Wednesday, February 24, 2010

Karl L. Matthies, et ux. v. Commissioner, 134 T.C. No. 6, Code Sec(s) 61; 402; 6662.
Case Information:
Code Sec(s): 61; 402; 6662
Docket: Docket No. 22196-07.
Date Issued: 02/22/2010
Judge: Opinion by THORNTON
A return that has a “reasonable basis” is not negligent. Sec. 1.6662-3(b)(1), Income Tax Regs. The “reasonable basis” standard is “significantly higher than not frivolous or not 12 (...continued) and (3) that the “Annual Reserve Increase” was $305,866.76. Petitioners' own brief indicates that at the end of policy year 2, Hartford Life's reserves in the insurance policy were $1,035,030. Petitioners have offered no explanation why the interpolated terminal reserve value was purportedly only $305,866.74 in the light of their representation that Hartford Life maintained a reserve of $1,035,030. patently improper.” Sec. 1.6662-3(b)(3), Income Tax Regs. This standard is satisfied if the return position is reasonably based on various types of enumerated authorities, including statutory provisions, regulations, revenue rulings, and notices published by the IRS, taking into account the relevance and persuasiveness of the authorities and subsequent developments. Secs. 1.6662- 3(b)(3), 1.6662-4(d)(3)(iii), Income Tax Regs. The “reasonable basis” standard is less stringent than the “substantial authority” standard (which entails “an objective standard involving an analysis of the law and application of the law to relevant facts”), which in turn is less stringent than the “more likely than not standard” (which asks whether there is “a greater than 50-percent likelihood of the position being upheld”). Secs. 1.6662-3(b)(3), 1.6662-4(d)(2), Income Tax Regs. The negligence penalty may be inappropriate where an issue to be resolved by the Court is one of first impression involving unclear statutory Bunney v. Commissioner, 114 T.C. 259, 266 (2000); language. Lemishow v. Commissioner, 110 T.C. 110, 114 (1998); Hitchins v. Commissioner, 103 T.C. 711, 719-720 (1994); see Everson v. United States, 108 F.3d 234, 238 [79 AFTR 2d 97-1335] (9th Cir. 1997) (stating that “When a legal issue is unsettled, or is reasonably debatable” a negligence penalty is generally not appropriate).
This Court has not previously addressed the tax treatment of a bargain sale of a life insurance policy under section 61 or 402(a) or the application of the “entire cash value” standard under the applicable regulations. In adopting the 2005 final section 402(a) regulations, the IRS stated that it was responding to the question under the then-existing regulations of whether “entire cash value” includes a reduction for surrender charges. T.D. 9223, 2005-2 C.B. 591. Furthermore, the amended section 402(a) regulations, which dispense with the “entire cash value” standard, indicate that for a bargain sale of an insurance contract that occurs before August 29, 2005, the bargain element is includable in income under section 61 but is not treated as a “distribution” under the subchapter of the Code that includes section 402. Sec. 1.402(a)-1(a)(1)(iii), Income Tax Regs. On supplemental brief respondent has modified his original position as to the applicability of this amended regulation. Respondent's shift in this regard, together with his explanation of his reasons for promulgating the amended section 402(a) regulations, is indicative of the uncertainty under the applicable regulations of the tax consequences of the transaction in question. We conclude that petitioners had a reasonable basis for their return position. 13 We hold that petitioners are not liable for the accuracy-related penalty for negligence.
Other contentions raised by the parties but not addressed in. this Opinion we deem to be moot or without merit. 14 To reflect the foregoing and concessions by respondent,

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