Favorable IRS rollover case

IRA rollover case under section 408

Ramzy M. Kopty and Lena Kopty, Appellants v. Commissioner of Internal Revenue Service, Appellee.

U.S. Court of Appeals, D.C. Circuit; 08-1171, March 6, 2009.

94 TCM 480, Dec. 57,177(M), TC Memo. 2007-343.

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JUDGMENT


Per Curiam: This appeal was considered on the record from the United States Tax Court and on the briefs filed by the parties. See Fed.R.App.P. 34(a)(2); D.C. Cir. Rule 34(j). It is

ORDERED AND ADJUDGED that the decisions of the United States Tax Court entered December 12, 2007, and February 5, 2008, be affirmed. The Tax Court did not clearly err in holding that Mr. Kopty completed a valid rollover of his J.D. Edwards stock to his Norwest Individual Retirement Account in 1998 that satisfied the requirements of 26 U.S.C. § 402(c) ("transfer of a distribution" to eligible retirement plan must be made within 60 days following "the day on which the distributee received the property"). See ASA Investerings Partnership v. Commissoner, 201 F.3d 505, 511 (D.C. Cir. 2000) (court of appeals reviews Tax Court's factual findings and mixed questions of law and fact for clear error). Mr. Kopty elected to treat the contribution as a rollover contribution when he deposited the stock into his IRA account in August 1998, well within 60 days of receiving the stock. See 26 C.F.R. § 1.402(c)-2 (A-13) (taxpayer elects to treat contribution as a rollover contribution, by "designating" to trustee of IRA that the contribution is a "rollover contribution"). Accordingly, the distributions appellants received from that IRA in 1999 and 2000 were taxable in the years of receipt. See 26 U.S.C. 408(d)(1).

Pursuant to D.C. Circuit Rule 36, this disposition will not be published. The Clerk is directed to withhold issuance of the mandate herein until seven days after resolution of any timely petition for rehearing or petition for rehearing en banc. See Fed.R.App.P. 41(b); D.C. Cir. Rule 41.







Ramzy M. and Lena Kopty v. Commissioner.

Dkt. No. 4188-05 , TC Memo. 2007-343, November 21, 2007.

[Appealable, barring stipulation to the contrary, to CA-DC

[Code Secs. 72 and 408]
IRA rollovers: Premature IRA distributions: --
A husband and wife were liable for income tax and the additional tax on early distributions from a rollover IRA because they did not introduce evidence that the brokerage account they established was not an IRA, or that the distributions from it were attributable to the husband's being disabled. Although the husband claimed that he did not intend to roll over his balance in an employee stock ownership plan (ESOP) into the IRA, the paperwork he executed was consistent with an intent to make a rollover, rather than take a distribution, and satisfied the requirements for establishing an IRA rollover account. The husband's heart problems, while serious, did not constitute a disability that would have avoided the additional tax on premature IRA distributions.

[Code Sec. 6651]
Penalties, civil: Late-filing penalty. --
A husband and wife were liable for a late-filing penalty because, despite the husband's health problems, and their ongoing correspondence with both the IRS and their financial institutions concerning an IRA distribution, they did not establish that their failure to file a return was due to reasonable cause




MEMORANDUM FINDINGS OF FACT AND OPINION

WHALEN, Judge: Respondent determined the following deficiencies in, and penalties with respect to, petitioners' Federal income tax for 1999 and 2000:



Additions to Tax/Penalties

Year Deficiency Sec. 6651(a)(1) Sec. 6662(a)

2000 1,000.00 None None

1999 $94,699.32 $23,674.83 $12,793.13


Unless stated otherwise, all section references in this opinion are to the Internal Revenue Code as in effect during the years in issue.

The issues for decision are: (1) Whether the distributions received by petitioners during 1999 and 2000 from petitioner Ramzy M. Kopty's individual retirement account (IRA) in the aggregate amounts of $331,500 and $10,000, respectively, are includable in petitioners' gross income, pursuant to section 408(d); (2) whether petitioners are subject to the 10-percent additional tax on early distributions imposed by section 72(t) on the distributions received by petitioners from Mr. Kopty's IRA during 1999 and 2000; (3) whether petitioners are liable for the addition to tax of $23,674.83 determined by respondent under section 6651(a)(1) for failure to file a timely return for 1999; and (4) whether petitioners are subject to the accuracy-related penalty of $12,793.13 determined by respondent under section 6662(a) with respect to their 1999 return.



OPINION




Taxability of the Distributions From Petitioner's IRA During 1999 and 2000
The principal issue in this case is whether petitioners are subject to tax, as provided by section 408(d)(1), on the aggregate distributions of $331,500 and $10,000 that they received from petitioner's IRA during 1999 and 2000, respectively. Petitioners argue that they are not subject to tax on those distributions because the account from which the distributions were made was not an IRA.

