                        T.C. Memo. 2011-267



                      UNITED STATES TAX COURT



                   BENNY NIPPS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 28387-09.             Filed November 10, 2011.



     Benny Nipps, pro se.

     William F. Castor, for respondent.



                        MEMORANDUM OPINION


     PARIS, Judge:   Respondent determined a deficiency of $13,668

in petitioner’s Federal income tax for 2007 and an accuracy-

related penalty under section 6662(a) and (b)(2)1 of $2,734 for a


     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the tax period at issue,
and all Rule references are to the Tax Court Rules of Practice
                                                   (continued...)
                                   - 2 -

substantial understatement of income tax.       The issues for

decision are:       (1) Whether petitioner’s unreported retirement

distribution related to an inherited individual retirement

account (IRA) is taxable, (2) whether petitioner had taxable

Social Security benefits, and (3) whether petitioner is liable

for an accuracy-related penalty under section 6662(a).

                                Background

       This case has been submitted fully stipulated under Rule

122.       The facts and exhibits have been stipulated and are

incorporated herein by reference.       At the time the petition was

filed, petitioner’s mailing address was in Oklahoma.

       Petitioner was a beneficiary of the IRA (inherited IRA) of

his cousin, Larry G. Harper, which was maintained by Landmark

Bank, N.A. (Landmark Bank).       On August 12, 2007, Mr. Harper died.

On November 29, 2007, petitioner opened an IRA account with

Landmark Bank to receive the funds from the inherited IRA.

Landmark Bank deposited the funds from the inherited IRA into

petitioner’s IRA account.

       When petitioner received the distribution from the inherited

IRA, he also received a document entitled Beneficiary’s

Distribution Notice and Certification Form and Payment

Instruction (beneficiary notice).       The beneficiary notice stated



       1
      (...continued)
and Procedure.
                               - 3 -

that by signing, petitioner certified that he was aware that

distribution was subject to Federal income tax.   It also stated

that Federal income tax would be withheld by the distributor

unless an election was made otherwise.

     The bottom portion of the beneficiary notice included a

substitute Form W-4P, Withholding Certificate for Pension or

Annuity Payments.   The substitute Form W-4P indicated that the

beneficiary had to:   Elect not to have income tax withheld from

the IRA distribution, elect to have income tax withheld of 10

percent of the amount distributed, or elect to have a specified

amount withheld.2   Petitioner signed and returned the substitute

Form W-4P to Landmark Bank but did not elect any of the choices

listed on the substitute Form W-4P.

     On November 29, 2007, petitioner opened a certificate of

deposit (CD) account at Landmark Bank.   Petitioner then requested

that Landmark Bank distribute the funds in his IRA, payable on

the same day, November 29, 2007.   Petitioner received the funds

in five separate checks, four3 of which were for $9,000 each and

the fifth of which was for $9,496.50.



     2
      The substitute Form W-4P differs greatly from the IRS’
original form. The original Form W-4P is a four-page document
consisting of two pages of instructions and a two-page worksheet
to calculate the appropriate withholding amount.
     3
      Although the checks from the bank appear to have been
issued on Nov. 29, 2007, the checks were not negotiated until
Dec. 6, 2007, and Jan. 28, Feb. 5 and 25, 2008.
                                 - 4 -

     Petitioner also received Social Security benefits of $42,198

during 2007.

     Petitioner timely filed his individual income tax return for

the 2007 taxable year.   On August 31, 2009, respondent issued a

notice of deficiency determining a deficiency in income tax and

an accuracy-related penalty under section 6662(a) and (b)(2) for

a substantial understatement of income tax.      Petitioner timely

filed a petition with the Court.

                              Discussion

Unreported IRA Distribution

     Gross income includes all income from whatever source

derived.   Sec. 61(a).   Amounts distributed from or paid out of an

IRA are generally includable in gross income by the payee or

distributee.   Sec. 408(d)(1).

     However, a distribution is not includable in gross income if

the entire amount of the distribution received by an individual

is paid into a qualified IRA for the benefit of that individual

within 60 days of the distribution.      This type of recontribution,

known as a “rollover contribution”, may occur outside of the 60-

day requirement when failure to waive the requirement would be

against equity and good conscience.      Sec. 408(d)(3)(I).

