                     T.C. Summary Opinion 2008-86



                        UNITED STATES TAX COURT



         MICHAEL LEON AND KARIN POLICKY TILLEY, Petitioners v.
              COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 26450-06S.              Filed July 21, 2008.



     Michael Leon and Karin Policky Tilley, pro sese.

     Frederick Lockhart, Jr., for respondent.



     ARMEN, Special Trial Judge:     This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect when the petition was filed.1    Pursuant to section

7463(b), the decision to be entered is not reviewable by any



     1
        Unless otherwise indicated, all subsequent section
references are to the Internal Revenue Code in effect for 2004,
the taxable year at issue, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
                               - 2 -

other court, and this opinion shall not be treated as precedent

for any other case.

     Respondent determined a deficiency in petitioners’ Federal

income tax of $28,579, as well as an accuracy-related penalty

under section 6662(a) of $3,555.80, for the taxable year 2004.

The issues for decision are:   (1) To what extent the

distributions received from Ms. Tilley’s section 401(k) plan are

taxable; (2) in what year they are taxable; (3) whether

petitioners are liable for the additional tax imposed on early

section 401(k) plan withdrawals under section 72(t); and (4)

whether petitioners are liable for a section 6662(a) negligence

penalty for not having included in gross income the taxable

distributions received from Ms. Tilley’s section 401(k) plan in

2004 on their 2004 Federal income tax return.

                            Background

     Some of the facts have been stipulated, and they are so

found.   We incorporate by reference the parties’ stipulation of

facts and accompanying exhibits.

     Petitioners resided in Colorado at the time the petition was

filed.

     Ms. Tilley began employment with American City Business

Journals, Inc. in 1992, and she participated in the company’s

section 401(k) plan (401(k) plan or the plan) until her

employment was terminated in October 2003.   In late 1999, Ms.
                              - 3 -

Tilley borrowed $40,958 from her plan account to purchase a home.

She signed a Promissory Note and Security Agreement in respect of

the loan which was governed by the terms of the plan.   The loan

was repayable with interest through semimonthly payroll

deductions over a 10-year term.   Ms. Tilley made the scheduled

payments until her employment was terminated.

     The outstanding balance of the loan became due and payable

at the time of Ms. Tilley’s termination, but petitioners did not

have the money to satisfy the obligation.   No payments were made

on the loan after her termination.    Pursuant to the terms of the

loan and the plan, the loan went into default in early 2004,

after the expiration of the 90-day grace, or cure, period.

     In March 2004, Fidelity Investments sent Ms. Tilley a

letter,2 notifying her that she had a deemed distribution from

the plan equal to the then-unpaid loan balance of $31,176.99.

The letter also identified this distribution as being fully

taxable and without any applicable statutory exception.3

     On April 19, 2004, Fidelity sent Ms. Tilley a check for

$61,479.94, which represented the $76,849.93 balance of her plan

account less $15,369.99 in Federal tax withholding.   Petitioners


     2
        Although Fidelity Investments sent the letter to Ms.
Tilley, Fidelity Management Trust Co. is listed as the plan’s
administrator. We use the name Fidelity to refer to these
entities interchangeably.
     3
        Ms. Tilley, born in 1954, was not 59½ at the time of the
distribution.
                                   - 4 -

deposited the entire $61,479.94 into their checking account

rather than depositing it into the individual retirement account

(IRA) they had established with Fidelity for Ms. Tilley.

      Fidelity issued a Form 1099-R, Distributions From Pensions,

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

Contracts, etc., for 2004 reporting a gross distribution to Ms.

Tilley of $108,026.92.     The distribution amount reflected the

gross distribution from the remainder of Ms. Tilley’s 401(k) plan

as well as the unpaid balance on the loan.       Although petitioners

included two other Form 1099-R distributions in their income on

their 2004 Federal income tax return, petitioners did not include

this distribution.     Respondent determined in the notice of

deficiency that petitioners were required to include Ms. Tilley’s

distribution in income.       Respondent also determined that the

distribution was subject to the 10-percent additional tax under

section 72(t) on early distributions from qualified retirement

plans.     Further, respondent determined that petitioners were

subject to a penalty under section 6662(a).

