Richard Essner v. Commissioner

• Court: United States Tax Court
• Decided: February 12, 2020
• Status: Published

Opinion

T.C. Memo. 2020-23

UNITED STATES TAX COURT

RICHARD ESSNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 7013-17, 1099-18.1 Filed February 12, 2020.

Richard Essner, pro se.

Mark A. Nelson and Sarah A. Herson, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

MARVEL, Judge: Respondent determined income tax deficiencies of

$117,265 and $101,750 and accuracy-related penalties under section 6662(a)2 of

1 At trial the Court consolidated these cases for purposes of trial and opinion. 2 All section references are to the Internal Revenue Code in effect at the relevant times, and all Rule references are to the Tax Court Rules of Practice and (continued...) -2-

[*2] $23,453 and $20,350 for petitioner’s 2014 and 2015 tax years, respectively.

After stipulations, the remaining issues for decision are whether: (1) petitioner

failed to report distributions from an inherited individual retirement account (IRA)

as income for 2014 and 2015, (2) respondent subjected petitioner to a duplicative

inspection of his books and records relating to his 2014 tax year in violation of

section 7605(b), and (3) petitioner is liable for the accuracy-related penalty under

section 6662(a) for tax year 2015.3

FINDINGS OF FACT

Petitioner resided in California when he filed his petitions in these

consolidated cases. Petitioner is a cancer surgeon by training and profession. In

2013 petitioner’s mother died, and he inherited an IRA that she had inherited from

her late husband, petitioner’s father.

After petitioner inherited the IRA, he took distributions from it in both 2014

and 2015. Specifically, petitioner received distributions of $360,800 and

$148,084 in 2014 and 2015, respectively. Before petitioner received the first

distribution in 2014, he researched the tax implications of an inherited IRA on the

2 (...continued) Procedure. 3 Respondent has conceded the accuracy-related penalty under sec. 6662(a) for tax year 2014. -3-

[*3] Internal Revenue Service’s (IRS) website, and he came to the conclusion that

he would not owe tax on the distributions. Petitioner engaged a return preparer for

his 2014 and 2015 returns, but he did not inform his return preparer that he had

received IRA distributions in 2014 and 2015 and did not ask for guidance from his

return preparer on the tax treatment of such transactions. Petitioner did not report

a distribution as income on his tax return for either year. However, respondent

and petitioner received Forms 1099-R, Distributions From Pensions, Annuities,

Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., reporting IRA

distributions to petitioner of $360,800 and $148,084 in 2014 and 2015,

respectively.

On March 21, 2016, the Commissioner’s Automated Underreporting (AUR)

program generated a notice informing petitioner that it had detected a discrepancy

between records of payments made to him and the amount of taxable income he

reported on his 2014 income tax return. The notice provided petitioner with the

opportunity to agree to the proposed changes or to provide more information

regarding the discrepancy identified by the AUR program. On May 31, 2016, the

AUR program generated another notice, again noting the discrepancy and

providing petitioner with the opportunity to provide substantiating records for his

position. On June 28, 2016, petitioner responded to both notices, stating in a -4-

[*4] handwritten note that he did not agree with the proposed changes. On

January 3, 2017, the AUR program generated a notice of deficiency for tax year

2014 (2014 notice), from which petitioner timely petitioned this Court for

redetermination of his 2014 deficiency at docket No. 7013-17.

Were this the only interaction petitioner had with the IRS regarding his

2014 tax year, this would be a straightforward case; but it is not. Concurrently

with the review by the AUR program, petitioner dealt with an individually directed

examination of his 2014 and 2015 tax years. Specifically, on October 20, 2016,

Tax Compliance Officer Hareshkumar Joshi (Officer Joshi) sent petitioner a Letter

3572, informing petitioner that his 2014 tax return had been selected for

examination4 and requesting that petitioner provide copies of his 2013 through

2015 income tax returns. Officer Joshi’s examination focused on various reported

travel, meal, and legal expenses but did not mention the IRA distribution

discrepancy that the AUR program had already identified.

