                          T.C. Summary Opinion 2017-57



                         UNITED STATES TAX COURT



                  GREGORY J. GOWEN, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 21365-15S.                         Filed July 24, 2017.



      Mark L. Rhoades, for petitioner.

      Arthur W. Peterson, III and Jason M. Kuratnick, for respondent.



                              SUMMARY OPINION


      JACOBS, Judge: This case was heard pursuant to the provisions of section

7463 of the Internal Revenue Code in effect when the petition was filed. Pursuant

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

and this opinion shall not be treated as precedent for any other case.
                                         -2-

      After concessions,1 the issues for decision are whether petitioner: (1) failed

to report as income a taxable retirement distribution of $46,703 in 2012; (2) is

liable for the 10% additional tax under section 72(t)(1) on early distributions from

a qualified plan and; (3) is liable for the section 6662(a) accuracy-related penalty.2

      All section references are to the Internal Revenue Code, as amended, in

effect for the year in issue. Rule references are to the Tax Court Rules of Practice

and Procedure.

                                     Background

      At the time he filed his petition, petitioner resided in New Jersey. Petitioner

holds a master’s degree in taxation and is a certified public accountant. He

considers himself to be an expert in the field of income tax, having been employed

by several large, international accounting firms, including Ernst & Young,

PricewaterhouseCoopers, and KPMG.

      On March 8, 2012, petitioner borrowed $50,000 from his KPMG section

401(k) retirement plan account administered by Merrill Lynch (a unit of Bank of



      1
        Respondent concedes an issue raised in the notice of deficiency relating to
petitioner’s alleged failure to report a $183 retirement distribution from BNY
Mellon.
      2
       Respondent also made certain alternative minimum tax determinations that
are purely computational.
                                         -3-

America N.A.). The terms of the loan required petitioner to make 120

semimonthly payments of $451.72, beginning on March 30, 2012, and ending on

March 15, 2017. Petitioner initially made the required payments, but after he lost

his job at KPMG, he stopped making payments, beginning with a missed payment

due on August 30, 2012. Merrill Lynch sent petitioner a notice dated October 23,

2012, stating: “Our records indicate that your loan payment is past due. Your

loan is in danger of being defaulted.” The notice also stated:

      We are required by law to enforce the provisions of the Promissory
      Note and Security Agreement for your loan dated 03/08/2012, to
      ensure the qualified status of the plan. If you default on the loan, the
      following action will be taken:

             The unpaid balance and accrued interest on the balance will be
             reclassified as a withdrawal.

             The taxable portions of the withdrawal will be recorded as
             taxable income.

             The taxable portion of the withdrawal will be taxable to you in
             the year of the default. It will be subject to ordinary income
             tax, and if you are under the age of 59 ½ at the time of the
             default, it may also be subject to a 10% tax penalty.

The notice further stated that the cure or default period expired at the “end of the

calendar quarter following the calendar quarter during which the payment was

missed.” Because the day of petitioner’s first missed payment, August 30, 2012,

was in the third calendar quarter of 2012, the cure or default period expired on
                                        -4-

December 31, 2012, the last day of the fourth quarter of 2012. Merrill Lynch sent

petitioner additional default notices on November 26 and December 26, 2012,

repeating the default notifications and warning him of the tax consequences of

default.

      Shortly after the default expiration date, December 31, 2012, the deemed

distribution was administratively processed, and Merrill Lynch, through Bank of

America N.A., reported a distribution to petitioner of $46,703, representing the

defaulted portion of his $50,000 loan, on Form 1099-R, Distributions From

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

Contracts, etc., sent to both petitioner and the Internal Revenue Service.

Petitioner’s correct address was printed on the Form 1099-R; he maintains he

never received it. Petitioner admits, however, that he received a distribution

statement sent by Merrill Lynch, dated January 7, 2013, which reported the

$46,703 deemed distribution.

