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IRS Didn’t Bear Burden Of Production On Code Sec. 72(T) Additional Tax

Ralim S. El (2014) 144 TC No. 9

The Tax Court has determined that a taxpayer received and failed to report a deemed taxable distribution from his retirement account. As a result, the taxpayer was liable for the Code Sec. 72(t) additional tax on this deemed taxable distribution as well as various penalties. The Tax Court found that the burden of production did not shift to IRS under Code Sec. 7491(c) with respect to the Code Sec. 72(t) additional tax because the additional tax was a “tax” and not a “penalty, addition to tax, or additional amount” within the meaning of Code Sec. 7491(c).

Background. Under the general rule of Code Sec. 72(p)(1)(A), taking a loan from a qualified retirement plan results in a deemed distribution that is taxable in the year in which the taxpayer receives the loan. However, Code Sec. 72(p)(2) provides an exception to the general rule for loans that satisfy certain requirements (that generally limit loan amount, loan terms and repayment period). Specifically, the loan amount can’t exceed the lesser of: (1) $50,000, or (2) 1/2 of the present value of the employee’s nonforfeitable accrued benefit under the plan. But a loan up to $10,000 is allowed, even if it’s more than half the employee’s accrued benefit. (Code Sec. 72(p)(2))

Early withdrawals from a qualified retirement plan, SIMPLE plan, or IRA result in an additional tax (reported on Form 5329) equal to 10% of the amounts withdrawn that are includible in gross income. (Code Sec. 72(t)(1)) The additional tax applies to all withdrawals unless specifically excepted. (Code Sec. 72(t)(2), Code Sec. 72(t)(3))

Under Code Sec. 7491(c), notwithstanding any other Code provision, IRS has the burden of production in any court proceeding with respect to the liability of any individual for any penalty imposed by the Code. In other words, IRS must come forward initially with evidence that it is appropriate to apply a particular penalty to the taxpayer.

Facts. In 2009, Ralim S. El was an assistant with the Manhattan Psychiatric Center and received wages of $48,001 for services that he provided. The Manhattan Psychiatric Center is run by the New York State Office of Mental Health. In 2009, the State of New York (New York) issued the taxpayer a Form W-2, Wage and Tax Statement, for 2009 that showed that the taxpayer had received $48,001 of wages, from which New York had withheld $2,217 of Federal income tax.

The taxpayer was a member of the Employees’ Retirement System (ERS) through the Manhattan Psychiatric Center. ERS is a member of the New York State and Local Retirement System (NYSLRS). The ERS retirement plan in which the taxpayer participated allows participants to take loans against their accounts, and loans from the ERS retirement plan are governed by rules established for the NYSLRS.

In years before 2009, the taxpayer had requested and received loans from his ERS retirement account. On Apr. 14, 2009, the taxpayer again requested a loan in the maximum allowable amount from ERS, which issued a loan of $5,993 to him on Apr. 29, 2009.

After ERS distributed the loan proceeds to him, the taxpayer’s retirement account showed that he had total contributions to his ERS retirement plan of $17,071 and that he had an outstanding loan balance of $12,802. ERS determined for 2009 that $2,802 of his loan proceeds was taxable. For 2009, the NYSLRS issued to the taxpayer a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., which reported that the taxpayer had received a taxable distribution of $2,802.

The taxpayer did not file a Federal income tax return for 2009.

IRS determined a deficiency in the taxpayer’s Federal income tax and additions to tax under Code Sec. 6651(a)(1) (dealing the penalty for failure to timely file a return) and Code Sec. 6651(a)(2) (dealing with the penalty for failure to pay the amount of tax shown on a return). The deficiency determination included additional tax under Code Sec. 72(t).

The issue. The Tax Court noted that it had not previously decided whether, under Code Sec. 7491(c), IRS bears the burden of production with respect to the additional tax under Code Sec. 72(t). (Milner, TC Memo 2004-111)

Court’s conclusion. The Tax Court held that the taxpayer failed to report his wage income and that he was required to file a return for 2009.

The Court further found that the taxpayer failed to report a deemed taxable distribution from his retirement account. The Court also concluded that the taxpayer was liable for the Code Sec. 72(t) additional tax on this deemed taxable distribution. The Court reasoned that after the taxpayer received the Apr. 29, 2009 loan proceeds, his loan balance in his ERS retirement plan account was $12,802. This was $2,802 greater than the greater of one-half of his “nonforfeitable accrued benefit” (i.e., one-half of $17,071) or $10,000. Thus, the taxpayer had a deemed taxable distribution of $2,802 from his ERS retirement plan account in 2009.

The Court also concluded that Code Sec. 7491(c) did not shift the burden of production to IRS with respect to the additional tax because the additional tax was a tax and not a “penalty, addition to tax, or additional amount” within the meaning of Code Sec. 7491(c) . The Court reasoned that Code Sec. 72(t) itself states that it imposes a “tax” and not a “penalty”, “addition to tax”, or “additional amount”; (2) several Code provisions expressly refer to the additional tax under Code Sec. 72(t) using the unmodified term “tax” (for example, Code Sec. 26(b)(2), Code Sec. 401(k)(8)(D), Code Sec. 401(m)(7)(A), Code Sec. 414(w)(1)(B), and Code Sec. 877A(g)(6)); and (3) the placement of Code Sec. 72(t) in subtitle A, chapter 1 of the Code indicates that it is a tax.

The Court also found that the taxpayer was liable for the Code Sec. 6651(a)(1) addition to tax for failing to timely file a return. However, the taxpayer wasn’t liable for the Code Sec. 6651(a)(2) addition to tax for failing to timely pay tax shown on a return. Where a taxpayer did not file a return, IRS must introduce evidence that a substitute for return satisfying the requirements of Code Sec. 6020(b) was made; IRS conceded that it failed to show that this was so.

The Court, in the exercise of its discretion, did not find the taxpayer liable for a Code Sec. 6673(a)(1) penalty for asserting frivolous or groundless positions. However, the taxpayer was warned by the Court.

 

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Meet Paul Raymond

Meet Paul Raymond

Mr. Raymond is a sought after speaker in tax controversy law by many attorney, accountant, and business groups and at the request of the Internal Revenue Service, has presented programs at the IRS Nationwide Tax Forum, attended by tax professionals throughout the United States.

Additionally, he continues to be an active member in the Section of Taxation, American Bar Association, where he was the Past Chair of the Employment Taxes Committee.

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