4 Generally, this Court does not look behind the notice of deficiency to see what occurred during the course of an examination. See Greenberg’s Express, Inc. v. Commissioner, 62 T.C. 324, 327 (1974). Petitioner’s sec. 7605(b) argument opens a narrow exception to that rule, however, so facts relating to the examination for petitioner’s 2014 tax year--and only his 2014 tax year--are material to these cases. The record does not make clear precisely when Officer Joshi’s examination for petitioner’s tax year 2015 began but that is not material to our analysis for petitioner’s 2015 tax year because he does not argue that respondent violated sec. 7605(b) with respect to tax year 2015. -5-

[*5] Because Officer Joshi did not know that the AUR program had issued

petitioner a notice of deficiency for tax year 2014, he continued his examination of

petitioner’s 2014 income tax returns after the date of the 2014 notice.

Specifically, Officer Joshi sent petitioner a Letter 915 on January 10, 2017,

attaching his examination report and proposed adjustments relating to petitioner’s

2014 tax year. On the basis of additional information petitioner provided, Officer

Joshi revised his proposed adjustments for petitioner’s tax year 2014 and, on

February 14, 2017, reflected those adjustments in a revised report. Neither the

original nor the revised report included an adjustment relating to petitioner’s IRA

distribution in 2014. In response, on March 10, 2017, petitioner sent a letter to

Officer Joshi requesting that he provide a copy of the original report to confirm

that the IRA distribution petitioner received in 2014 was not taxable.

As noted above, however, on March 27, 2017, petitioner timely petitioned

this Court in response to the notice of deficiency generated by the AUR program

on January 3, 2017. In his petition, petitioner noted the ongoing examination and

negotiation with Officer Joshi relating to his 2014 tax year.

On October 23, 2017, respondent issued a notice of deficiency to petitioner

relating to his tax year 2015 (2015 notice), determining a deficiency of $101,750 -6-

[*6] and an accuracy-related penalty under section 6662(a) of $20,350. Petitioner

timely petitioned this Court in response to the 2015 notice.

OPINION

The Commissioner’s determinations in a notice of deficiency are presumed

correct, and the taxpayer generally bears the burden of proving that those

determinations are incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933). When a case is appealable to the U.S. Court of Appeals for the Ninth

Circuit, as these cases appear to be absent a stipulation to the contrary, see sec.

7482(b)(1)(A), (2), the Commissioner’s determination that a taxpayer

underreported income is presumed correct only if it is supported by a minimal

factual foundation, see Palmer v. United States, 116 F.3d 1309, 1313 (9th Cir.

1997). Once the determination is so supported, the burden shifts to the taxpayer to

prove that the determination is incorrect. Id.

I. Underreported Income

Section 61(a) defines gross income as “all income from whatever source

derived”, including gross income from pensions. See sec. 61(a)(11). Respondent

contends that he received information returns reporting IRA distributions to

petitioner in 2014 and 2015 from petitioner’s inherited IRA. Respondent also

contends that petitioner did not report a distribution as income for either year and -7-

[*7] that he has failed to prove that any part of the retirement distributions he

received was excludible from income.

At trial petitioner did not contest that he received retirement distributions in

the amounts shown on the information returns. Rather, his position is that a

portion of each distribution is not taxable because it represents his late father’s

original investment in the account. At trial petitioner stated that he had contacted

the financial institutions that had held the IRA--TD Ameritrade and Fidelity--

seeking documentation to determine the portion that represented his late father’s

original investment. Unfortunately, neither institution had the records he sought.

At trial he conceded that he could not substantiate that any portion of the

distributions represented a return of his late father’s original investment.

We find credible petitioner’s statement at trial that he attempted to find

records that could substantiate his position, and we sympathize with him for the

dilemma in which he found himself when he inherited his late father’s IRA. But

petitioner bears the burden of proving respondent’s determinations to be incorrect,

and he has not.5 Therefore, we must sustain respondent’s determinations.