                                Discussion

A.   Taxable Distributions

      1.    Burden of Proof

      Generally, the Commissioner’s determinations are presumed

correct, and the taxpayer bears the burden of proving those

determinations wrong.     Rule 142(a); INDOPCO, Inc. v.
                                - 5 -

Commissioner, 503 U.S. 79, 84 (1992); Welch v. Helvering, 290

U.S. 111, 115 (1933).    Under section 7491 the burden of proof may

shift from the taxpayer to the Commissioner if the taxpayer

produces credible evidence with respect to any factual issue

relevant to ascertaining the taxpayer’s tax liability.     Sec.

7491(a)(1).    In this case there is no such shift because

petitioners did not allege that section 7491 was applicable, nor

did they establish that they fully complied with the requirements

of section 7491(a)(2).    The burden of proof remains on

petitioners.

     2.   Balance of the 401(k) Plan Account

     Generally, a distribution from a qualified plan such as Ms.

Tilley’s 401(k) plan is includable in the distributee’s gross

income in the year of distribution.     See secs. 61(a)(11), 72,

401(a), 402(a), 408(d), 4974(c)(1).     Therefore, the balance of

Ms. Tilley’s 401(k) plan account, $76,849.93, was disbursed in a

taxable distribution to Ms. Tilley in April 2004.      Accordingly,

$15,369.99 in Federal taxes was withheld by Fidelity.

     Petitioners testified that they had intended to roll over

the money into Ms. Tilley’s IRA.    Amounts moved from one

qualified plan to another may be treated as a rollover

contribution if the transaction is completed within 60 days and

meets certain other requirements.    Sec. 408(d)(3).   Partial

rollovers are permitted.    Sec. 408(d)(3)(D).   Petitioners did not
                                 - 6 -

take advantage of the rollover provisions.      Regardless of their

original intentions, petitioners cashed the check and spent the

money.

       Four years later, petitioners urge the Court to grant them a

waiver of the 60-day requirement.     See sec. 408(d)(3)(I).   They

argue that Fidelity made a mistake sending them the check and

that they would now be willing to put the money into Ms. Tilley’s

IRA.    On these facts we decline to grant the waiver, and we do so

without offense to equity or good conscience.

       3.   Loan Balance

       Section 72(p)(1)(A) treats loans from qualified plans as

taxable distributions.     See sec. 72(p)(1)(A), (4)(A)(i)(I);

Plotkin v. Commissioner, T.C. Memo. 2001-71; Patrick v.

Commissioner, T.C. Memo. 1998-30, affd. per curiam without

published opinion 181 F.3d 103 (6th Cir. 1999); Prince v.

Commissioner, T.C. Memo. 1997-324.       However, section 72(p)(2)(A)

provides an exception for certain loans; the mere making of a

loan that does not exceed one-half of the nonforteitable accrued

benefit of the employee under the plan, that is repayable within

5 years, and that provides for substantially level amortization

does not give rise to a deemed distribution.      See sec. 72(p)(2);

see also sec. 72(p)(1)(B)(ii) (providing an exception to the 5-

year repayment requirement for loan proceeds used to purchase a

primary residence).
                                 - 7 -

     Although a loan may initially satisfy the requirements of

section 72(p)(2)(A) at the time that it is made, a deemed

distribution may nevertheless occur subsequently because of the

failure to repay the loan in accordance with the loan agreement.

Sec. 72(p)(2).    Accordingly, if a default occurs, a distribution

is deemed to occur at that time in the amount of the then-

outstanding balance of the loan.    It is clear that Ms. Tilley

defaulted on her loan and thus had a deemed distribution from her

401(k) plan account; the issue here is the date on which the

default-–and thus the deemed distribution--occurred.

     Petitioners argue that because the entire loan balance

became due and payable upon Ms. Tilley’s termination of

employment pursuant to an acceleration clause in the plan

documents (“Upon * * * termination of employment, the entire

outstanding principal and accrued interest shall be immediately

due and payable”.), the missed installment payment took place in

October 2003.    Petitioners argue that any distribution,

therefore, took place in 2003.

     It is true that it was in October 2003 when Ms. Tilley first

missed her payment.    However, the plan documentation provided to

us by petitioners shows that the plan had a 90-day grace, or

cure, period.    The plan documents explain that “The Plan

Administrator shall treat a loan in default if any scheduled

repayment remains unpaid more than 90 days”.    Therefore, Ms.
                                - 8 -

Tilley’s default under the plan did not occur until the

expiration of the cure period in 2004.