      In addition to the aforementioned deemed distribution, petitioner received

two other distributions from his qualified retirement plan. On July 31, 2012,

petitioner withdrew $36,000 from his KPMG section 401(k) retirement plan
                                         -5-

account, and on November 13, 2012, he withdrew another $50,000 from that

account. All told, petitioner received gross distributions from his KPMG section

401(k) retirement plan account of $132,703 in 2012.

      Petitioner received an extension of time to file his Federal income tax

return; even so he filed his Form 1040, U.S. Individual Income Tax Return, for

2012 late, on October 21, 2013. On his 2012 tax return petitioner reported income

of $216,147 consisting of wages of $122,776, pensions and annuities of $86,000

(the total of the amounts he withdrew from his KPMG section 401(k) retirement

plan account), and unemployment compensation of $7,371. Petitioner did not

report the deemed distribution from Merrill Lynch, claiming that (1) he did not

receive the Form 1099-R and (2) he believed that the distribution statement sent

by Merrill Lynch indicated that the deemed distribution had occurred on January

7, 2013. Petitioner did not report any liability with respect to the section 72(t)(1)

10% additional tax on early retirement distributions even though he was 51 years

old on December 31, 2012.

                                     Discussion

      In an unreported income case, such as the instant matter, a presumption of

correctness attaches to the Commissioner’s determination after he provides a

minimal evidentiary foundation. See Rule 142(a); United States v. McMullin, 948
                                          -6-

F.2d 1188, 1192 (10th Cir. 1991); Anastasato v. Commissioner, 794 F.2d 884, 887

(3d Cir. 1986), vacating and remanding on other grounds T.C. Memo. 1985-101.3

Moreover, if an information return, such as a Form 1099-R, is the basis for the

Commissioner’s determination of a deficiency, section 6201(d) may apply to shift

the burden of production to the Commissioner if in any court proceeding the

taxpayer asserts a reasonable dispute with respect to the income reported on the

information return and the taxpayer has fully cooperated with the Commissioner.

See McQuatters v. Commissioner, T.C. Memo. 1998-88. Petitioner has not

challenged the accuracy of the information reported on the Form 1099-R.

         We do not decide this case by reference to the placement of the burden of

proof.

I.       Underreported Retirement Income Distribution

         A distribution from a qualified plan, such as petitioner’s section 401(k)

retirement plan account, is generally includible in the income of the distributee in

the year of distribution. Sec. 402(a). If a participant or beneficiary of a qualified

plan receives a loan from the plan, that amount is generally treated as a taxable


         3
       In certain circumstances the burden of proof with respect to factual matters
may shift to the Commissioner. Sec. 7491(a). Petitioner does not argue that sec.
7491(a) applies herein, nor did he show that he met its requirements for shifting
the burden of proof.
                                         -7-

distribution in the year received. Sec. 72(p)(1)(A). However, loans are excepted

from this general rule under section 72(p)(2) if certain requirements are met:

(1) the outstanding loan does not exceed a statutorily defined maximum amount,

sec. 72(p)(2)(A); (2) the loan is to be repaid within five years, unless it is a home

loan, sec. 72(p)(2)(B); and (3) except as provided in regulations, the loan has

substantially level amortization over the term of the loan with payments not less

frequently than quarterly, sec. 72(p)(2)(C). In addition, section 1.72(p)-1, Q&A-3,

Income Tax Regs., requires that the loan be “evidenced by a legally enforceable

agreement”.

      The section 72(p)(2) exception ceases to apply when the “loan from a

qualified employer plan no longer satisfies the requirement of section 72(p)(2)(C)

* * * [because] the participant fails to make a loan payment either on the date that

it is due or within the allowed grace period.” Martinez v. Commissioner, T.C.

Memo. 2016-182, at *8 (quoting Duncan v. Commissioner, T.C. Memo. 2005-

171); accord sec. 1.72(p)-1, Q&A-4, Income Tax Regs. (explaining further that

such a failure would result in a deemed distribution), Q&A-10(a) (providing that a

plan administrator may allow a cure or grace period which cannot continue beyond

the last day of the calendar quarter following the calendar quarter in which the

required installment payment was due and that section 72(p)(2)(C) will not be
                                        -8-

considered to have been violated if the installment payment is made not later than

the end of the cure period). If the taxpayer fails to make the required loan

payments, the amount of the deemed distribution is the amount that equals the

outstanding balance of the loan (including accrued interest) at the time of failure.