5 Although there was a failure of proof in these cases, petitioner’s general contentions, construed broadly, are not unfounded. For example, he may have been entitled to exclude some portion of these distributions from income if he could have proven a specific amount of “[n]ondeductible contributions to * * * (continued...) -8-

[*8] II. Section 7605(b)

Petitioner also argues that respondent should be barred from assessing the

proposed deficiency for 2014 because he violated section 7605(b) by conducting a

second inspection of petitioner’s books and records for 2014.6

Section 7605(b) provides: “No taxpayer shall be subjected to unnecessary

examination or investigations, and only one inspection of a taxpayer’s books of

account shall be made for each taxable year unless the taxpayer requests otherwise

or unless the Secretary, after investigation, notifies the taxpayer in writing that an

additional inspection is necessary.” As this Court has noted elsewhere,

“[a]lthough these two limitations may practically overlap, they are separately

stated.” Digby v. Commissioner, 103 T.C. 441, 446 (1994). We therefore

5 (...continued) [the account] minus any prior withdrawals or distributions of nondeductible contributions”. Hoang v. Commissioner, T.C. Memo. 2006-47, 2006 WL 695362, at *3; see also Estate of Kahn v. Commissioner, 125 T.C. 227, 231-232 (2005) (citing secs. 408(d)(1) and 691(a)(1)(B)). He could not, however, and has failed to carry his burden of proof as to the issue. 6 Respondent argues as a threshold matter that petitioner failed to raise this issue in his pleadings and so he is precluded from raising it now. See Rule 34(b)(4). Because petitioner is self-represented, and because the parties appear to have tried the sec. 7605(b) issue by consent, we address the sec. 7605(b) issue. See Rule 41(b)(1). -9-

[*9] consider whether this examination was either “unnecessary” or involved an

unauthorized second inspection of petitioner’s books and records.

In doing so we note that the Supreme Court has explained that section

7605(b) imposes “no severe restriction” on the Commissioner’s power to

investigate taxpayers. United States v. Powell, 379 U.S. 48, 54 (1964).

Accordingly, the provision is read narrowly. See De Masters v. Arend, 313 F.2d

79, 85-86 (9th Cir. 1963). For instance, this Court has stated that “mere

communication with the taxpayer does not fall within the scope of” section

7605(b). Seidel v. Commissioner, T.C. Memo. 2005-67, 2005 WL 730077, at *13.

Additionally, section 7605(b) does not limit the Commissioner’s ability to

assemble and consult third-party records related to a taxpayer’s tax liability. See

Hubner v. Tucker, 245 F.2d 35, 38-39 (9th Cir. 1957). Nor does it limit the

Commissioner’s ability to review already-filed tax returns in his possession. See

Estate of Sower v. Commissioner, 149 T.C. 279, 289 (2017).

Petitioner contends that because both the AUR program and Officer Joshi

examined his 2014 tax return concurrently, respondent violated section 7605(b).

In support petitioner introduced his correspondence with both the AUR program

and Officer Joshi. Petitioner contends that this correspondence shows that Officer

Joshi’s examination was unnecessary (given that it extended past the date when - 10 -

[*10] the AUR program generated the notice of deficiency with respect to 2014)

and that it required an unauthorized second inspection of petitioner’s books and

records (given that Officer Joshi’s examination ran parallel to and appears to have

come to positions at odds with the AUR adjustments that underlie the IRS’

position taken in the notice).

Respondent counters that he issued the 2014 notice on the basis of the AUR

program’s review of petitioner’s 2014 return--not Officer Joshi’s individual

examination. Moreover, respondent contends that the AUR program’s review was

based entirely on third-party information returns and petitioner’s already-filed

2014 income tax return--in other words, without reference to petitioner’s books

and records. Respondent argues that no examination took place during AUR

program review, so there was neither an unnecessary examination nor a

duplicative inspection of petitioner’s records. Accordingly, respondent contends

that section 7605(b) is thereby inapplicable.

