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John U. Fazi and Sylvia Fazi v. Commissioner, 13874-93 (1995)

Court: United States Tax Court Number: 13874-93 Visitors: 33
Filed: Dec. 19, 1995
Latest Update: Mar. 03, 2020
Summary: 105 T.C. No. 29 UNITED STATES TAX COURT JOHN U. FAZI AND SYLVIA FAZI, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 13874-93. Filed December 19, 1995. P, a dentist, incorporated C and established three pension plans. P was an employee of C. Plan 2 was frozen in 1982. Plan 2 was merged into plan 1 in 1986. P dissolved C in 1986 and distributed all of the assets in the plan 1 trust to employees, including P, in 1987. We held in Fazi v. Commissioner, 102 T.C. 695 (1994) (Fa
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105 T.C. No. 29



                UNITED STATES TAX COURT



     JOHN U. FAZI AND SYLVIA FAZI, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 13874-93.              Filed December 19, 1995.



     P, a dentist, incorporated C and established three
pension plans. P was an employee of C. Plan 2 was
frozen in 1982. Plan 2 was merged into plan 1 in 1986.
P dissolved C in 1986 and distributed all of the assets
in the plan 1 trust to employees, including P, in 1987.
We held in Fazi v. Commissioner, 
102 T.C. 695
(1994)
(Fazi I), that plan 1 was not qualified and its related
trust was not exempt during 1985, 1986, and 1987. We
also held that, except for amounts conceded by R, P was
taxable in 1987 on the assets distributed to P from
plan 1. In Fazi I, R conceded on brief that the
taxable distribution to P from plan 1 for 1987 had to
be reduced by contributions made on P's behalf for 1985
and 1986, including P's share of the amount merged from
plan 2 to plan 1 during 1986. This concession was
accepted without review or analysis of the underlying
substantive issues related to the concession.
                                    - 2 -


          R determined that P is taxable in 1986 on the
     amounts contributed to plans 1 and 3 on his behalf for
     that year, including the amount merged from plan 2 into
     plan 1. R's notice of deficiency was mailed more than
     3 years, but less than 6 years, after the filing of P's
     1986 tax return. R now admits that, but for judicial
     estoppel, P should not be taxed in 1986 on his share of
     the merged amount, but rather when it was distributed
     to him in 1987. P argues that judicial estoppel does
     not apply and that R is barred by the statute of
     limitations from asserting a deficiency for 1986.

          Held, P's share of the merged amount is not
     taxable to P in the year of merger; Fazi I clarified.
     Held, further, judicial estoppel does not prevent P
     from denying liability. Held, further, the 1986 tax
     year is not open for redetermination.



     Paul A. Kasicky, for petitioners.

     Julia L. Wahl and Janine H. Bosley, for respondent.



                                  OPINION

     VASQUEZ, Judge:      Respondent determined a deficiency in

petitioners' 1986 Federal income tax in the amount of $160,904.

The deficiency is attributable to the merger of plan 2, a

qualified pension plan, into plan 1, an unqualified pension plan,

and actual corporate contributions made to unqualified pension

plans 1 and 3 on petitioners' behalf.1         The 1986 tax year is only


1
   Plan 1 and its related trust were retroactively disqualified in Fazi v.
Commissioner, 
102 T.C. 695
, 706 (1994), for plan years ending in 1985, 1986,
and 1987. The parties have stipulated that plan 3 and its related trust were
disqualified for the same reasons plan 1 was disqualified, for plan years
ending 1985, 1986, and 1987. However, the parties have not stipulated whether
plan 2 was disqualified prior to its merger into plan 1 in 1986. The only
reference the parties make to plan 2 is that it was frozen in 1982.
                                                                (continued...)
                                    - 3 -


open for redetermination if section 6501(e)(1),2 the 6-year

statute of limitations, applies.        Section 6501(e)(1) can only

apply if the amount merged from the qualified pension plan to the

unqualified pension plan (the merged amount) is properly

includable in petitioners' income in the year of the merger,

1986.   Consequently, we must first decide whether the merged

amount is properly includable in petitioners' 1986 income as a

contribution or by application of the doctrine of judicial

estoppel.3    If the year is open for redetermination, we must also

decide whether contributions made by the corporation to

unqualified pension plans in 1986 on behalf of petitioners are

taxable to petitioners when contributed and whether an increase

in the vested account balance of petitioners in an unqualified

pension plan is taxable to petitioners in 1986, the year of the

increase.

