                                  T.C. Memo. 2016-37



                         UNITED STATES TAX COURT



                     SYED NAVAID, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 328-13.                            Filed March 3, 2016.


      James O. Creech, III and Jane Zhao, for petitioner.

      Alexander R. Roche, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      PARIS, Judge: Respondent determined a deficiency in Federal income tax

of $36,979 and an accuracy-related penalty under section 6662(a)1 of $7,396 for

petitioner’s 2010 taxable year.


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

[*2] In a stipulation of settled issues the parties settled all of the deficiency

issues before trial.2 After concessions, the remaining issue is whether petitioner is

liable for the section 6662(a) accuracy-related penalty for 2010.

                                FINDINGS OF FACT

      Some of the facts are stipulated and are so found. The stipulation of facts

and the exhibits attached thereto are incorporated herein by this reference.

Petitioner resided in California when he timely filed his petition.

      Petitioner was born and raised in Pakistan, and his native language is Hindi.

While living in Pakistan petitioner went to pharmacy school where he received a

bachelor’s degree. Petitioner emigrated from Pakistan 33 years ago to the United

States and enrolled in a local literacy program as a nonnative English speaker. In

1984 petitioner received his pharmaceutical license from the State of Illinois.

      Petitioner had no background and had never taken any courses in finance or

tax return preparation. For every year since moving to the United States petitioner

has filed a tax return with the Internal Revenue Service (IRS). Petitioner has

never prepared his own tax return and, instead, used a paid preparer. Petitioner

      2
        Petitioner conceded that he had taxable interest income of $13, taxable
retirement income of $109,154, and taxable dividend income of $284 for 2010.
Respondent conceded that even though petitioner was under the age of 59-1/2 he
is not liable for the sec. 72(t) 10% additional tax on early distributions from his
retirement account for 2010.
                                         -3-

[*3] recognized that he should be careful with his tax documents and

recordkeeping, and he tried to provide all of his tax documents to his paid

preparer. Additionally, petitioner tried to keep his tax records and IRS paperwork

for 10 years.

      In 2001 petitioner ran a small pharmacy in addition to working at a Federal

Government hospital. On April 19, 2001, he was charged, along with two other

codefendants, with diversion of pharmaceuticals from the Department of Veterans

Affairs, and subsequently he was indicted. On October 13, 2006, petitioner

entered a plea of guilty to one count of conspiracy to defraud the United States

under 18 U.S.C. sec. 371 (2006). United States v. Navaid, No. 06-CR-56-1 (N.D.

Ill. Oct. 13, 2006) (sentencing order). Petitioner was sentenced to 18 months in

prison and three years of supervised release. In addition, petitioner was jointly

and severally liable, along with his two codefendants, for restitution of $670,000

to be paid for the benefit of the Department of Veterans Affairs. By District Court

order, restitution was payable to the Clerk of the Court, U.S. District Court (Clerk

of the District Court). The restitution judgment was entered on October 13, 2006.

Pursuant to 18 U.S.C. sec. 3613(c) (2006), upon the entry of the judgment a lien

arose on all of petitioner’s property and rights to property.
                                        -4-

[*4] A citation to discover assets directed to Charter One Bank/Citizens Bank

was served on December 5, 2006, with statutory notice to petitioner. The citation

to discover assets ordered Charter One Bank/Citizens Bank to “produce all

documents and things in your possession or control concerning * * * as they relate

to the property, income, or assets of the judgment debtor [petitioner]”.

      On December 12, 2006, pursuant to the citation to discover assets, Charter

One Bank/Citizens Bank filed an answer stating that, at the time the citation was

served, Charter One Bank/Citizens Bank had no record of petitioner’s accounts,

which he had previously disclosed as an individual retirement account (IRA)

containing approximately $100,000. Upon receiving Charter One Bank/Citizens

Bank’s answer reflecting no record of accounts, petitioner was ordered to account

for the transfer or dissipation of these funds. Petitioner produced account

statements reflecting an IRA at Charter One Bank/Citizens Bank.

      In spring 2008 petitioner was released from prison. On July 3, 2008,

Charter One Bank/Citizens Bank filed an amended answer stating that, at the time

the citation was served, Charter One Bank/Citizens Bank had record of an IRA

certificate of deposit of $117,786 belonging to petitioner.

      On July 25, 2008, the U.S. District Court for the Northern District of Illinois

issued an “Order Imposing Lien” stating that “[d]ue to Navaid’s concerns about
                                         -5-

[*5] the joint and several liability of his yet-to-be sentenced co-defendants, the

parties have agreed to extend the citation lien against Navaid’s IRA at Charter One

Bank/Citizens Bank until further court order.”

