                  T.C. Summary Opinion 2003-43



                     UNITED STATES TAX COURT



   DENNIS W. FARLEY, JR. AND JANICE J. FARLEY, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 7920-01S.                Filed April 22, 2003.



     Dennis W. Farley, Jr. and Janice J. Farley, pro se.

     Dennis R. Onnen, for respondent.



     COUVILLION, Special Trial Judge:    This case was heard

pursuant to section 7463 of the Internal Revenue Code in effect

at the time the petition was filed.1    The decision to be entered




     1
          Unless otherwise indicated, subsequent section
references are to the Internal Revenue Code in effect for the
years at issue. Rule references are to the Tax Court Rules of
Practice and Procedure.
                              - 2 -


is not reviewable by any other court, and this opinion should not

be cited as authority.

     In the notice of deficiency, respondent determined the

following deficiencies in Federal income taxes against

petitioners for the years indicated:


                 Year                 Deficiency

                 1995                   $6,713
                 1996                    8,000
                 1997                    8,200


The sole issue for decision is whether petitioners are liable for

the 10-percent additional tax on early distributions from

qualified retirement plans under section 72(t)(1) for the years

at issue and, more particularly, whether the distributions in

question constitute “part of a series of substantially equal

periodic payments (not less frequently than annually) made for

the life (or life expectancy) of the employee” within the intent

and meaning of section 72(t)(2)(A)(iv).2

     Some of the facts were stipulated.    Those facts, with the

annexed exhibits, are so found and are made part hereof.




     2
          Respondent also determined that a $17,125 loan to
petitioners from one of their qualified plans during 1995
constituted a deemed distribution under sec. 72(p) and was also
subject to the additional tax under sec. 72(t)(1). Petitioners
did not challenge that adjustment at trial; consequently, the
Court considers that adjustment as conceded by petitioners.
                                 - 3 -


Petitioners’ legal residence at the time the petition was filed

was Albuquerque, New Mexico.

     Dennis W. Farley, Jr. (petitioner) was born December 25,

1942.    In January 1994, he retired from United Missouri Bank in

Kansas City, where he had been employed for more than 31 years.3

At the time of his retirement, petitioner was 52 years of age.

Upon retirement, petitioner received lump-sum distributions from

qualified pension and profit-sharing accounts totaling $274,610.

These funds were timely rolled over into self-directed individual

retirement accounts (IRA accounts) pursuant to section 402(c).

During 1995, petitioner commenced receiving periodic

distributions from his IRA accounts.

        Petitioner calculated the amount of his periodic

distributions by first calculating an amortized growth rate of

his IRA accounts based on a life expectancy of 30.4 years.     After

determining the projected growth of the accounts over this

period, petitioner concluded he could withdraw (or receive

distributions) from his accounts of $80,040 annually.      He rounded



     3
          Paragraph 4 of the stipulation states that petitioner
retired from United Missouri Bank in 1995. However, petitioner
testified that the actual date was Jan. 1994. The Court is not
bound by a stipulation of fact that appears contrary to the facts
disclosed by the record. Rule 91(e); Blohm v. Commissioner, 994
F.2d 1542, 1553 (11th Cir. 1993), affg. T.C. Memo. 1991-636;
Estate of Eddy v. Commissioner, 115 T.C. 135 (2000). The
difference in the dates is not material to the issue in this
case.
                                - 4 -


this figure to $80,000.    The amortized growth rate petitioner

used to determine the value of his accounts 30.4 years hence was

29 percent per year.4    The sole purpose of this process was to

determine the maximum amount that could be distributed to

petitioner from his qualified plans that would avoid imposition

of the 10-percent additional tax under section 72(t) and would

satisfy the provisions of section 72(t)(2)(A)(iv).

     Petitioner used the 29-percent annual growth rate by

analyzing the performances of various mutual funds and their

rates of return over a given period of years.    From a group of 83

funds, he selected seven mutual funds in which he would invest

his IRA account funds.    Using rates of return for these funds

that he obtained from the Internet, petitioner took the

cumulative return of each of the seven funds, which he divided by

the relevant number of years to arrive at that fund’s average

annual return.   He used data dating back 5 years for five of the

funds, 3 years for one fund, and 1 year for another fund.

Petitioner then added up these averages and divided by seven,

resulting in an overall average annual return of 34.65 percent



     4
          At trial, petitioner introduced a schedule based on an
assumed life expectancy of 27 years for purposes of calculating
his periodic distribution amount. However, respondent pointed
out, and petitioner did not dispute, that petitioner actually
used a life expectancy factor of 30.4 years as set forth in Table
V of sec. 1.72-9, Income Tax Regs. Respondent did not challenge
petitioner’s use of a life-expectancy factor of 30.4 years.
                               - 5 -


for the seven funds.   Petitioner reduced that figure to 29

percent to allow for a “margin of error”.   He used 5-year rates

of return, where available, even when a fund had been in

existence longer because, as he stated: “I figured a five-year

return was reasonable for my purposes, you know, simply because

the markets change considerably over time.”

     Petitioner began making monthly withdrawals out of his

qualified accounts based on these calculations.   He received

distributions of $50,000 in 1995, $80,000 in 1996, and $82,000 in

1997.   Petitioner admitted that the 1997 distribution of $82,000

was in error, and he corrected that error by reducing his

distribution to $78,000 the following year, which year is not

before the Court.   In subsequent years, petitioner resumed his

scheduled periodic distributions of $80,000 per year.

     On their Federal income tax returns for 1995, 1996, and

1997, petitioners reported the periodic distributions as income.

The deemed distribution of $17,125 in 1995 was also reported as

income on their 1995 return.   Respondent thereafter determined

that the distributions were subject to the 10-percent additional

tax under section 72(t).

