Frederick D. Todd, II & Linda D. Todd, Petitioners

T.C. Met o. 2011-123 UNITED STATES TAX COURT FREDERICK D. TODD, II AN LINDA D. TODD, Petitioners E COMMIS ÍONER OF INT RNAL REVENUE Respondent Docket No.

2 378-06 Filed-June 6, 2011.

David B. Shi .er and San a Shivpuri, for petitioners.

Angela B. Fr edman, Jason W A d rson, and David S. Weiner, f or respondent .

MEMO DUM FINDINÖS OF

CT AND OPINION

HAINES, Judc : After con ession , the issues for decision are:

(1) Whether petitioner F ederick D. Todd IIs (petitioner) received a' taxabl distributio f $400 000 from United Employee Benežit Fun (UEB ) n 2002; ( ) alt na ively, i petitioner did not receive a tax ble distribution fr m UEBF in 2002, whether

SERVED JUN - 6 2011

petitioner received $412,973 of discharge of indebtedness income in '2003; (3) whether petitioners are liable for an addition to tax under section 6651(a) (1) for 2003; and (4) whether petitioners are liable for a section 6662 penalty for 2002 or 2003.

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

The stipulations of facts and the eihibits attached thereto are incorporated herein by this reference. At the time they filed their petition, petitioners resided in Texas .

FINDINGS OF FACT

Petitioner was a practicing neurosurgeon employed by Frederick D. Todd, II, M.D. , P.A.

(corporation) ,; a Texas corporation of which petitioner was the sole shareholder, director, and president.

The corporation also employed, a few individuals who worked with petitioner.

On August 18, 1995, petitioner signed an application on behalf of the corporation to become a member of the American- Workers Master Contract Group (AWMCG) , authonizing AWMCG to represent the corporation in negotiations with the National Production Workers Union Local 707 (Local 707) , the union representing the corporation' s semployees .

The corporation agreed IUnless otherwise ind.icated, section references are to the Internal Revenue Code (Code) as amended and in effect for the years in issue. Rule references are to the Tax Court Rules of Practiåe and Procedure . dollar.

Amounts are rounded down to the nearest t to provide eligible employees with r death bEnefit only (DBO) plan-organized through the Anefican WorkeÈs Benefit Fúnd' (AWBF), a welfare benefit fundlestâb]ished tween AWMCG and Local 707 a The agreeme it' provided t hat uþ n as covered änployèe 9 death, AWBF-would þrovide therémployee''s'designat;ed beneficiary with an amount equaFtoMight times thei emplóýee's annual income up to $6 million . Howeven - AWBF' s obligat ion to pay "a death bene f it ceased if the co::poration's covered mployee was voluntarily or involuntarily te:aninated' or etired; if the corporation¯ ceased making contaributl.ons;¯ or if the mast coritract between the union and the master contract/ cjž·oup was not renewed.

As an eligible employee of the corpoStiòÑ, etitiòner enrolled in the DBO plan, designating petit:ioner Linda D. Todd as the beneficiary of the »$6 million death benefit.

A few òf petitioner''s fellow eligible employees also pé.rticipated ih the DBÒ plah.

On September 5, 1995, petitionär* submitted "an apþlication, for life insurance to Southland life Insur nce Co.

(Southland) on behalf of AWBF.

On November e.⁵, 1995, Southland' issued a $6 million universa³ life insurance policy (policy No. 5160) on pe t it iorier ' s =li f e to AWBF .

The annual preinium on poli No 516 0 was approximately $1007000 he policy was dwned solely by AWBF to Iprovi~de insurance to fund ti å deat h benefit owed by AWBF to petitionee' s wife i'f petition r died.

The- corporation mahe yearly contributioris to AWBF onabehaJ f of petitioner and' hia fellow covered, employees and deducted those payments under section 419A(f) (5) .

Upon receipt of the corporation's yearly contribution, AWBF paid the premium on policy No 5160 .

On July 21, 1999, petitioner submitted another application for life insurance to Southland. - On October 1, 1999,- Southland ~ issued a $6 million indexed universal, life insurance policy (policy No. 8889) on petitioner' s life that required, an annual premium of approximately $100, OOO. On,December 3, 1999, petitioner transferred ownership of policy No. 8889 to AWBF.

