                         T.C. Memo. 2004-258



                       UNITED STATES TAX COURT



         ISABEL MOLINA AND ISAAC MOLINA, JR., Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 4026-03L.                Filed November 10, 2004.


     Isabel Molina & Isaac Molina, Jr., pro sese.

     Abbey B. Garber, Alvin A. Ohm, and Kathryn Patterson, for

respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     VASQUEZ, Judge:    Pursuant to section 6330(d),1 petitioners

seek review of respondent’s determination to proceed with

collection of their 2000 tax liability.


     1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
                               - 2 -

                        FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.    At the time they filed

the petition, Isabel and Isaac Molina, Jr., resided in Dallas,

Texas.

     In 1998, Mr. Molina borrowed $20,0002 (1998 loan) from his

section 401(k) retirement savings plan (retirement plan) with the

City of Dallas (the city).   Shortly after he received the 1998

loan, Mr. Molina began making a series of equal monthly payments

(as part of a repayment schedule) on the 1998 loan.

     In March 1999, the city terminated Mr. Molina’s employment.

At the time of his termination, the balance on the 1998 loan was

$19,619.74 and the remaining term was 2.33 years.    Mr. and Mrs.

Molina made no further monthly payments on the 1998 loan after

Mr. Molina’s termination because the city did not have a system

for them to make monthly payments on the 1998 loan after Mr.

Molina’s employment was terminated.    Additionally, after his

termination the city offset the 1998 loan with funds from the

retirement plan.


     2
        At trial and on brief, the parties consistently referred
to the amount Mr. Molina borrowed in 1998 as being $20,000.
Documents from the retirement plan for the period ending Dec. 31,
1998, list the amount Mr. Molina borrowed as $20,800. This
discrepancy, however, does not affect the outcome of this case.
For convenience, we shall refer to the amount borrowed as being
$20,000.
                                 - 3 -

       On Form 1099-R, Distributions From Pensions, Annuities,

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

etc., for 2000 the city reported $19,619.74 as a distribution to

Mr. Molina.

       In October 2001, Mr. and Mrs. Molina filed their 2000 joint

Federal income tax return.    Among other things, on their 2000

return Mr. and Mrs. Molina reported (1) a $19,620 distribution

from the retirement plan, (2) $1,962 of tax on an early

distribution from a qualified pension plan, (3) a total income

tax liability of $12,801, and (4) a balance due of $5,777 after

subtracting their withholding.    They did not remit any payment

with their 2000 return.    Mr. and Mrs. Molina reported the $19,620

distribution on their 2000 return because they believed they were

obligated to report this amount after receiving the Form 1099-R.

       On May 13, 2002, respondent received a Form 656, Offer in

Compromise (OIC), from Mr. and Mrs. Molina.    Mr. and Mrs. Molina

attached a letter dated May 10, 2002 (May 2002 letter), to their

OIC.    The May 2002 letter explained that the city’s reporting the

$19,620 distribution as income in 2000 represented a

“bureaucratic inconsistency” and there was doubt as to liability

for their 2000 tax year.    Respondent did not process the OIC

because Mr. and Mrs. Molina left blank the space listing the

amount offered.
                                - 4 -

     On October 4, 2002, respondent mailed Mr. and Mrs. Molina a

letter asking them to fill in the blank for the amount offered.

On October 16, 2002, respondent received the OIC from Mr. and

Mrs. Molina listing $2,107.42 as the amount offered.

     After receiving a Notice of Intent to Levy and Notice of

Your Right to a Hearing, Mr. and Mrs. Molina timely submitted a

request for a section 6330 hearing (hearing request).   As part of

their hearing request, Mr. and Mrs. Molina attached the May 2002

letter to the Form 12153, Request for a Collection Due Process

Hearing.   The May 2002 letter raised the issue of the underlying

liability for 2000, noted the city made an error reporting the

$19,620 distribution in 2000, and proposed an OIC as a collection

alternative.

     Sometime before February 14, 2003, Mr. and Mrs. Molina had a

section 6330 hearing (hearing) with Appeals Officer Norman

Becker.    At the hearing, Mr. and Mrs. Molina raised the issue of

whether they were liable for tax on the $19,620 distribution from

the retirement plan.   Appeals Officer Becker also considered Mr.

and Mrs. Molina’s eligibility for an OIC based on doubt as to

liability and doubt as to collectibility.

     On February 14, 2003, respondent issued Mr. and Mrs. Molina

a Notice of Determination Concerning Collection Action(s) Under

Section 6320 and/or 6330.   Appeals Officer Becker determined that

Mr. and Mrs. Molina properly reported the $19,620 distribution on
                               - 5 -

their 2000 return and that they had sufficient income and assets

to pay their 2000 tax liability in full.   Respondent rejected the

OIC, concluding there was no doubt as to liability or

collectibility.

     In the petition, under the statement of disagreement, Mr.

and Mrs. Molina referenced the May 2002 letter, which they

attached to the petition.

                              OPINION

     Pursuant to section 6330(c)(2)(A), a taxpayer may raise at

the section 6330 hearing any relevant issue with regard to the

Commissioner’s collection activities, including spousal defenses,

challenges to the appropriateness of the Commissioner’s intended

collection action, and alternative means of collection.     Sego v.

