                        T.C. Memo. 2007-19



                      UNITED STATES TAX COURT



BIDYUT K. BHATTACHARYYA AND DIANA T. BHATTACHARYYA, Petitioners
                               v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 15024-04.             Filed January 30, 2007.



     Bidyut K. Bhattacharyya and Diana T. Bhattacharyya, pro

sese.

     Wesley F. McNamara, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     HAINES, Judge:   Respondent determined a deficiency in

petitioners’ 2000 Federal income tax of $314,372 and an addition
                               - 2 -

to tax under section 6651(a)(1) of $38,837.1   After concessions,2

the issues for decision are:   (1) Whether respondent’s and

petitioners’ motions to conform pleadings to the evidence should

be granted; (2) whether petitioners received but failed to report

certain items of income; (3) whether petitioners are liable for a

10-percent additional tax under section 72(t) on early

distributions from qualified retirement plans; (4) whether

petitioners are entitled to certain itemized deductions; (5)

whether petitioners are liable for any alternative minimum tax;

and (6) whether petitioners are liable for an addition to tax

under section 6651(a)(1).

                        FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts, supplemental stipulation of facts, and

the second supplemental stipulation of facts and attached

exhibits are incorporated herein by this reference.   At the time

they filed their petition, petitioners resided in Beaverton,

Oregon.




     1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended, and all Rule references
are to the Tax Court Rules of Practice and Procedure. All
amounts are rounded to the nearest dollar.
     2
        The parties have agreed to certain issues, either in the
stipulation of facts, at trial, or on brief, and respondent has
conceded other issues. The parties’ agreements and concessions
are discussed herein.
                                - 3 -

     Bidyut K. Bhattacharyya (petitioner) was born on October 8,

1955, and Diana T. Bhattacharyya (Mrs. Bhattacharyya) was born on

January 19, 1960.   From July 16, 1984, until October 21, 2000,

petitioner was employed by Intel Corporation (Intel).

A.   Income From Salary, Bonuses, Stock Options, and Other
     Sources

     During 2000, petitioner received compensation from Intel in

the form of a salary, bonuses, and through the exercise of

nonqualified stock options.    On January 11, 2000, petitioner

exercised a nonqualified stock option granted by Intel to

purchase 800 shares of stock at $8.391 per share.     The market

price on January 11, 2000, was $92.00 per share, resulting in a

realized gain of $66,887.    On April 17, 2000, petitioner

exercised a nonqualified stock option granted by Intel to

purchase 5,000 shares of stock at $8.391 per share.     The market

price on April 17, 2000, was $116.4062 per share, resulting in a

realized gain of $540,076.    Petitioner exercised the nonqualified

stock options through an investment brokerage account with

Merrill Lynch (Merrill Lynch brokerage account).

     Intel issued petitioner a Form W-2, Wage and Tax Statement,

for 2000 (the Intel Form W-2), which reported total wages, tips,

and other compensation of $746,191.     Of that amount, $606,963

represented the gain realized by petitioner on the exercise of

the nonqualified stock options.
                              - 4 -

     During 2000, petitioners received a State income tax refund

of $34,500 for State income taxes paid with respect to their 1999

tax year.

B.   Petitioner’s Intel Retirement Plans

     At the time he terminated his employment, petitioner

maintained three Intel retirement plans, Plan 15104, Plan 15105,

and Plan 15106.

     Plan 15104 was a nonqualified deferred compensation plan

called the Sheltered Employee Retirement Plan Plus (or SERP+) and

was administered by Fidelity Investments Institutional Operations

Company (Fidelity Institutional) on behalf of Intel.    On December

22, 2000, petitioner received $285,603 from Intel, representing

the full distribution of Plan 15104 in the gross amount of

$372,850 less Federal and State withholding taxes.   Fidelity

Institutional issued petitioner a Form W-2 with respect to Plan

15104 for 2000 (the Plan 15104 Form W-2).   The parties stipulated

that the Plan 15104 Form W-2 accurately reflected the

distribution amount, withholding taxes paid, that petitioner made

no employee contributions, and that no portion of the

distribution was rolled over into another account.

     Plan 15105 was a qualified retirement plan called the Intel

Corporation 401(k) Savings Plan and was administered by Fidelity

Institutional on behalf of Intel.   Petitioner borrowed money from

Plan 15105 and made payments through payroll withholding.
                                - 5 -

Petitioner ceased making payments after he terminated his

employment, and the loan was considered in default.   The loan was

repaid in 2000 by an offsetting distribution from Plan 15105 of

$15,552.   During October or November of 2000, petitioner made a

direct rollover of $286,390 from Plan 15105 into his Fidelity

Investments IRA Rollover Account (Fidelity IRA).   Fidelity

Institutional issued petitioner a Form 1099-R, Distributions From

Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs,

Insurance Contracts, etc., with respect to Plan 15105 for 2000

(the Plan 15105 Form 1099-R).   The parties stipulated that the

Plan 15105 Form 1099-R accurately reflected the offsetting

distribution made in satisfaction of the loan and the direct

rollover into the Fidelity IRA, indicated that petitioner made

employee contributions of $1,108, and reported a taxable amount

of $14,443.

     Plan 15106 was a qualified retirement plan called the Intel

Corporation Profit Sharing Retirement Plan and was administered

by Fidelity Institutional on behalf of Intel.   Petitioner

borrowed money from Plan 15106 and made payments through payroll

withholding.   Petitioner ceased making payments after he

terminated his employment, and the loan was considered in

default.   The loan was repaid in 2000 by an offsetting

distribution from Plan 15106 of $30,623.   On November 6, 2000,

petitioner made a direct rollover of $463,930 from Plan 15106
                                - 6 -

into his Fidelity IRA.    Fidelity Institutional issued petitioner

a Form 1099-R with respect to Plan 15106 for 2000 (the Plan 15106

Form 1099-R).    The parties stipulated that the Plan 15106 Form

1099-R accurately reflected the offsetting distribution made in

satisfaction of the loan and the direct rollover into the

Fidelity IRA, indicated that petitioner made no employee

contributions, and reported a taxable amount of $30,623.