Mr. Kopty had established that account with Norwest in 1998, and he funded it by making a purported rollover contribution of the stock he had received as a distribution from the J.D. Edwards ESOP. According to petitioners, they learned in 2004, during the audit of their returns for 1999 and 2000, that Mr. Kopty had failed to complete the rollover contribution within 60 days following the day on which he had received the stock from the ESOP, as required by section 402(c)(3). We discuss the basis for petitioners' assertion that Mr. Kopty failed to make a valid rollover in more detail below.

Based on the factual premise that Mr. Kopty failed to make a valid rollover, petitioners contend that Mr. Kopty's account at Norwest was not an IRA within the meaning of section 408(a) and they are not subject to tax on the distributions from that account. Furthermore, petitioners argue that the determination made by respondent in the notice of deficiency is based upon Norwest's incorrect conclusion that Mr. Kopty had made a valid rollover of his J.D. Edwards & Co. stock in 1998. They argue that, because Norwest's conclusion was wrong, the notice of deficiency, based thereon, must also be wrong. According to petitioners:

respondents [sic] relied on the erroneous bank determination that the 1998 roll over of the ESOP to the IRA account * * * was valid and relied on the erroneous reporting that followed that determination by the bank. * * * Hence, respondent's determination in paragraph 3 [of the notice of deficiency] and consequently the deficiency notice is null and void.

Petitioners do not explain the legal basis, or cite any authority, for their conclusion that they are not subject to tax on the distributions from Mr. Kopty's account at Norwest. The general rule is that any amount "paid or distributed out of" an IRA is subject to tax as prescribed by section 72. See sec. 408(d)(1). Petitioners seem to be arguing that Mr. Kopty's Norwest account is disqualified from being an IRA because it was funded by an excess contribution. To the contrary, an IRA is not necessarily disqualified by the fact that it accepted excess contributions, even if it was funded entirely with excess contributions. See Orzechowski v. Commissioner [Dec. 34,983] 69 T.C. 750 (1978), affd. [79-1 USTC ¶9220] 592 F.2d 677 (2d Cir. 1979); see also Boggs v. Commissioner [Dec. 41,360] 83 T.C. 132 (1984), affd. [85-2 USTC ¶9721] 774 F.2d 740 (7th Cir. 1985); Benbow v. Commissioner [Dec. 41,268] 82 T.C. 941 (1984). In another context we concluded that excess contributions were not subject to tax when distributed by an IRA. See Campbell v. Commissioner [Dec. 51,884] 108 T.C. 54 (1997) (holding that the taxpayer received basis to the extent of his "investment in the contract" under section 72(e)(6)). Petitioners have not made any such argument in this case.

Respondent urges the Court to reject petitioner's position. Respondent asserts that "the record clearly reflects that the position taken by petitioners on their 1998 return was correct" and that a valid rollover of the distribution received from the ESOP was made in that year. Furthermore, respondent points out that petitioners' 1998 return reported the receipt of the ESOP distribution in the amount of $467,817 and reported that the taxable amount of such distribution was "NONE". Respondent asserts that "petitioners are estopped, pursuant to the duty of consistency doctrine, from adopting a position on their 1999 and 2000 tax returns inconsistent with the position taken on their 1998 Return."

We agree with respondent that, under the facts of this case, Mr. Kopty made a valid rollover of the stock distribution he received from the J.D. Edwards ESOP in 1998. Accordingly, we reject the factual premise of petitioners' argument that Mr. Kopty's account at Norwest was not an IRA, and we find that the distributions from that account during 1999 and 2000 are subject to tax under sections 408(d)(1) and 72(a). We do not reach respondent's second point that petitioners are estopped under the duty of consistency from taking a different position on their 1999 and 2000 returns.

In order to fully address petitioners' argument, we must set out petitioners' argument in more detail. Petitioners acknowledge that they physically transferred the J.D. Edwards & Co. stock certificate to Norwest within 60 days of the date on which they received it, but they contend that they did not irrevocably elect to make a rollover contribution to the IRA at that time. According to petitioners, the stock certificate "was hand-delivered to Norwest Bank [only] for safekeeping until the shares become our [sic] unrestricted and eventually sold." They assert that "the bank placed the restricted shares by mistake in the new account while the bank proceeded with the paperwork to un-restrict and sell the shares."

Petitioners contend that the stock certificate did not properly become invested in the IRA account until October 2, 1998, when Mr. Kopty executed the Norwest form entitled "Self-Directed IRA Rollover/Direct Rollover Documentation". Petitioners point out that October 2, 1998, is 79 days after Mr. Kopty had constructively "received" the certificate on July 15, 1998, and is beyond the 60-day period specified in section 402(c)(3) during which a distributee is required to transfer the property distributed to an eligible retirement plan. Petitioners further contend that the form executed on October 2, 1998, was not properly completed and did not serve to transfer the stock to Norwest. In effect, petitioners' position is that Mr. Kopty did not elect to treat the contribution of his J.D. Edwards & Co. stock certificate as a rollover contribution until October 2, 1998, when he executed the Norwest form entitled "Self-Directed IRA Rollover/Direct Rollover Documentation".

