In August 2000, taxpayer Laura Ung purchased a residence on Ellen Drive in West Covina, Calif. (the Ellen Drive property).  She subsequently re-titled the property to herself and her brother, Chamnam D. Ung, as joint tenants.  From 2002 through 2006, Laura listed the Ellen Drive property as her contact and mailing address.  In 2006, Laura and Chamnam, as joint tenants, sold the Ellen Drive property.

In 2007, Homecomings Financial LLC conveyed title to a different property, Kam Court, to Chamnam.  Although Laura’s name appeared in the address portion of the deed that indicated where the clerk was to send the deed after it was recorded, her name didn’t appear on the Kam Court deed itself. 

In January 2008, Laura requested a withdrawal of $20,000 from a retirement account she held at Morgan Stanley.  She listed the Kam Court property as the address to where Morgan Stanley should mail her check, and on Jan. 25, 2008, Morgan Stanley mailed the check to that address.  In March 2008, Laura received $256 as a distribution from a retirement account she held at Fidelity Investments (Fidelity).  The check Fidelity issued listed the Kam Court property as Laura’s mailing address. 

In 2011, the Internal Revenue Service sent Laura a notice of deficiency for $8,778 and an accuracy-related penalty of $1,654.  On May 2, 2011, Laura filed a petition with the U.S. Tax Court for redetermination of the deficiency.  On May 13, 2013, the Tax Court ruled in favor of the IRS, holding that Laura: 1) didn’t qualify under any exception and was therefore liable for the 10 percent additional tax for early distributions from her retirement plans; and 2) was liable for accuracy-related penalties(Ung v. Commissioner, T.C. Memo. 2013-126 (May 13, 2013)). 

 

Ten Percent Tax Applies

Internal Revenue Code Section 72(t) imposes an additional tax of 10 percent on premature distributions (that is, distributions from retirement plans made before a taxpayer reaches the age of 59½).  Because Laura was not 59½ or older, the only way to avoid the additional tax was to try to satisfy one of the exceptions under IRC Section 72(t)(2).  One of those exceptions, Section 72(t)(2)(F), covers premature distributions for first-time homebuyers.  A first-time homebuyer may claim an exception for a lifetime distribution up to and including $10,000 (Section 72(t)(8)(B)).

To qualify for this exception, the distribution from a retirement account may not exceed $10,000 and must be used within 120 days of receipt to pay qualified acquisition costs relating to a principal residence for a first-time home buyer.  A “first-time homebuyer” is someone who hasn’t had a present ownership in a principal residence during the 2-year period ending on the date of acquisition of another principal residence.  “Qualified acquisition costs” include the costs of acquiring, constructing or reconstructing a residence.”  They also include reasonable settlement, financing or other closing costs. 

Laura failed to qualify for this exception on several counts.  First, although Laura claimed she used the $20,000 Morgan Stanley distribution for a down payment on the Kam Court property, she didn’t “own” the property because her name wasn’t on the deed.  Second, she wasn’t a first-time homebuyer, because she owned the Ellen Drive property within two years of the purchase of the Kam Court property.  Third, she didn’t use the $20,000 for qualified acquisition costs in the year the Kam Court property was purchased—2007.  And, as an aside, the Tax Court noted that even if Laura satisfied the exception, only $10,000 of the distribution, not $20,000, would be eligible under the exception. 

As to the $256 early distribution from her Fidelity account, Laura presented no evidence to the Tax Court as to why she shouldn’t have to pay the 10 percent additional tax.  As such, the 10 percent additional tax penalty applied.

 

Accuracy-Related Penalty Applies

IRC Sections 6662(a) and 6662(b)(2) impose a 20 percent penalty on the part of a tax underpayment attributable to a “substantial” understatement of income tax.  “Substantial” under Section 6662(b)(2) means an understatement that exceeds the greater of 10 percent of the tax required to be shown on a return or $5,000.  There’s an exception to this provision: A taxpayer can demonstrate that she acted in good faith and there was reasonable cause for the underpayment.  “Reasonable cause” and “good faith” are made on a case-by-case basis. 

In this instance, the Tax Court noted that Laura had her tax returns prepared by

Pedro Aguilar of P.A. Mortgage, Inc.  Although she provided Pedro with some records and information, she didn’t give him the 2008 Forms 1099-MISC, Miscellaneous Income, issued by both Morgan Stanley and Fidelity.  To avoid accuracy-related penalties, a taxpayer must, among other things, provide “necessary and accurate information” to her advisor and actually rely in good faith on the advisor’s judgment.  Laura admitted that she didn’t review her 2008 tax return prior to filing it and testified that she should have reviewed it prior to signing it.  She also admitted that she was irresponsible in not giving Pedro all of the documents relevant to 2008, including Forms 1099-MISC and her Forms W-2 Wage and Tax Statement.  The court thus found that she didn’t rely in good faith and accordingly, there wasn’t reasonable cause for the underpayment.  As a result, Laura was liable for Section 6662(a) accuracy-related penalties.

 

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