C.   Petitioner’s Individual Retirement Accounts (IRAs)

     As described above, petitioner made direct rollovers from

Plan 15105 and Plan 15106 to his Fidelity IRA totaling $750,320

in 2000.   Petitioner received the following distributions from

his Fidelity IRA:

                Date                     Amount
                Nov. 2, 2000            $100,000
                Nov. 9, 2000              10,000
                Nov. 9, 2000              20,000
                Nov. 16, 2000             30,000
                  Total                  160,000

     On November 9 and 16, 2000, petitioner made direct rollovers

of $500,000 and $62,930, respectively, from his Fidelity IRA into

another IRA administered by US Bancorp Piper Jaffray (US Bancorp

IRA).   On November 10 and 17, 2000, petitioner received

distributions of $500,000 and $62,930, respectively, from his US

Bancorp IRA.
                                - 7 -

     On December 11, 2000, petitioner transferred 815 shares of

Intel stock from his Fidelity IRA into his US Bancorp IRA.      On

December 22, 2000, the Intel stock was sold, and petitioner was

issued a check for $27,000.

     US Bancorp issued petitioner a Form 1099-R with respect to

his US Bancorp IRA for 2000.    The Form 1099-R reflected the

distributions of $500,000 and $62,930, and the check for $27,000,

for total distributions of $589,930.

D.   Petitioners’ 1999 Federal Income Tax Return

     Petitioners filed a joint Federal income tax return for 1999

on June 18, 2003.3   Petitioners reported adjusted gross income of

$564,156, itemized deductions of $427,211, a total tax of

$33,735, an overpayment of tax of $116,498.    Petitioners

requested a refund of $105,228 and that $11,270 be applied to

their estimated tax for 2000.    Petitioners’ 1999 tax return did

not include a Form 6251, Alternative Minimum Tax--Individuals.

     Respondent examined petitioners’ 1999 tax year and

determined that petitioners were not entitled to a refund or

estimated tax credit and were liable for alternative minimum tax

of $105,616.   On November 17, 2003, respondent assessed

additional tax of $105,616 and interest of $33,935.    The

Certificate of Official Record for petitioners’ 1999 tax year




     3
         Petitioners’ 1999 tax year is not at issue.
                                - 8 -

reflects that this assessment of additional tax and interest was

“abated” on November 8, 2004.

     On October 27, 2004, petitioners filed a refund suit in U.S.

District Court for the District of Oregon, at docket No. CV-04-

01563-KI.   By opinion and order dated March 16, 2005, the

District Court dismissed petitioners’ suit for lack of subject

matter jurisdiction.   On May 22, 2006, the Court of Appeals for

the Ninth Circuit affirmed the District Court’s dismissal for

lack of subject matter jurisdiction.    Bhattacharyya v.

Commissioner, 180 Fed. Appx. 763 (9th Cir. 2006).

E.   Petitioners’ 2000 Federal Income Tax Return

     Petitioners filed a joint Federal income tax return for 2000

on May 19, 2003.   Petitioners reported wages, salaries, tips,

etc., of $746,191, the amount reported by Intel on the Form W-2.

On an attached “Exhibit II”, petitioners summarized their IRA and

retirement plan distributions and rollovers as follows:
                                 - 9 -

Plan              Amt. withdrawn    Rollover amt.    Notes
Fidelity IRA        $100,000                --
Fidelity IRA          10,000             $10,000     “Direct
                                                     rollover
                                                     correction”
Fidelity IRA          20,000              10,000     “Direct
                                                     rollover
                                                     correction”
Fidelity IRA         500,000             500,000     Direct
                                                     rollover to US
                                                     Bancorp IRA

Fidelity IRA          30,000                --
US Bancorp IRA       500,000             285,603
US Bancorp IRA        62,931                --
US Bancorp IRA        27,000                --
  Total            1,249,931             805,603


Based on Exhibit II, petitioners reported total taxable IRA

distributions of $444,327.     Petitioners also reported total

pension distributions of $372,850, reflecting the distribution

from Plan 15104, but they determined that only $192,850 was

taxable.   After including interest income, dividend income, other

income, and a capital loss of $3,000, petitioners reported

adjusted gross income of $1,402,076.      Petitioners’ reported

adjusted gross income did not include:      (1) The State income tax

refund of $34,500;4 (2) $180,000 of the distribution from Plan


       4
        The parties agree that petitioners are liable for Federal
income tax in 2000 on the State income tax refund received in
                                                   (continued...)
                              - 10 -

15104; (3) the offsetting distributions made in satisfaction of

the loans from Plan 15105 and Plan 15106 of $15,552 and $30,623,

respectively; and (4) $305,603 of the IRA distributions.

     On an attached Schedule A, Itemized Deductions, petitioners

reported itemized deductions of $1,118,870, summarized by

petitioners as follows:

        Type of Expense      Amount         Notes
        Option Int          $37,738         US Bank Corp.
        Option Int          186,370         Merrill Lynch
        MLF                  71,657         Merrill Lynch
                                            Fees
        US Bank Fees         26,000         US Bank Fees
        Opt.int              20,164         Merrill Lynch
        Cash Pay            330,979         Merrill Lynch,
                                            to protect
                                            Taxable income
        Cash Pay            123,000         Merrill Lynch,
                                            to protect
                                            Taxable income
        Other               322,962         Merrill Lynch,
                                            to protect
                                            Taxable income
          Total           1,118,870


Petitioners reported taxable income of $213,977, tax of $60,080,

tax on IRAs and other retirement plans of $63,717, and total tax




     4
        (...continued)
2000.
                                - 11 -

of $123,797.5    After deducting total payments of $282,821,

petitioners requested a refund of $131,024 and that $28,000 be

applied to their 2001 estimated tax.     Petitioners’ 2000 tax

return did not include a Form 6251 or any other calculation of

their alternative minimum tax liability.

