                  T.C. Summary Opinion 2007-107



                      UNITED STATES TAX COURT



          ANTIM G. AND JANE V. STRAUS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 22555-05S.            Filed June 25, 2007.



     Antim G. and Jane V. Straus, pro sese.

     Charles E. Graves, for respondent.



     GOLDBERG, Special Trial Judge:   This case was heard pursuant

to the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed.    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.   Unless otherwise indicated, subsequent

section references are to the Internal Revenue Code in effect for
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the year in issue, and all Rule references are to the Tax Court

Rules of Practice and Procedure.

     Respondent determined a deficiency in petitioners’ Federal

income tax for the year 2003 in the amount of $5,879, and an

accuracy-related penalty of $1,176 under section 6662.    The

issues for decision are whether the distributions of the cash

value of a whole life insurance policy and interest in 2003 are

taxable to petitioners, and whether petitioners are liable for

the accuracy-related penalty under section 6662 arising from a

substantial understatement of tax for that year.

                             Background

     The stipulation of facts and the attached exhibits are

incorporated herein by reference.     At the time the petition was

filed, petitioners resided in Springfield, Missouri.

     When Katherine Straus, petitioners’ daughter, was 3 years

old, petitioners purchased a whole life insurance policy (policy)

from Northwestern Mutual Life Insurance Company (Northwestern

Mutual) which insured Katherine.    Petitioners were listed as the

sole owners on the policy.   Annual premiums on the policy were

approximately $1,000.   Petitioners purchased the policy for the

purpose of covering educational costs for Katherine if and when

she decided to pursue a college degree.    Katherine graduated from

high school in 2000, and thereafter enrolled at Southwest
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Missouri State University.   At the time of Katherine’s

graduation, the cash surrender value of the policy was $27,097.

     Petitioners received two loans on the policy in 2001.      The

first loan, for $5,000, was received on April 5, 2001.    The

second loan, also for $5,000, was received on December 11, 2001.

Both loans carried an interest rate of approximately 8 percent.

     Sometime in 2003, and precipitated by a downturn in

petitioners’ business income caused by post-9/11 factors,

petitioners decided to cash out the policy so as to pay

Katherine’s current school expenses and set aside funds for the

remainder of her college education.

     Northwestern Mutual reported to respondent a gross

distribution to petitioners in 2003 in the amount of $23,153,

with the taxable portion of that amount being $19,204.    In

addition to this distribution, Merrill Lynch and Commerce Bank

reported interest distributions in 2003 to petitioners in the

amounts of $25 and $17, respectively.   Petitioners reported

neither the Merrill Lynch nor the Commerce Bank distribution on

their 2003 return.   After the Commissioner adjusted petitioners’

income to reflect receipt of these distributions, petitioners’

income was increased to a point where they no longer qualified to

take a Tuition and Fees Deduction in the amount of $3,000.      The

combination of these circumstances resulted in the deficiency at

issue.
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                            Discussion

     The Commissioner’s determinations are presumed correct, and

taxpayers generally bear the burden of proving otherwise.       Welch

v. Helvering, 290 U.S. 111, 115 (1933).   Petitioners did not

argue that section 7491 is applicable in this case, nor did they

establish that the burden of proof should shift to the

respondent.   Moreover, the issue involved in this case, inclusion

of items in gross income, is a legal one to be decided on the

record without regard to the burden of proof.    Petitioners,

therefore, bear the burden of proving that respondent’s

determination in the notice of deficiency is erroneous.    See Rule

142(a); Welch v. Helvering, supra at 115.

     Section 61(a) provides that gross income means all income

from whatever source derived, including “Interest” and “Income

from life insurance.”   Sec. 61(a)(4), (10).    The sole exception

to the inclusion of income from life insurance lies in section

101, which specifically excludes from gross income amounts

received “under a life insurance contract, if such amounts are

paid by reason of the death of the insured.”    Sec. 101(a)(1).