Sec. 1.72(p)-1, Q&A-10(b), Income Tax Regs.

      The record herein demonstrates that petitioner borrowed $50,000 from his

KPMG section 401(k) retirement plan account on March 8, 2012, and that he

failed to make required payments beginning with the missed August 30, 2012,

payment. Merrill Lynch sent petitioner multiple letters alerting him to the missed

payments and warning him of the tax consequences if the missed payments were

not made by the expiration of the cure period.

      Petitioner concedes that the balance of the loan outstanding as of the

expiration of the cure period is deemed to be a taxable distribution. However,

petitioner maintains that the cure period expired in 2013 and thus the distribution

is deemed a taxable event for that year, not for 2012 as respondent asserts.

Petitioner maintains that the loan notices sent on October 23, November 26, and

December 26, 2012, informed him “that your loan was ‘in danger of being in

default’” and that it was not until January 7, 2013, that Merrill Lynch issued him a

distribution information statement reporting the deemed distribution from his
                                         -9-

default. Moreover, petitioner claims he never received a Form 1099-R reporting

the deemed distribution. Petitioner posits:

      Treasury Regulation 1.72(B) [sic] does not mandate a maximum cure
      period. Therefore, the plan administrator has ability to define the
      cure period which Petitioner was told by Merrill Lynch was six
      months. Petitioner’s reliance on the statement of Merrill Lynch was
      reasonable. In addition, it was reasonable for Petitioner to rely on the
      communications from Merrill Lynch throughout 2012 that the loan
      was not yet in default, as well as the communication from Merrill
      Lynch that the loan was deemed a distribution on January 7, 2013.

      Petitioner’s position is not correct. The applicable regulation does, in fact,

designate a “maximum cure period”. Section 1.72(p)-1, Q&A-10(a), Income Tax

Regs., provides:

      Failure to make any installment payment when due in accordance
      with the terms of the loan violates section 72(p)(2)(C) and,
      accordingly, results in a deemed distribution at the time of such
      failure. However, the plan administrator may allow a cure period and
      section 72(p)(2)(C) will not be considered to have been violated if the
      installment payment is made not later than the end of the cure period,
      which period cannot continue beyond the last day of the calender
      quarter following the calendar quarter in which the required
      installment payment was due.

At trial petitioner maintained that this regulation, in fact, supported his contention.

In response to his counsel, Mark Rhoades, who asked him: “[W]hat is your

understanding of the regulation as to when a distribution will be deemed a
                                        - 10 -

distribution for a 401(k) loan, with regard to the counting quarters[?]”, petitioner

stated:

      MR. GOWEN: Well, in terms of the distribution itself, my
      interpretation would be that the language of the calendar quarters
      should actually be viewed as quarters of a year, and therefore, it
      shouldn’t be based upon the fact of when you lost your job.

      For instance, somebody was unemployed in June would actually get
      six months of cure period, versus somebody that would get laid off in
      August, as I was. That only gets four months of cure period.

      So it didn’t seem to equate, and under the--you know, the statute that
      that made sense, that one individual would be treated differently, and
      that the calendar quarter was somehow magical in its intent of, you
      know, terminating the cure period.

      MR. RHODES: So to your understanding the first quarter--in your
      situation the first payment was missed in August, correct?

      MR. GOWEN: Correct.

      MR. RHODES: So the first quarter, in your understanding, was
      August, September, October?

      MR. GOWEN: Right.

      MR. RHODES: Then the second quarter would have been
      November, December, January; is that correct?

      MR. GOWEN: That’s correct.

Petitioner ignores the plain language of the regulation in making his argument.

The regulation makes no mention of a six-month cure period. It merely provides
                                        - 11 -

that the cure period cannot continue beyond the last day of the calendar quarter

following the calendar quarter in which the required installment payment was due.