     In response to a letter from respondent inquiring about the

absence of an alternative minimum tax computation, petitioners

sent respondent a letter on September 15, 2003, and attached a

Form 1040X, Amended U.S. Individual Income Tax Return

(petitioners’ first Form 1040X).    On petitioners’ first Form

1040X, petitioners included a Form 6251, determined an

alternative minimum tax liability of $56,827, but reduced their

income by more than $630,000 and claimed a refund of $9,270.

Respondent did not file petitioners’ first Form 1040X.

     On May 25, 2004, respondent issued petitioners a notice of

deficiency.     Respondent determined a deficiency in petitioners’

2000 Federal income tax of $314,372, based on respondent’s

determination that petitioners were liable for alternative

minimum tax of $314,371.6    Respondent also determined that




     5
        It is unclear how petitioners calculated the tax on IRAs
and other retirement plans, but $63,717 is apparently
petitioners’ calculation of a 10-percent additional tax under
sec. 72(t).
     6
        Respondent also increased petitioners’ itemized
deductions by $1 to correct a rounding error made by petitioners.
                              - 12 -

petitioners were liable for an addition to tax under section

6651(a)(1) of $38,837.

     On June 26, 2004, petitioners sent respondent a letter and

attached another Form 1040X (petitioners’ second Form 1040X).

Petitioners’ second Form 1040X was identical to petitioners’

first Form 1040X, but the letter included an additional

explanation of the changes made by petitioners to their original

Federal income tax return.   Respondent did not file petitioners’

second Form 1040X.

     Petitioners filed their petition with this Court on August

20, 2004.   Petitioners requested the Court to determine that they

are due a refund “$9000 (Back Approx.)”.   Respondent filed an

answer on September 29, 2004, but did not seek an increased

deficiency or addition to tax.

     This case was called during the Court’s regular trial

session in Portland, Oregon, beginning December 5, 2005.     On

February 21, 2006, respondent filed a Motion for Leave to Amend

Answer to Conform to Evidence Presented at Trial and to Claim an

Increased Deficiency and Addition to Tax, with Accompanying

Proposed Amendment to Answer (respondent’s motion to conform the

pleadings to the evidence) under Rule 41(b).   In the amendment to

answer, which was lodged with the Court on February 21, 2006,

respondent asserted that petitioners were liable for an increased
                                - 13 -

deficiency of $561,309, and an increased section 6651(a)(1)

addition to tax of $100,571.

     On November 3, 2006, petitioners filed a Motion for Amended

Petition Consistent with the Evidences Presented at Trial, and to

Claim a Refund by Petitioners for $76,890.00, with Accompanying

Proposed Amended Petition (petitioners’ motion to conform

pleadings to the evidence) under Rule 41(b).

                               OPINION

I.   Respondent’s and Petitioners’ Motions To Conform Pleadings
     to the Evidence

     As a preliminary matter, we must determine whether

respondent’s and petitioners’ motions to conform pleadings to the

evidence should be granted.    Section 6214(a) requires a claim for

increased deficiency to be asserted at or before the hearing or

rehearing.   It is well established that the word “hearing” used

in section 6214(a) includes all Tax Court proceedings in a case

through entry of decision.     Henningsen v. Commissioner, 243 F.2d

954, 959 (4th Cir. 1957), affg. 26 T.C. 528 (1956); Law v.

Commissioner, 84 T.C. 985, 989 (1985).    Rule 41(b) allows the

parties to amend their pleadings to conform with the evidence

presented at trial.7   Whether a motion seeking an amendment to


     7
         Rule 41(b) provides in part:

     (1) Issues Tried by Consent: When issues not raised by
     the pleadings are tried by express or implied consent
     of the parties, they shall be treated in all respects
                                                   (continued...)
                              - 14 -

the pleadings to conform to the evidence should be allowed is

within the sound discretion of the Court.   Commissioner v. Estate

of Long, 304 F.2d 136, 143-145 (9th Cir. 1962).    If granting the

motion would result in unfair surprise or prejudice to the

nonmoving party, the motion should be denied.     Church of

Scientology v. Commissioner, 83 T.C. 381, 469 (1984), affd. 823

F.2d 1310 (9th Cir. 1987).

     In respondent’s motion to conform pleadings to the evidence

and in the lodged amendment to answer, respondent asserts an

increased deficiency of $561,309, and an increased addition to

tax under section 6651(a)(1) of $100,571.   The increased

deficiency is not based on petitioners’ liability for alternative

minimum tax, as was the deficiency asserted in the notice of

deficiency.   Instead, the increased deficiency results from the




     7
      (...continued)
     as if they had been raised in the pleadings. The
     Court, upon motion of any party at any time, may allow
     such amendment of the pleadings as may be necessary to
     cause them to conform to the evidence and to raise
     these issues, but failure to amend does not affect the
     result of the trial of these issues.

     (2) Other Evidence: If evidence is objected to at the
     trial on the ground that it is not within the issues
     raised by the pleadings, then the Court may receive the
     evidence and at any time allow the pleadings to be
     amended to conform to the proof, and shall do so freely
     when justice so requires and the objecting party fails
     to satisfy the Court that the admission of such
     evidence would prejudice such party in maintaining such
     party’s position on the merits.
                               - 15 -

increase in income and the disallowance of many of petitioners’

itemized deductions.