      By March 31, 2010, petitioner had paid $115,876 of the joint and several

liability and his codefendants had paid $99,364, leaving a balance of $454,760

owing on the restitution. On April 5, 2010, the United States filed a “Renewed

Motion for Turnover Orders” with the District Court having identified additional

assets of the codefendants. The motion identified petitioner’s IRA certificate of

deposit investment and sought to have Charter One Bank/Citizens Bank turn over

the IRA certificate of deposit.3

      On April 12, 2010, the U.S. District Court entered a “Turnover Order”

naming “Third Party Citation Respondent”, Charter One Bank/Citizens Bank. In

its “Turnover Order” the U.S. District Court for the Northern District of Illinois

ordered:

             Respondent Charter One Bank/Citizens Bank shall liquidate
      Navaid’s IRA certificate of deposit and submit its full liquidated
      value, approximately $117,786, to the Clerk of the Court. This court-
      ordered distribution shall not be subject to any additional tax or
      penalty. Murillo v. Commissioner of Internal Revenue, 1998 WL

      3
       Additional “Third Party Citation Respondents”, Metropolitan Life
Insurance Co. and Harris Direct n.k.a. E*Trade Securities, were notified to
liquidate assets identified as petitioner’s.
                                        -6-

[*6] 6462 (No. 18163-96, U.S. Tax Ct., Jan 12, 1998) (involuntary
     distributions are not subject to 10% additional tax on early
     distributions from IRAs).

In 2011 RBS Citizens Bank4 on behalf of the “Third Party Citation Respondent”

reported to the Commissioner that it issued a Form 1099-R, Distributions From

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

Contracts, etc., for the IRA distribution of $109,154.

       Petitioner was never notified of the IRA liquidation or distribution by either

the bank or the District Court. Petitioner first learned of the IRA liquidation when

he received a statement from his bank and saw a zero balance in his IRA. After

receiving the statement petitioner immediately went to the bank to try to find out

what had happened. Petitioner spoke with a manager at the bank who said he

would look into the matter. Petitioner kept going back to the bank and kept

calling to see what had happened with his account, but no one from the bank,

including a bank manager, gave him a response to his inquiries or any documents

showing whether the funds had been paid to the Clerk of the District Court

according to the previous “Turnover Order” instructions. Eventually, petitioner

      4
       The stipulation of facts states that RBS Citizens Bank reported to
respondent that it had issued a Form 1099-R to petitioner. In 1988 Citizens Bank
was acquired by the Royal Bank of Scotland Group (RBS). On August 31, 2004,
Charter One Bank was acquired by RBS Citizens Bank. No tax withholding was
reported on Form 1099-R.
                                         -7-

[*7] inferred that the turnover had been completed. No evidence in the record

shows that the bank attempted to mail petitioner a Form 1099-R or that the bank

actually mailed petitioner a Form 1099-R. The only document in the record is a

computer-generated form from RBS Citizens Bank sent to the IRS. Additionally,

the District Court records do not reflect either a notice to petitioner of received

funds or confirmation that the proceeds were applied to the restitution account.

      Petitioner hired a paid preparer for his 2010 tax return. Petitioner provided

his paid preparer with his business receipts and Forms 1099-MISC, Miscellaneous

Income, for his pharmacy activities but did not provide a copy of the “Turnover

Order”. Although the following Forms 1099 were reported to the IRS, the income

was not included on the income tax return: a Form 1099-R reporting the $109,154

IRA distribution from RBS Citizens Bank; a Form 1099-INT, Interest Income,

reporting interest income of $13 from EMC Mortgage Corp.; a Form 1099-DIV,

Dividends and Distributions, reporting taxable dividend income of $159 from

Metropolitan Life Insurance Co.; and a Form 1099-DIV reporting taxable dividend

income of $125 from E*Trade Securities.

      On October 1, 2012, respondent issued a notice of deficiency to petitioner

determining that petitioner did not report $13 of interest income, $284 of taxable
                                        -8-

[*8] dividend income,5 and $109,154 of taxable retirement distributions. The

notice of deficiency determined that petitioner was liable for the section 72(t) 10%

additional tax. Respondent now concedes that petitioner is not liable for the

section 72(t) 10% additional tax under the “Turnover Order” and seeks a reduced

deficiency and a reduced accuracy-related penalty.

      On December 16, 2013, petitioner contacted the Center for Economic

Progress Low-Income Taxpayer Clinic (clinic) to discuss this tax case. After

consultation with the clinic attorneys, petitioner understood that he should have

included the IRA distribution on his 2010 tax return. The parties memorialized in

their stipulation of settled issues that petitioner concedes the underlying income

tax deficiency, but the accuracy-related penalty remains at issue.

