                         T.C. Summary Opinion 2017-43



                         UNITED STATES TAX COURT



    RICHARD LEE FANN AND BEVERLY SELENA FANN, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 18356-15S.                         Filed June 28, 2017.



      Richard Lee Fann and Beverly Selena Fann, pro sese.

      William Maule and Mark J. Tober, for respondent.



                              SUMMARY OPINION


      GERBER, 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 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 is not reviewable by any

other court, and this opinion shall not be treated as precedent for any other case.

      The issues for our consideration are: (1) whether for 2012 any portion of

petitioners’ distribution from an individual retirement account is excepted from

the 10% additional tax imposed by section 72(t) for early withdrawal and (2)

whether petitioners are liable for an accuracy-related penalty under section

6662(a).

                                    Background

      Petitioners resided in Alabama at the time their petition was filed. They

petitioned in response to respondent’s determination of a $12,665 income tax

deficiency and a $2,533 penalty under section 6662(a) for an underpayment

attributable to a substantial understatement of income tax for the 2012 tax year.

The income tax deficiency is due to the 10% additional tax on early withdrawal

from a retirement account pursuant to section 72(t). During 2012 Mrs. Fann was

50 years of age when she requested and received a premature $126,648

distribution from her Verizon Pension Plan account. Petitioners’ 2012 adjusted

gross income was $156,594. The distribution was sought because of petitioners’

job loss, medical problems, and large debt.
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        When the distribution was received, it had been reduced by 20% for income

tax withholding, leaving the net amount available for petitioners to satisfy

outstanding debt, pay medical bills, and cover daily basic living expenses.

Petitioners reported the full amount of the distribution on their joint 2012 Form

1040, U.S. Individual Income Tax Return. At the time of the distribution

petitioners were insolvent and in a state of financial hardship. Because of the loss

of Mrs. Fann’s employment, petitioners did not have medical insurance during

2012.

        During the pendency of their examination, petitioners substantiated $6,939

of medical expenses that they paid with proceeds from the distribution. Petitioners

each used a blood pressure medication, and they paid $2,000 during 2012 for the

medication in addition to the $6,939 substantiated and agreed to by respondent.

        Petitioners prepared their 2012 income tax return without the assistance of a

tax professional. At the time they prepared the return, they understood that all tax

due had been withheld from the distribution as reflected on tax information

received from the bank that made the distribution. They did not report a 10% tax

on an early withdrawal from a retirement account.
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                                    Discussion2

      There is no dispute about whether the retirement account distribution during

2012 constitutes gross income subject to Federal income tax. See secs. 61(a) and

(b), 72(a)(1).3 The dispute is about whether the distribution is subject to the 10%

additional tax imposed by section 72(t).

       Section 72(t)(1) provides for an additional tax of 10% on early withdrawals

from qualified retirement plans. Petitioners argue that their financial hardship and

medical bills should except them from the 10% additional tax. Section 72(t)(2)

provides for several exemptions from the additional tax. The following exception

is relevant:

             (B) Medical expenses.--Distributions made to the employee
      * * * to the extent such distributions do not exceed the amount
      allowable as a deduction under section 213 to the employee for
      amounts paid during the taxable year for medical care * * *.

      Respondent agrees that petitioners have substantiated medical expenses of

$6,939, and petitioners proved in Court that they paid an additional $2,000.



      2
      There is no dispute in this case concerning the burden of proof or
production.
      3
       As a general rule, if a taxpayer receives a distribution from a qualified
retirement plan before attaining the age of 59-1/2, sec. 72(t) imposes an additional
tax equal to 10% of the portion of the distribution which is includible in the
taxpayer’s gross income
                                        -5-

Section 213(a) provides that eligible medical expenses may be deducted to the

extent they exceed 7.5% of adjusted gross income. Petitioners’ adjusted gross

income for 2012 was $156,594, and they paid $8,939 in unreimbursed medical

expenses that year. Because petitioners’ unreimbursed medical expenses did not

exceed $11,744 (7.5% of $156,594)--the floor for an allowable deduction under

section 213--it follows that they are ineligible for the medical expense exception

provided in section 72(t)(2)(B). See Dwyer v. Commissioner, 106 T.C. 337, 343

(1996); McGraw v. Commissioner, T.C. Memo. 2013-152.

      Petitioners maintain that the 10% additional tax should not apply because

Mrs. Fann was compelled to seek the distribution in response to extreme economic

hardship. We have considered similar claims and found no authority for a general

financial hardship exception to the imposition of the 10% additional tax on early

distributions. See Arnold v. Commissioner, 111 T.C. 250, 255 (1998); Dollander

v. Commissioner, T.C. Memo. 2009-187; Milner v. Commissioner, T.C. Memo.

2004-111. Clearly petitioners’ situation is compelling and sympathetic, but we are

without authority to remedy it in these circumstances.

      Finally, we consider whether petitioners are liable for an accuracy-related

penalty under section 6662(a). Section 6662(a) and (b)(1) and (2) imposes an

accuracy-related penalty of 20% on the portion of an underpayment attributable to
                                        -6-

negligence, disregard of rules or regulations, or a substantial understatement of

income tax.

      The Commissioner bears the burden of production with respect to penalties.

Sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). Once the

burden of production is met, the taxpayer must come forward with evidence

sufficient to show that the penalty does not apply. Higbee v. Commissioner, 116

T.C. at 447. Petitioners’ understatement of tax is $12,665. The understatement

exceeds the greater of 10% of the tax required to be shown or $5,000. Thus, the

understatement is substantial for purposes of section 6662(d)(1)(A), and

respondent’s burden of production has been met.

      Section 6664(c)(1) provides a defense to the section 6662(a) penalty for any

portion of an underpayment for which the taxpayers had reasonable cause and

acted in good faith. Therefore the 2012 accuracy-related penalty under section

6662(a) would apply unless we find under section 6664(a) that the underpayment

was due to reasonable cause and that petitioners acted in good faith. Neonatology

Assocs., P.A. v. Commissioner, 115 T.C. 43 (2000), aff’d, 299 F.3d 221 (3d Cir.

2002).

      Section 1.6664-4, Income Tax Regs., provides guidance as to what

constitutes the reasonable cause and good faith exception to section 6662(a)
                                        -7-

penalties. The decision as to whether a taxpayer acted with reasonable cause and

in good faith is made on a case-by-case basis, taking into account all pertinent

facts and circumstances. See sec. 1.6664-4(b)(1), Income Tax Regs. We consider

the extent of the effort a taxpayer makes to assess the taxpayer’s proper tax

liability. Circumstances that may indicate 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.

      In the setting of this case, petitioners reported the $126,648 withdrawal

from Mrs. Fann’s retirement account as part of their income and paid tax at

ordinary income rates. When they prepared their return, petitioners believed that

tax due on the withdrawal had been withheld and remitted to respondent. In

addition, petitioners believed that their medical bills and financial hardship were

acceptable reasons for early withdrawal of retirement funds.

      Respondent contends that there is a substantial understatement of income

tax, but does not contend that there was negligence or disregard of rules or

regulations. In these circumstances, and considering petitioners’ testimony,

education and explanation, we hold that petitioners’ actions were reasonable.

Accordingly, the accuracy-related penalty does not apply.
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To reflect the foregoing,

                                        Decision will be entered for

                                  respondent with respect to the income

                                  tax deficiency and for petitioners with

                                  respect to the section 6662(a) penalty.