     Petitioners object to respondent’s motion to conform

pleadings to the evidence, arguing:     (1) An evidentiary ruling

made by the Court during trial prevents respondent from seeking

an increased deficiency; and (2) an amendment to answer would

result in unfair surprise and would prejudice petitioners because

the amendment is based on grounds different from those asserted

in the notice of deficiency.

     Petitioners also filed a motion to conform pleadings to the

evidence.   Petitioners assert that, based on the evidence and

testimony presented at trial, they are entitled to a refund in

the amount of $76,890, instead of the approximately $9,000

asserted in the petition.    Respondent does not object to the

granting of petitioners’ motion to conform pleadings to the

evidence.

     Petitioners’ objection notwithstanding, we find that

granting respondent’s or petitioners’ motions to conform

pleadings to the evidence would not result in unfair surprise or

prejudice to either party.    Petitioners’ argument that an

evidentiary ruling made by the Court prevents respondent from

seeking an increased deficiency is based on a misunderstanding of

the Court’s evidentiary ruling.    Petitioners focus on Exhibit 42-

R, which was a Form 4549, Income Tax Examination Changes,
                               - 16 -

prepared by respondent and shown to petitioners on the morning of

trial.   Essentially, Exhibit 42-R summarized respondent’s

interpretation of the impact the exhibits attached to the

parties’ joint stipulations of fact had on petitioners’ tax

liability.    The Court did not admit Exhibit 42-R into evidence.

Petitioners appear to argue that, because the Court did not admit

Exhibit 42-R into evidence, the Court rejected the arguments

contained therein.   The Court’s ruling was limited to the

admissibility of Exhibit 42-R and was not a ruling on the merits

of respondent’s arguments contained therein.    The increased

deficiency and addition to tax sought by respondent are not based

on Exhibit 42-R, but instead are based on the exhibits admitted

into evidence as part of the parties’ joint stipulations of fact.

The Court’s ruling on Exhibit 42-R does not affect respondent’s

ability to rely on the exhibits admitted into evidence in seeking

an increased deficiency and addition to tax.

     Petitioners’ argument that an amendment to answer would

result in unfair surprise or prejudice is not persuasive.    The

amendment to answer would change the issue in this case from

whether petitioners are liable for alternative minimum tax to

whether petitioners received and did not report certain items of

income and whether they are entitled to certain itemized

deductions.   As stated above, in seeking an increased deficiency

and addition to tax, respondent relies on exhibits attached to
                              - 17 -

the parties’ joint stipulations of fact.     Petitioners rely on

these same exhibits in seeking an increased refund.      Petitioners

cannot expect to use this evidence to seek an increased refund

and at the same time shield themselves from an increased

deficiency or addition to tax based on the same evidence.

Additionally, respondent informed petitioners at various times

before trial, including in respondent’s pretrial memorandum, that

respondent intended to raise the issues asserted in the amendment

to answer.   Petitioner’s testimony also demonstrated his

knowledge of respondent’s intention.

      Accordingly, we shall grant respondent’s and petitioners’

motions to conform pleadings to the evidence.

II.   Items of Income

      Generally, taxpayers bear the burden of proving that the

Commissioner’s determinations are incorrect.     Rule 142(a); Welch

v. Helvering, 290 U.S. 111, 115 (1933).     However, the

Commissioner bears the burden of proof with respect to any new

matter or increases in deficiency.     Rule 142(a).   Once the

Commissioner produces evidence sufficient to establish a prima

facie case, the burden shifts to the taxpayers of coming forward

with evidence sufficient to rebut the Commissioner’s proof.      See

King v. Commissioner, T.C. Memo. 1995-524; Cally v. Commissioner,

T.C. Memo. 1983-203 (citing Papineau v. Commissioner, 28 T.C. 54

(1957)).
                              - 18 -

     Respondent asserts that petitioners received unreported or

underreported taxable income from the following sources:      (1)

$372,850 from the distribution from Plan 15104, of which only

$192,850 was reported; (2) $14,443 and $30,623 from the

offsetting distributions made in satisfaction of the loans from

Plan 15105 and Plan 15106, respectively, none of which was

reported; and (3) $749,930 on the distributions from the Fidelity

IRA and the US Bancorp IRA, of which only $444,327 was reported

as being taxable.8   Respondent raised these matters in the

amendment to answer, not in the notice of deficiency, and now

seeks an increased deficiency based in part on these new matters.

Therefore, respondent bears the burden of proof with respect to

these new matters.   See Rule 142(a).

     Petitioners dispute respondent’s assertions and argue that,

of the $746,191 reported as taxable income on the Intel W-2,

$606,963 is not included in gross income.9




     8
        Petitioners also received but did not report a State
income tax refund of $34,500. As noted above, the parties agree
that petitioners are liable for Federal income tax in 2000 on
that refund. See supra note 4.
     9
        On petitioners’ first and second Forms 1040X, petitioners
assert that their taxable income should be reduced by $632,639.
In their amended petition and on brief, petitioners argue that
their taxable income should be reduced by $606,963. The origin
of this discrepancy is unclear.
                               - 19 -

     A.    Distribution From Plan 15104

     Gross income means all income from whatever source derived,

including income from pensions.    Sec. 61(a)(11).   However,

distributions of after-tax employee contributions from a pension

plan constitute a nontaxable return of capital.      See Lange v.

Commissioner, T.C. Memo. 2005-176.

