$163,106.30, constitute the taxable portion of the transfer refund.

If petitioner had not transferred to the pension system but rather had remained a member of the retirement system, he would have been entitled to retire at an appropriate age and receive a normal service retirement benefit, including a regular monthly annuity. He would not, however, have been entitled to receive a transfer refund because a transfer refund is only payable to those who elect to transfer from the retirement system to the pension system.

As a result of transferring from the retirement system to the pension system, petitioner became, and presently is, a member of the pension system. As a member of the pension system, petitioner will be entitled to receive a retirement benefit based upon his salary and his creditable years of service, specifically including those years of creditable service recognized under the retirement system. However, because petitioner received the transfer refund on account of transferring from the retirement system to the pension system, petitioner's monthly annuity will be less than the monthly annuity that he would have received if he had not transferred to the pension system but had ultimately retired under the retirement system.6

Rollover of Petitioner's Transfer Refund

Within 60 days of receiving the transfer refund, petitioner deposited the taxable portion thereof into two individual retirement accounts (IRA's), as follows:

On December 26, 1989, petitioner deposited $82,900 of the transfer refund into an IRA with Loyola Federal Savings & Loan (the Loyola IRA).

On January 2, 1990, petitioner deposited $81,206.39 of the transfer refund into an IRA with Delaware Charter Guarantee & Trust Co. (the Delaware Charter IRA).7

6 It should be recalled that petitioner remained employed by the State of Maryland at the time that this case was submitted to the Court.

7 Petitioner deposited a total amount of $164,106.39 into his two IRA's. However, the taxable portion of petitioner's transfer refund was only $163,106.30. This discrepancy is not explained in the record.

Distribution of the Loyola IRA

On or about April 11, 1991, Loyola Federal Savings & Loan distributed, and petitioner received, the account balance of petitioner's IRA; i.e., $90,662.11, which consisted of petitioner's initial deposit and earnings as follows:

In a letter to Delaware Charter Guarantee & Trust Co., dated April 8, 1991, petitioner requested that his IRA be converted into a non-IRA account prior to April 15, 1991. In such letter, petitioner stated: "To avoid further IRS penalties I must have the IRA account closed by April 15, 1991.” Petitioner's IRA was converted into a non-IRA account on June 11, 1991.

The balance of petitioner's Delaware Charter IRA, upon conversion into a non-IRA account, was $90,818.53, which consisted of petitioner's initial deposit and earnings as follows:

IRA deposit
Earnings

Account balance on conversion

Petitioners' 1989 Return

$81,206.39

9,612.14 90,818.53

On their Federal income tax return for 1989, petitioners did not include in gross income any of the taxable portion of the transfer refund; i.e., $163,106.30. In 1991, petitioners amended their 1989 income tax return to include the taxable portion of the transfer refund in gross income. See Dorsey v. Commissioner, T.C. Memo. 1995-97 (a taxpayer who was employed for 1 year after transferring from the retirement system to the pension system was required to include the transfer refund in income in the year of receipt); cf. Adler v.

Commissioner, 86 F.3d 378 (4th Cir. 1996), vacating and remanding T.C. Memo. 1995-148 (where a member of the retirement system retired shortly after receiving his transfer refund, such member received the transfer refund "on account of" retirement and was not required to include such amount in income in the year of receipt).

Petitioners' 1991 Return

On their Federal income tax return for 1991, petitioners disclosed the receipt of distributions from petitioner's IRA's in the total amount of $181,481. Of this amount, petitioners reported $8,762 as the taxable amount.

The Notice of Deficiency

In the notice of deficiency, respondent determined that the difference between the amount distributed from petitioner's IRA's (i.e., $90,662.11 + $90,818.53 = $181,480.64) and the amount reported as taxable ($8,762); i.e., $172,719, was includable in petitioners' gross income for 1991. As a corollary, respondent also determined that petitioners were liable for the 15-percent excise tax imposed by section 4980A. The Parties' Concessions

The distribution from petitioner's Delaware Charter IRA is deemed to have occurred before the due date of petitioners' income tax return for the year in which the contribution to that IRA was made. For that reason, respondent concedes on brief that petitioner's Delaware Charter IRA distribution qualifies for relief pursuant to section 408(d)(4), and that only the portion of such distribution representing earnings; i.e., $9,612.14, is includable in petitioners' gross income.8 As a result of this concession, the threshold amount that must be exceeded before the excise tax under section 4980A may be imposed is no longer satisfied; thus, respondent also concedes that petitioners are not liable for such excise tax.9

Petitioners concede that the earnings on petitioner's contributions to petitioner's Delaware Charter IRA and Loyola IRA are includable in petitioners' gross income.