                                Background

                             This case was submitted fully

stipulated.    All of the facts are stipulated and are so found.


1
 (...continued)
Respondent states in her brief that plan 2 was qualified. We will treat this
as a concession on respondent's part that plan 2 was qualified.
2
   Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the year in issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure.
3
   Respondent determined in the notice of deficiency that the merged amount
should be treated as a contribution. Respondent's briefs argue that
petitioner should be judicially estopped from denying that the merged amount
is taxable as a contribution. We are not ruling on, and express no opinion
on, whether the merged amount could constitute a distribution.
                                    - 4 -


The stipulation of facts and attached exhibits are incorporated

herein by this reference.

      Petitioners were married to each other at all relevant times

and resided in Weirton, West Virginia, at the time the petition

was filed.    Petitioners, John U. Fazi (Mr. Fazi) and Sylvia Fazi

(Mrs. Fazi), were employees of Dr. J.U. Fazi, Dentist, Inc.

(corporation), a West Virginia corporation.

      The corporation established and operated three employee

pension benefit plans:      (1) The Dr. J.U. Fazi, Dentist, Inc.

Employees Pension Plan, a money purchase pension plan (plan 1);

(2) the Dr. J.U. Fazi, Dentist, Inc. Employee Profit Sharing Plan

(plan 2); and (3) the Dr. J.U. Fazi, Dentist, Inc. Retirement

Plan, a defined benefit plan (plan 3).

      Plan 1, when originally adopted by the corporation in 1972,

was qualified4 under section 401, and the accompanying trust was

a qualified, tax-exempt trust under section 501.            Plan 1 and its

trust maintained their qualified status until the plan year

ending August 31, 1985.       We held in Fazi v. Commissioner, 
102 T.C. 695
(1994) (Fazi I), that plan 1 was not qualified, and its

employee trust was not exempt, for the plan years ending in 1985,

1986, and 1987 due to the corporation's failure to adopt formally



4
   Throughout the relevant statutes, regulations, and opinions of the courts,
the terms "qualified" and "exempt" have occasionally been used synonymously,
and the terms "unqualified" and nonexempt" have also been synonymously used.
For convenience, the terms "qualified" and "unqualified" may be used in
situations where they refer to or modify the employee trust, rather than the
plan.
                                - 5 -


a plan complying with changes made in the applicable law by the

Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L.

97-248, 96 Stat. 324; the Deficit Reduction Act of 1984 (DEFRA),

Pub. L. 98-369, 98 Stat. 494; and the Retirement Equity Act of

1984 (REA), Pub. L. 98-397, 98 Stat. 1426.

     The corporation contributed $29,152 to the plan 1 account of

Mr. Fazi and $3,950 to the plan 1 account of Mrs. Fazi for the

year ending August 31, 1986.   Mr. Fazi was 100 percent vested in

his plan 1 account during the 1985 and 1986 plan years.    Mrs.

Fazi was 60 percent vested in her plan 1 account in 1985 and 80

percent vested in 1986.   Consequently, Mrs. Fazi's vested

interest in the 1986 contribution was $3,160.    Mrs. Fazi's

increased vesting from 1985 to 1986 resulted in her becoming

vested in an additional $750 from contributions made to her

account in plan 1 for years prior to the plan year ending August

31, 1986.

      Plan 2, when originally adopted by the corporation in 1972,

was qualified under section 401, and the accompanying trust was a

qualified, tax-exempt trust under section 501.    Plan 2 was frozen

as of August 31, 1982, and was subsequently merged into plan 1 on

or about May 31, 1986.    (This merger will hereinafter be referred

to as the plan merger.)   The plan 2 assets were transferred to

the plan 1 trust.   Mr. Fazi's account under plan 1 increased by

$277,138 as a result of the plan merger (the amount of his
                                - 6 -


account in plan 2).    Mr. Fazi was 100 percent vested in his plan

2 account at the time of the plan merger.

     Plan 3, when originally adopted by the corporation in 1979,

was qualified under section 401, and the accompanying trust was a

qualified, tax-exempt trust under section 501.   Plan 3 and its

trust were disqualified by respondent, for the same reasons plan

1 was disqualified, for the plan years ending August 31, 1985,

August 31, 1986, and August 31, 1987.