     The Plan 15104 Form W-2 reflects a gross distribution to

petitioner from Plan 15104 of $372,850 and that petitioner made

no employee contributions to Plan 15104.    The parties stipulated

the accuracy of the Plan 15104 Form W-2, and no evidence in the

record contradicts the Plan 15104 Form W-2.    This evidence, if

not rebutted, is sufficient for respondent to meet his burden of

proving that petitioner received a distribution of $372,850 from

Plan 15104 and that no employee contributions were made to Plan

15104.    The burden shifts to petitioners to come forward with

evidence that all or a portion of that distribution is not

included in their gross income.

     On their tax return, petitioners reported the distribution

of $372,850 from Plan 15104, but they asserted that only $192,850

of that amount was taxable.    In the information accompanying

petitioners’ second Form 1040X, petitioners further reduced the

amount they reported as taxable to $132,674.    Petitioners’ theory

is that the distribution contained after-tax employee

contributions, and thus only a portion of the distribution was
                              - 20 -

taxable.   Petitioners explain their theory on brief:

     [In] 2000 [the] bonus received was $79568.00. * * *
     The federal tax withheld on that money was $10,582.54.
     * * * [the] remaining * * * bonus amount went in SERP+
     account for the tax year 2000. * * * Petitioners
     estimated about 1/2 of the SERP money [came] from
     depositing bonus money after paying tax and remaining
     is the growth of the money due to investment by
     Fidelity. Thus $186425.25, which is exactly 1/2 of the
     total distribution, was assumed growth and inserted in
     * * * the form 1040.

     Petitioners’ estimation that approximately half of the Plan

15104 distribution consisted of after-tax employee contributions

is contrary to the Plan 15104 Form W-2, on which Fidelity

Institutional reported that no employee contributions were made.

No evidence in the record supports petitioners’ claim.10

Petitioners have not met their burden of coming forward with

evidence that all or a portion of that distribution is not

included in their gross income.

     Therefore, we find that the distribution of $372,850 from

Plan 15104 is included in petitioners’ gross income.




     10
        Petitioners cite Exhibit 21-J as evidence that half of
the Plan 15104 distribution was comprised of employee
contributions. Exhibit 21-J, a pay statement from Intel dated
Oct. 31, 2000, indicates that a total “SERP deferral” of $39,784
had been made between Jan. 1 and Oct. 31, 2000. Petitioner
maintained several accounts that were at various times referred
to as “SERP” accounts. Exhibit 21-J does not indicate that the
“SERP deferral” was made with respect to Plan 15104 and does not
otherwise contradict the Form W-2 issued by Fidelity
Institutional.
                               - 21 -

     B.     Distributions From Plan 15105 and Plan 15106

     Petitioners did not report any distributions made from Plan

15105 or Plan 15106 on their Federal income tax return.    However,

petitioners received Forms 1099-R from Fidelity Institutional,

which reflected:    (1) An offsetting distribution of $15,552 was

made from Plan 15105 in satisfaction of petitioner’s loan from

Plan 15105; (2) petitioner made employee contributions to Plan

15105 totaling $1,109; (3) due to the employee contributions, the

taxable amount of the offsetting distribution from Plan 15105 was

$14,443; (4) an offsetting distribution of $30,623 was made from

Plan 15106 in satisfaction of petitioner’s loan from Plan 15106;

and (5) petitioner made no employee contributions to Plan 15106.

The parties stipulated the accuracy of the Forms 1099-R, and no

evidence in the record contradicts the Forms 1099-R.    This

evidence is sufficient for respondent to meet his burden of

proof.    Therefore, we find that $14,443 and $30,623 of the

offsetting distributions from Plan 15105 and Plan 15106,

respectively, are included in petitioners’ gross income.11

     C.    IRA Rollovers and Distributions

     In general, distributions from an IRA are included gross

income in the year received.    Sec. 408(d)(1).   A distribution to



     11
        Petitioners did not introduce evidence to contradict the
Forms 1099-R, nor did they address the distributions on brief.
We find that petitioners abandoned any argument that the
offsetting distributions are not included in their gross income.
                              - 22 -

the individual for whose benefit an IRA is maintained is excluded

from gross income, however, if the entire amount is paid into an

IRA for the benefit of the same individual within 60 days.    Sec.

408(d)(3)(A).   Exclusion of a rollover from one IRA to another

can only be made by an individual once during any 1-year period.

Sec. 408(d)(3)(B).   However, the transfer of a taxpayer’s funds

directly from the trustee of one IRA to the trustee of another

IRA, in a fashion that does not involve any payment directly to

the taxpayer, is not a “rollover” for purposes of section

408(d)(3) and therefore does not trigger or violate the 1-year

limitation.   Rev. Rul. 78-406, 1978-2 C.B. 157; see also Crow v.

Commissioner, T.C. Memo. 2002-178; Martin v. Commissioner, T.C.

Memo. 1992-331, affd. without published opinion 987 F.2d 770 (5th

Cir. 1993).

     On their Federal income tax return, petitioners reported the

rollovers of $286,390 from Plan 15105 and $463,930 from Plan

15106 to the Fidelity IRA, the subsequent direct rollovers of

$500,000 and $62,390 from the Fidelity IRA to the US Bancorp IRA,

and the distributions from the Fidelity IRA and the US Bancorp

IRA to petitioners totaling $749,930.    The parties agree that the

rollovers from Plan 15105 and Plan 15106 to the Fidelity IRA and

the direct rollovers of $500,000 and $62,930 from Fidelity IRA to

the US Bancorp IRA are excluded from income.    See sec. 402(c);

Rev. Rul. 78-406, 1978-2 C.B. 157.     The parties also agree that
                               - 23 -

petitioners received distributions totaling $749,930 from the

Fidelity IRA and the US Bancorp IRA.    However, the parties

disagree as to what extent the distributions totaling $749,930

are included in petitioners’ gross income.