According to the regulations promulgated under section 402, an election to treat a contribution to an IRA as a rollover contribution is made simply by designating the contribution as a rollover contribution. The regulations promulgated under section 402 provide as follows:

In order for a contribution of an eligible rollover distribution to an individual retirement plan to constitute a rollover and, thus, to qualify for current exclusion from gross income, a distributee must elect, at the time the contribution is made, to treat the contribution as a rollover contribution. An election is made by designating to the trustee, issuer, or custodian of the eligible retirement plan that the contribution is a rollover contribution. This election is irrevocable. Once any portion of an eligible rollover distribution has been contributed to an individual retirement plan and designated as a rollover distribution, taxation of the withdrawal of the contribution from the individual retirement plan is determined under section 408(d) rather than under section 402 or 403. Therefore, the eligible rollover distribution is not eligible for capital gains treatment, five-year or ten-year averaging, or the exclusion from gross income for net unrealized appreciation on employer stock. [Sec. 1.402(c)-2, Q&A-13, Income Tax Regs.; emphasis added.]

Thus, no particular form is required by the regulations in order to designate a contribution as a rollover contribution.

In this case, petitioner opened a "Rollover IRA" at Norwest on July 8, 1998, and he hand-delivered his J.D. Edwards & Co. stock certificate to Norwest on August 4, 1998, several days after the transfer agent had mailed the stock certificate to him. According to the receipt issued to petitioner by a representative of Norwest, "Deposit to account" was the purpose for which Norwest received petitioner's stock certificate. Petitioner's only account at Norwest was the "Rollover IRA" which he had opened by submitting an application to Norwest on or about July 8, 1998. Furthermore, the statement issued by Norwest for petitioner's IRA for the period ending August 31, 1998, reflects a "stock rollover" of 10,323 shares of J.D. Edwards & Co. stock on August 24, 1998. Thus, it is evident that Norwest, the trustee, issuer, or custodian of the IRA, believed that petitioner had designated his J.D. Edwards & Co. stock as a "rollover contribution" to his IRA. See sec. 1.402(c)-2, Q&A-13, Income Tax Regs.

Petitioner's contribution of J.D. Edwards & Co. stock to his IRA and his designation of the contribution as a rollover contribution took place well within 60 days of receipt as required by section 402(c)(3). This is true no matter what we use as the starting date, that is, "the day on which the distributee received the property distributed." See sec. 402(c)(3). In this case, the starting date of the 60-day period could be the date on which petitioner constructively received the stock, July 15, 1998. See generally Rev. Rul. 82-75, 1982-1 C.B. 116 and Rev. Rul. 81-158, 1981-1 C.B. 205 (holding that, for purposes of section 402, the distributee received shares from an employer established profit-sharing plan that qualified under section 401(a) when the trustee of the plan delivered to the transfer agent stock certificates previously issued in the trustee's name, together with written instructions to reissue the certificates in the name of the distributee). The starting date could also be the date on which petitioner actually received the stock. Petitioner actually received the stock certificate between July 30, 1998, when the transfer agent mailed it to him, and August 4, 1998, when he hand-delivered the stock certificate to Norwest.

Furthermore, in this case, the 60-day period is satisfied regardless of the date used as the date of the "transfer of a distribution". See sec. 402(c)(3). That date could be August 4, 1998, the day on which petitioner hand-delivered the certificate to Norwest, or August 24, 1998, the day on which Norwest recorded the transfer on its statement for petitioner's IRA for the period ending August 31, 1998.

Petitioners do not deny that they intended to rollover the distribution which Mr. Kopty received in 1998 from the J.D. Edwards & Co. ESOP. Further, they do not deny that Mr. Kopty delivered his J.D. Edwards & Co. stock certificate to Norwest on August 4, 1998. What they argue is that when Mr. Kopty hand-delivered the stock certificate to Norwest on August 4, 1998, he intended to give the certificate to Norwest only for safekeeping, pending the reissuance of the stock without restriction and its sale. Petitioners assert that Norwest made a mistake by depositing the stock into petitioner's IRA before October 2, 1998, the date on which petitioner executed the Norwest form entitled "Self-Directed IRA Rollover/Direct Rollover Documentation".

One problem we have with this factual contention is that there is nothing in the record, other than petitioners' testimony, to substantiate it. Certainly, Mr. Kopty did nothing to call this alleged mistake to the attention of the Norwest representative who issued the receipt for Mr. Kopty's stock certificate. Additionally, Mr. Kopty said nothing about this alleged mistake when he received the August 1998 statement for his IRA on which was recorded a "stock rollover DS" on August 24, 1998, consisting of 10,323 shares of J.D. Edwards & Co. stock.