     The corporation contributed $10,300 to the plan 3 account of

Mr. Fazi for the year ending August 31, 1986.    Mr. Fazi was 100

percent vested in his account during the 1985 and 1986 plan

years.

     Petitioners received no distributions from plans 1, 2, or 3

in 1986.   In 1987, petitioners' accounts in plan 1 were

distributed to them.   This distribution included the $277,138

amount merged into plan 1 from plan 2, the merged amount.

     All of the plans were operated in compliance with the

amendments required by TEFRA, DEFRA, and REA for all relevant

plan years.

     Petitioners filed their 1986 Federal income tax return on

April 15, 1987.   The amount of gross income stated in

petitioners' 1986 Federal income tax return and their share of

income from pass-through entities totals $395,108.   Petitioners'

1986 Federal income return made no references to the plan merger
                                - 7 -


or the merged amounts.   Respondent mailed petitioners a notice of

deficiency on March 31, 1993.

     Fazi I

     A review of the arguments and our holding of Fazi I is

necessary to understand the issues in this case.   Fazi I dealt

with the taxability of the distributions from disqualified plan 1

in 1987.   Mr. Fazi dissolved the corporation in 1986 and

distributed all of the assets in the plan 1 trust to the

employees during 1987.   Mr. Fazi timely attempted to roll over

his distribution to an individual retirement account.    Although

plan 1 was in operational compliance at all times, we held that

"petitioners are taxable on the distributions received to the

extent they exceed contributions made for or by them for 1985 and

1986, including the amount merged from plan 2 to plan 1 during

1986."   Fazi I, 
102 T.C. 714
.   In so holding, we overruled our

decision in Baetens v. Commissioner, 
82 T.C. 152
(1984), revd.

777 F.2d 1160
(6th Cir. 1985), which would have allowed

distributions attributable to amounts contributed while plan 1

was qualified to be rolled over, tax free, into an individual

retirement account.

     The rationale for exempting amounts contributed to the

unqualified plan in 1985 and 1986 from taxation when distributed

in 1987 was that those amounts were taxable to petitioners when

the contributions were made:    "respondent has conceded that the

taxable distribution for 1987 should not include those
                                    - 8 -


contributions made during 1985 or 1986 because they would be

taxable to petitioners in the years contributions were made to an

unqualified trust and not at the time of distribution."              Fazi I,

supra at 713.

     Respondent conceded in Fazi I that the merged amount would

be taxable in 1986, rather than 1987.         Petitioners, in Fazi I,

argued for taxing the merged amounts prior to 1987, rather than

in 1987, albeit on different theories.5         We accepted respondent's

concession in Fazi I as to the timing of the taxability of the

merged amount without analysis of the underlying substantive

issues.

                                Discussion

     Whereas Fazi I dealt with the taxability to petitioners of

distributions made in 1987 from a nonexempt trust, this case

deals with the taxability to petitioners of contributions to a

nonexempt trust by the corporation in 1986 and whether the merged

amount should be taxed in the same manner as a contribution.              We

must first decide if petitioners should be taxed on the merged

amount in 1986.     Only if the merged amount is properly includable

in petitioners' gross income in 1986 is the 6-year limitations

period applicable and the year open to adjustment.            If the merged



5
   Petitioners argued that secs. 83 and 402(b) combined to make incremental
increases in their interests in the nonexempt trusts taxable, though not
because they were "contributions" in the traditional usage of the word.
Petitioners also argued that the merged amount would be taxable in years prior
to 1987 because, under secs. 402(b)(1) and 72, their interests in the
nonexempt trust were "made available" to them in such prior years.
                                    - 9 -


amount is not properly includable in 1986, the 6-year limitations

period will not apply and the other adjustments set forth in the

notice of deficiency will be barred since the sum of those other

adjustments does not exceed 25 percent of petitioners' gross

income.   The Court, in Fazi I, did not purport to decide the

taxability of amounts in 1986; it could only determine tax

liability for 1987.      Sec. 6214(b).

Taxability of the Merged Amount

      In this case, respondent originally argued that the merged

amount was taxable to petitioners in the year of merger, 1986.