     Under the current regulations, when a participant fails to

make payments in accordance with the terms of a loan, the loan is

treated as no longer meeting the requirements of section

72(p)(2)(C) and a deemed distribution results.      Sec. 1.72(p)-1,

Q&A-4, Income Tax Regs.   The deemed distribution occurs at the

time the installment payment was due but not made.      Sec. 1.72(p)-

1, Q&A-10, Income Tax Regs.    The current regulations also provide

that the deemed distribution will not occur if the installment

payment due is made before the end of any cure period permitted

by the plan administrator.    Sec. 1.72(p)-1, Q&A-10, Income Tax

Regs.   In other words, under the current regulations, the deemed

distribution would clearly not occur until the close of any cure

period provided under the plan.    However, Ms. Tilley’s loan was

made in 1999, before the effective date of the current

regulations.   See sec. 1.72(p)-1, Q&A-22, Income Tax Regs.

Accordingly, the final regulation is not applicable to the case

at bar.

     Before the promulgation of the final regulation, a proposed

regulation had been issued containing the same provisions.      See

sec. 1.72(p)-1, Q&A-4, Q&A-10, Proposed Income Tax Regs., 60 Fed.

Reg. 66235, 66236 (Dec. 21, 1995).      The proposed regulation,

however, was to apply only to loans made after a certain period
                               - 9 -

after the final regulation had been published.   Sec. 1.72(p)-1,

Q&A-19, Proposed Income Tax Regs., 60 Fed. Reg. 66237 (Dec. 21,

1995).   Further, a proposed regulation is given no more weight

than a position advanced by the Commissioner on brief.   KTA-

Tator, Inc. v. Commissioner, 108 T.C. 100, 102-103 (1997); F.W.

Woolworth Co. v. Commissioner, 54 T.C. 1233, 1265-1266 (1970).

     Given that the regulations do not shed light on this

dispute, the only logical way to reach a conclusion is to examine

the facts before us and, in particular, the plan documents.     The

materials provided to us at trial suggest that the plan’s

administrator defines date of default as being 90 days following

an outstanding payment’s due date. Although petitioners point to

the plan’s loan acceleration clause and urge us to adopt their

argument that the default occurred immediately upon Ms. Tilley’s

termination of employment, a far more reasonable interpretation

is that the acceleration clause merely controls the amount due at

termination (i.e., the entire balance of the loan becomes due and

payable) and does not negate the 90-day cure period.   Further,

petitioners’ own actions belie their argument that they believed

the deemed distribution occurred in 2003, as they did not report

the deemed distribution on their 2003 Federal income tax return.

     The record demonstrates that the balance due at the time of

the default–-the date at which cure was no longer possible–-was
                                   - 10 -

$31,176.99.    Thus, pursuant to section 72(p)(1)(A), a $31,176.99

distribution is deemed to have been made in 2004.

      Section 402(a) provides generally that distributions from a

qualified plan are taxable to the distributee in the taxable year

in which the distribution occurs, pursuant to the provisions of

section 72, and thus the $31,176.99 deemed distribution was

taxable in 2004.

B.   10-Percent Additional Tax

      Section 72(t) imposes an additional tax on a distribution

from a qualified retirement plan made prior to a taxpayer’s

attaining the age of 59½ unless an enumerated exception applies.

For example, the additional tax does not apply to distributions

that are made to a beneficiary on or after the death of the

employee or that are attributable to the employee’s being

disabled.     See sec. 72(t)(2).    The additional tax equals 10

percent of the portion of such distribution that is includable in

gross income.     The additional tax is intended to discourage

premature distributions from retirement plans.       Dwyer v.

Commissioner, 106 T.C. 337, 340 (1996); see also S. Rept. 93-383,

at 134 (1973), 1974-3 C.B. (Supp.) 80, 213.

      Petitioners had a deemed distribution of $31,176.99 from the

balance of Ms. Tilley’s loan and an actual distribution of

$76,849.93 (from which taxes were withheld) from the closure of

her 401(k) plan account.     Ms. Tilley had not yet attained the age
                              - 11 -

of 59½ at the time of the distributions, nor did any of the other

statutory exceptions to the additional tax apply.    See sec.

72(t)(2).

      Petitioners do not, in fact, argue that any statutory

exception applies.   Their only argument as to why they should not

be subject to the additional tax is that “they didn’t cause the

withdrawal” and that Fidelity made a mistake in failing to roll

over the money into Ms. Tilley’s IRA.    But petitioners did

receive a distribution, and they did use the money distributed.

Further, alleged mistakes of the sort claimed here are not among

the enumerated exceptions to the additional tax.    Petitioners are

therefore liable for it.4   See Arnold v. Commissioner, 111 T.C.