     Petitioner contends that the additional tax is not owed

because the distributions were “part of a series of substantially

equally periodic payments (not less frequently than annually)

made for the life (or life expectancy) of the employee or the
                               - 6 -

joint lives (or joint life expectancies) of such employee and his

designated beneficiary.”   Sec. 72(t)(2)(A)(iv).    Petitioners must

prove they are not liable for the 10-percent additional tax.

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).5

     Section 72(t)(2)(A)(iv) does not provide how to determine or

calculate a series of substantially equal periodic payments to

qualify for the exception.   However, the IRS has provided three

permissible methods for calculating such a series.     IRS Notice

89-25, Q&A-12, 1989-1 C.B. 662, 666.   Petitioner chose the second

of the three methods, known as the fixed amortization method.

Rev. Rul. 2002-62, 2002-42 I.R.B. 710.   The fixed amortization

method involves amortizing a taxpayer’s IRA account balance over

the account owner’s life expectancy at an interest rate that does

not exceed a reasonable rate of interest on the date that

payments commence.   IRS Notice 89-25, Q&A-12, 1989-1 C.B. supra

at 666.   The parties agree that the fixed amortization method

provided in IRS Notice 89-25 is a permissible way to calculate a

series of substantially equal periodic payments.6


     5
          Sec. 7491, under certain circumstances, places the
burden of proof on respondent with respect to a taxpayer’s
liability for taxes in court proceedings arising in connection
with examinations commencing after July 22, 1998. In this case,
the examination of petitioners’ returns commenced before the
effective date; therefore, the burden remains with petitioners.
     6
          Although the Court is not bound by IRS Notice 89-25,
1989-1 C.B. 662, its methodology will be applied based on the
                                                   (continued...)
                               - 7 -

     Respondent determined that petitioner did not use a

reasonable rate of interest in calculating the amortizable growth

of his qualified plan accounts.   Respondent also contends that,

even if the interest growth rate used was reasonable, the $82,000

distribution in one year impermissibly modified a series of

payments that were required to be substantially equal in order to

escape the additional tax.

     The fixed amortization method utilized by petitioner

requires that a taxpayer use a reasonable rate of interest in

calculating a schedule of substantially equal payments.

Respondent argued that petitioner’s rate of interest of 29

percent was not reasonable because of three “fallacies”,

summarized as follows:   Petitioner miscalculated the average

annual return of the seven funds,7 high short-term returns cannot

be sustained over a longer period, and past performance is not

predictive of future performance.   Rejecting petitioner’s

methodology, respondent recalculated the average annual returns

of the seven funds used by petitioner.   Respondent determined




     6
      (...continued)
agreement of the parties.
     7
          Respondent argued that, by taking the cumulative return
of each fund and dividing it by the relevant number of years to
arrive at an average annual return, petitioner ignored the
effects of compounding and overstated each fund’s rate of return.
                                 - 8 -

that the funds in question had an average rate of return of 23.01

percent rather than the 34.65 percent claimed by petitioner.

     Petitioner admitted at trial to having made the

computational errors claimed by respondent in calculating the

average rates of return.    However, he argued that he did not

intend for the money in his IRA accounts to remain invested in

those seven funds indefinitely.     Rather, he intended to maintain

investments in funds that were performing to his satisfaction.

He stated:    “I don’t leave the money in the same mutual fund all

the time.    I move it to whoever is doing the best job at any

given time.   Money is portable.    So I can take it out of fund A

and put it in fund B.”    He further explained:   ”the idea is to

stay on top of the situation enough so you move your money to the

funds that are performing.”    Petitioner also admitted that the

funds he selected in 1995 did not all continue to earn a rate of

return higher than 29 percent.     However, he argued that such a

rate was still sustainable and gave current examples of high

performance funds.    At trial, petitioner was invested in only one

of the original seven funds considered in calculating the

periodic withdrawal amount.    He attributed this to having

followed the approach of moving money around when necessary to

maximize his rate of return to try to attain the growth-rate

percentage used in calculating the amount of allowable

distribution that could be made each year.
                                - 9 -

     The Court agrees with respondent that petitioner did not use

a reasonable growth rate in calculating the periodic

distributions.   Neither party cited any case law directly on

point that would establish a means by which a reasonable growth

rate can be determined to calculate a series of substantially

equal periodic payments within the meaning of section

72(t)(2)(A)(iv).   However, with reference to the fixed

amortization method, IRS Notice 89-25 cites one example that

assumes that an interest rate of 8 percent is reasonable for a

50-year old individual with a life expectancy of 33.1.    The

record fails to persuade the Court that a 21-percent departure

from this example is reasonable.    Petitioner’s age at the time of

the first distribution was approximately 52, and his life

expectancy was 30.4 years.    These factors are comparable to the

example in IRS Notice 89-25.    The interest rate petitioner used

differed significantly.    In effect, his use of such a generous

growth rate would allow premature distributions in contravention

of the legislative purpose underlying the section 72(t) tax,

namely, to discourage premature distributions from IRA’s.       Arnold

v. Commissioner, 111 T.C. 250, 255 (1998).    Although petitioner

presented evidence to establish the basis upon which he arrived

at the chosen growth rate, that evidence fails to establish that

such a rate was “reasonable” within the intent and meaning of

section 72(t)(2)(A)(iv).
                             - 10 -

     Because petitioner’s interest rate was not reasonable, the

10-percent additional tax is due on the periodic distributions.

The Court finds it unnecessary to address respondent’s

alternative contention that the annual distributions to

petitioner were not equal.

     Reviewed and adopted as the report of the Small Tax Case

Division.



                                        Decision will be entered

                                   for respondent.