                                     OPINION

      Section 6662(a) and (b)(1) and (2) authorizes a 20% penalty on the portion

of an underpayment of income tax attributable to: (1) negligence or disregard of

rules or regulations, or (2) a substantial understatement of income tax. Under

section 7491(c), the Commissioner bears the burden of production with regard to

penalties. Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once the

      5
       The Form 1099-INT and Forms 1099-DIV for interest income and taxable
dividend income were not included in the record but were reflected on the notice
of deficiency attached to the petition.
                                         -9-

[*9] Commissioner has met the burden of production, the taxpayer has the burden

of proving that the penalties are inappropriate because of, for example, reasonable

cause or substantial authority. See Rule 142(a); Hall v. Commissioner, 729 F.2d

632, 635 (9th Cir. 1984), aff’g T.C. Memo. 1982-337; Higbee v. Commissioner,

116 T.C. at 446-447.

Substantial Understatement

      Section 6662(a) and (b)(2) imposes a penalty of 20% on the portion of the

underpayment of tax attributable to a substantial understatement of income tax.

Section 6662(d)(1)(A) defines a “substantial understatement of income tax” as an

understatement in an amount exceeding, as relevant here, $5,000. See sec.

6662(d); sec. 1.6662-4(b), Income Tax Regs. The term “understatement” is

defined as the excess of the amount of tax required to be shown on the return over

the amount shown reduced by any rebate. Sec. 6662(d)(2)(A). Section

6662(d)(2)(B) reduces the amount of an understatement by the portion of the

understatement for which: (1) there is substantial authority for the taxpayer’s tax

treatment of the item, or (2) there is adequate disclosure in the return of the

relevant facts affecting the item’s tax treatment and there is a reasonable basis for

the taxpayer’s treatment of the item.
                                        - 10 -

[*10] Here, the understatement of income tax is greater than $5,000. Thus, the

understatement is substantial for purposes of the section 6662(a) accuracy-related

penalty. The Court concludes that respondent met his burden of production in

showing that petitioner substantially understated his Federal income tax for 2010.

That being so, it is petitioner’s burden to establish that the imposition of the

penalty is not appropriate. See Higbee v. Commissioner, 116 T.C. at 447; see also

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Petitioner’s position

with respect to the IRA and the other unreported income is not supported by any

substantial authority and was not adequately disclosed.

      No penalty may be imposed under section 6662 with respect to any portion

of an underpayment upon a showing that the taxpayer acted with reasonable cause

and in good faith. Sec. 6664(c)(1). Reasonable cause requires that the taxpayer

exercised ordinary business care and prudence as to the disputed item. United

States v. Boyle, 469 U.S. 241, 246 (1985). The term “good faith” has no precise

definition but means, among other things, (1) an honest belief and (2) the intent to

perform all lawful obligations. Sampson v. Commissioner, T.C. Memo. 2013-212,

at *18. The determination of whether a taxpayer acted with reasonable cause and

in good faith is made on a case-by-case basis, taking into account all pertinent
                                         - 11 -

[*11] facts and circumstances. Higbee v. Commissioner, 116 T.C. at 448;

Sampson v. Commissioner, at *18.

      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.;

see also Remy v. Commissioner, T.C. Memo. 1997-72. Circumstances that may

also indicate reasonable cause and good faith include an honest misunderstanding

of fact or law that is reasonable in light of all of the facts and circumstances,

including the experience, knowledge, and education of the taxpayer. Higbee v.

Commissioner, 116 T.C. at 449; Sampson v. Commissioner, T.C. Memo. 2013-

212; Remy v. Commissioner, T.C. Memo. 1997-72; sec. 1.6664-4(b)(1), Income

Tax Regs.

      Respondent contends that petitioner did not exercise ordinary care and

prudence in attempting to determine his proper tax liability for 2010. Respondent

asserts that petitioner was aware of the “Turnover Order”, knew that his IRA had

in fact been liquidated, and still made no attempt to determine whether the amount

was taxable. According to respondent, petitioner has a professional career and is

highly educated. Consequently, his experience, knowledge, sophistication, and

education show that it would be reasonable for him to realize that the “Turnover

Order” had tax implications for the IRA distribution.
                                        - 12 -

[*12] Furthermore, respondent asserts that petitioner did not act in good faith

because he failed to provide all the relevant information to his paid preparer. In

order to rely on the advice provided by the taxpayer’s return preparer, the taxpayer

must “disclose a fact that it knows, or reasonably should know, to be relevant to

the proper tax treatment of an item.” Sec. 1.6664-4(c)(1)(i), Income Tax Regs.

Moreover, respondent asserts that petitioner unilaterally decided that the

“Turnover Order” and the IRA distribution were not items he needed to disclose to

his paid preparer because petitioner believed his criminal history was too personal

and too embarrassing to disclose to his paid preparer. Respondent contends that

petitioner also made no attempt of his own to determine whether the IRA

distribution was taxable after learning that his IRA had been liquidated.