On January 28, 2000, AWBF rolled policy No. 5160, which had an accumulation value of $315,773, into policy No. 8889 pursuant to section 1035, resulting in sa single, $6 million policy on petitioner's life.

On December, 18, 2000, AWBF merged into United Employees Benefit Fund (UEBF) .

UEBF was a welfare benefit fund established between Professional Workers Master Contract Group and the Union of: Needletrades, Industrial and Textile Employees, Local 2411 (Local 2411) , to provide a -DBO plan to eligible employees of part:ic-i.pating employers. - Before November 2001 petitioner's corporation made yearly contributions to AWBF on behalf of petitioner -and his fellow covered employees and deducted those payments as contributions to AWBF. After receiving notice of the transfer of the insurance policies on the lives of the corporat,ion' s employees from AWBF to UEBF on November 15, 2001, thê corporation nade contributions to UEBF, which paid the premiums on the Southland life insur nce policies held on the a lives of petitioner and his covered mployees.

Under artic le 8 of the UEBF Tru t Agreement (trust agreement) , the employer and employee trustees had discretionary authority 'to make loans to a plan participant on a nondiscriminatory basis.A Upontan a plication and written eiidence of an. energency orrserious financial hardship from the eligible -employee, - the truste a could make a· loan up to the amount of the present-value to othe- d ath benefit.

David Fensler was "a certified employee benefit spe ialist and was the employer trustee and administrator of oth -UE]BF and AWE,F.

James Skonicki was thesemployee-trustee .oftUÈBF from before 1998 through 2002.

On Ma'y' 20, 2002 Southland no ified etitioner'srinsurance agent that the maximum available distribution from policy No.»8889 was $400, 000 and that any greater distriipution would cause the policy to lapee.

On Ju]y 11, 2002, petitioner submitted to UEBF an application for loan of $400, 000 for "unexpected housing costs" .

2The loan requirements of AWBF and UEBF were the same .

3The present value of the death enefit as to be actuarially computed using antassumec interest rate of 8 percent and an assumed mortality of age 75.

Upon receipt of petitioner's loan application, Mr. Fensler recommended to Mr. Skonicki that the loan* to petitioner-be approved. Neither Mr. Fensler nor Mr. Skonicki- made further inquiries into the hardship claimed by petitioner.

On August 26, 2002, Mr. Fensler submitted a policy loan request to Southland requesting a loan of $400,000 on policy No. 8889.,: However, after receiving the loan check, Mr. Fenslei- decided that the 4.7,6- percent interest rate charged by Southland on the loan made the choice of a partial surrender from policy No. 8889 a better prospect.⁵ Ori August 30, 2002, pétitioner agreed to a distribution, which would reduce the face value of policy No.

8889 to $5,600,000.

On September 18, 2002, Southland reissued a check for $400,000 to UEBFsrepresenting the distribution from policy No. 8889. »Upon receipt of the funds from Southland, NUEBF issued a check for $400,000 to peti'tioner on :September 25 2002.

On October 25; 2002, the corporation made its annual contribution to -UEBF for petitioner' s DBO plan, and on January 7, 2003, UEBF 40ur reference to the transaction as a loan is made for ease This reference is not dispositive of of discussion. of the transaction, and the determination of whether the transaction between petitioner and UEBF is a valid debt for tax purposes is the subject of discussion below.

the status "The midterm applicable Federal rate, aþÿlic'ablé Y.o ioans with terms of 3 to 9 years, was 3.75 percent for loans - originating in September 2002. 53, 2002--2 C.B. 427. The long-term applicable Federal rate for loans óriginating in September 2002 was 5.23 percent. e Rev., Rul. 2002-53, 2002-2 C.B. at 428.

See sec. 1274 (d) ; Rev. Rul. 2002- made a premium payment to Solithland on policy- No.⁴ 8889 After 2003, however, petitioner's orporation st opped making its annual contributions to UEBF on- beh lf of etitioner' s' DBO plan, and UEBF ceàsed premi.um payments on pol y No. 8889.

