                         T.C. Memo. 2006-72



                       UNITED STATES TAX COURT



               STEPHEN DARYL ROYAL, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 19001-04.             Filed April 11, 2006.



     Stephen Daryl Royal, pro se.

     Bradley C. Plovan, for respondent.



                         MEMORANDUM OPINION


     CHIECHI, Judge:    Respondent determined a $5,324 deficiency

in, and a $1,065 accuracy-related penalty under section 6662(a)1

on, petitioner’s Federal income tax (tax) for his taxable year



     1
      All section references are to the Internal Revenue Code in
effect for the year at issue. All Rule references are to the Tax
Court Rules of Practice and Procedure.
                                - 2 -

2002.    The issues remaining for decision are:2

     (1) Is petitioner required to include $25,940.49 in his

gross income for his taxable year 2002?    We hold that he is.

     (2) Is petitioner entitled for his taxable year 2002 to the

earned income tax credit?    We hold that he is not.

                             Background

     Virtually all of the facts have been stipulated by the

parties and are so found.

     At the time petitioner filed the petition in this case, his

legal residence was in Baltimore City, Maryland.

     During 2002, petitioner was an employee of the U.S. Postal

Service (Postal Service) until he retired in that year because of

disability.

     The U.S. Office of Personnel Management (OPM) approved

petitioner’s retirement from the Postal Service because of

disability.    In a letter dated July 29, 2002, OPM advised peti-

tioner as follows:

     Your application for disability retirement has been
     approved.

     According to information we have received from your
     agency, you have not been separated from Government
     service. Therefore, we are notifying your agency of
     the approval and asking them to separate you. We are
     asking them to give us your last day of pay. Payment
     of annuity cannot start until after your last day of
     pay. If you have sick leave remaining, the last day of
     pay will be the day your sick leave is exhausted. We

     2
      At trial, petitioner conceded the accuracy-related penalty
under sec. 6662(a) that respondent determined.
                               - 3 -

     are asking your agency to send us your final separation
     records so we can establish your final annuity rate.

     We cannot start your annuity payments until we receive
     confirmation that you have applied for Social Security
     disability benefits. If you have not already done so,
     you must now apply for them. Please send us a copy of
     the receipt (or notice of allowance or disallowance)
     which you receive from the Social Security Administra-
     tion after you file the application.

     If the Social Security Administration awards you
     monthly benefits, you must also notify OPM of the
     amount of the monthly Social Security benefit and
     effective date of payment immediately upon becoming
     eligible * * *.

     During petitioner’s employment with the Postal Service, he

made contributions to a retirement account (petitioner’s TSP

retirement account) that he maintained with the Federal Thrift

Savings Plan.3   At a time or times not disclosed by the record,

petitioner borrowed money from petitioner’s TSP retirement

account.   When petitioner retired from the Postal Service in

2002, he had the following two loans from that account outstand-

ing (collectively, petitioner’s loans):   Loan number 0130267-E in

the amount of $10,477.89 (petitioner’s $10,477.89 loan) and loan

number 9800963-R in the amount of $15,462.60 (petitioner’s

$15,462.60 loan).4



     3
      The record does not disclose the terms of the Federal
Thrift Savings Plan in which petitioner participated while he was
an employee of the Postal Service.
     4
      The record does not disclose the respective terms of peti-
tioner’s loans.
                               - 4 -

     Petitioner was sent a notice dated September 4, 2002, with

respect to each of petitioner’s loans.   Such notice informed

petitioner that he was required to repay in full by December 3,

2002, the loan to which such notice pertained and that if he did

not do so, a taxable distribution would be declared with respect

to the unpaid principal and unpaid interest to September 16,

2002, with respect to such loan.   Petitioner did not repay

petitioner’s loans.

     On September 23, 2002, the Federal Thrift Savings Plan sent

petitioner two letters (collectively, September 23, 2002 let-

ters), one of which pertained to petitioner’s $10,477.89 loan

(September 23, 2002 letter pertaining to petitioner’s $10,477.89

loan) and the other of which pertained to petitioner’s $15,462.60

loan (September 23, 2002 letter pertaining to petitioner’s

$15,462.60 loan).   The September 23, 2002 letter pertaining to

petitioner’s $10,477.89 loan stated in pertinent part:

     You were sent a notice dated 09/04/02, informing you
     that, because you separated after your Thrift Savings
     Plan (TSP) loan was issued, you must repay your loan in
     full by 12/03/02, or a taxable distribution would be
     declared. Because you forfeited your right to repay
     the loan in full, effective 09/16/02, a taxable distri-
     bution in the amount of $10,477.89 has been declared in
     connection with the unpaid principal and unpaid inter-
     est to 09/16/02, on * * * [petitioner’s $10,477.89]
     loan.