Commissioner, 114 T.C. 604, 609 (2000); Goza v. Commissioner, 114

T.C. 176, 180 (2000).   If a taxpayer received a statutory notice

of deficiency for the years in issue or otherwise had the

opportunity to dispute the underlying tax liability, the taxpayer

is precluded from challenging the existence or amount of the

underlying tax liability.   Sec. 6330(c)(2)(B); Sego v.

Commissioner, supra at 610-611; Goza v. Commissioner, supra at

182-183.

     Petitioners did not receive a statutory notice of deficiency

for 2000.   Respondent assessed petitioners’ 2000 tax on the basis

of the 2000 return.   Petitioners raised the issue of their
                                - 6 -

underlying liability for 2000 in their hearing request, at the

hearing, and in the petition.   Accordingly, petitioners’

underlying liability is properly before the Court, and we review

that issue de novo.    See Montgomery v. Commissioner, 122 T.C. 1

(2004); Sego v. Commissioner, supra; Goza v. Commissioner, supra.

We shall review the remainder of respondent’s determination for

an abuse of discretion.   See Sego v. Commissioner, supra.

     Section 402(a) provides generally that distributions from a

qualified plan are taxable to the distributee, in the taxable

year of the distributee in which distribution occurs, pursuant to

section 72.   Section 72(p)(1)(A) provides the general rule that

proceeds of a loan from a qualified employer plan to a plan

participant are treated as a taxable distribution to the

participant in the year in which the loan proceeds are received.

See Patrick v. Commissioner, T.C. Memo. 1998-30, affd. 181 F.3d

103 (6th Cir. 1999).    Section 72(p)(2), however, provides an

exception to this general rule.   Under this exception, a loan is

not treated as a taxable distribution if:   (1) The principal

amount of the loan (when added to the outstanding balance of all

other loans from the same plan) does not exceed a specified

limit, sec. 72(p)(2)(A); (2) the loan, by its terms, must be

repaid within 5 years from the date of its inception or is made

to finance the acquisition of a home which is the principal

residence of the participant, sec. 72(p)(2)(B); and (3) the loan
                                - 7 -

must have substantially level amortization with quarterly or more

frequent payments required over the term of the loan, sec.

72(p)(2)(C).

     Petitioners contend that the $19,620 distribution was not

taxable in 2000.3   Respondent argues that section 72(p) and the

final regulation thereunder support the conclusion that Mr.

Molina received the $19,620 distribution from the retirement plan

in 2000.

     Under the 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 section 72(p)(2)(C) requirement,

thereby resulting in a deemed distribution.    Sec. 1.72(p)-1, Q&A-

4, Income Tax Regs.    Such a deemed distribution occurs at the

time the installment payment was due but not made and equals the

entire outstanding balance of the loan at the time of such

failure.   Sec. 1.72(p)-1, Q&A-10, Income Tax Regs.   The 1998

loan, however, was made before the effective date of this

regulation.    Sec. 1.72(p)-1, Q&A-22, Income Tax Regs.




     3
        In his reply brief, respondent argues that petitioners
raised this argument for the first time on brief. Respondent’s
argument is without merit. Petitioners raised this argument in
the May 2002 letter which they attached to their OIC, the hearing
request, and the petition. Furthermore, at the calendar call, a
colloquy between petitioners and the Court made it clear that
petitioners contended that 2000 was the incorrect year for taxing
the $19,620 distribution from the retirement plan. Petitioners
stated that they had asserted this “from the beginning”.
                                - 8 -

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 these same provisions.

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

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).    Generally, proposed regulations are afforded 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).

     Nevertheless, we find that respondent’s position in the

proposed regulation makes more sense than respondent’s litigating

position that the distribution occurred in 2000.    See Garcia v.

Commissioner, T.C. Memo. 1998-203 (reaching this conclusion

regarding another question and answer contained in the same

proposed regulation), affd. without published opinion 190 F.3d

538 (5th Cir. 1999).    Additionally, the substantially level

amortization requirement under section 72(p)(2)(C) has been

interpreted as requiring that payment of principal and interest

be made in substantially level amounts over the term of the loan.
                                 - 9 -

Plotkin v. Commissioner, T.C. Memo. 2001-71; Estate of Gray v.

Commissioner, T.C. Memo. 1995-421.

     Mr. Molina stopped making monthly payments on the 1998 loan

in March 1999.   Additionally, the city no longer required monthly

installment payments on the 1998 loan, and had no provision for

Mr. Molina to continue making monthly installment payments on the

1998 loan, after Mr. Molina’s termination.       Thus, after March

1999, the 1998 loan was no longer required to be repaid by means

of level amortization.   See sec. 72(p)(2)(C).      Accordingly,

pursuant to section 72(p), no distribution includable in Mr.

Molina’s gross income occurred in 2000.

     It is unclear from the record, however, whether, after

application of our holding that petitioners did not have to

report the $19,620 deemed distribution in 2000, petitioners’ tax

liability for 2000 remains unpaid.       Accordingly, we will direct

the parties to submit computations showing the correct amount of

petitioners’ tax liability for 2000.

     To reflect the foregoing,



                                              An appropriate order

                                         will be issued.