The trust agreement pro ided th t a loans from UEBF hadsto be secured by a pledg'e of the actuarial y determined present value of the eligible employee' s death, ben f t and: evidenced by an executed promissary nòte that prövid d for payments at least quarteil .

The :rust -agreement talsol required tthat the loan bear a reasonable³ rate of³ interest taking into accouiit the interest rates charged by -pèrsons ina the business of lending money for loans which would be made und r similar ciròumstances .

Six months mfterathe $400, 000 check was delivered to petitioner, and after Mr. Fensler provided an amortization- e schedule, on March"2r, 2003, etitionet signed a promissory note to UEBF in the anount of $400 000 .

The stated intereste on the note was 1 percent, ândsthe n tes pro ided, that⁵ petitioner'make quarterly instal ment payment of $20, 527/ beginning son November 1, 2002, and -continuing until the ni>te was paid.

The note andathe triist a reement alsonincluded -an älternative me^anti öf repayment, referred to by petitioners :as a "dual repayment mechanism" .

in the absence of quarterly payments by petitioner, tEe dual repayhent mechanism allowed-UEBF to deduct the òutstending loan b lance from any payment or distribution due from UEBF to the participant or his beneficiary.

According to UEBF, the dual repayment mechanism prevented a participant from defaulting on his obligation-torrepay the loan while any payments or distributions were due to the participant under the terms of the agreement. At the end of 2002.and 2003, petitioner owed a principal balance of $400,000.

As of the date of trial, petitioner had not made any payments on the note, and UEBF had taken no action to collect on the note.

The trust agreement required that UEBF hire an auditor to conduct a certified audit and issue, an opinion as to the.UEBF financial statements.

An accounting firm conducted a certified audit and, despite the dual repayment mechanism and its purported protection against default, determined that the purported loan to petitioner was :bi default because of the nonreceipt of payments.

For theataxable years 2002 and 2003, the auditor required UEBF to report the loan as uncollectible or-in -default in 2002 and 2003 on Schedules G of Forms 5500, Annual Return/Reportsof Employee Benefit Plan. UEBFrand its trustees issued a statement expressing disagreement with the auditor, explaining that the dual repayment mechanism prevented the loan from entering default under the terms of the trust agreement and UEBF's policies and procedures .

The statement likewise explained that the loan was not in default or suncollectible because petitioner's death benefit owed by JEBF under £1 e DBO plan would provide the necessary collateral for the payment of the promissory note.

On July 5, 2005, petiti nërs filed delinquent32002 and 2003 Federal incotne tax returns.

I On Sept mber 21, 2006, trespondent issued a notice determining-deficien ies fore2002 and 2003 of $65, 237 and $16, 719, respectively, t gether with section 6662 (a) penalties of $13 047/' and $3, 344 res ectively.

The deficiencies were base~d prima:rily on unreported dividends from -life insurance contributions inade on petitio er' s - behalf by the corporation and denial of petitioners' claimed chari able contribution deductions.

Pet tioners file a pet tion with the Tax Court for 2002 and 2003 on December 21 2006:

* In-preparat·.on for trial respo dent discovered petitioner had recéived a $600,000 distribùtion froin UEBF ine 2002.

,Arguing that the distribution was taxable upon receipt respondent filed an amenèlment to answer and aseerted an increased deficiency for 2002 of $224, 269 and an incre sed -pe alty nder' section 6662 (a) of $44,854. Respondent alter ativel argued thati if the $400 000 distribution was a valid, loan the iÅdebtedness was discharged in 2003 and resulted: in a defici ncy for '2003 of $165, 596 and a penalty urider section 6662-(a) of $33,139 Respondent also asserted an addit ion to tax under section 6651(a) (1-) of $29/184 for 2003 -but none for 2002.

OPINION -

I.

Burden of Proof As a general rule the taxpayer bears the burden of proving that the Commissioner' s determinations set forth in a notice of deficiency are erroneous. Rule 142(a) (1); Welch v. Helvering, 290 U.S. 111 (1933) . However, the Commissioner has the burden of proof as to any new issue or increased deficiency. Rule 142 (a) (1) . Respondent concedes that he bears the burden of proof because the only issues to be decided were raised in the amendment to answer.

