                   T.C. Summary Opinion 2011-16



                      UNITED STATES TAX COURT



         PAULETTE A. AND MATTHEW D. MALENA, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 29211-09S.             Filed February 24, 2011.




     Paulette A. Malena, pro se.

     Christopher A. Pavilonis, for respondent.



     ARMEN, Special Trial 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   Pursuant to section

7463(b), the decision to be entered is not reviewable by any


     1
        Unless otherwise indicated, all subsequent 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.
                              - 2 -

other court, and this opinion shall not be treated as precedent

for any other case.

     Respondent determined a deficiency in petitioners’ 2007

Federal income tax of $15,743, as well as a section 6662(a)

accuracy-related penalty of $3,132.

     After the dismissal of petitioner Matthew D. Malena,2 the

issues for decision are:

     (1) Whether petitioner Paulette A. Malena (petitioner)

received unreported income, principally in the form of a taxable

distribution under section 72(p) related to a defaulted loan;

     (2) whether petitioner is entitled to a mortgage interest

deduction on Schedule A, Itemized Deductions, greater than that

allowed by respondent in the notice of deficiency;

     (3) whether petitioner is entitled to a medical expense

deduction greater than that claimed by her on her return as

filed;

     (4) whether petitioner is liable for a 10-percent additional

tax under section 72(t) by virtue of a taxable distribution under

section 72(p); and


     2
        Petitioner Matthew D. Malena, a resident of the State of
Florida at the time that the petition was filed, did not execute
the stipulation, nor did he appear at trial. Accordingly, the
Court granted respondent’s motion to dismiss this case as to him
for lack of prosecution. See Rule 123(b). However, the decision
to be entered against petitioner Matthew D. Malena will be
consistent with the decision to be entered against petitioner
Paulette A. Malena as to the deficiency in tax and the accuracy-
related penalty. See Rule 123(d).
                                - 3 -

     (5) whether petitioner is liable for a section 6662(a)

accuracy-related penalty.

                            Background

     Some of the facts have been stipulated, and they are so

found.   We incorporate by reference the parties’ stipulation of

facts and accompanying exhibits.   Petitioner resided in the State

of Florida when the petition was filed.

     Petitioner and Mr. Malena (husband) fell on hard times in

2007 caused by the combination of petitioner’s poor health and

her husband’s losing his job.

     Petitioner suffered from several maladies.   She saw multiple

medical specialists and took costly prescription drugs.   To ease

the financial burden of petitioner’s medical issues, petitioner’s

husband borrowed $32,075 from his section 401(k) plan (401(k)) in

March 2007.   Later that year, petitioner’s husband was let go

from his job, and he defaulted on the loan, at which time the

outstanding balance was $29,143.

     Petitioner and her husband filed a joint Federal income tax

return for 2007.   On the return, petitioner did not report the

defaulted loan of $29,143 from her husband’s 401(k).

     Petitioner attached to her joint return for 2007 a Schedule

A.   On the Schedule A, petitioner claimed deductions for, inter
                               - 4 -

alia, home mortgage interest of $54,356 and medical expenses of

$27,008.3

     Relying on various Forms 1099 from third-party payors,

including petitioner’s husband’s former employer, respondent

determined in the notice of deficiency that petitioner failed to

report the aforementioned defaulted loan, as well as a class

action lawsuit recovery of $883, unemployment compensation of

$825, dividends of $13, and interest income of $10.

     Relying on various Forms 1098, Mortgage Interest Statement,

from third-party lenders, respondent also determined in the

notice of deficiency that petitioner paid mortgage interest of

$36,829 and therefore disallowed $17,527 of the amount claimed on

Schedule A, $54,356.   In contrast, respondent did not disallow

any part of petitioner’s deduction for medical expenses other

than to adjust the amount of the deduction in order to reflect

the increase in petitioner’s adjusted gross income.   See sec.

213(a).

     Finally, respondent determined in the notice of deficiency

that petitioner was liable for (1) a 10-percent additional tax

under section 72(t) in respect of the defaulted loan from her

husband’s 401(k) and (2) an accuracy-related penalty under

section 6662(a).



     3
        As required by sec. 213(a), petitioner reduced the
$27,008 amount by 7.5 percent of adjusted gross income.
                               - 5 -

                            Discussion

A.   Burden of Proof

      In general, the Commissioner’s determinations in a notice of

deficiency are presumed correct, and the taxpayer bears the

burden of showing that those determinations are erroneous.     Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

      Pursuant to section 7491(a)(1), the burden of proof as to

factual matters may shift from the taxpayer to the Commissioner

under certain circumstances.   Petitioner did not allege that

section 7491 applies, nor did she introduce the requisite

evidence to invoke that section.   See sec. 7491(a)(2)(A) and (B).

Therefore, petitioner bears the burden of proof.4   See Rule

142(a).

B.   Unreported Income

      Gross income includes all “‘accessions to wealth, clearly

realized, and over which the taxpayers have complete dominion.’”