      Petitioner, on the other hand, asserts he qualifies for the section 6664(c)

exception and should not be liable for the accuracy-related penalty based on a

substantial understatement of income tax. Petitioner testified that he did not show

the “Turnover Order” to his paid preparer because he did not believe that it was a

tax document and he did not want to show an embarrassing unrelated document

disclosing his criminal history. At the time he filed his tax return, petitioner did

not realize that there would be any tax implications with respect to the court-

ordered seizure of the IRA because he did not receive any monetary distribution
                                        - 13 -

[*13] from the liquidation of the IRA certificate of deposit. Additionally, the bank

officers were never able to explain how the account was liquidated; petitioner

never received a Form 1099-R from the bank, nor did he ever receive notice from

the District Court that the funds had been applied to the restitution account.

      Finally, petitioner asserts that he qualifies for the reasonable cause

exception because he had an honest misunderstanding of the tax law at the time he

filed his 2010 tax return. He asserts that it was the lack of knowledge, and not the

lack of good faith, that resulted in the omission of the IRA distribution from his

tax return. Petitioner claims that this honest misunderstanding of the tax law, in

addition to his history of tax compliance, good recordkeeping habits, and hiring a

paid preparer, shows that he acted reasonably and in good faith.

      Respondent asserts that a reasonable and ordinarily prudent person would

recognize from the “plain language” of the “Turnover Order” that there was a

potential tax impact from the court-ordered IRA distribution. However, the

wording in the “Turnover Order” is unclear and does not place an ordinary

taxpayer on notice of a specific tax obligation. On its face, the sentence “[t]his

court-ordered distribution shall not be subject to any additional tax or penalty” is

ambiguous. A precise application of Murillo v. Commissioner, T.C. Memo. 1998-

13, 1998 WL 6462, at *1, aff’d without published opinion, 166 F.3d 1201 (2d Cir.
                                        - 14 -

[*14] 1998), would state that when a defendant forfeits funds in his retirement

plan account as part of the terms of a criminal plea, the distribution shall not be

subject to the 10% additional tax under section 72(t). See United States v. Novak,

476 F.3d 1041, 1063 n.25 (9th Cir. 2007). Accordingly, the Court finds that

petitioner’s interpretation of the “Turnover Order” was not unreasonable or

negligence per se.

      Furthermore, it should be noted that the IRS itself made a mistake in regard

to the tax treatment of the “Turnover Order”. Initially the IRS determined that

petitioner was liable for a section 72(t) 10% additional tax on his court-ordered

IRA distribution, and only later conceded that petitioner should not have been

liable for the section 72(t) additional tax as the Government had seized his IRA.

The IRS’ actions show that neither the “Turnover Order” nor an accurate

application of Murillo was overwhelmingly obvious. The Court finds that

petitioner reasonably believed that the “Turnover Order” was not a tax document.

      However, the Court finds that petitioner did not act with reasonable cause

and in good faith because he never took any additional steps to determine whether

the court-ordered IRA distribution was taxable when he found out his IRA of

$109,154 had been liquidated. Petitioner testified that when he received a bank

statement showing a zero balance in his IRA, he immediately went to the bank to
                                        - 15 -

[*15] ask about the transaction history. A bank manager investigated the IRA but

did not provide petitioner any documentation reflecting the IRA’s ultimate fate.

The bank never gave him a response to his inquiries nor any documents showing

that the funds had been paid to the Clerk of the District Court according to the

“Turnover Order” instructions. Eventually, petitioner inferred that the turnover

from the bank had probably been completed although the District Court did not

acknowledge receipt of any of the money. Additionally, petitioner also testified

that he did not receive a Form 1099-R from the bank and did not receive any

documents from the IRS regarding the seizure of his IRA.

       That said, petitioner should have disclosed the IRA liquidation even if he

did not understand the tax ramifications. Even though petitioner did not receive a

Form 1099-R, his nonreceipt of any Form 1099 did not convert a taxable item to a

nontaxable item. See Vaughn v. Commissioner, T.C. Memo. 1992-317, aff’d

without published opinion, 15 F.3d 1095 (9th Cir. 1993). The liquidated IRA

itself was enough to put petitioner on notice that he had a duty to report the

information on his tax return. Additionally, petitioner did not act with reasonable

cause and in good faith when he failed to inform his paid preparer about his

dividend income and his interest income for 2010. Therefore, the Court finds that

on the basis of these facts, although petitioner did not act negligently per se, he did
                                        - 16 -

[*16] not act with reasonable cause and good faith when he did not adequately

disclose in the return the relevant facts affecting the item’s tax treatment.

Accordingly, the Court will impose an accuracy-related penalty for an

underpayment due to a substantial understatement of income tax for 2010.

      The Court has considered all of the arguments made by the parties and to

the extent they are not addressed herein, they are considered unnecessary, moot,

irrelevant, or without merit.

      To reflect the foregoing and the concessions of the parties,


                                                      Decision will be entered

                                                 under Rule 155.