     Respondent argues that $749,930 is included in petitioners’

gross income.12   The record establishes, and petitioners do not

dispute, that during November and December 2000, petitioners

received distributions from the Fidelity IRA totaling $160,000

and from the US Bancorp IRA totaling $589,930.    Respondent has

met his burden of establishing a prima facie case that

petitioners received IRA distributions totaling $749,930.

Petitioners bear the burden of coming forward with evidence that

all or a portion of the IRA distributions are not included in

their gross income.

     Petitioners argue that $285,603 of the $500,000 distribution

from the US Bancorp IRA was rolled over into another IRA and is




     12
        Petitioners argue that the numbers proposed by
respondent “should be discarded due to inconsistency and
generation of various random numbers generated by respondent in
[sic] various times.” At various times during preparation for
trial, respondent changed his position regarding what amount of
the rollovers and distributions were includable in petitioners’
gross income. It is worth noting that, on each occasion,
respondent reduced the amount included in petitioners’ gross
income as petitioners substantiated the various rollovers. Our
ultimate conclusion on this issue is not based on the changes in
respondent’s position, but instead is based on the record.
                               - 24 -

thus not included in their gross income.13   Petitioners provided

no evidence that such a rollover took place, or that the rollover

took place within 60 days of the distribution.    Petitioners were

in a superior position with respect to access to information that

would prove the amount and date of the alleged rollover.      By

failing to produce such information, petitioners have failed to

meet their burden of coming forward with evidence that $285,603

of the IRA distributions is not included in their gross income.

     Therefore, we find that the distributions from the Fidelity

IRA and the US Bancorp IRA totaling $749,930 are included in

petitioners’ gross income.

     D.     Income From the Exercise of Intel Stock Options

     Gross income includes compensation for services, “including

fees, commissions, fringe benefits, and similar items”.       Sec.

61(a)(1).    Section 83(a) provides in pertinent part that if

property is transferred to a taxpayer in connection with the

performance of services (e.g., stock transferred to a taxpayer


     13
        On their Federal income tax return, petitioners reported
that only $444,327 of the $749,930 in distributions from the
Fidelity IRA and the US Bancorp IRA was included in their gross
income. Petitioners’ position was based on their assertion that
$20,000 of the $160,000 in distributions from the Fidelity IRA
and $285,603 of the $500,000 distribution from the US Bancorp IRA
were rolled over into another IRA. On brief, petitioners claimed
that only $285,603 of the $500,000 distribution from the US
Bancorp IRA was rolled over into another IRA and conceded that
$469,091 was includable in their gross income. Thus, we find
that petitioners have abandoned their argument that $20,000 of
the $160,000 in distributions from the Fidelity IRA was rolled
over into another IRA.
                              - 25 -

upon the exercise of a stock option), the excess of the fair

market value of the property (stock) over the amount, if any,

paid for the property (the exercise price) shall be included in

the taxpayer’s gross income in the first year in which the

taxpayer’s rights in the property are not subject to a

substantial risk of forfeiture.   See Montgomery v. Commissioner,

127 T.C. 43, 53-54 (2006).

     Petitioners assert that, of the $746,191 in taxable income

reported on the Intel W-2, $606,963 is not included in gross

income.   Petitioners do not address this assertion in detail.

However, it appears that petitioners are arguing that the

$606,963 should be treated as long-term capital gain, which could

be offset by long-term capital losses realized in 2000, and thus

would not be included in their gross income.   Petitioners’

position is without merit.

     Petitioner exercised on January 11 and April 17, 2000,

nonqualified stock options granted to him by Intel, resulting in

realized gains of $66,887 and $540,076, respectively (the spread

between the exercise price and the market price of the stock on

the dates of exercise).   This gain is not recognized as long-term

capital gain.   Instead, section 83(a) and section 1.83-1(a)(1),

Income Tax Regs., establish that such gain is ordinary income

included in petitioners’ gross income as compensation in 2000,
                               - 26 -

the year of exercise.14   Therefore, we find that the $746,191 in

taxable income reported on the Intel W-2, including the $606,963

attributable to the exercise of nonqualified stock options, is

included in petitioners’ gross income as ordinary income.

III. Additional Tax on Early Distributions From Qualified
     Retirement Plans and IRAs

     Section 72(t)(1) imposes a 10-percent additional tax on

early distributions from qualified retirement plans.   Qualified

retirement plans are defined to include IRAs as defined in

section 408(a) and (b).   Secs. 72(t)(1), 4974(c).   The 10-percent

additional tax does not apply to certain distributions, including

distributions made after an employee attains age 59-1/2 and

distributions attributable to the employee’s disability.    Sec.

72(t)(2)(A)(i), (iii).    Respondent alleges that petitioners are

liable for the 10-percent additional tax on the taxable

distributions from Plan 15105 and Plan 15106 (both qualified

retirement plans) of $14,443 and $30,623, respectively, and on

the taxable distributions totaling $749,930 from the Fidelity IRA

and the US Bancorp IRA.

     Petitioners were born in 1955 and 1960, respectively.    The

qualified retirement plan distributions and the IRA distributions



     14
        Petitioners do not argue that the stock was subject to a
substantial risk of forfeiture. Thus, the gain was recognized at
the time petitioner acquired beneficial ownership of the stock
(the time of exercise). See sec. 83(a); Walter v. Commissioner,
T.C. Memo. 2007-2.
                               - 27 -

were made in 2000, before petitioner or Mrs. Bhattacharyya

attained age 59-1/2.15   Petitioners do not allege and the record

does not reflect that the distributions were attributable to

disability, or that the distributions otherwise qualify for an

exception to the 10-percent additional tax.     In fact, petitioners

state on brief that “Petitioners do understand that petitioners

have to pay 10% penalty tax on the amount stated above * * * This

is consistent with IRC section 72(t)(1).”     Therefore, we find

that petitioners are liable for the 10-percent additional tax on

the early distributions from Plan 15105 and Plan 15106 of $14,443

and $30,623, respectively, and on the early distributions

totaling $749,930 from the Fidelity IRA and the US Bancorp IRA.