James v. United States, 366 U.S. 213, 219 (1961) (quoting

Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).




      4
        Insofar as the sec. 72(t) issue (discussed infra in the
text) is concerned, we note that regardless of whether the
additional tax under that section is a penalty or an additional
amount to which sec. 7491(c) applies, and regardless of whether
the burden of production with respect to this additional tax
would be on respondent, respondent has satisfied any burden of
production with respect to the distribution. See H. Conf. Rept.
105-599, at 241 (1998), 1998-3 C.B. 747, 995.
                                - 6 -

     We begin with the loan from petitioner’s husband’s 401(k),

as that loan gives rise to the most significant of respondent’s

income determinations.

     Section 402(a) provides generally that distributions from a

qualified plan are taxable to the distributee in the taxable year

in which the distribution occurs, pursuant to the provisions of

section 72.   A plan such as petitioner’s husband’s 401(k)

constitutes a qualified plan.   We turn therefore to section 72.

     Under the general rule of section 72(p)(1)(A), the making of

a loan from a qualified plan gives rise to a deemed distribution

that is taxable in the year in which the loan is received.    See

sec. 72(p)(4)(A)(i)(I).   See generally Owusu v. Commissioner,

T.C. Memo. 2010-186; Plotkin v. Commissioner, T.C. Memo. 2001-71.

However, section 72(p)(2)(A) provides an exception to the general

rule for certain loans.

     Although a loan may initially satisfy the requirements of

section 72(p)(2)(A) at the time that it is made and thus be

excepted from the general rule of section 72(p)(1)(A), a deemed

distribution may nevertheless occur subsequently because of the

failure to repay the loan consistent with the loan agreement,

e.g., because of the failure to amortize the loan on a

substantially level basis.   Sec. 72(p)(2)(C).   Accordingly, if a

default occurs, a distribution is deemed to occur at that time in
                                - 7 -

the amount of the then outstanding balance of the loan.        Owusu v.

Commissioner, supra; Plotkin v. Commissioner, supra.

      In the present case, there is no dispute that petitioner’s

husband defaulted on the 401(k) loan in 2007.     The record

demonstrates that the balance due at the time of the default was

$29,143.   Thus, pursuant to section 72(p)(1)(A), a distribution

is deemed to have been made at such time and in such amount, and,

pursuant to section 402(a), the distribution is taxable.

      Regarding the more modest items of income that respondent

determined were not reported, petitioner essentially conceded

their inclusion in income, as she did not address the issue at

trial.5

      In view of the foregoing, respondent’s income determinations

are sustained.

C.   Deduction for Home Mortgage Interest

      Deductions are allowed solely as a matter of legislative

grace, and the taxpayer bears the burden of proving his or her

entitlement to them.    Rule 142(a); INDOPCO, Inc. v. Commissioner,

503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292

U.S. 435, 440 (1934).   The taxpayer also bears the burden of

substantiating claimed deductions.      Sec. 6001; Hradesky v.



      5
        Indeed, petitioner expressly conceded in the petition
that unemployment compensation of $825 and interest income of $10
were “owed”.
                               - 8 -

Commissioner, 65 T.C. 87, 89 (1975), affd. per curiam 540 F.2d

821 (5th Cir. 1976).

      A deduction is allowed for any qualified residence interest.

Sec. 163(h)(2)(D).   Deductible interest includes interest from

both acquisition and home equity indebtedness.    Sec. 163(h)(3).

      Petitioner claimed a mortgage interest deduction of $54,356

on her return.   At trial, petitioner made no argument and

provided no substantiation for the portion thereof that

respondent disallowed ($17,527).

      In view of the foregoing, we sustain respondent’s

determination that petitioner is entitled to a mortgage interest

deduction of only $36,829.

D.   Deduction for Medical Expenses

      On her return, petitioner claimed a deduction for medical

expenses of $27,008 (prior to application of the 7.5 percent

floor prescribed by section 213(a)).    In the notice of

deficiency, respondent did not disallow any part of this

deduction other than to adjust it in order to reflect the

increase in petitioner’s adjusted gross income.    See sec. 213(a).

      At trial, petitioner argued that she incurred additional

medical expenses in 2007 and that those additional expenses would

offset her unreported income, thereby reducing, if not

eliminating, the deficiency in tax.    However, petitioner’s

testimony, even in concert with the modest documentary evidence
                               - 9 -

that she introduced, is insufficient to demonstrate that she

incurred medical expenses in an amount greater than $27,008, as

originally claimed by her and allowed by respondent.   On this

issue we therefore hold against petitioner.

E.   Additional Tax Under Section 72(t)

      Section 72(t)(1) imposes an additional tax on an early

distribution from a qualified retirement plan equal to 10 percent

of the portion of such distribution that is includable in gross

income.6   As previously discussed, failure to make an installment

payment when due in accordance with the terms of a loan from a

qualified retirement plan may result in a taxable distribution.

Sec. 72(p)(1).   Accordingly, a loan balance that constitutes a

taxable distribution is subject to the 10-percent additional tax

under section 72(t) on early distributions.   See Owusu v.