Furthermore, petitioners' argument presupposes that no rollover to Mr. Kopty's IRA at Norwest could take place for purposes of section 402(c) unless and until the form entitled "Self-Directed IRA Rollover/Direct Rollover Documentation" was submitted to Norwest. To the contrary, as discussed above, the regulations promulgated under section 402 merely require the contribution to be designated a rollover contribution. The Norwest form which petitioner executed on October 2, 1998, entitled "Self-Directed IRA Rollover/Direct Rollover Documentation" may have been helpful in terms of petitioner's relationship with Norwest, to document Mr. Kopty's wishes, but it was not essential for purposes of finding a rollover contribution under section 402(c).

Finally, petitioners' assertion that Mr. Kopty transferred the stock certificate to Norwest only for safekeeping until the shares could be reissued in unrestricted form and sold is contradicted by Mr. Kopty's actions. The fact is that Mr. Kopty executed the form on October 2, 1998, well before the shares were registered in unrestricted form and sold on November 16, 1998. Indeed, it appears that Mr. Kopty may have executed the form even before he returned to Norwest the paperwork necessary to permit the registration and sale of the shares. As mentioned above, the completed paperwork to permit the registration and sale of petitioner's stock was not received from petitioner by Norwest's office in Boulder until October 7, 1998.

Based on the facts of this case, we find that Mr. Kopty made an irrevocable election to roll over, to his IRA, the distribution of stock he had received from the J.D. Edwards ESOP. We further find that petitioner made this irrevocable election within the 60-day period required by section 402(c)(3).



Ten Percent Additional Tax on Early Distributions
The second issue in this case is whether petitioners are liable for the 10-percent additional tax on early distributions from qualified retirement plans imposed by section 72(t)(1). Respondent applied the 10-percent additional tax on the aggregate distributions of $331,500 made by petitioner's IRA in 1999 and the aggregate distributions of $10,000 made by the IRA in 2000. Accordingly, respondent determined taxes under section 72(t)(1) for 1999 and 2000 in the amounts of $31,500 and $1,000, respectively.

Petitioners argue that section 72(t)(1) does not apply to any of the subject distributions because all of them qualify under the exception set forth in section 72(t)(2)(A)(iii) for distributions "attributable to the employee's being disabled within the meaning of subsection (m)(7)". Section 72(m)(7) provides as follows: "an individual shall be considered disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration". See also sec. 1.72-17A(f)(1), Income Tax Regs. Whether an impairment constitutes a disability is to be determined with reference to all of the facts in the case. Sec. 1.72-17A(f)(2), Income Tax Regs. The regulations provide examples of impairments which would ordinarily be considered as preventing substantial gainful activity. One of those examples is the following:

Diseases of the heart, lungs, or blood vessels which have resulted in major loss of heart or lung reserve as evidenced by X-ray, electrocardiogram, or other objective findings, so that despite medical treatment breathlessness, pain, or fatigue is produced on slight exertion, such as walking several blocks, using public transportation, or doing small chores * * * [Sec. 1.72-17A(f)(2)(iii), Income Tax Regs.]

The regulations point out that the existence of one or more of the impairments described therein, including the one quoted above, "will not, however, in and of itself always permit a finding that an individual is disabled as defined in section 72(m)(7)." See sec. 1.72-17A(f)(2), Income Tax Regs. Furthermore, the regulations caution that any impairment must be evaluated in terms of whether it does in fact prevent the individual from engaging in his customary or any comparable substantial gainful activity. Id. In order to meet the requirements of section 72(m)(7), the regulations provide that "an impairment must be expected either to continue for a long and indefinite period or to result in death." Sec. 1.72-17A(f)(3), Income Tax Regs. An impairment which is remediable does not constitute a disability, and an individual will not be deemed disabled if it can be diminished to the extent that the individual can engage in his customary or any comparable substantial gainful activity. Sec. 1.72-17A(f)(4), Income Tax Regs. Furthermore, a taxpayer may be engaged in a gainful activity even though he realizes a net loss from that activity during the year. See Dwyer v. Commissioner [Dec. 51,340] 106 T.C. 337, 341 (1996).

In this case, petitioners introduced into evidence certain medical records involving the medical treatment of Mr. Kopty's heart condition. Based upon those records they claim that "from 1999 onwards, Ramzy Kopty was disabled due to heart failure and unable to engage in any substantial gainful activity." According to petitioners, Mr. Kopty "had no income after 2000 which is reflected in petitioners['] tax returns for the years 2001, 2002, 2003, 2004." Petitioners assert that Mr. Kopty receives long-term disability benefits from the U.S. Social Security Administration. Based upon Mr. Kopty's heart disease, petitioners assert that they are not subject to the 10-percent additional tax on early distributions under section 72(t) because all of the distributions are attributable to Mr. Kopty's being disabled within the meaning of section 72(m)(7).

