                        T.C. Memo. 2011-210



                     UNITED STATES TAX COURT



      NEIL G. HEILMAN AND PEGGY J. HEILMAN, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 5827-10.               Filed August 30, 2011.



     Neil G. Heilman and Peggy J. Heilman, pro sese.

     Jayne M. Wessels, for respondent.


                        MEMORANDUM OPINION


     MORRISON, Judge:   The IRS issued a deficiency notice to the

petitioners, Neil G. and Peggy J. Heilman, determining

deficiencies in income tax of $9,017 and $9,756 for the tax years

2007 and 2008, respectively, and determining that the Heilmans

were liable for section 6662(a) penalties of $1,803.40 for 2007
                                    -2-

and $1,951.20 for 2008.1      The IRS has conceded the theory on

which it based its determinations in the deficiency notice.         It

has raised a new argument that would result in reduced income-tax

deficiencies of $6,424 and $7,061 for 2007 and 2008 and section

6662(a) penalties of $1,284.80 and $1,412.20 for 2007 and 2008,

respectively.       The issues to be resolved are (1) whether the

Heilmans are entitled to the additional child tax credits

provided by section 24(d) for 2007 and 2008 and (2) whether they

are liable for penalties under section 6662(a) for 2007 and 2008.

We determine that they are not entitled to the additional child

tax credits and that they are liable for penalties.

       This case was submitted fully stipulated pursuant to Rule

122.       Neil and Peggy Heilman resided in Pennsylvania when they

filed their petition.

                                Background

1.     The Heilmans’ Tax Returns

       The Heilmans timely filed their federal income tax returns

for the tax years 2007 and 2008.       According to the stipulation,

their “income in the taxable years 2007 and 2008, except for

small amounts of interest and taxable refunds, credits or offsets

of state and local income taxes, is attributable to petitioner

Neil G. Heilman’s net earnings from his carpentry business.”


       1
      All references to sections are to the Internal Revenue Code
as in effect for tax years 2007 and 2008. All Rule references
are to the Tax Court Rules of Practice and Procedure.
                                -3-

During 2007 and 2008 Neil Heilman had a valid, approved Form

4029, Application for Exemption From Social Security and Medicare

Taxes and Waiver of Benefits, on file with the IRS.   He was

therefore exempt from self-employment tax.2   The Heilmans paid no

self-employment tax on the income from Neil Heilman’s carpentry

business for the tax years 2007 and 2008.

     The Heilmans claimed dependency exemption deductions for

nine dependent children on their federal income tax return for

the tax year 2007.   They claimed that eight of the nine children

were qualifying children for the purposes of the child tax credit

and the additional child tax credit.   The Heilmans claimed an

additional child tax credit of $6,424 for the tax year 2007.

     The Heilmans claimed dependency exemption deductions for ten

dependent children on their federal income tax return for the tax

year 2008.   They claimed that nine of the ten children were

qualifying children for the purposes of the child tax credit and

the additional child tax credit.   They claimed an additional

child tax credit of $7,061 for the tax year 2008.




     2
      Sec. 1401(a) and (b) imposes a tax on self-employment
income, but sec. 1402(g) authorizes the government to exempt an
individual whose religious faith forbids the acceptance of social
insurance payments. Sec. 1402(c)(6) provides that if a sec.
1402(g) exemption is in effect for an individual, the
individual’s services are not among the trades and businesses
subject to the self-employment tax.
                                 -4-

2.     The Heilmans’ Dispute With the IRS

       On January 14, 2010, the IRS mailed the Heilmans a

deficiency notice.    The notice reflected the imposition of self-

employment tax on Neil Heilman’s income from his carpentry

business, which resulted in deficiencies of $9,017 and $9,756 for

the tax years 2007 and 2008, respectively.    The deficiency notice

also determined penalties pursuant to section 6662(a) of

$1,803.40 and $1,951.20 for the tax years 2007 and 2008,

respectively.