     Rollover contributions from inherited IRAs are specifically

excluded from tax-free rollover treatment.      Sec. 408(d)(3)(C).

An IRA is considered inherited if the individual for whose
                                - 5 -

benefit the account is maintained acquired that account by reason

of the death of another individual who was not the individual’s

spouse.   Sec. 408(d)(3)(C)(ii).    However, an individual may still

avoid being taxed on the inherited IRA if the funds in the IRA

are transferred from one account trustee to another account

trustee without the IRA owner or beneficiary ever gaining control

of the funds.   See Jankelovitz v. Commissioner, T.C. Memo. 2008-

285; Crow v. Commissioner, T.C. Memo. 2002-178.

     Petitioner inherited funds from a nonspousal IRA,

transferred the funds into an IRA, and then withdrew the funds

from the IRA on the same day.   The Court does not have to

determine whether petitioner made a valid trustee-to-trustee

transfer of the IRA funds.   By withdrawing the funds from his

IRA, petitioner is subject to the standard income tax rules for

distributions from an IRA.   Petitioner must include in income the

amount transferred from his Landmark Bank IRA to his checking

account at Landmark Bank.

Social Security Benefits

     Section 86 requires the inclusion in gross income of up to

85 percent of Social Security benefits received.    Social Security

benefits are defined to include any amount received by reason of

entitlement to a monthly benefit under title II of the Social

Security Act.   Sec. 86(d)(1)(A).   Petitioner’s Social Security
                                - 6 -

benefits are therefore includable in income to the extent

provided in section 86.

Accuracy-Related Penalty

       Under section 6662(a) and (b)(2), a taxpayer may be liable

for a penalty of 20 percent of the portion of an underpayment

which is attributable to a substantial understatement of income

tax.    A substantial understatement of income tax exists for any

taxable year if the amount of the understatement exceeds the

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

return or $5,000.    Sec. 6662(d)(1).   The Commissioner bears the

burden of production with respect to penalties.      Sec. 7491(c);

Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001).      Respondent

has met his burden as petitioner’s understatement exceeds both 10

percent of the tax required to be shown and $5,000.

       Section 6664(c)(1) provides that no penalty shall be imposed

if there was reasonable cause for the underpayment and the

taxpayer acted in good faith.    The determination of whether a

taxpayer acted with reasonable cause and in good faith depends

upon the facts and circumstances.    Sec. 1.6664-4(b)(1), Income

Tax Regs.    Circumstances indicating that a taxpayer acted with

reasonable cause and good faith include “an honest

misunderstanding of fact or law that is reasonable in light of

all the facts and circumstances, including the experience,

knowledge, and education of the taxpayer.”     Id.
                                  - 7 -

      Petitioner, who lacked knowledge and experience in tax law,

reasonably believed that the correct Federal income tax would be

withheld by Landmark Bank.     The beneficiary notice stated that

Landmark Bank would withhold Federal income tax unless petitioner

elected otherwise.   Petitioner did not elect out of this

withholding.   He reasonably relied on Landmark Bank’s lack of

withholding of Federal income tax as basis for his position that

the distribution was not taxable.     While petitioner is liable for

the tax, as the payor’s withholding obligation does not excuse

taxpayers from the duty to report and pay the resulting tax, the

Court finds that he had a reasonable basis to believe that the

correct withholding would occur and that absent that withholding,

the amount was not taxable.    See Church v. Commissioner, 810 F.2d

19, 20 (2d Cir. 1987); Chenault v. Commissioner, T.C. Memo. 2011-

56.   Accordingly, petitioner is not liable for the section

6662(a) accuracy-related penalty to the extent it is related to

the inherited IRA, as he acted in good faith although with a

misunderstanding of the law.

      In reaching the foregoing holdings, the Court has considered

the parties’ arguments, and, to the extent not addressed herein,

concludes that they are moot, irrelevant, or without merit.

      To reflect the foregoing,


                                            Decision will be entered

                                      under Rule 155.