As to the distributions made during 1999, we do not accept petitioners' assertion that the distributions are attributable to Mr. Kopty's being disabled. According to the medical records submitted by petitioners, Mr. Kopty was briefly treated in the emergency room of the American Hospital in Dubai on November 29, 1999, and approximately 1 week later, on December 6, 1999, returned to engage in a treadmill test. According to petitioners' brief: "petitioner was diagnosed in 1999 with Pectoris Spasm and Ischemia which limited petitioner's ability to have gainful activity from 1999 onwards and that the same disease led to an myocardial infarction (MI) in March 2000." That diagnosis, however, did not even take place until December 6, 1999, at the earliest. By that time, all of the distributions for 1999 had been made. In our view, the record of this case fails to show that any of the distributions made during 1999 in the amount of $331,500 were attributable to Mr. Kopty's being disabled.

As to the distributions made during 2000, Mr. Kopty was admitted to the American Hospital in Dubai on March 3, 2000, with the symptoms of a heart attack. Approximately 2 weeks later, he was transported to a hospital in Belgium where he underwent coronary bypass and mitral valve repair on March 25, 2000. Mr. Kopty was released on April 10, 2000, but was readmitted from time to time for further treatment through the end of June 2000. The medical records submitted by petitioners make it clear that Mr. Kopty's heart attack and related medical problems between March and June of 2000 were serious. Mr. Kopty's treating physician in Belgium wrote on July 29, 2000: "since March 3, 2000 Mr. Kopty had to stop his professional activities. It seems obvious that these activities will have to be strongly reduced in the future."

The record in this case, however, makes it difficult to find that Mr. Kopty was "disabled" within the meaning of section 72(m)(7) by his heart condition. First, after June of 2000 he continued to travel between Dubai and Belgium. He testified at trial about the steps which he had to take in order to close his business in Dubai and "relocate" to Belgium. Furthermore, petitioners' income tax return for 2000 includes a Schedule C of Mr. Kopty's sole proprietorship which reflects business expenses of $52,457 for the year. The expenses claimed on that Schedule C include travel expenses of $2,450, expenses for meals of $1,760, and telephone expenses of $6,380. The business activities suggested by those expenses belie petitioners' claim that Mr. Kopty was "unable to engage in any substantial gainful activity" during the year. See sec. 72(m)(7). Significantly, petitioners' return for 2000 also reports that Mr. Kopty received wages of $22,795.28 from J.D. Edwards World Solutions. Finally, Mr. Kopty presented his case at trial. The Court had an opportunity to observe him over the course of 2 days. The Court detected no medical disability in his presentation of the case to the Court.



Addition to Tax Under Section 6651(a)(1) Determined With Respect to Petitioners' 1999 Return
The time for filing petitioners' 1999 return was extended to December 15, 2000. Petitioners filed their 1999 return on November 21, 2001, and, thus, they failed to file a timely return. Accordingly, respondent determined an addition to tax under section 6651(a)(1) of $23,674.83 in the notice of deficiency. We find that respondent satisfied his burdens of production under section 7491(c) with respect to the addition to tax under section 6651(a). See Higbee v. Commissioner [Dec. 54,356] 116 T.C. 438, 446-447 (2001).

Petitioners argue that they are not liable for the addition to tax under section 6651(a)(1) because their failure to file a timely return for 1999 was due to reasonable cause and not due to willful neglect. See sec. 6651(a)(1). According to petitioners, reasonable cause for the late filing of their 1999 return is demonstrated by three points: First, Mr. Kopty's medical history, including his heart attack on March 3, 2000, and his related medical issues; second, the alleged fact that petitioners never received the Form 1099-R issued by Norwest for 1999 reporting the distributions from Mr. Kopty's IRA during the year totaling $331,500; and third, the fact that petitioners reported a loss on their 1999 return and did not believe that the filing of their 1999 return was an urgent matter, especially in light of Mr. Kopty's medical problems during that year.

Petitioners assert the late filing of their 1999 return was not due to willful neglect. According to petitioners, they were "proactive with the ESOP issue" in that they corresponded with J.D. Edwards & Co. through Mr. Kopty's letter dated February 9, 2000, and they communicated with the Internal Revenue Service through Mr. Kopty's letters dated April 15, 2000, May 27, 2000, and October 4, 2000, and Mr. Kopty's telephone call on September 26, 2000.