II.

Loan or Plan Distribution .

« The parties agree that petitioner received $400,000 from UEBF on September 25, 2002. Petitioners maintain that the distribution was a loan which petitioner intended to repay.

Respondent argues that. the distribution from UEBF to petitioner was taxable income.

The parties agree that UEBF did not distribute the funds in satisfaction of its obligation to petitioner's beneficiaries unders the DBO plan.

Section 61(a) provides the following -broad definition of the term "gross-income":

"Except as otherwise provided in sthis subtitle, gross income means all income from whatever source derived" . Exclusions from gross income must be narrowly construed. Commissioner v. Schleier, 515 U.S. 323, 328 (1995) .

One such exclusion excepts the receipt of loan proceeds from gross income because the tem orary economic benefid of income is ofiser by a corresponding ob igation to repay:

- United States v.

Rochelle, 384 F. 2d 748 751 (5th Cir 1967) ; Dennis v.

Commissioners T.

. Memo. 1997-275. , However for genuine indebtedness to de present tl ere must be both good-faith intent on the part of the borrower to repay the debt and good-faith intent by the lender to enforce payment of the debt. Estate of Chism v. Commissioner, 322 F 2d 956, 960 (9th Cir. 1963), affg.

Chism Ice Cream Co. v. Commissioner T.C. Memo. 1962-6; Wright v.

Commissioner, T.C. Memo. 1992-60.

The U.S. Court of Appeals for tie Fifth -Circuit, to which an appeal in this case would lie absent a stipulation otherwise, has held that whether a transaction constitutes a loan for income tax purposes is a factual question involving several considerations, and a distinguishing characteristic of a loan is the intention of the parties that the money advanced be repaid.

Moore v. United States, 412 F.2d 974, 978 (5th, Cir. 1969) .

Important factora considered by courts in finding a bona fide debt are whether:

(1) The promise td> repay was evidenced by a note or other instrument; (2) interest was charged; (3) a fixed schedule for repayments was est ablis ed; (4) collateral was given to secure payment ; (5) repayments were made; (6) the borrower had a reasonable pros pect of repaying the loan, and whether the lender " had suf f inient funds to advano e the loan; and (7) the L parties conducted themselves as if the transaction was a loan.

See Goldstein v. Commissioner, T.C. Memo. 1980-273 (and cases cited therein) .

We address, each factor in turn.

A. Whether the Promise To Repay Was Evidenced by a Note or Other Instrument A note or other instrument is indicative of a debtor- creditor relationship.

Teymourian v. Commissioner, T.C. Memo.

2005-232. However, an instrument will be given little weight when the form of the instrument fails to correspond with the substance of the transaction. Provost v. Commissioner, T.C.

Memo. 2000-177.

On September 25, 2002, UEBF issued a $400, 000 check to petitioner. Six months later, on March 21, 2003, petitioner signed a promissory note to UEBF for a loan of $400, 000 . Despite a the requirements within the trust agreement, the parties failed to contemporaneously memorialize the indebtedness when the money was distributed to petitioner.

Moreover, the record further reflects that neither petitioner nor UEBF adhered to the terms of the promissory note or the trust agreement that governed the transaction.

UEBF failed to charge a market rate of interest, petitioner did not make quarterly payments as required under the promissory note, and UEBF did not attempt to collect the amount owed or any portion thereof after petitioner defaulted.

For the foregoing reasons, the Court finds that neither petitioner nor UEBF strictly complied with the terms of the loan agreement or the promissory r ote.

Thus, the Court gives tthe promissory note 1.ittle-weight.

.This factor indicates the parties didsnot intend t establish a debtor creditor relationship at the time the funds were advanced.

.

"Whethe DIntereèt Was Charged The payment of interest indicates the existence of a bona fide loan. Welch v. Commissioner, 2O⁴ F.3d 1228, 1230 (9th .Cir.

2000),4affgr. T.C Memo. 1998-121; Teymourian v. Commissioner, supray-Morrison . Commissioner, T.C.

,Memo. 2005 53.