The September 23, 2002 letter pertaining to petitioner’s

$15,462.60 loan stated in pertinent part:

     You were sent a notice dated 09/04/02, informing you
                              - 5 -

     that, because you separated after your Thrift Savings
     Plan (TSP) loan was issued, you must repay your loan in
     full by 12/03/02, or a taxable distribution would be
     declared. Because you forfeited your right to repay
     the loan in full, effective 09/16/02, a taxable distri-
     bution in the amount of $15,462.60 has been declared in
     connection with the unpaid principal and unpaid inter-
     est to 09/16/02, on * * * [petitioner’s $15,462.60]
     loan.

     Both September 23, 2002 letters further advised petitioner:

     This amount [of taxable distribution declared] will be
     reported as taxable income for 2002. You may also be
     liable for a tax penalty on this amount due to an early
     withdrawal. Because your Federal income tax liability
     may be affected by this distribution and/or tax pen-
     alty, you may wish to adjust your withholding amounts
     accordingly. In certain circumstances, you can roll
     all or any portion of an amount equal to this distribu-
     tion over into an Individual Retirement Arrangement
     (IRA) or other eligible plan and avoid current taxa-
     tion. You should consult with your tax advisor con-
     cerning taxation of this distribution.

     You will be sent the appropriate tax form by January
     31, 2003. The Internal Revenue Service will be sent a
     notice of this distribution by February 28, 2003, as
     required by law.

     At no time after petitioner retired from the Postal Service

did he open an individual retirement account.

     Petitioner filed Form 1040A, U.S. Individual Income Tax

Return, for his taxable year 2002 (petitioner’s 2002 return).     In

that return, petitioner showed his occupation as “Retired” and

claimed (1) head of household filing status, (2) his two children

as dependents, and (3) the earned income tax credit.   In peti-

tioner’s 2002 return, petitioner reported wages of $12,703.22,

“Pensions and annuities” of $33,118.49, of which he claimed only
                              - 6 -

$7,178 was taxable, unemployment compensation of $4,403, total

income of $24,284.22, and adjusted gross income of $24,284.22.

Attached to petitioner’s 2002 return were, inter alia:   (1) Form

CSA 1099R, Statement of Annuity Paid, for 2002 issued to peti-

tioner by OPM Retirement Programs that showed a gross annuity

amount of $7,178, tax withheld of $630, original contributions of

$4,110, and taxable annuity “UNKNOWN” and (2) Form 1099-R,

Distributions From Pensions, Annuities, Retirement or Profit-

Sharing Plans, IRAs, Insurance Contracts, etc., for 2002 issued

to petitioner by the Federal Thrift Savings Plan (TSP Form 1099-

R) that showed a gross distribution of $25,940.49, a taxable

amount of $25,940.49, and employee contributions or insurance

premiums of $0.

     Respondent issued a notice of deficiency (notice) to peti-

tioner for his taxable year 2002.   In the notice, respondent

determined for that year that petitioner must include in his

gross income $25,940.49, the total amount of petitioner’s loans,

that he is not entitled to the earned income tax credit, and that

he is liable for the accuracy-related penalty under section

6662(a).

                           Discussion

     Although respondent must have commenced respondent’s exami-

nation of petitioner’s 2002 return after July 22, 1998, the

parties do not address section 7491(a).   On the record before us,
                                - 7 -

we find that petitioner has failed to carry his burden of estab-

lishing that he satisfied the applicable requirements of section

7491(a)(2).    On that record, we conclude that petitioner has the

burden of proof with respect to the issues that remain in this

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

(1933).

Petitioner’s Loans

     The Federal Thrift Savings Plan in which petitioner partici-

pated while he was an employee of the Postal Service is treated

as a qualified trust described in section 401(a)6 that is exempt

from taxation under section 501(a).     Sec. 7701(j)(1)(A).   Any

contribution to, or distribution from, the Federal Thrift Savings

Plan is treated in the same manner as contributions to, or

distributions from, such a trust.    Sec. 7701(j)(1)(B).

     For purposes of section 72, if during any taxable year a

participant receives directly or indirectly any amount as a loan

from a qualified employer plan, such amount generally is to be

treated as having been received by such individual as a distribu-

tion from such plan.    Sec. 72(p)(1)(A).   For purposes of section

72(p), the term “qualified employer plan” means, inter alia, a

plan described in section 401(a) that includes a trust exempt


     5
      See supra note 2.
     6
      Sec. 401(a) sets forth the requirements for a qualified
stock bonus, pension, or profit-sharing plan of an employer for
the exclusive benefit of his employees or their beneficiaries.
                                   - 8 -

from taxation under section 501(a).        Sec. 72(p)(4)(A)(i)(I).