We do not believe that petitioners have shown that their failure to file a timely 1999 return was due to reasonable cause and not due to willful neglect. As stated above, we agree that Mr. Kopty's heart attack in March of 2000 and his related surgeries and medical care through June of 2000 were serious. Nevertheless, the record of Mr. Kopty's correspondence and other activities during the year fails to explain why petitioners did not file, or could not have filed, their return for 1999 on or before the due date, December 15, 2000. Indeed, notwithstanding Mr. Kopty's medical condition, petitioners filed their 1998 return on October 18, 2000. At that point, they had ample time before the due date of the 1999 return in which to file that return as well. Furthermore, we reject petitioners' assertion that they should be relieved of the addition to tax under section 6651(a)(1) because they did not receive the Form 1099-R from Norwest or because they did not think that the filing of that return was "an urgent matter".



Imposition of the Accuracy-Related Penalty Under Section 6662(a) With Respect to Petitioners' 1999 Return
Respondent determined petitioners' liability for the accuracy-related penalty under section 6662(a) to be $12,793.13. Respondent determined that a portion of the underpayment of tax required to be shown on petitioners' 1999 return is attributable to negligence or disregard of rules or regulations, or to a substantial understatement of income tax. See sec. 6662(b)(1) and (2). For this purpose, "the term 'negligence' includes any failure to make a reasonable attempt to comply with the provisions of this title, and the term 'disregard' includes any careless, reckless, or intentional disregard." Sec. 6662(c). An understatement of income tax is "substantial" if the amount of the understatement exceeds the greater of (a) 10 percent of the tax required to be shown on the return, or (b) $5,000. Sec. 6662(d)(1)(A).

We agree with respondent that the portion of the underpayment of tax on which respondent imposed the accuracy-related penalty is attributable to negligence or disregard of rules or regulations. Furthermore, we find that respondent has carried his burden of production with respect to the addition to tax under section 6662(a). See Higbee v. Commissioner, supra at 448-449.

Petitioners' return for 1998 reported the ESOP distribution of $467,817 and further reported the taxable amount of that distribution as "NONE". That return is consistent with the Form 5498 issued by Norwest for the year 1998 which shows rollover contributions of $411,629.63, and it is consistent with the Norwest statement for petitioner's IRA for the period ending August 31, 1998, showing a stock rollover into the account on August 24, 1998, consisting of 10,323 shares of J.D. Edwards & Co. stock. Petitioners' 1998 return was not filed until October 4, 2000, by which time almost all of the money in Mr. Kopty's IRA had been withdrawn. In filing their 1998 return claiming that the ESOP distribution was not taxable, petitioners knew, or should have known, that the distributions from Mr. Kopty's IRA during 1999 and 2000 were subject to tax under section 408(d). Accordingly, when they filed their return for 1999 on November 21, 2001, and reported none of the distributions as income, we agree with respondent that the portion of the underpayment of tax resulting therefrom is attributable to negligence or disregard of rules or regulations. Furthermore, petitioners not only failed to report the IRA distributions during 1999 as taxable income, but they also failed to report any of the dividend income in the amount of $6,093.21 earned by the IRA during 1999.

Petitioners assert that they are not liable for the accuracy-related penalty under section 6662(a) for three reasons. First, petitioners claim that, at the time they filed their 1999 return, they did not know whether the rollover in 1998 was valid because "respondents [sic] never answered their several assistance appeals" and petitioners had not received the Form 1099-R for 1999 from Norwest. Second, petitioners assert that respondent has determined their liability for the accuracy-related penalty "to hide their [sic] [respondent's] negligence of not responding to petitioners appeal for assistance with the ESOP transaction". Third, petitioners assert that they "exercised extreme duty of care towards to the ESOP transaction issue under severe circumstances of being abroad and seriously ill".

In summary, petitioners argue that, before they filed their 1999 return, they asked for advice from respondent concerning the validity of the rollover in 1998, and, when they received no response from their inquiries from respondent, they did the best they could under the circumstances of being abroad and with Mr. Kopty's health issues. Petitioners appear to invoke the reasonable cause exception under section 6664(c) which provides that no penalty shall be imposed with respect to any portion of an understatement if it is shown that there was a reasonable cause for such portion and the taxpayer acted in good faith with respect to such portion.

We agree that petitioners corresponded with representatives of the Internal Revenue Service prior to filing their 1999 return (Mr. Kopty's letter dated May 27, 2000, which was sent on June 6, 2000, and his transmittal letter dated October 4, 2000). We also agree that Mr. Kopty engaged in correspondence with Norwest and J.D. Edwards & Co. during 2000 regarding the distribution from the ESOP. That correspondence shows that Mr. Kopty was unhappy about the fact that his shares of J.D. Edwards & Co. stock were not sent until July 30, 1998, and were unregistered shares that could not be immediately sold. According to one of petitioner's letters to J.D. Edwards & Co., the "ESOP shares were supposed to have been received in April 'clear for sales' from J.D. Edwards." During the delay, the value of the shares decreased from $467,766.10, the value on July 15, 1998, to $336,022.08, the value of the shares on November 16, 1998, when they were sold. Petitioner was concerned by the fact that the Form 1099-R which he received from the ESOP was based upon the value of the shares on July 15, 1998, and showed the taxable amount of such distribution to be $42,695.14. When Mr. Kopty stated in his letter to the Internal Revenue Service dated May 27, 2000: "also we would like to request from you any suggestions that will help us resolve this matter", he was referring to this valuation issue. Similarly, petitioner's letter dated October 4, 2000, transmitting petitioners' 1998 tax return to the Internal Revenue Service, refers to the same error in the Form 1099-R. Petitioners' letter states: "under the circumstances I would like you to consider all of the above points while reviewing this situation and confirm to me your finding." Petitioner's letter was again asking the Internal Revenue Service to review the Form 1099-R issued by the ESOP on which petitioner's shares of J.D. Edwards & Co. stock were valued as of July 15, 1998, in the amount of $467,766.10, whereas the net proceeds from the sale of the stock on November 16, 1998, were $336,022.08.