       On March 8, 2010, the Heilmans filed a Tax Court petition to

challenge the deficiency notice.    In the petition, the Heilmans

argued that they were exempt from self-employment tax under

section 1402(g).    The IRS filed its answer on April 22, 2010,

taking the same position as it had in the deficiency notice--that

the carpentry-business income was subject to the self-employment

tax.    On September 10, 2010, the Court notified the parties that

the case would be tried during a weeklong session of trials to

begin February 14, 2011.    On January 31, 2011, the IRS submitted

its pretrial memorandum, which did not identify the imposition of

the self-employment tax on the carpentry-business income as an

issue.    It stated that the only issues to be resolved are whether

the Heilmans are entitled to the additional child tax credits

under section 24(d) and whether they are liable for the section

6662(a) penalties.    The pretrial memorandum stated that the
                                -5-

deficiencies in dispute are $6,424 for 2007 and $7,061 for 2008

and that the amounts of the section 6662(a) penalties in dispute

are $1,284.80 for 2007 and $1,412.20 for 2008.   The pretrial

memorandum the Heilmans submitted advised that the only issue is

whether they are entitled to the additional child tax credits

under section 24(d).   It identified the amounts in dispute as:

     •    $6,424 in “Deficiencies/Liabilities” for 2007,

     •    $7,061 in “Deficiencies/Liabilities” for 2008,

     •    $1,284.80 in “Additions/Penalties” for 2007, and

     •    $1,412.20 in “Additions/Penalties” for 2008.

     On February 14, 2011, the case was called to be scheduled

for trial.   Instead the parties filed a joint motion to submit

the case without trial under Rule 122.   The parties also

submitted a stipulation that stated in part:

     The only issues remaining for resolution in this case
     are whether petitioners’ gross income derived from
     petitioner Neil G. Heilman’s trade or business, which
     income is exempt from the tax on self-employment income
     pursuant to I.R.C. § 1402(g), qualifies as earned
     income within the meaning of I.R.C. § 24(d), thereby
     permitting petitioners to take the additional child tax
     credit under I.R.C. § 24(d) for the taxable years 2007
     and 2008, and whether petitioners are subject to the
     penalty under I.R.C. § 6662(a) for the taxable years
     2007 and 2008.

The parties stipulated further that if the Heilmans are not

entitled to the additional child tax credits under section 24(d),

their deficiencies in income tax are $6,424 and $7,061 for the

tax years 2007 and 2008, respectively, and the penalties under
                                -6-

section 6662(a) are $1,284.80 and $1,412.20 for the tax years

2007 and 2008, respectively.   The Court granted the motion to

submit the case without trial and ordered the parties to file

simultaneous opening briefs on or before April 16, 2011, and

reply briefs on or before May 16, 2011.

     On March 16, 2011, the IRS filed a motion for leave to file

an amendment to the answer to conform the pleadings to the proof

under Rule 41(b).   The motion stated that after consideration of

the case by the IRS Office of Appeals, the IRS conceded that the

Heilmans were not subject to self-employment tax.   Therefore,

according to the motion, the matters raised in the petition were

no longer at issue.   The motion stated that the IRS wished the

Court to resolve the following new issue:   “that petitioners were

not entitled to the additional child tax credit and were also

liable for the penalty under I.R.C. § 6662(a) for the taxable

years 2007 and 2008.”   The motion stated that the IRS had been

advised that the Heilmans did not object to the motion.   The

Court granted the motion.   The amendment to the answer conceded

that Neil Heilman was exempt from the tax on self-employment

income.   The amendment to the answer asserted that the Heilmans

are not entitled to the additional child tax credits under

section 24(d) for 2007 and 2008 and that they are liable for

section 6662(a) penalties of $1,284.80 and $1,412.20 for 2007 and

2008, respectively.
                                 -7-

                             Discussion

I.   Additional Child Tax Credits

     Section 24(a) allows a taxpayer a tax credit of $1,000 per

child.    Section 24(b)(3) provides that the credit available under

section 24(a) is limited to the taxpayer’s tax liability (as

calculated before the credit).   An additional portion referred to

as the “additional child tax credit” is refundable and is

computed as relevant here under section 24(d)(1)(B)(i), as the

amount equal to “15 percent of so much of the taxpayer’s earned

income (within the meaning of section 32) which is taken into

account in computing taxable income for the taxable year as

exceeds $10,000.”3   See, e.g., H. Conf. Rept. 111-16, at 515

(2009).

     The Heilmans reported a tax liability for 2007 of $1,576 (as

calculated before the child tax credit and the additional child

tax credit).   Of the $8,000 credit allowable under section 24(a),

they claimed a child tax credit of $1,576 and an additional child

tax credit of $6,424.   For 2008 the Heilmans reported a tax

liability of $1,939 (as calculated before the child tax credit

and the additional child tax credit).     Of the $9,000 credit



     3
      For 2007 the $10,000 threshold was modified for inflation.
Sec. 24(c)(3). The modified threshold was $11,750. Rev. Proc.
2006-53, sec. 3.04, 2006-2 C.B. 996, 999. For 2008 the $10,000
threshold was replaced with an $8,500 threshold. Sec. 24(d)(4)
(before amendment by the American Recovery and Reinvestment Act
of 2009, Pub. L. 111-5, sec. 1003(a), 123 Stat. 313).
                                  -8-

allowable under section 24(a), they claimed a child tax credit of

$1,939 and an additional child tax credit of $7,061.     As

discussed next, the Heilmans are not entitled to additional child

tax credits for 2007 and 2008 because they did not have any

earned income.    The term “earned income” is defined by section

32(c)(2)(A) as:

          (i) wages, salaries, tips, and other employee
     compensation, but only if such amounts are includible
     in gross income for the taxable year, plus

          (ii) the amount of the taxpayer’s net earnings from
     self-employment for the taxable year (within the
     meaning of section 1402(a)), * * *

Section 1402(a) provides that the term “net earnings from self-

employment” is the gross income derived by an individual from a

“trade or business”, less the deductions attributable to the

trade or business.     Section 1402(c) provides:

          SEC. 1402(c). Trade or Business.--The term “trade
     or business”, when used with reference to self-
     employment income or net earnings from self-employment,
     shall have the same meaning as when used in section 162
     (relating to trade or business expenses), except that
     such term shall not include--

                   *     *    *    *    *    *     *

               (6) the performance of service by an
          individual during the period for which an
          exemption under subsection (g) is effective with
          respect to him.

There was a section 1402(g) exemption in effect for Neil Heilman

during 2007 and 2008.     It is uncontested that Neil Heilman’s

carpentry business was “the performance of service”.     The
                                  -9-

Heilmans were therefore not engaged in a “trade or business” for

purposes of determining their net earnings from self-employment

and their earned income.   Having no earned income, they are not

entitled to additional child tax credits.

     The Heilmans argue that Neil Heilman “carries on a trade or

business as a carpenter, and therefore meets the definition of a

taxpayer having earned income.”    This argument ignores section

1402(c)(6), which excludes from the definition of a trade or

business the performance of services while an exemption under

section 1402(g) is effective.

     The Heilmans also argue that because Neil Heilman’s

carpentry-business income is included in taxable income for

income tax purposes it therefore results in an increase in the

limit under section 24(d)(1)(B)(i).     This is incorrect.   The

increase in the limitation effected by section 24(d)(1)(B)(i) is

equal to 15 percent of “the taxpayer’s earned income (within the

meaning of section 32) which is taken into account in computing

taxable income for the taxable year”.     For an amount to be

counted for purposes of section 24(d)(1)(B)(i), it must satisfy

two conditions.   First, it must be “earned income”; second, it

must be “taken into account in computing taxable income”.       The

carpentry-business income is taken into account in computing

taxable income, sec. 61, but it is not earned income, secs.
                                  -10-

24(d)(1)(B)(i), 32(c)(2)(A)(ii), 1402(a), (c)(6).        And it

therefore does not increase the section 24(d)(1)(B)(i) limit.

II.   Section 6662(a) Penalties

      In its opening brief, the IRS contends that the Heilmans had

conceded in the stipulation that they are liable for the section

6662(a) penalties for 2007 and 2008 if they are not entitled to

the additional child tax credits.        In their answering brief the

Heilmans assert that they cannot be held liable for the penalties

under section 6662(a) because the issue is not properly before

the Court:

      The original Notice of Deficiency had a different issue
      on it, and the government conceded that issue, and the
      penalties along with it. When this new issue was
      raised petitioners had no objection, however they did
      not realize that penalties under I.R.C. Section
      6662(a), were still being applied. Since the issue
      that we are now debating was not even part of the
      original notice how can petitioners be subject to a
      penalty that was not even part of the issue the IRS
      raised.

The IRS is entitled to raise issues in the answer that it did not

raise in the notice of deficiency.       It could therefore raise in

the answer a new theory of why the Heilmans were liable for self-

employment tax and penalties.     In the stipulation, the Heilmans

conceded that they are liable for penalties if they are not

entitled to the additional child tax credits.       They have not

shown cause to be excused from the stipulation.       See Stamm Intl.

Corp. v. Commissioner, 90 T.C. 315, 321-322 (1988) (wrongful
                                 -11-

misleading conduct is grounds for relieving other party of

settlement agreement, but unilateral mistake is not).

     We hold that the Heilmans have deficiencies in income tax of

$6,424 and $7,061 for 2007 and 2008, respectively, and are liable

for penalties under section 6662(a) of $1,284.80 and $1,412.20

for 2007 and 2008, respectively.

     To reflect the foregoing,


                                             Decision will be entered

                                        for respondent.