Tellingly, section 1.72(p)-1, Q&A-10(c), Income Tax Regs., contains the

following example:

      (i) On August 1, 2002, a participant has a nonforeitable account
      balance of $45,000 and borrows $20,000 from a plan to be repaid
      over 5 years in level monthly installments due at the end of each
      month. After making all monthly payments due through July 31,
      2003, the participant fails to make the payment due on August 31,
      2003 or any other monthly payments due thereafter. The plan
      administrator allows a threemonth [sic] cure period.

             (ii) As a result of the failure to satisfy the requirement that the
      loan be repaid in level installments pursuant to section 72(p)(2)(C),
      the participant has a deemed distribution on November 30, 2003,
      which is the last day of the three-month cure period for the August
      31, 2003 installment. The amount of the deemed distribution is
      $17,157, which is the outstanding balance on the loan at November
      30, 2003. Alternatively if the plan administrator had allowed a cure
      period through the end of the next calendar quarter, there would be a
      deemed distribution on December 31, 2003 equal to $17,282, which
      is the outstanding balance of the loan at December 31, 2003.

      Petitioner, like the plan participant in the regulation example, failed to make

the required loan payments in August, which is in the third calendar quarter.

Petitioner’s cure period, like the plan participant’s cure period in the example,

expired at the end of the fourth calendar quarter: December 31. Thus, petitioner,

like the plan participant in the example, is deemed to have received a taxable
                                         - 12 -

distribution as of December 31, 2012. The fact that Merrill Lynch issued

petitioner a statement on January 7, 2013, documenting that a distribution had

been made does not change this. The January 7, 2013, statement did not indicate

when the distribution had occurred.

        In sum, petitioner received a taxable retirement distribution of $46,703 in

2012.

II.     Section 72(t)(1) 10% Additional Tax on Early Withdrawals

        Amounts received by a taxpayer from a qualified plan are generally subject

to a 10% additional tax on early distributions under section 72(t)(1) unless one of

several exceptions set forth in section 72(t)(2) applies. Those exceptions include:

(1) distributions made on or after the taxpayer attains age 59½; (2) distributions

that are part of a series of substantially equal periodic payments over the life of the

taxpayer; (3) distributions after separation from service after the taxpayer reaches

age 55; (4) distributions made with respect to certain medical expenses;

(5) distributions made to make payments pursuant to a qualified domestic relations

order; and (6) certain employee stock option program distributions. See Arnold v.

Commissioner, 111 T.C. 250, 255 (1998) (“The legislative purpose underlying the

section 72(t) tax is that ‘premature distributions from IRA’s frustrate the intention
                                        - 13 -

of saving for retirement, and section 72(t) discourages this from happening.’”

(quoting Dryer v. Commissioner, 106 T.C. 337, 340 (1996))).

      Petitioner reported retirement distributions of $86,000, representing the July

and November distributions, on his 2012 Federal income tax return; he did not pay

the section 72(t)(1) 10% additional tax on that amount. Furthermore, as we held

supra part I, petitioner received a $46,703 taxable retirement distribution on

December 31, 2012; he did not pay the section 72(t)(1) 10% additional tax on that

amount.

      Petitioner has not established that he meets any of the exceptions

enumerated in section 72(t)(2). Instead, petitioner asserts that he suffered

financial hardship during 2012 and therefore is not subject to the section 72(t)(1)

10% additional tax. Petitioner points to section 1.401(k)-1(d)(3)(i), Income Tax

Regs., to support his position. Section 1.401(k)-1(d)(1)(ii), Income Tax Regs.,

provides that a distribution made by a retirement plan is permitted in cases of “the

employee’s hardship”. Section 1.401(k)-1(d)(3)(i), Income Tax Regs., provides:

      A distribution is treated as made after an employee’s hardship for
      purposes of paragraph (d)(1)(ii) of this section if and only if it is
      made on account of the hardship. For purposes of this rule, a
      distribution is made on account of hardship only if the distribution
      both is made on account of an immediate and heavy financial need of
      the employee and is necessary to satisfy the financial need. The
      determination of the existence of an immediate and heavy financial
                                        - 14 -

      need and of the amount necessary to meet the need must be made in
      accordance with nondiscriminatory and objective standards set forth
      in the plan.