* For a detailed analysis of sec. 408(d)(4), see Childs v. Commissioner, T.C. Memo. 1996–267; Thompson v. Commissioner, T.C. Memo. 1996–266.

9 Insofar as petitioner Elam Campbell might otherwise be concerned, see sec. 4980A(b); Johnson v. Commissioner, 74 T.C. 1057, 1062 (1980), affd. 661 F.2d 53 (5th Cir. 1981).

In view of the foregoing concessions, the only issue remaining for decision is whether $82,900 of the distribution received by petitioner from his Loyola IRA (i.e., $90,662.11 less $7,762.11 that petitioners concede is taxable earnings) is taxable under sections 408(d)(1) and 72.

Discussion

1. General Legal Background

Generally, a taxpayer is entitled to deduct the amount contributed to an IRA. Sec. 219(a); sec. 1.219-1(a), Income Tax Regs. The deduction in any taxable year, however, may not exceed the lesser of $2,000 or an amount equal to the compensation includable in the taxpayer's gross income for such taxable year. In addition, the amount of the deduction is limited where the taxpayer was, for any part of the taxable year, an “active participant" in a retirement plan qualified under section 401(a) or a plan established for its employees by the United States, by a State or political subdivision thereof, or by any agency or instrumentality of any of the foregoing. Sec. 219(g)(1), (5)(A)(i), (iii). In the case of an active participant who files a return as a single individual, the deduction is reduced using a ratio determined by dividing the excess of the taxpayer's modified adjusted gross income (modified AGI) over $25,000, by $10,000.10 Sec. 219(g)(2) and (3). In the case of an active participant who files a joint return, the deduction is reduced using a ratio determined by dividing the excess of the taxpayer's modified AGI over $40,000 by $10,000. Id.

Notwithstanding the foregoing limitation, section 408(o) permits individuals to make designated nondeductible IRA contributions to the extent that deductible contributions are not allowable because of the active participant reduction rule set forth in section 219(g). Sec. 408(o)(1) and (2). Specifically, an individual may make nondeductible contributions to the extent of the excess of (1) the amount allowable as a deduction under section 219 determined without regard to the reduction for active participants over (2) the amount allow

10 As relevant herein, modified adjusted gross income means adjusted gross income computed without regard to any deduction for an IRA. Sec. 219(g)(3)(A).

able as a deduction under section 219 determined with regard to such reduction. Sec. 408(o)(2).

As relevant herein, a contribution to an IRA that exceeds the amount allowable as a deduction under section 219(a), computed without regard to the active participant reduction rule under section 219(g), is considered an excess contribution. Sec. 4973(b).11

In the present case, petitioner made an excess contribution to his Loyola IRA in the amount of $80,900 for 1989 (i.e., $82,900 less $2,000). The genesis of such contribution was in petitioner's retirement savings which petitioners reported as income on their amended Form 1040 for 1989. This contribution was distributed to petitioner by his IRA on April 11, 1991.

As a general rule, any amount "paid or distributed out of" an IRA is includable in gross income by the taxpayer in the manner provided under section 72. Sec. 408(d)(1). Section 72(e) is applicable, inter alia, to amounts received under an annuity contract but not received as an annuity. The distribution received by petitioner on April 11, 1991, falls into this category.

Amounts received before the annuity starting date are includable in income to the extent allocable to income on the contract and are not includable in income to the extent allocable to the investment in the contract. 12 Sec. 72(e)(2)(B). Thus, section 72(e)(2)(B) effectively gives a taxpayer a basis in the taxpayer's IRA to the extent of his or her investment in the contract. The investment in the contract is defined in section 72(e)(6) as the aggregate amount of consideration paid for the contract reduced by the amount received that was previously excludable from gross income. The amount of a distribution allocable to the investment in the contract, and thus distributed tax-free, is the portion of the amount received that bears the same ratio to the amount received as

11 As relevant herein, an excess contribution may also be viewed as the amount of an IRA contribution that exceeds the sum of (1) the deductible limit under sec. 219(a), computed with regard to sec. 219(g), and (2) the nondeductible limit under sec. 408(o). S. Rept. 99-313, at 545 (1986), 1986-3 C.B. (Vol. 3) 1, 545.

12 Under sec. 72(c)(4), "annuity starting date" is defined as the first day of the first period for which an amount is received as an annuity under the contract. Petitioner received a single payment in the amount of $90,662.11 from his Loyola IRA prior to drawing annuity payments from his retirement account. Thus, the distribution was received by petitioner before the annuity starting date and, accordingly, sec. 72(e)(2)(B) applies.