Section 72(a) provides that gross income includes any amount

received as an annuity under a life insurance contract.     Given

these statutory predicates, there is no authority upon which we

may declare the distributions at issue in this case exempt from

inclusion in gross income and accordingly, exempt from taxation.
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     We also note that petitioners conceded at trial that the

distributions at issue were, in fact, received by them and should

be included in their gross income for 2003.    After this

concession, and with respect to only the life insurance

distribution, petitioners proffered three creative, yet

misguided, arguments as to why the Court should enter a decision

in their favor.   For the foregoing reasons, we decline to follow

petitioners’ reasoning.

     First, petitioners argue that the Northwestern Mutual

distribution should be excluded from their gross income as it is

not actually a life insurance policy but rather a custodial

account.   Custodial accounts are investment accounts, opened

under the Uniform Transfer to Minors Act, where the minor is the

listed owner of the account and its assets, and a custodian

manages the account until the minor reaches the age of

distribution for their State of residence.    Earnings, up to a

certain amount, are taxed at the minor’s income tax bracket.

     In this case, the policy fails to satisfy the elements of a

custodial account.   The policy at issue was owned solely by

petitioners, and they did not substantiate that Katherine had any

ownership interest in or control over the policy.    Petitioners

mistakenly argue that because the policy was “in Katie’s name,”

and they were its owners, it should follow that the policy be

regarded as a custodial account.   The policy, however, was
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purchased on Katherine’s life and not, as petitioners contend,

“in her name.”   Accordingly, and even though it was petitioners’

intent to use the policy for Katherine’s education, it does not

follow that the policy was akin to a custodial account.   Whole

life insurance and custodial accounts are distinct and separate

investment devices, and one cannot be the other.

     Second, petitioners argue that the Northwestern Mutual

distribution should be treated as a long-term capital gain and

were this treatment to apply, petitioners’ carryover loss in 2003

($27,703) would more than offset the taxable portion of the

distribution ($19,204).   As to this argument, petitioners rely on

the reasoning that life insurance falls within the definition of

a capital asset.

     When a life insurance policy, such as the one at issue, is

not a straight-term policy, it will generally have a cash

surrender value.   If the policy owner surrenders the policy, the

holder will then pay the cash surrender value in accordance with

policy terms, after withholding for any outstanding loans against

the policy at the time of surrender.   Under section 1.72-

11(d)(1), Income Tax Regs., if the amount received by the holder

is greater than the holder’s basis in the policy, the owner will

recognize income in the amount of the difference.   This income

will then be treated as ordinary income, irrespective of the

rather inclusive notion of what qualifies as a capital asset,
                                -7-

since the surrender of the policy is not deemed as a “sale or

exchange” as required for capital assets under section 1211.

Accordingly, we cannot accept petitioners’ reasoning that, as a

capital asset, the proceeds from the Northwestern Mutual

distribution should be excluded from their gross income.

     Third, and finally, petitioners argue that had they known

that the Northwestern Mutual distribution would be included in

their 2003 gross income they would have certainly taken planning

steps to eliminate this result; namely, by making tax-free gifts

to Katherine.   Petitioners argue that the Court should treat the

distributions now as if they did, in fact, do this and

accordingly, exclude the entire distribution from their gross

income, treat the entire distribution as transferred to their

daughter, and then allow either petitioners or their daughter to

pay tax on the distribution at Katherine’s applicable income tax

rate (approximately 10 percent).   Simply put, there is no

authority under which we may provide such relief.   Taxpayers are

bound to the form in which they cast their transaction.

Commissioner v. Natl. Alfalfa Dehydrating & Milling Co., 417 U.S.

134, 148-149 (1974).   Accordingly, we sustain respondent’s

determination as to the amount in deficiency.

     As to the second issue, whether petitioners are liable for

the accuracy-related penalty arising from a substantial

understatement of tax under section 6662, we start our discussion
                                -8-

under section 6662(a), which provides that taxpayers may be

liable for a 20-percent penalty on the portion of an underpayment

of tax attributable to negligence or disregard of rules or

regulations or to a substantial underpayment of tax.   Sec.

6662(a) and (b)(1) and (2).   No penalty, however, is imposed

under section 6662 if there is reasonable cause for the

underpayment of tax and the taxpayer has acted in good faith.