IV.   Itemized Deductions

      Deductions are a matter of legislative grace and are

allowable only as specifically provided by statute.16     See

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); Joseph v.

Commissioner, T.C. Memo. 2005-169.      Itemized deductions allowed




      15
        Nor had petitioner attained age 55 so as to be eligible
for an exception based on his separation from service. See sec.
72(t)(2)(A)(v).
      16
        Generally, taxpayers also bear the burden of proving
they are entitled to deductions. INDOPCO, Inc. v. Commissioner,
503 U.S. 79, 84 (1992); Joseph v. Commissioner, T.C. Memo. 2005-
169. However, the resolution of this issue does not depend on
which party bears the burden of proof, and we resolve this issue
based on the preponderance of the evidence in the record.
                               - 28 -

for individual taxpayers are set forth in part VI and part VII of

subchapter B, chapter 1, subtitle A of the Internal Revenue Code.

See secs. 161-222.

     Petitioners assert that they are entitled to itemized

deductions totaling $1,118,870, as originally set forth in their

Federal income tax return.    Respondent concedes that petitioners

are entitled to deduct the following expenses totaling $243,363

as itemized deductions:    (1) $37,738, identified by petitioners

as “Option Int” for “US Bank Corp.”, as investment interest

expenses under section 163; (2) $186,370, identified by

petitioners as “Option Int” for “Merrill Lynch”, as investment

interest expenses under section 163; and (3) $19,255 of the

$20,164 identified by petitioners as “Opt.int” for “Merrill

Lynch”, as investment interest expenses under section 163.

Respondent also concedes that petitioners are entitled to deduct

the following expenses as miscellaneous itemized deductions,

totaling $84,581:    (1) $71,657, identified by petitioners as

“MLF” or “Merrill Lynch Fees”, as expenses for the production of

income under section 212; and (2) $12,924 of the $26,000

identified by petitioners as “US Bank Fees”, as expenses for the

production of income under section 212.”17   However, respondent


     17
        Petitioners have not objected to respondents’
characterization of these expenses as miscellaneous itemized
deductions. An impact of this characterization is that such
deductions are subject to sec. 67(a), which states: “In the case
                                                   (continued...)
                               - 29 -

argues that petitioners are not entitled to deduct the remaining

expenses, including:    (1) $909 of the $20,164 identified by

petitioners as “Opt.int” for “Merrill Lynch”; (2) $13,076 of the

$26,000 identified by petitioners as “US Bank Fees”; (3) $330,979

and $123,000, identified by petitioners as “Cash Pay” and

described as “Merrill Lynch, to protect Taxable income”; and (4)

$322,962, identified by petitioners as “Other” and described as

“Merrill Lynch, to protect Taxable Income”.    Respondent raised

these matters in the amendment to answer, not in the notice of

deficiency, and now seeks an increased deficiency based in part

on these new matters.    Therefore, respondent bears the burden of

proof with respect to these new matters.    See Rule 142(a).

     The “Opt.int” expense of $20,164 represents interest

petitioners purportedly paid on margin loans issued by Merrill

Lynch.    Respondent concedes that petitioners are entitled to

deduct this type of expense as an itemized deduction.    However,

respondent argues that a monthly account statement for

petitioner’s Merrill Lynch brokerage account shows that only

$19,255 was paid.    The monthly account statement cited by

respondent shows that petitioner paid $19,255 in interest on

margin loans issued by Merrill Lynch during the month of August.


     17
      (...continued)
of an individual, the miscellaneous itemized deductions for any
taxable year shall be allowed only to the extent that the
aggregate of such deductions exceeds 2 percent of adjusted gross
income.”
                              - 30 -

A yearend account statement shows that petitioners paid a total

of $186,370 in interest on margin loans during 2000.    The $19,255

appears to be a portion of the $186,370, which respondent already

conceded petitioners were entitled to deduct.   The record

establishes that petitioners paid only $186,370 in interest to

Merrill Lynch and did not pay an additional $20,164 as claimed on

their return.   Nevertheless, based on respondent’s concession, we

find that petitioners are entitled to an additional itemized

deduction of $19,255.

     The “US Bank Fees” expense of $26,000 represents bank fees

petitioners purportedly paid to US Bancorp.   Respondent concedes

that petitioners are entitled to deduct this type of expense as a

miscellaneous itemized deduction.   However, respondent argues

that petitioners are entitled to deduct only $12,924 in bank

fees.   The US Bancorp statements of account show that petitioners

paid $12,924 in bank fees to US Bancorp in 2000.   There is no

evidence of a greater payment.   The statements of account are

sufficient for respondent to meet his burden of proof.

Therefore, we find that petitioners are entitled to a

miscellaneous itemized deduction of only $12,924 with respect to

the US Bancorp fees.

     The “Cash Pay” expenses of $330,979 and $123,000, and the

“Other” expenses of $322,962, represent deposits made by

petitioner into his Merrill Lynch brokerage account to exercise
                               - 31 -

his nonqualified stock options and to acquire other stock.     The

costs of acquiring stock, a capital asset, are capital in nature

and are not currently deductible but instead are included in the

stock’s tax basis.   See Woodward v. Commissioner, 397 U.S. 572,

575 (1970); Lychuk v. Commissioner, 116 T.C. 374, 388-389 (2001);

Pappas v. Commissioner, T.C. Memo. 2002-127; see also secs. 1012,

1221(a).   Therefore, we find that petitioners are not entitled to

deduct the “Cash Pay” and “Other” expenses.