She now concedes that the merged amount should have been taxed in

1987, the year it was distributed to petitioners.6            Respondent

states on brief that:

      Upon reconsideration, however, respondent's interest in
      sound tax administration requires that she inform the
      Court that she has reached a different conclusion. The
      correct result in Fazi I would have been to include the
      full amount of Plan 002 assets in petitioners' income
      for 1987. In respondent's view, the merger of Plan
      002, a qualified plan, with Plan 001, a nonqualified
      plan, resulted in the immediate disqualification of
      Plan 002. The 1986 merger did not represent a
      "contribution" to Plan 001, but rather a pooling of
      nonqualified assets all of which should have been taxed
      on distribution in 1987, consonant with the remainder
      of the Court's opinion in Fazi I and with I.R.C. sec.
      402(b)(2) and Treas. Reg. sec. 1.402(b)-1(c).

In Fazi I, we accepted respondent's concession that the merged

amount was not taxable in 1987.        Consequently, we are reluctant


6
   Respondent, in Fazi I, originally argued that the merged amount was taxable
to petitioners in 1987, but later conceded that it was properly taxable in
1986. Hence, respondent's position on this issue has come full circle.
                                - 10 -


to accept her concession in this case that the merged amount is

taxable in 1987 without substantive review.

     Plan 1 became unqualified and its accompanying trust became

nonexempt starting with its plan year ending August 31, 1985.

Plan 2 was merged into plan 1 in May of 1986.    The single plan

and trust remaining after the merger was plan 1, the survivor of

the merger.   Section 402(b) governs the tax treatment of a

beneficiary of a nonexempt trust:

          (b) TAXABILITY OF BENEFICIARY OF NONEXEMPT
     TRUST.--Contributions to an employees' trust made by an
     employer during a taxable year of the employer which
     ends within or with a taxable year of the trust for
     which the trust is not exempt from tax under section
     501(a) shall be included in the gross income of the
     employee in accordance with section 83 (relating to
     property transferred in connection with performance of
     services), except that the value of the employee's
     interest in the trust shall be substituted for the fair
     market value of the property for purposes of applying
     such section. * * *

Pursuant to the general rules of section 83, the merged amount

would be taxable to petitioners in 1986 only if it was a

contribution by the employer.    If a defined contribution plan,

such as a money purchase plan or a profit sharing plan is not

qualified, the participant is taxed on the amount contributed and

allocated to the participant's account during the nonqualified

years to the extent substantially vested.    Sec. 1.402(b)-1(a)(1),

Income Tax Regs.   Mr. Fazi was fully vested in both plans 1 and

2.   There were no distributions from any plan in 1986.   The

survivor of the merger was a nonqualified plan, plan 1.
                                - 11 -


Therefore, the issue becomes whether the merged amount is the

equivalent of an employer contribution to a nonqualified plan.

     The employer, the corporation, had already contributed the

assets to the frozen plan, plan 2, prior to 1983; it could not

contribute assets that it did not own.      In Albertson's, Inc. v.

Commissioner, 
95 T.C. 415
, 426 (1990), affd. 
42 F.3d 537
(9th

Cir. 1994), the Court stated:

     Contributions to qualified plans are held and invested
     by the trustee or insurance company until the time of
     distribution to the employee. The assets contributed
     to the trustee or insurance company cease to be assets
     of the employer and are not subject to the debts,
     obligations, and creditors of the employer. * * *

     A review of the law applicable to plan mergers is necessary

to determine if a plan beneficiary should be taxed when pension

plans merge.   The regulations define a merger of plans to mean a

"combining of two or more plans into a single plan."      Sec.

1.414(l)-1(b)(2), Income Tax Regs.       Although the regulations are

specific and detailed concerning the requirements of a plan

merger, there is no reference to beneficiaries' being taxable as

a consequence of a plan merger.    The legislative history of

section 414(l) is also devoid of any suggestion that a merger

could constitute a taxable event for a beneficiary.

     The case closest to point is William Bryen Co. v.

Commissioner, 
89 T.C. 689
(1987).    In that case, an unqualified

money purchase plan was merged into an otherwise qualified money

purchase plan, resulting in the disqualification of the surviving
                                   - 12 -


plan.    The Court referred to the merger as a "pooling" of the two

plans.    
Id. at 693.
   The Court did not hold, or even mention, if

the merged amount constituted a contribution.

     In our case, if the merged amount were a contribution by the

corporation, then plan 1 would have been grossly overfunded for

1986.    The parties have stipulated that the plans were in

operational compliance; i.e., not overfunded.