Sec. 6664(c)(1).

     Pursuant to section 7491(c), respondent bears the burden of

production with respect to the issue presented under section

6662.   In order to meet respondent’s burden of production,

respondent must come forward with sufficient evidence indicating

that it is appropriate to impose the accuracy-related penalty.

Higbee v. Commissioner, 116 T.C. 438, 446 (2001). The burden of

proof remains with petitioner with respect to the

accuracy-related penalty that respondent determined in the

notice. See Rule 142(a); Welch v. Helvering, 290 U.S. at 115;

Higbee v. Commissioner, supra at 446-447.

     It is respondent’s position that petitioners’ underpayment

for 2003 was attributable to:   (1) Negligence or disregard of the

Code, and (2) a substantial understatement of tax.   For purposes

of section 6662(b)(2), a substantial understatement is equal to

the excess of the amount of tax required to be shown in the tax

return over the amount of tax shown in such return, sec.
                                -9-

6662(d)(2)(A), and is substantial in the case of an individual if

the amount of the understatement for the taxable year exceeds the

greater of 10 percent of the tax required to be shown in the

return for that taxable year or $5,000, sec. 6662(d)(1)(A).      The

amount of the understatement is to be reduced by that portion of

the understatement which is attributable to (1) “the tax

treatment of any item by the taxpayer if there is or was

substantial authority for such treatment”, sec. 6662(d)(2)(B)(i),

or (2) any item if (a) “the relevant facts affecting the item’s

tax treatment are adequately disclosed in the return or in a

statement attached to the return”, sec. 6662(d)(2)(B)(ii)(I), and

(b) “there is a reasonable basis for the tax treatment of such

item by the taxpayer”, sec. 6662(d)(2)(B)(ii)(II).

     The accuracy-related penalty under section 6662(a) does not

apply to any portion of an underpayment if it is shown that there

was reasonable cause for, and that the taxpayer acted in good

faith with respect to, such portion.   Sec. 6664(c)(1).    The

determination of whether the taxpayer acted with reasonable cause

and in good faith depends on the pertinent facts and

circumstances, including the taxpayer’s efforts to assess such

taxpayer’s proper tax liability, the knowledge and experience of

the taxpayer, and the reliance on the advice of a professional,

such as an accountant.   Sec. 1.6664-4(b)(1), Income Tax Regs.
                                -10-

     Petitioners, at trial, conceded that they should have

reported on their 2003 return the respective distributions that

Northwestern Mutual, Merrill Lynch, and Commerce Bank made to

them during 2003.   Petitioners do not dispute that they received

Forms 1099 for each of the distributions at issue.    Petitioners

also concede that the understatement of tax on their 2003 return

exceeds the greater of 10 percent of the tax required to be shown

in that return or $5,000.   See sec. 6662(d)(1)(A).   Given

petitioners’ concessions in this case, we find that respondent

has satisfied his burden of production with respect to section

7491(c) and the accuracy-related penalty.

     In response, petitioners contend that they are not liable

for the accuracy-related penalty with respect to the Northwestern

Mutual distribution because they reasoned on a good-faith belief

that the cash surrender value from the policy should be excluded

from their gross income.    In determining whether a taxpayer has

acted in good faith, generally the most important factor “is the

extent of the taxpayer’s effort to assess the taxpayer’s proper

tax liability.”   Sec. 1.6664-4(b)(1), Income Tax Regs.

     We are not convinced, based on the record before us, that

petitioners took any steps prior to the filing of their 2003

return to assess the income tax treatment of the Northwestern

Mutual distribution.   Moreover, we note that it was only after

they received their notice of deficiency that petitioners thought
                               -11-

in earnest about how they could recharacterize that distribution

so as to avoid its inclusion in their gross income.     We note,

with emphasis, that none of petitioners’ arguments to this end

are based in the Code or the regulations promulgated thereunder.

Accordingly, we find that petitioners did not act in good faith

with respect to any portion of the underpayment for their 2003

taxable year.   See sec. 6664(c)(1); sec. 1.6664-4(b)(1), Income

Tax Regs.


                                          Decision will be entered

                                      for respondent.