The trust agreement provided that a reasonab]:ea rate ãof interest should be charged, taking":.nto- account the interest Eates charged by persone:in the business of le ding monèy under, similar a circumstances. Southland cha ged a rate of 4e⁷⁶ percent orr a similar loan; and petitioner acknowl dges- that the 1-percent interest rate chCrged on the romissory; note was lower than the market rate..

The failure* of UEBF and petitioner to agree to a reasonable market rate ofuinterest as dictated by, the trust agreementi indicat es the parties did mot intend toi éstablish a - debtor-creditior Telationship atethe time the funds wereradvanced.

C. Whéther a Fixed Schedule for Repayment Was Established A fixed schedule for rep ymènt is indicativemofaalbona-fide loan. Welch v. Lommissioner, supra at 1231; Teymourian v.

Commidsíoner, su ra. Evidence that a creditor -did not intend to enforce payment cr was indiffÈrent to -the-exact time ansadvance was repaid indicates a bona fide loan did not exist. Gooding Amusement Co. v.- Commissioner, 23 T.C. 408, 418-419 (1954), e affd 236 F.2d 159 (6th Cir. 1956) ; Provost v. Commissioner, sunra According to the promissory note, petitioner was to make - quarterly installment payments of $20, 527 beginning on November 1, 2002, and continuing until the note was fully paids :Three months after the first payment was due, UEBF provided petitioner with an' amortization schedule reflecting quarterly payments that should have been paid beginning on November 1, 2002. Almost 4 months after the first payment was due, the parties finally executed the. promissory note. Petitioner did not make any a payments to UEBF, and UEBF -never attempted to collect the amount owed after each default.

This. factor indicates the parties did not intend to establish a debtor-creditor relationship at the time the funds were advanced.

D.

• Whether Collateral Was Given To Secure Payment Respondent argues that petitioner provided no collateral because he did not own or, have any rights in the Southland insurance policies purchased on his life .

AWBF secured the potential death benefit obligation by purchasing policy No 5160 from Southland.

On July 21, 1999, petitioner purchased his own policy from Southland, policy No. 8889. However, on December 3 1999,7 petitioner transferred ownership of policy No. 8889 to AWBF, which rolled. the balance of policy No. 5160 into policy No.

8889.

-After the merger of AWBF and UEBF in 2000, policy No. 8889 became the prope ct-y of UEBF. At th time of the purported loan, petitioner -did not own the polic'y, d no access to the casha value of, the pollcy, and"had nd rig ts to the proceeds from the policy.

Thusó respondent conrectly tates thät theapolicy cannot be treated as collateral for petitioner's purported loan.

In response petitioners claim hat thevdeathabenefit owed to them by UEBF under the DBO plan, nd nc t the Southland insurance policies⁴ provided the ne~cessary collateral for the payment of the promissory note .

Pet tioners argue that when combined with thd death-benefit owed by UEBF, theidual repayment mechanism served as collateral since any balance remaining. on the loan at the time of petitione s dea h would reduce ther death benefit payable by UEBF to hi beneficiaries. AThus,a petitioner claims he provided the necessary collateral despite making no payments or relír.gisishing controlrover- any property in favor of

UEBF.

In our analysis below we find ther dua L epayment mechanism does not serie as a valid repayment method⁴ for purposes of classifying the <iistribùtion to petitioners .as a bona, fide- loan.

However®, the mechanism could ervera security between the , parties for the' gromissory no e .

Fo ,example, if :petitioner died having met all ccnditions pre edent utitling him to-death benefits, UEBF wculd receive $5,600, 00 from Southland and would be obligated to:pay $6 million to petitioner's beneficiary.

,The dual repayment mechanism agreed to by petitioners providess security and allows UEBF to deduct the $400,000 distribution from the death benefit obligation.

- This factor indicates the parties possible intent to establish a debtor-creditor relationship at the time the funds were advanced.

r E .

Whether Repayments Were Made Repayment is ansindication that a loan is bona fide. Haber v. Commissioner, 52 T.C.;255, 266 (1969), affd. 422 F22d 198s (5th Cir. 1970) .* Although petitioner signed a promissory note obligating him to make quarterly. payments beginning in November .