In none of petitioner's correspondence with the Internal Revenue Service does he raise a question about the validity of the rollover of J.D. Edwards & Co. stock into his IRA or the Forms 1099-R issued to report the distributions from the IRA in 1999 and 2000. In fact, petitioners' opening brief states that they did not become aware "that the ESOP rollover was invalid in 1998 due to the 60 days rollover rule" until the audit of their 1999 and 2000 returns which took place between April and September of 2004. We reject any suggestion that petitioners raised with respondent, before the audit of their returns, an issue concerning the validity of the rollover contribution of J.D. Edwards & Co. stock to Mr. Kopty's IRA. In conclusion, we find that petitioners have not shown that there was reasonable cause for the understatement of tax required to be shown on their 1999 return or that they acted in good faith with respect thereto.



Computational Errors
In their posttrial brief, petitioners allege three "computational errors" for the first time in these proceedings. The first computational error involves the amount of the net operating loss for taxable 2000 that can be carried back to 1999. According to petitioners, respondent miscalculated the net operating loss by basing the calculation on adjusted gross income of -$5,522, rather than on -$15,522, the correct amount.

Petitioners failed to raise this issue in their petition, and it is not before the Court. We do not consider an issue that has not been pleaded. See, e.g., Frentz v. Commissioner [Dec. 27,452] 44 T.C. 485, 491 (1965), affd. [67-1 USTC ¶9363] 375 F.2d 662 (6th Cir. 1967); Sicanoff Vegetable Oil Corp. v. Commissioner [Dec. 22,310] 27 T.C. 1056, 1066 (1957) (and the cases cited thereon), revd. on other grounds [58-1 USTC ¶9233] 251 F.2d 764 (7th Cir. 1958). This is particularly true in a case like this where the issue cannot be considered without surprise and prejudice to the other party. See Estate of Mandels v. Commissioner [Dec. 33,147] 64 T.C. 61, 73 (1975). Furthermore, we note that the difference of $10,000, about which petitioners complain, is due to the inclusion in gross income of the distributions of $10,000 from Mr. Kopty's IRA during the year.

The second so-called computational error alleged by petitioners involves deductions for moving expenses under section 217(a). Apparently, during the audit of petitioners' returns, petitioners submitted a letter in which they claimed moving expenses in the amount of $5,770 for 1999 and $1,950 for 2000. In the notice of deficiency, respondent did not determine that petitioners were allowed moving expenses. Petitioners ask the Court "to order the moving expense correction."

Petitioners did not raise this matter in their petition. This is a new issue that was raised for the first time after trial. As stated above, we do not consider an issue that has not been pleaded. See, e.g., Frentz v. Commissioner, supra; Sicanoff Vegetable Oil Corp. v. Commissioner, supra. This is particularly true in a case like this where the issue cannot be considered without surprise and prejudice to the other party. See Estate of Mandels v. Commissioner, supra. Accordingly, we will not consider it.

Finally, petitioners argue that interest on underpayments under section 6601(a) should be computed from the date when the tax return was due, taking into consideration extensions of time to file, rather than from the original due date of the return. Petitioners ask the Court to rule that interest on any underpayment for taxable 1999 should begin on December 15, 2000, rather than on April 15, 2000.

Petitioners are correct when they state in their brief that this issue is not properly before the Court at this time. Moreover, we note that, pursuant to section 6601(a), interest begins to run on "the last date prescribed for payment" of the tax and, pursuant to section 6151(a), an extension of time for filing an income tax return does not extend the time for paying the tax due.

Based upon the foregoing,

Decision will be entered for respondent.