250, 255 (1998); Schoof v. Commissioner, 110 T.C. 1, 11 (1998);

Clark v. Commissioner, 101 T.C. 215, 224-225 (1993); Swihart v.

Commissioner, T.C. Memo. 1998-407.

C.   Negligence Penalty

      Section 6662(a) imposes a penalty equal to 20 percent of any

underpayment that is attributable to either negligence or

disregard of rules or regulations.     See sec. 6662(a) and (b)(1).

The term “negligence” includes any failure to make a reasonable

attempt to comply with the provisions of the internal revenue


      4
        Regardless of whether the sec. 72(t) additional tax is a
penalty or an additional amount under sec. 7491(c), respondent
has satisfied his burden of production with respect to the
distribution. See Milner v. Commissioner, T.C. Memo. 2004-111
n.2.
                                - 12 -

laws.     Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.    The

term “disregard” includes any careless, reckless, or intentional

disregard.     Sec. 6662(c); sec. 1.6662-3(b)(2), Income Tax Regs.

Respondent determined that petitioners are liable for this

penalty.

      By virtue of section 7491(c), the Commissioner has the

burden of production with respect to a taxpayer’s liability for

any penalty.     To meet this burden, the Commissioner must produce

sufficient evidence indicating that it is appropriate to impose

the relevant penalty.     Higbee v. Commissioner, 116 T.C. 438, 446

(2001).     Once the Commissioner meets the burden of production,

the taxpayer must come forward with persuasive evidence that the

Commissioner’s determination is incorrect.     Id.

        Respondent satisfied his burden of production under section

7491(a)(1) because the record clearly demonstrates that

petitioners failed to include Ms. Tilley’s 401(k) plan

distributions in their gross income despite being required to do

so.     Accordingly, we hold that respondent satisfied his burden.

        Section 6664 provides an exception to the imposition of an

accuracy-related penalty if the taxpayer establishes that there

was reasonable cause for the understatement and that the taxpayer

acted in good faith with respect to that portion.       Sec.

6664(c)(1); sec. 1.6664-4(b), Income Tax Regs.       The taxpayer

bears the burden of proving that he or she acted with reasonable
                              - 13 -

cause and in good faith.   See sec. 6664(c)(1); see also Higbee v.

Commissioner, supra at 446; sec. 1.6664-4(b)(1), Income Tax Regs.

The determination of whether a taxpayer acted with reasonable

cause and good faith is made on a case-by-case basis.   Sec.

1.6664-4(b)(1), Income Tax Regs.   Generally, the most important

factor is the extent of the taxpayer’s effort to assess the

proper tax liability for such year.    Id.

     Petitioners claim that they relied on the Fidelity

representative’s assertion that the distribution was not taxable

and thus should not be held responsible for the penalty.    Good

faith reliance on professional advice concerning tax laws may be

a defense to the negligence penalty.    Neonatology Assocs., P.A.

v. Commissioner, 115 T.C. 43, 99 (2000), affd. 299 F.3d 221 (3d

Cir. 2002); see also United States v. Boyle, 469 U.S. 241, 250-

251 (1985); sec. 1.6664-4(b)(1), Income Tax Regs.   However,

“Reliance on professional advice, standing alone, is not an

absolute defense to negligence, but rather a factor to be

considered.”   Freytag v. Commissioner, 89 T.C. 849, 888 (1987),

affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868 (1991);

see also sec. 1.6664-4(b)(1), Income Tax Regs.   In order to be

considered as such, the reliance must be reasonable.    See Freytag

v. Commissioner, supra at 888; sec. 1.6664-4(b)(1), Income Tax

Regs.
                              - 14 -

      Petitioners did not have reasonable cause to believe that

the $108,026.92 distribution they received from Ms. Tilley’s plan

account was not taxable.   In fact, they received three Forms

1099-R that year, and we are not persuaded by petitioners’

allegation that they believed this distribution alone was not

taxable.   Further, it was not reasonable for petitioners to rely

on a Fidelity call-center representative for tax advice.

Accordingly, we sustain respondent’s determination on this issue.

D.   Conclusion

      We have considered all of petitioners’ arguments and, to the

extent we did not specifically address them, we conclude they are

without merit.

      Any remaining adjustments listed in the notice of deficiency

are mechanical in nature, and their resolution flows from this

decision. To reflect our disposition of the disputed issues,



                                         Decision will be entered

                                    for respondent.