2002, as of the date of trial petitioner had not made any payments toward the purported loan.

. Petitioners argue that "the dual repayment imechanism serves as a valid method of repayment.

For a valid -debt to exist for tax purposes, there must exist an unconditional obligation to repay. Midkiff v. Commissioner;

If a repayment mechanism is too contingent and indefinite, the alternative spayment method is not recognized.

Zappo v. Commissioner, 81 T.C. 77, 87-88 (1983) 17- Despite pètdioners' charac'teri ation of the transaction and the dual repayment mechanism, there ie sicjnificant conditions precedent to-petitioners' receipt of a death benefit 'under the DBO plan from UEBF.

If the dorporat±on ce'ased participation in the' IJEBF plan, i the covered employee was voluntarily or , involuntarily te:aninat~ed or r tired, or if athe smaster contract group and LocalG411 failed to renew their agreement, then UEBF was not required to pay any b nefits Thus, even if petitioner had rights to a death benefit the rights were contingent because if any of the fo e ing conditions w re present at the t-ime of his death, his be neficiaries Would not receive benefits from

UEBF.

Because tl e purported benefits were contingent upon multiple future events, petitioner cannot reasonably rely on the death benefit as an alternati e payment method to show that the loan would be unconditionally repaid This factor indicates the parties did not :ntend to establish a debtor-creditor relationship at t he time the funds were advanced.

F.

the Borrowe Had a Reasonable Prospect Whethe of Repiving ,the Loa Sufficient Funds To Advance the Loan and Whether the Lender Had This factor is best dete mined by looking to whether there was a reasonable expectation of repayment in light of the economic realities of the sit ation" at the time the funds were advanced. Fisher v. Commissi ner, 54 T.C. 905, 909-910 (1970) .

A reasonable proE pect of repa ment at the time the funds were advanced indicates the existence of a bona fide loan. Welch v.

Commissioner, 204 F. 3d at ,1231.

Petitioner earned a substantial .living as a neurosurgeon, and there was a reasonable prospect of petitioner' s repaying the purported loan.

This factor favors the existence of a debtor- creditor relationship between. the parties.

G. Whether the Parties Conducted' Themselves as if the Transaction Were a Loan The conduct of the parties may be sufficient to indicate the existence of a loan. Baird v. Commissioner, 25 T.C. 387, 395 (1955) ; Teymourian v. Commissioner, T.C. Memo. 2005-232; Morrison v. Commissioner, T.C. Memo. 2005-53.

Petitioners produced little evidence showing UEBF and petitioner conducted themselves in a manner indicating that UEBF's distribution of $400,000 to petitioner was a loan.

Although petitioner executed a loan application and a promissory note, neither party strictly abided by their terms. First, petitioner failed to provide any written evidence of the unexpected housing costs that necessitated the loan application, and UEBF made no further inquiry into the hardship.

Second, the interest rate was below market, petitioner failed to make any quarterly payments as required under the promissory note, and UEBF never attempted collection. Third, the promissory note was not executed for almost 6 months after the funds were advanced.

Lastly, petitioner's corporation ceased making contributions to UEBF to fund petitioner's de th benefit shortly after petitioner received the $400, 000 distrïbution from UEBF.

This fãctor indicates the- part s did not intend to establish* a dëbtor-~ci-editor relatió hip at the time the funds were advanced H.

Conclusion In accordancedith our analysis above, respondent has met his burden offproving that the distr butidn of $400,000 did not constitute a bon fide loan.

On this record, the Court holds that petitione~rs' improperly failed toureport as income the $400, 000 UEBF die tributed to ;>etitioner- in 2002.

' Because of our findings herein, it is unnëceesa'ry to address the parties' arguments regarding³ a discharge of indebtedness by UEBF'or the - year in which it occurred.

» III. Penalties ar d Additions to Tax A.

Addition to Tax Under Sect: on 6651(a) (1) Sectiori -6653 (a) (1) impos as an addition to-tax inethe case of any failure to" t-imely file a Federal income tax return unless sit is shown that such failure is due to reasonäble cause and not willful neglect. K showinge of reasonable cause requires petitioners to demonstrate théy exercised ordinary business care and prudence and nevertheless were ur able to file the return by the due date.