     As respondent acknowledges, the merger, or pooling, of an

exempt trust into a nonexempt trust is not a contribution.

Therefore, a plan merger is not a contribution that creates

income for the beneficiaries of a surviving trust.           Mr. Fazi did

not receive a net increase in his account balances; his account

balance in plan 1 increased by the same amount that his account

balance in plan 2 decreased.       Contrary to respondent's claims,

the Court in Fazi I merely accepted respondent's incorrect

concession that the merged amount was not taxable in 1987; we did

not hold that the merged amount was a contribution to the

surviving plan.7



7
   In Fazi I, 
102 T.C. 703
n.7, we stated: "Further, respondent points out
that the merging of plan 2 into plan 1 during 1986 would be taxable in 1986,
rather than in 1987 as determined in the notice of deficiency." (Emphasis
added.) We further stated:

     respondent has conceded that the taxable distribution for 1987
     should not include those contributions made during 1985 or 1986
     because they would be taxable to petitioners in the years
     contributions were made to an unqualified trust and not at the
     time of distribution. Additionally, because the amount in plan 2
     was merged into plan 1 during May 1986, a year in which the plans
     and the trusts were unqualified, that amount would likewise be
     taxable in 1986, rather than 1987. [Id. at 713; emphasis added.]
                               - 13 -


     It is within this Court's discretion to accept or reject a

concession.   However, acceptance of a concession does not mean

that the Court has evaluated and accepted the underlying

substantive issues or legal principles supporting the concession.

We may accept a concession or choose to decide the underlying

substantive issues as justice requires.    Jones v. Commissioner,

79 T.C. 668
, 673 (1982); McGowan v. Commissioner, 
67 T.C. 599
,

601, 605 (1976).   As a practical matter, the Court may accept

concessions of law in the interests of judicial economy.    The

parties, in Fazi I, chose to focus their time and energy on

arguing whether we should overrule Baetens v. Commissioner, 
82 T.C. 152
(1984), revd. 
777 F.2d 1160
(6th Cir. 1985).    The issue

of taxability of the merged amount in 1987 was conceded by

respondent on brief; it was not a contested issue.    The Court, in

Fazi I, did not purport to rule as to the merits of this issue.

     To the extent, if any, that Fazi I states that a merger of a

frozen pension plan into an unqualified plan is taxable to the

beneficiaries in the year of merger, it is dicta.    However, the

issue of whether the merged amount is taxable to petitioners in

1986 does not end here.

Are Petitioners Judicially Estopped from Asserting that the
Merged Amount is not Taxable in 1986

     Respondent, on brief, attempts to raise the doctrine of

judicial estoppel against petitioners.    Petitioners correctly

point out that Rule 39 requires avoidance or affirmative
                                 - 14 -


defenses, including estoppel, to be set forth in a party's

pleadings.    Respondent, in violation of Rule 39, did not plead

judicial estoppel.    Therefore, respondent cannot raise the

doctrine of judicial estoppel for the first time in her briefs.

Barbados #7 v. Commissioner, 
92 T.C. 804
, 813 (1989).     However,

the purpose of the doctrine is to protect the courts, not the

parties.    "The doctrine of estoppel is intended to protect the

courts rather than the litigants, so it follows that a court,

even an appellate court, may raise the estoppel on its own motion

in an appropriate case."     In re Cassidy, 
892 F.2d 637
, 641 (7th

Cir. 1990) (fn. ref. omitted) (citing Allen v. Zurich Ins. Co.,

667 F.2d 1162
, 1168 n.5 (4th Cir. 1982)).    The United States

Court of Appeals for the Fifth Circuit acknowledged the right of

appellate courts to raise the doctrine of judicial estoppel but

reserved doing so "Absent a flagrant threat to the judicial

process".    American Bank v. C.I.T. Constr., 
944 F.2d 253
, 258

(5th Cir. 1991).    We have recently raised the doctrine of

judicial estoppel sua sponte in Shackelford v. Commissioner, T.C.

Memo. 1995-484.    We conclude that the Court may consider the

issue of judicial estoppel in the present case.