     Section 72(p)(2) sets forth an exception to the general rule

of section 72(p)(1)(A).       Section 72(p)(2) provides in pertinent

part:

     SEC. 72.     ANNUITIES; CERTAIN PROCEEDS OF ENDOWMENT AND
                  LIFE INSURANCE CONTRACTS.

        *         *       *         *         *       *       *

            (2)   Exception for certain loans.--

                 (A) General rule.--Paragraph (1) [of section
            72(p)] shall not apply to any loan to the extent
            that such loan (when added to the outstanding
            balance of all other loans from such plan whether
            made on, before, or after August 13, 1982), does
            not exceed the lesser of--

                       (i) $50,000, reduced by the excess (if
                  any) of--

                            (I) the highest outstanding balance
                       of loans from the plan during the 1-year
                       period ending on the day before the date
                       on which such loan was made, over

                            (II) the outstanding balance of
                       loans from the plan on the date on which
                       such loan was made, or

                       (ii) the greater of (I) one-half of the
                  present value of the nonforfeitable accrued
                  benefit of the employee under the plan, or
                  (II) $10,000.

            For purposes of clause (ii), the present value of
            the nonforfeitable accrued benefit shall be deter-
            mined without regard to any accumulated deductible
            employee contributions (as defined in subsection
            (o)(5)(B)).

                 (B) Requirement that loan be repayable within
            5 years.--
                                 - 9 -

                       (i) In general.--Subparagraph (A) shall
                  not apply to any loan unless such loan, by
                  its terms, is required to be repaid within 5
                  years.

        *         *       *       *       *       *       *

                 (C) Requirement of level amortization.--Ex-
            cept as provided in regulations, this paragraph
            shall not apply to any loan unless substantially
            level amortization of such loan (with payments not
            less frequently than quarterly) is required over
            the term of the loan.

     The record does not disclose when petitioner borrowed the

money from petitioner’s TSP retirement account that was evidenced

by petitioner’s loans.    Nor does the record disclose the respec-

tive terms of those loans or the terms of the Federal Thrift

Savings Plan in which petitioner participated while he was an

employee of the Postal Service.    The Court is unable to determine

from the instant record whether each of petitioner’s loans

qualified for the exception under section 72(p)(2).    Nonetheless,

it appears that each of those loans did so qualify.    In this

connection, the respective September 23, 2002 letters pertaining

to petitioner’s $10,477.89 loan and petitioner’s $15,462.60 loan

that the Federal Thrift Savings Plan sent to petitioner stated in

pertinent part:

     You were sent a notice dated 09/04/02, informing you
     that, because you separated after your Thrift Savings
     Plan (TSP) loan was issued, you must repay your loan in
     full by 12/03/02, or a taxable distribution would be
     declared. Because you forfeited your right to repay
     the loan in full, effective 09/16/02, a taxable distri-
     bution * * * has been declared in connection with the
     unpaid principal and unpaid interest to 09/16/02 * * *.
                              - 10 -

     If petitioner’s loans did not qualify for the exception

under section 72(p)(2), the Federal Thrift Savings Plan probably

would have notified petitioner that each such loan was to be

treated when made as a distribution from petitioner’s TSP retire-

ment account.   See sec. 72(p)(1)(A).   In that event, the Federal

Thrift Savings Plan would not have sent petitioner the respective

September 23, 2002 letters pertaining to petitioner’s $10,477.89

loan and petitioner’s $15,462.60 loan.   It appears from those

letters that petitioner’s loans qualified for the exception under

section 72(p)(2) and that, when petitioner did not repay each of

petitioner’s loans as directed by the Federal Thrift Savings

Plan, the Federal Thrift Savings Plan made a distribution from

petitioner’s TSP retirement account of an amount to discharge or

offset the outstanding balance of each such loan.7   Cf. Duncan v.

Commissioner, T.C. Memo. 2005-171; sec. 1.72(p)-1, Q&A-13(a)(1)

and (2) and (b), Income Tax Regs.   Those regulations, effective

for loans made on or after January 1, 2002, provide:



     7
      TSP Form 1099-R showed that in 2002 the Federal Thrift
Savings Plan made a gross distribution to petitioner of
$25,940.49, all of which was taxable. In petitioner’s 2002
return, petitioner reported “Pensions and annuities” of
$33,118.49, of which he included only $7,178 in his gross income.
The difference between “Pensions and annuities” of $33,118.49
that petitioner reported in petitioner’s 2002 return and $7,178
of such pensions and annuities that petitioner included in his
gross income equals $25,940.49, the total amount of (1) peti-
tioner’s loans outstanding at the time of his retirement from the
Postal Service in 2002 and (2) the taxable distribution to
petitioner reported in TSP Form 1099-R.
                                - 11 -

          Q-13: How does a deduction (offset) of an account
     balance in order to repay a plan loan differ from a
     deemed distribution?