Petitioner asserts that “[a]s the regulation under section 401(k) allows all facts and

circumstances to be considered”, the definition of hardship should be broadly

construed. Petitioner concludes that “he was unable to repay the 401(k) loan due

to a combination of divorce and job loss, thus qualifying as a double financial

hardship.” Petitioner’s position is flawed.

      We do not doubt that petitioner endured financial hardship during 2012.

But the regulation upon which petitioner relies is limited to authorizing qualified

plans to make distributions to beneficiaries under certain circumstances, one of

which occurs when a beneficiary incurs financial hardship. In other words, section

1.401(k)-1(d)(3)(i), Income Tax Regs., permitted the KPMG section 401(k)

retirement plan to make the distributions to petitioner, but it did not provide for an

exception to the 10% additional tax under section 72(t)(1). And as we stated in

Arnold v. Commissioner, 111 T.C. at 255: “[N]o exception exists under section

72(t) for financial hardship.” See also Duffy v. Commissioner, T.C. Memo. 1996-

556; Pulliam v. Commissioner, T.C. Memo. 1996-354.

      In sum, petitioner is liable for the section 72(t)(1) 10% additional tax on the

$132,703 in distributions from his KPMG section 401(k) retirement plan account.
                                       - 15 -

III.   Section 6662(a) Accuracy-Related Penalty

       Respondent determined that petitioner was liable for a $5,876 accuracy-

related penalty. Section 6662(a) and (b)(1) and (2) imposes a 20% accuracy-

related penalty on any portion of an underpayment attributable to negligence or

disregard of rules or regulations or a substantial understatement of income tax. An

understatement of income tax is substantial for purposes of section 6662(b)(2) if it

exceeds the greater of 10% of the tax required to be shown on the return or

$5,000. Sec. 6662(d)(1)(A).

       Section 7491(c) provides that the Commissioner bears the burden of

production with regard to penalties and must come forward with sufficient

evidence indicating that it is appropriate to impose the section 6662(a) accuracy-

related penalty. See Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once

the Commissioner has met his burden of production, the taxpayer bears the burden

of establishing that an exception applies. Id. at 446-447.

       The Commissioner has satisfied his burden of production with respect to

petitioner’s substantial understatement of income tax. Petitioner failed to report

the $46,703 deemed distribution he received from his KPMG section 401(k)

retirement plan account, and he failed to report and pay the section 72(t)(1) 10%

additional tax. Petitioner reported a tax liability of $42,474 on his 2012 income
                                       - 16 -

tax return. Respondent determined a deficiency of $29,465, but respondent

conceded a minor amount of that deficiency. See supra note 1. We are satisfied

that the understatement of tax exceeds 10% of the tax required to be shown on

petitioner’s 2012 income tax return, which will be greater than $5,000. Thus, the

Commissioner has shown there is a substantial understatement of income tax.

      A taxpayer may avoid liability for the accuracy-related penalty if he

demonstrates that he had reasonable cause for the underpayment and acted in good

faith with respect to the underpayment. Sec. 6664(c)(1). Reasonable cause and

good faith are determined on a case-by-case basis, taking into account all pertinent

facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs.

      Petitioner has made no argument with respect to the imposition of the

section 6662(a) accuracy-related penalty. Petitioner holds a master’s degree in

taxation, is a certified public accountant, and has been employed by several large

international public accounting firms. He did not consult any other tax

professional when withdrawing money from his KPMG section 401(k) retirement

plan account; he relied on his own expertise. Consequently, we sustain

respondent’s determination to impose the section 6662(a) accuracy-related

penalty.
                                - 17 -

To reflect the foregoing, including respondent’s concession,


                                         Decision will be entered

                               under Rule 155.