     Respondent argues that petitioners are judicially estopped

from arguing that the merged amounts are not taxable as

contributions in 1986 because, in Fazi I, petitioners

successfully asserted the position that the merged amount was

taxable prior to 1987.     Petitioners argue that judicial estoppel
                               - 15 -


does not apply since they never maintained the position that the

merged amount was a contribution, their position was not accepted

by the Court since respondent conceded it, and references in

Fazi I to the 1986 tax year are just dicta.    For the reasons

explained below, we believe that petitioners have the better

argument.

     The Tax Court unequivocally accepted the doctrine of

judicial estoppel in Huddleston v. Commissioner, 
100 T.C. 17
, 28-

29 (1993):

          We hold that the doctrine of judicial estoppel is
     available in the Tax Court to be used in appropriate
     cases, such as the one before us, to prevent parties
     from taking positions that are inconsistent with those
     previously asserted by the parties and accepted by
     courts and that would result in inappropriate and
     prejudicial consequences to the courts.

We used judicial estoppel in Huddleston to prevent the petitioner

in that case from denying that he had fiduciary authority to act

on behalf of a decedent's estate.   Judicial estoppel may apply to

issues of law as well as factual issues:    "In certain

circumstances a party may properly be precluded as a matter of

law from adopting a legal position in conflict with one earlier

taken in the same or related litigation."     Allen v. Zurich Ins.

Co., supra at 1166; see In re Cassidy, supra at 641; Reynolds v.

Commissioner, 
861 F.2d 469
(6th Cir. 1988).    Judicial estoppel

must be used with caution:   "Judicial estoppel is applied with

caution to avoid impinging on the truth-seeking function of the

court because the doctrine precludes a contradictory position
                               - 16 -


without examining the truth of either statement."    Teledyne

Indus., Inc. v. NLRB, 
911 F.2d 1214
, 1218 (6th Cir. 1990); see

Allen v. Zurich Ins. Co., supra at 1166.

      Petitioners cite Huddleston for the proposition that

judicial estoppel requires a party to have "affirmatively

persuaded a court" to accept their "particular position".

Huddleston v. 
Commissioner, supra
at 26.   "Judicial estoppel

generally requires acceptance by a court of the prior position".

Id. The Court
later defined what it meant by "acceptance":

      Acceptance by a court does not mean that the party
      being estopped prevailed in the prior proceeding with
      regard to the ultimate matter in dispute, but rather
      only that a particular position or argument asserted by
      the party in the prior proceeding was accepted by the
      court. [Id.; citation omitted.]

The Court in Fazi I did not accept an argument or position of

petitioners; it accepted respondent's concession.

      Judicial estoppel is a doctrine adopted to protect the

Court; the Court has discretion as to when it should be used:

"Estoppel is an equitable concept, and its application is

therefore within the court's sound discretion."     In re 
Cassidy, 892 F.2d at 642
.   Petitioners' actions are not causing any

"inappropriate and prejudicial consequences" to the Court.      We

have not been misled or whipsawed by petitioners; any loss to the

revenue has been the direct result of respondent's erroneous

concession in Fazi I.   The elements required for judicial
                                 - 17 -


estoppel, as established by the Court in Huddleston, are not

present in this case.

Has the 3-Year Statute of Limitations Run Against Respondent

        Section 6501(a) generally provides that any tax due may be

assessed within 3 years from the later of the due date of the

return or the date the tax return is actually filed.     Coleman v.

Commissioner, 
94 T.C. 82
, 89 (1990); Bailey v. Commissioner, T.C.

Memo. 1970-64, affd. per curiam 
439 F.2d 723
(6th Cir. 1971).

However, section 6501(e)(1)(A) provides that any tax due may be

assessed within 6 years from the later of the due date of the

return or the date the tax return is actually filed where a

taxpayer, on the tax return, omits from gross income an amount

properly includable therein that is in excess of 25 percent of

the amount of gross income reported on the tax return.     Colony,

Inc. v. Commissioner, 
357 U.S. 28
, 36 (1958); Estate of Frane v.

Commissioner, 
98 T.C. 341
, 354 (1992), affd. in part, revd. in

part 
998 F.2d 567
(8th Cir. 1993); Bailey v. 
Commissioner, supra
.

Respondent has the burden of proof, under section 6501(e), to

show:    (1) That the amount omitted from gross income exceeds 25

percent of the gross income reported on the tax return; and (2)

that the amount omitted from gross income was properly includable

in the taxpayer's gross income.     Colestock v. Commissioner, 
102 T.C. 380
, 383 (1994); Bardwell v. Commissioner, 
38 T.C. 84
, 92

(1962), affd. 
318 F.2d 786
(10th Cir. 1963); Reis v.