Sec. 301.6651- (c) (1 Proced. & Admin. Regs.

Petitioner filed their eturns or 2002 and 2003 on July 5, 2005. Respondent did not assert a.section 6651(a) (1) addition to tax for 2002.

The amount of the section 6651(a) (1). addition to tax is a computational matter based on the m amount of tax- due.

Tc the extent respondent bears the, burden, of proving an increased section 6651(a) (1) addition to tax, respondent has ,met this burden if petitioners' concessions result in an increased deficiency for 2003.

See sec. 7491(c) ; Higbee v. Commissioner, 116 T.C. 438,e 446-447/ (2001) ; Howard v. Commissioner, T.C. Memo.

2005-144 Petitioners admit that they did not have reasonable cause fori their failure to timely file and failed to argue that the addition- should not apply. - Accordingly, we conclude- that petitioners are liables for an addition to stax under section 6651(a) (1) for 2003 in an amount to be determined in the Rule 155 computation.

B.

Accuracy-Related Penalty Under Section 6662 Petitioners contest the imposition of an accuracy-related penalty for 2002.4 Section 6662(a) and (b) (1) ands (2) imposes a 20=percent accuracy-related penalty upon any underpayment of Federal income tax attributable to a taxpayer' s negligence or disregard of rules or regulations, or substantial understatement 'Because of the parties' concessions and our holding- thatt petitloners itüproperly Êailed to report the $400, 000 distribut'ion as income in 2002, we find it unnecessary to address respondent's alternative position regarding the imposition of related penalty for 2003 or petitioners' response thereto.

the accuracy- of income tax. Sectionu6662 (c') defines negligence asaincluding any failure to make a-reasonäble at empt t o comply with the a provïsions of ths- Code and d fines isregard as any careless, reckless, or intentional dis egard. Disregardtof rules- or regulationseis c ireless if the taxpayer does not exercise reasonable diligence to edetermine th correctness of a tax return position that is contrary ato then rul or regulation.

Sec 1.6662-3(b) (2), income iTax Regs. Di regard .of rules or regulations ist reckless lif the' taxpayer makes little or no effort to determine whether a rule cr regul tion lexists.

Id.

An understatement is substantial if it exceeds the greater of 10 percent sof the .tax required t be shown on the return or $5,000.

Sec. 6662 (d) (1) (A) .

Under section 7491(c) , the Commissionier bears the burden of production with- respect toopehaltiessand must come forward with suf f icient evidence indicating that it -is appropriate to impose penalties. Higbee v. Commissioner, supra at 446-447. Once respondent meets his burden of production, petitioners bear the burden of proof as to substan ial aut hority, reasonable cause, or similar provisiors. 21 In- An amendment to answer, respondent asserted an incrEased penalty based on the asserted increased deficiency for each year at issue.

To thesextent respondent a bears the burden of proof for the increased 2002 penalty, we find that respondent has met that burden.

See Bhattacharyya v.

Commissioner, T.C. Memo. 2007-19; Howard v. Commissioner, supra.

Respondent has proved that petitioners improperly excluded from income in 2002 the $400,000 distribution from UEBF, which exceeds both 10 percent of the tax required to be shown on the return'and $5,000. Respondent has also shown that :petitioners negligently "disregarded rules and regulations by- failing to make a reasonable attempt to ascertain the correctness of the e treatment of the distribution. Petitioners arranged for a distribution from the policy, accepted funds, and made no attempt to make payments on sthe purported loan, thus defaulting.

Moreover, petitioner provided no -evidence that he discussed his failure to meet the terms of his purported loan with his tax return preparer or made any attempt to determine the correct treatment of his failure to report any income associated with the distribution on his income tax return.

This evidenceris sufficient to indicate that it is appropriate to impose a penalty under section 6662(a) for 2002, except to any portion of the underpayment as -to which petitioners acted with reasonable cause and in good faith.

See sec. 6664(c) (1); Higbee v. Commissioner, supra at 448.

The decision as t:o whether a taxpayer acted with reasonable cause and in good faith is made on at case-by-case basis, taking into account all of'the pertinent-facts and , circumstances.