Commissioner, supra; Plotkin v. Commissioner, supra.

      The additional tax under section 72(t) does not apply to

certain distributions from qualified retirement plans.   The only

exception relevant herein is found in section 72(t)(2)(B), which

excepts from the additional tax such distributions that do not

exceed the amount allowable as a deduction under section 213 for

amounts paid during the taxable year for medical care.



      6
        Petitioner’s husband’s 401(k) account constitutes a
qualified retirement plan for purposes of sec. 72(t). See sec.
4974(c)(1).
                                - 10 -

     In the present case, petitioner paid medical expenses of

$27,008, but under section 213(a) a deduction is allowed only to

the extent that the amount paid for medical care exceeds 7.5

percent of the taxpayer’s adjusted gross income.    Therefore,

under the clear language of section 72(t)(2)(B), we hold that the

portion of the defaulted loan that equals the amount of the

deduction allowed for medical expenses under section 213 is

excepted from the 10-percent additional tax under section 72(t);

regrettably for petitioner, the balance of such loan is subject

to the additional tax.   See Duncan v. Commissioner, T.C. Memo.

2005-171.

      In view of the foregoing, respondent’s determination on this

case is sustained only in part.

F.   Accuracy-Related Penalty

      Section 6662(a) and (b)(2) imposes a penalty equal to 20

percent of the amount of any underpayment attributable to a

substantial understatement of income tax.    An understatement is

“substantial” if the understatement exceeds the greater of 10

percent of the tax required to be shown on the return or $5,000.

Sec. 6662(d)(1)(A).   The term “understatement” means the excess

of the tax required to be shown on the return over the tax

actually shown on the return.    Sec. 6662(d)(2)(A).

      Section 6664(c)(1) provides an exception to the imposition

of the accuracy-related penalty with respect to any portion of an
                               - 11 -

underpayment if the taxpayer establishes that there was

reasonable cause for the underpayment and that the taxpayer acted

in good faith with respect to that portion.    See sec. 1.6664-

4(a), Income Tax Regs.    The determination of whether the taxpayer

acted with reasonable cause and in good faith is made on a case-

by-case basis, taking into account the pertinent facts and

circumstances.    Sec. 1.6664-4(b)(1), Income Tax Regs.    Generally,

the most important factor is the extent of the taxpayer’s effort

to assess the proper tax liability for such year.    Id.

       With respect to a taxpayer’s liability for any penalty,

section 7491(c) places on the Commissioner the burden of

production, thereby requiring the Commissioner to come forward

with sufficient evidence indicating that it is appropriate to

impose the penalty.    Higbee v. Commissioner, 116 T.C. 438, 446-

447 (2001).    Once the Commissioner meets his burden of

production, the taxpayer musts come forward with persuasive

evidence that the Commissioner’s determination is incorrect.      See

id. at 447; see also Rule 142(a); Welch v. Helvering, 290 U.S. at

115.

       The Commissioner may satisfy his burden of production for

the accuracy-related penalty on the basis of a substantial

understatement of income tax by showing that the understatement

on the taxpayer’s return satisfies the definition of

“substantial”.    E.g., Graves v. Commissioner, T.C. Memo. 2004-
                               - 12 -

140, affd. 220 Fed. Appx. 601 (9th Cir. 2007); Janis v.

Commissioner, T.C. Memo. 2004-117, affd. 461 F.3d 1080 (9th Cir.

2006), affd. 469 F.3d 256 (2d Cir. 2006).

     In the instant case, respondent has satisfied his burden of

production because the record demonstrates the presence of a

substantial understatement of income tax attributable to, inter

alia, unreported income.    See sec. 6662(d)(1)(A); Higbee v.

Commissioner, supra at 447-449.    Accordingly, petitioner bears

the burden of proving that the accuracy-related penalty should

not be imposed.   See sec. 6664(c)(1); Higbee v. Commissioner,

supra at 446.

     Insofar as the understatement of income tax is attributable

to the taxable distribution under section 72(p), we conclude that

there was reasonable cause for the underpayment and that

petitioner acted in good faith.   See sec. 6664(c)(1).   The

provisions of section 72(p) are highly technical and not

intuitive, particularly to a taxpayer such as petitioner who,

given her education and experience, did not (and could not

reasonably be expected to) comprehend the tax consequences of her

husband’s defaulted loan.   To that extent we hold that petitioner

should be absolved from liability for the accuracy-related

penalty.   Otherwise, however, we are unpersuaded by petitioner

and we therefore sustain the penalty insofar as the

understatement of income tax is attributable to the other items
                             - 13 -

of unreported income and to the disallowance of the mortgage

interest deduction.

                           Conclusion

     We have considered all of the arguments made by the parties,

and, to the extent that we have not specifically addressed those

arguments, we conclude that they do not support results contrary

to those reached herein.

     To reflect the foregoing,


                                        Decision will be entered

                                   under Rule 155.