          A-13: (a) Difference between deemed distribution
     and plan loan offset amount.--(1) Loans to a partici-
     pant from a qualified employer plan can give rise to
     two types of taxable distributions--

          (i) A deemed distribution pursuant to section
     72(p); and

             (ii) A distribution of an offset amount.

          (2) As described in Q&A-4 of this section, a
     deemed distribution occurs when the requirements of
     Q&A-3 of this section are not satisfied, either when
     the loan is made or at a later time. A deemed distri-
     bution is treated as a distribution to the participant
     or beneficiary only for certain tax purposes and is not
     a distribution of the accrued benefit. A distribution
     of a plan loan offset amount (as defined in § 1.402(c)-
     2, Q&A-9(b))[8] occurs when, under the terms governing a


     8
      Sec. 1.402(c)-2, Q&A-9, Income Tax Regs., describes a
distribution of a planned loan offset amount as follows:

          Q-9: What is a distribution of a plan loan offset
     amount * * *?

         *         *       *       *       *       *      *

          A-9: (b) Definition of plan loan offset amount.
     For purposes of section 402(c), a distribution of a
     plan loan offset amount is a distribution that occurs
     when, under the plan terms governing a plan loan, the
     participant’s accrued benefit is reduced (offset) in
     order to repay the loan (including the enforcement of
     the plan’s security interest in a participant’s accrued
     benefit). A distribution of a plan loan offset amount
     can occur in a variety of circumstances, e.g., where
     the terms governing a plan loan require that, in the
     event of the employee’s termination of employment or
     request for a distribution, the loan be repaid immedi-
     ately or treated as in default. A distribution of a
     plan loan offset amount also occurs when, under the
                                                   (continued...)
                              - 12 -

      plan loan, the accrued benefit of the participant or
      beneficiary is reduced (offset) in order to repay the
      loan (including the enforcement of the plan’s security
      interest in the accrued benefit). A distribution of a
      plan loan offset amount could occur in a variety of
      circumstances, such as where the terms governing the
      plan loan require that, in the event of the partici-
      pant’s request for a distribution, a loan be repaid
      immediately or treated as in default.

           (b) Plan loan offset. In the event of a plan loan
      offset, the amount of the account balance that is
      offset against the loan is an actual distribution for
      purposes of the Internal Revenue Code, not a deemed
      distribution under section 72(p). * * *

Id.

      On the record before us, we find that petitioner has failed

to carry his burden of showing that he is not required to include

$25,940.49 in his gross income for his taxable year 2002.

Claimed Earned Income Tax Credit

      In petitioner’s 2002 return, petitioner claimed the earned

income tax credit.   Section 32(a)(1) permits an eligible individ-

ual an earned income tax credit against such individual’s tax

liability.   The earned income tax credit is calculated as a

percentage of the individual’s earned income.   Sec. 32(a)(1).

Section 32(a)(2) limits the credit allowed.   Section 32(b)



      8
       (...continued)
      terms governing the plan loan, the loan is cancelled,
      accelerated, or treated as if it were in default (e.g.,
      where the plan treats a loan as in default upon an
      employee’s termination of employment or within a speci-
      fied period thereafter). A distribution of a plan loan
      offset amount is an actual distribution, not a deemed
      distribution under section 72(p).
                                  - 13 -

prescribes different percentages and amounts that are to be used

to calculate the credit depending on whether the eligible indi-

vidual has no qualifying children, one qualifying child, or two

or more qualifying children.       Respondent does not dispute that

petitioner’s daughters that he claimed as dependents in peti-

tioner’s 2002 return are qualifying children for purposes of the

earned income tax credit.

       For taxable year 2002, the earned income tax credit is

completely phased out if an individual who has two qualifying

children and who is not married filing jointly9 has adjusted

gross income that equals or exceeds $33,178.       See sec.

32(b)(1)(A) and (2); Rev. Proc. 2001-59, 2001-2 C.B. 623, 625-

626.       In petitioner’s 2002 return, petitioner claimed adjusted

gross income of $24,284.22.       We have held that petitioner must

include $25,940.49 in his gross income for 2002.       As a result,

petitioner’s adjusted gross income for that year is $50,224.71.

       On the record before us, we find that petitioner has failed

to carry his burden of establishing that he is entitled for his

taxable year 2002 to the earned income tax credit.

       To reflect the foregoing and petitioner’s concession,


                                        Decision will be entered for

                                   respondent.


       9
      Petitioner claimed head of household filing status in
petitioner’s 2002 return.