     As described above, respondent met his burden of proving

that petitioners are entitled to itemized deductions of only

$243,363 and miscellaneous itemized deductions of only $84,581.

However, petitioners argue that they are entitled to deduct the

claimed expenses in full in 2000 because respondent allowed them

to deduct similar expenses in 1999.18   Petitioners’ argument is

without merit.   Each taxable year stands alone, and respondent

may challenge in a succeeding year what was condoned or agreed to

in a former year.    Rose v. Commissioner, 55 T.C. 28, 31-32

(1970); Jeanmarie v. Commissioner, T.C. Memo. 2003-337; Boatner



     18
        Petitioners also argue that respondent cannot challenge
their itemized deductions because the Court admitted into
evidence Exhibit 38-P. Exhibit 38-P was offered by petitioners
as a summary of their arguments. Similar to their argument
regarding Exhibit 42-R, discussed supra pp. 15-16, petitioners’
argument is based on a misunderstanding of the Court’s
evidentiary ruling. The admission of Exhibit 38-P into evidence
does not establish the truth of petitioners’ assertions made in
that exhibit, nor does it preclude respondent from contesting
those assertions.
                                - 32 -

v. Commissioner, T.C. Memo. 1997-379, affd. 164 F.3d 629 (9th

Cir. 1998).   Respondent’s allowance of certain itemized

deductions in 1999 does not establish petitioners’ entitlement to

similar deductions in 2000.

      For the above-stated reasons and to reflect respondent’s

concessions, we find that petitioners are entitled to itemized

deductions of $243,363 and miscellaneous itemized deductions of

$84,581.

V.    Alternative Minimum Tax

      In the notice of deficiency, respondent determined that

petitioners were liable for alternative minimum tax of $314,371.

Petitioners’ alternative minimum tax liability was triggered in

part by the itemized deductions claimed on their Federal income

tax return.   Respondent concedes that, if petitioners are

entitled to itemized deductions and miscellaneous itemized

deductions only to the extent conceded by respondent, the

alternative minimum tax will not apply.    As found above,

petitioners are entitled to itemized deductions and miscellaneous

itemized deductions only to the extent conceded by respondent.

Therefore, a determination regarding petitioners’ alternative

minimum tax liability is unnecessary.

VI.   Section 6651(a)(1) Addition to Tax

      Section 6651(a)(1) imposes an addition to tax for failure to

file a return on the date prescribed (in this case, April 16,
                               - 33 -

2001), unless the taxpayer can establish that such failure is due

to reasonable cause and not willful neglect.    In the notice of

deficiency, respondent asserted that petitioners were liable for

a section 6651(a)(1) addition to tax of $38,837.     In the

amendment to answer, respondent asserted an increased section

6651(a)(1) addition to tax of $100,571, based on the asserted

increased deficiency.

       Respondent bears the burden of production with respect to

petitioners’ liability for the section 6651(a)(1) addition to

tax.    See sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438,

446-447 (2001).    To meet his burden of production, respondent

must come forward with sufficient evidence indicating that it is

appropriate to impose the addition to tax.    See Higbee v.

Commissioner, supra at 446-447.    Respondent has met his burden of

production because the parties stipulated that petitioners’ 2000

Federal income tax return was filed on May 19, 2003, more than 25

months after it was due.

       Once respondent meets his burden of production, petitioners

bear the burden of proving that their failure to timely file was

due to reasonable cause and not willful neglect.19    To show


       19
        Respondent bears the burden of proof with regard to any
increased deficiency. See Rule 142(a). However, the amount of
the sec. 6651(a)(1) addition to tax is a computational matter
based on the amount of tax due. To the extent respondent bears
the burden of proving an increased sec. 6651(a)(1) addition to
tax, respondent has met this burden because, as discussed supra,
                                                   (continued...)
                              - 34 -

reasonable cause, petitioners must show that they “exercised

ordinary business care and prudence and [were] nevertheless

unable to file the return within the prescribed time”.     Sec.

301.6651-1(c)(1), Proced. & Admin. Regs.     For illness or

incapacity to constitute reasonable cause, petitioners must show

that they were incapacitated to a degree that they could not file

their returns.   Williams v. Commissioner, 16 T.C. 893, 905-906

(1951); see, e.g., Joseph v. Commissioner, T.C. Memo. 2003-19

(“Illness or incapacity may constitute reasonable cause if the

taxpayer establishes that he was so ill that he was unable to

file.”).

     Petitioners argue that their failure to file was due to

reasonable cause because petitioner was sick and because their

return preparer had a brain tumor.     Petitioners have not

introduced any evidence to corroborate these allegations, nor

have they explained how long petitioner was sick, how serious his

illness was, why Mrs. Bhattacharyya was unable to fulfill

petitioners’ filing obligations, or why they were unable to find

another return preparer.   We find that petitioners did not have

reasonable cause for their failure to file timely.     Therefore, we




     19
      (...continued)
the record shows that petitioners are liable for an increased
deficiency. See Howard v. Commissioner, T.C. Memo. 2005-144.
                             - 35 -

hold that petitioners are liable for a section 6651(a)(1)

addition to tax.20

VII. Conclusion

     Based on the above, petitioners are liable for an increased

deficiency in income tax, an increased addition to tax under

section 6651(a)(1), and are not entitled to a refund.

     In reaching our holdings, we have considered all arguments

made, and, to the extent not mentioned, we conclude that they are

moot, irrelevant, or without merit.

     To reflect the foregoing,


                                           Decision will be entered

                                      under Rule 155.




     20
        Because petitioners filed their return more than 25
months after it was due, the addition to tax under sec.
6651(a)(1) will be 25 percent of the amount required to be shown
as a tax on the return. See sec. 6651(a)(1). The amount of the
addition to tax should be determined by the parties as part of
their Rule 155 computations.