Commissioner, 
1 T.C. 9
, 12-13 (1942), affd. 
142 F.2d 900
(6th
                                - 18 -


Cir. 1944).   The above factors must be shown by a preponderance

of the evidence.    Armes v. Commissioner, 
448 F.2d 972
, 974 (5th

Cir. 1971), affg. in part and revg. T.C. Memo. 1969-181.

     We explained the mechanics of how the burden of going

forward with the evidence works and when it shifts in Adler v.

Commissioner, 
85 T.C. 535
, 540 (1985):

           The bar of the statute of limitations is an
     affirmative defense, and the party raising it must
     specifically plead it and carry the burden of proof
     with respect thereto. Rules 39, 142(a). Where the
     party pleading such issue makes a showing that the
     statutory notice was issued beyond the normally
     applicable statute of limitations, however, such party
     has established a prima facie case. At that point, the
     burden of going forward with the evidence shifts to the
     other side, and the other party has the burden of
     introducing evidence to show that the bar of the
     statute is not applicable. Where the other party makes
     such a showing, the burden of going forward with the
     evidence then shifts back to the party pleading the
     statute, to show that the alleged exception is invalid
     or otherwise not applicable. The burden or proof,
     i.e., the burden of ultimate persuasion, however, never
     shifts from the party who pleads the bar of the statute
     of limitations. See Stern Bros. & Co. v. Burnet, 
51 F.2d 1042
(8th Cir. 1931), affg. 
17 B.T.A. 848
(1929);
     * * *

     Petitioners filed their 1986 Federal income tax return on

April 15, 1987.    Respondent issued her notice of deficiency on

March 31, 1993.    Consequently, the deficiency is timely only if

the 6-year statute of limitations applies.

     Petitioners plead the 3-year statute of limitations as a bar

to respondent's deficiency determination.    Respondent pleads the

6-year statute of limitations in her answer.    Petitioners argue

that respondent has failed to meet her burden to show a greater
                                 - 19 -


than 25-percent omission from gross income of an amount properly

includable in gross income.    Petitioners also argue that they

have adequately disclosed the omitted amount in the corporation's

Forms 5500 and 5310 filings.    Respondent counters by alleging

that the disclosure needs to be in the individual tax return

itself, that the disclosure was inadequate, and that petitioners

are estopped from arguing against the 6-year statute of

limitations.

     We need not decide the disclosure issue since respondent has

failed to meet her initial burden of going forward with the

evidence to show that the bar of the 3-year statute of

limitations is not applicable.     The parties agree as to the

amount of gross income reported on petitioners' 1986 individual

Federal income tax return.    There is no question that petitioners

omitted the merged amount from gross income.     The merged amount

is clearly greater than 25 percent of the gross income amount.

Consequently, the only issue is whether respondent has

established, by a preponderance of the evidence, that the merged

amount is "properly includable" in petitioners' gross income for

1986.

     Respondent asserts that petitioners are estopped from

arguing that the merged amount is not properly includable in

their gross income for 1986.    We have held that petitioners are

not estopped from asserting that the merged amount is not taxable

in 1986.   Petitioners have made the required prima facie case;
                                 - 20 -


they have established that the deficiency notice was issued

beyond the normally applicable statute of limitations.    The

burden of showing, by a preponderance of the evidence, that the

merged amount is properly includable in petitioners' gross income

for 1986 is on respondent.

     Respondent has conceded in her briefs that, but for the

doctrine of judicial estoppel, the merged amount is properly

taxable in 1987, the year of distribution.    We have accepted

respondent's concession, for the reasons described above.    We

hold that respondent has failed to make the showing necessary to

avail herself of the 6-year statute of limitations.

Consequently, petitioners' 1986 individual Federal income tax

return is not open for redetermination.    Therefore, we need not

consider the remaining issues.

     We are aware that petitioners will escape taxation of the

contributions made on their behalf in 1986 and on the merged

amount.   However, this result is a consequence of respondent's

failure to issue a deficiency notice before the limitations

period ran.

     To reflect the foregoing,

                                      Decision will be entered

                                 for petitioners.

Source:  CourtListener

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