At the outset, we note that petitioner’s interactions with the IRS--both

through the AUR program and his correspondence with Officer Joshi--would be

confusing to an ordinary taxpayer. Various offices of the IRS contacted petitioner

without coordination, without clarity as to what the other parts were doing, and

without providing petitioner a clear explanation as to why the IRS was speaking - 11 -

[*11] out of many mouths. A taxpayer ought not to have been subjected to such a

byzantine examination. However, we are not empowered to police what ought to

have occurred in an examination; we are limited to considering whether section

7605(b), as written, was violated. See Greenberg’s Express, Inc. v. Commissioner,

62 T.C. 324, 327 (1974).

Under section 7605(b), the AUR program’s matching of third-party-reported

payment information against petitioner’s already-filed 2014 tax return is not an

examination of petitioner’s records. See Hubner, 245 F.2d at 38-39. Therefore,

no second examination of petitioner’s books and records could have occurred,

regardless of the concurrent actions of Officer Joshi. Additionally, as we have

found above, petitioner failed to properly report income from the 2014 distribution

from the retirement account, and he has conceded other adjustments for tax year

2014. Therefore, respondent’s examination of petitioner’s 2014 tax return was not

unnecessary. While we understand petitioner’s frustration with the process of this

examination, we cannot say that a failure to communicate and coordinate within

the IRS--standing alone--violates section 7605(b). We therefore agree with

respondent. - 12 -

[*12] III. Section 6662(a) Accuracy-Related Penalty

In the 2015 notice respondent determined that petitioner was liable for the

accuracy-related penalty under section 6662(a). Section 6662(a) authorizes the

Commissioner to impose a 20% penalty on an underpayment of tax attributable to,

among other things, any substantial understatement of income tax within the

meaning of section 6662(b)(2). A substantial understatement means an

understatement that exceeds the greater of $5,000 or 10% of the income tax

required to be shown on the return for the taxable year. Sec. 6662(d)(1)(A). A

taxpayer may be excused from this penalty if the taxpayer can show that there was

reasonable cause for and that the taxpayer acted in good faith with regard to the

underpayment. Sec. 6664(c)(1). Whether a taxpayer acted in good faith and with

reasonable cause is determined on the basis of the totality of the facts and

circumstances, including “the experience, knowledge, and education of the

taxpayer.” Sec. 1.6664-4(b)(1), Income Tax Regs.

The Commissioner bears the burden of production as to accuracy-related

penalties, which he may satisfy by providing sufficient evidence to indicate that it

is appropriate to impose the relevant penalty. Sec. 7491(c); Higbee v.

Commissioner, 116 T.C. 438, 446 (2001). As part of his burden of production, the

Commissioner must also prove that he complied with the supervisory approval - 13 -

[*13] requirement of section 6751(b)(1). Graev v. Commissioner, 149 T.C. 485

(2017), supplementing and overruling in part 147 T.C. 460 (2016).

Respondent determined that petitioner understated his 2015 income tax by

$98,962, which is greater than 10% of the income tax that should have been

reported, which is greater than $5,000. Before trial the parties stipulated a copy of

the Civil Penalty Approval Form, signed by Officer Joshi’s supervisor on July 25,

2017. The parties also stipulated that the 2015 notice contained the first formal

assertion of a penalty under section 6662(a) to petitioner, and it was issued on

October 23, 2017. Respondent has thereby met his burden of production with

respect to the accuracy-related penalty for tax year 2015. Moreover, we have

sustained respondent’s determinations regarding the IRA distribution petitioner

received in 2015, and petitioner has conceded the other adjustments in the 2015

notice. Accordingly, petitioner is liable for the accuracy-related penalty unless he

can prove that he acted with reasonable cause and in good faith with respect to his

underpayment. See sec. 6664(c)(1).

In 2015 petitioner received a large distribution from his inherited IRA.

Petitioner sought to determine the tax consequences of that distribution by

consulting the IRS website. Petitioner did not, however, inform his return

preparer that he had received the distribution or ask his return preparer about the - 14 -

[*14] tax consequences of IRA distributions generally. Given petitioner’s

background and the substantial size of the distribution, this is not reasonable. We

therefore conclude that petitioner did not have reasonable cause for his

underpayment and that he is liable for the accuracy-related penalty under section

6662(a) and (b)(2) for tax year 2015.

We have considered the remaining arguments made by the parties and, to

the extent not discussed above, conclude those arguments are irrelevant, moot, or

without merit.

To reflect the foregoing,

Appropriate decisions will be entered.