
related penalty is inapplicable to the taxes and penalties
imposed on one-half of petitioner’s 1993 IRA distributions.
In reaching our holdings herein, we have considered all
arguments made by the parties, and, to the extent not discussed
above, we find those arguments to be irrelevant or without merit.
To reflect the foregoing and concessions,
Decision will be entered
under Rule 155.
10
(...continued)
the reasonable basis standard. Sec. 1.6662-3(b)(3), Income Tax
Regs., as amended by T.D. 8790, 1998-50 I.R.B. 4. Among the
authorities set forth in sec. 1.6662-4(d)(3)(iii), Income Tax
Regs., are private letter rulings issued after Oct. 31, 1976.