Early withdrawal penalty. --Payments Under Annuity, Endowment, And Life Insurance Contracts: Premature Distributions: Early withdrawal penalty

The IRS has released guidance regarding when distributions from a nonqualified annuity would satisfy Code Sec. 72(q)(2)(D) and, as a result, be exempted from the penalty tax under Code Sec. 72(q)(1). Code Sec. 72 sets forth rules for the taxation of amounts received under an annuity contract. Under Code Sec. 72(q)(2)(D), the 10 percent penalty for an early will not be imposed if the taxpayer can satisfy one of the listed exceptions. A distribution will be treated as satisfying Code Sec. 72(q)(2)(D) if the taxpayer uses one of the three methods described in Notice 89-25, 1989-1 CB 662, as modified by Rev. Rul. 2002-62, 2002-2 CB 710, to determine whether distribution payments are part of a series of substantially equal payments. The three methods include the required distribution method, the fixed amortization method, and the fixed annuitization method.

Notice 2004-15, 2004-1 CB 526.

An individual did not recognize gain upon the direct transfer of a portion of funds invested in an old annuity to a new annuity because the transaction qualified as a nontaxable exchange under Code Sec. 1035. Therefore, she was not liable for the 10% early withdrawal penalty under Code Sec. 72(q) on any portion of her withdrawal from the old annuity contract. The taxpayer was essentially in the same position after the exchange as she was before the exchange. The same funds, less the surrender fee, were still invested in annuity contracts and she did not personally receive the use or benefit of these funds since they were originally invested in the first annuity contract.

D.E. Conway, 111 TC 350, Dec. 53,010 (Acq.).

The IRS has released guidance finalizing, with changes and clarifications, the rules governing tax free exchanges of annuities known as "partial exchanges". Interim guidance was in response to Conway, 111 T.C. 350, Dec. 53,010 (1999) (Acq.), which allowed such exchanges to qualify under Code Sec. 1035 and avoid tax imposed under Code Sec. 72. The new guidance is effective for qualifying transfers that are completed on or after June 30, 2008. Notice 2003-51, 2003-2 CB 361, superseded.

Rev. Proc. 2008-24, I.R.B. 2008-13, 684.

An attorney and his wife were required to include annuity distributions in income and were liable for the early withdrawal penalty. The court rejected the taxpayers' argument that the annuity distributions were excludable from income as a tax-free rollover. The distributions were not made from a qualified annuity and, as a result, were not eligible for tax-free rollover treatment. The distributions were used to pay higher education expenses. This exception to the early withdrawal penalty, however, applies only to qualified plans. There is no such exception for distributions from nonqualified plans.

A.J. Sadberry, 87 TCM 982, Dec. 55,547(M), TC Memo. 2004-40. Aff'd, per curiam,, CA-5 (unpublished opinion), 2005-2 USTC ¶50,644, 153 FedAppx 336.

A taxpayer who received early distributions from certain Code Sec. 403(b) retirement annuity accounts was subject to the 10-percent tax imposed by Code Sec. 72(t). Because the accounts were funded by a Code Sec. 501(c)(3) organization, the taxpayer argued that her distributions were subject to Code Sec. 72(q) and, therefore, avoided the penalty. However, Code Sec. 72(t)(1) explicitly imposes early withdrawal penalties on retirement accounts established and funded by Code Sec. 501(c)(3) organizations.

E. D. Mitchell, 91 TCM 1172, Dec. 56,516(M), TC Memo. 2006-101.

A husband and wife were liable for income tax and the additional tax on early distributions from a rollover IRA because they did not introduce evidence that the brokerage account they established was not an IRA, or that the distributions from it were attributable to the husband's being disabled. Although the husband claimed that he did not intend to roll over his balance in an employee stock ownership plan (ESOP) into the IRA, the paperwork he executed was consistent with an intent to make a rollover, rather than take a distribution, and satisfied the requirements for establishing an IRA rollover account. The husband's heart problems, while serious, did not constitute a disability that would have avoided the additional tax on premature IRA distributions.

R.M. Kopty, 94 TCM 480, Dec. 57,177(M), TC Memo. 2007-343.

A husband and wife were liable for income tax, the additional tax on early distributions, and the accuracy-related penalty after they received an early distribution from a Simplified Employee Plan IRA and failed to roll over the amount into a new IRA. Although the husband asked his law firm bookkeeper to send a check to his broker within 60 days of receiving the distribution, the broker never received the funds or opened a new IRA for the couple. The couple's argument that the rollover failure was not their fault was rejected. The taxpayers should have been aware that the broker never received the funds because they never received any monthly IRA statements and because the check written by the husband's law firm had never been cashed.

B.S. Atkin, 95 TCM 1364, Dec. 57,398(M), TC Memo. 2008-93.

An individual's proposed annual withdrawals of equal amounts from his annuity contract qualified as substantially equal periodic payments under Code Sec. 72(q)(2)(D). Consequently, they were not subject to the 10% penalty for premature distributions from annuity contracts under Code Sec. 72(q). The amount withdrawn for each year was calculated by using the amortization method described in Notice 89-25, 1989-1 CB 662. The interest rate used was a one-time calculation that would not vary from year to year and was deemed reasonable.

IRS Letter Ruling 200113022, December 29, 2000.