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

Reliance on professiona advice mây constitutesreasonable cause and good faith if, under all the"ùi cumstances, such reliarice was reasonable an the täxpåfer aatëd in good faith.

Freytaqav.. Commissionei 89 7 C. 849, 888 (1987), affd. 904-F:2d 1011 (5t-h Cir. 1990), affd. 501 U.S. 8a⁸ (1991); sec. 1.6664- 4(b) (1) Income Tax Regs. Hcdevei, he taxpayer cannot avoid the penalty merelg bf ha'ving a professional adviser read a summary of the transaction and loffer advice tha assumes the facts presented are true.

See N6vinger vn Conmissioner .Cr Memo.

-1991'-289.

Moreover, the profesäional' s advice must e based on all >ërtin'e'nt acts and cïrchmstances; a d, if the adviser is not versed in the nontax factors, merè~reliance on the tax adviser may not suffice.

See Addingtbn v. U it ed States, 205 F.3d 54; 58 (2d Cir. 2000) ; iCollins v. Coümisåïoner, 857 F.2d 1383, 1386 (9th Cir. 19Š8) affg Disteživ. Commissi ner, T.C. Memos 198'7-21'7; Freytag v² Commissioner, supra at"888, 889¥.

For attaxpàyer's relianc on ad ice tp bensufficientTy reasonable so; as to inegate po sible iability for the acóuracy- related penalty, thë Court ha státe that! a taxpayer must eatisfy a three-prong tëst by showing:

(1) The adviser was av dompetent þrofeñiorial wdó had sufficient expertise to jiistify reliance; (2) ~tte taxpayer p ovided the adYiser with the necessaEy and acfúi-ate iñform tion; and (3) the taxpayer actually reliéd in good' f ith on'the a viser judgme^nt . » Neonatology Associates P.A. v. Commissioner, 115 T.C. 43, 99 (2000), affd, 299 F.3d 221 (3d Cir. 2002) .

Petitioners claim that,they relied on the tax advice of Jeffrey Oerke, C.P.A., who prepared their 2002 return, and thus reasonable cause exists . However,' there is no evidence that Mr .

Oerke had any particular expertise in employee benefit plans,or that petitioners thought he had such expertise.

Furthermore, petitioners failed to show thatethey provided Mr. Oerke with all the- necessary and accurate information to properly prepare their returns or evaluate the purported loan. Petitioner testified that althought he provided Mr. Oerke with a copy of the .promissory note, he was unsure whether Mr. Oerke received,any documents related to the 'DBO benefit plan. Finally, the recórd- indicates that petitioner did not seek or receive an opinion from Mr. 30erke regarding the validity of the purported loan transaction.

Instead, Mr. Oerke merely prepared petitioners' income tax return for 2002 from the documents petitioners provided.

As we have stated, reliance on the mere fact that a certified public accountant has prepared a tax return does not mean that he or she opined on any or all of the items reported herein. E at 100.

For all of the foregoing reasons, petitioners are precluded from now arguing that they relied on the tax advice of Mr. Oerke.

a . We conclude that petitioners's underpayment for 22002 was the result of their substantial,understatement of income.tax and -25 their negligence and disregar of rules or regulations under section 6662.

W also conclu e that petitione a are not entitled to the reasonabl cause and g od fai h defense under section 6664 because they did not rely on heir a countant.

Thus, we find that petitioners are liable f r the accuracy-related penalty for 2002 pursuant to section 6662 in an mount to be determined in the Rule 155 com utation.

We do not impose a section 6662 penalty for 2003.

The Court, n reaching i s holdings, has considered all arguments made, and, to the e tent n t mentioned, concludes that they are moot, i relevant, or without merit.

To reflect t e foregoing Decision will be entered under Rule 155.

96. T.C. 724, 734-735 (1991) ("Indebtedness is 'an existing, unconditional, and legally enforceable obligation for the payment of a principal sum.'", affd. sub nom. Noguchi v. Commissioner, 992' F.2d 226 (9th Cir. 1993) (quoting Howlett v. Commissioner, 56 T.C. 951, 960 -(1971) ) ) .