Failure to Provide Factual Support for Claimed Disability Costs Taxpayer Change of Avoiding 10% Addition to Tax

While in update courses we tend to discuss the nuances of the law, in real world tax return and IRS examination contexts our client’s problems most often are not the law, but rather the lack of records and documentation to establish the client’s right to a claimed tax benefit.  That certainly was the problem in the case of Trainito v. Commissioner, TC Summary Opinion 2015-37.

The IRS had assessed taxes against Mr. Trainito for specific items.  First, the IRS assessed the 10% addition to tax for a premature distribution from a retirement account under IRC §72(t).  Second, the IRS had assessed tax for an unreported amount of cancellation of debt income reported to the IRS by Wells Fargo Bank.

Mr. Trainito did not claim that he did not have a distribution from his retirement account before attaining age 59 ½, nor did he dispute that he had cancellation of indebtedness that took place during the year. 

Rather he claimed qualification under provisions that would exempt him from having a liability triggered for these items.

First, Mr. Trainito claimed that he was exempt from the premature distribution penalty under IRC §72(t) because he was disabled (as defined by §72(m)(7)) at the time of the distribution, thus not hit with the 10% addition due to the exception found at IRC §72(t)(2)(A)(iii).  Mr. Trainito suffered from diabetes and that condition he claimed meant he was disabled.  He claimed, in addition that we was suffering from depression.

As well, he claimed that he was insolvent at the time the debt was discharged, thus allowing him to exclude the amount from income pursuant to IRC §108(a)(1)(B).

The taxpayer recited the proper provisions of the tax law that would have eliminated the balance he was trying to collect—but he failed to offer sufficient proof.

On the disability issue he noted that he was discovered unconscious in his home during that year, was hospitalized in a diabetic coma and, when he left the hospital, suffered permanent physical consequences of that event.  All of which was true—but he had withdrawn the funds from the retirement plan prior to that date.

The Court noted that while Mr. Trainito was almost certainly severely diabetic two months before his diabetic comma event took place (which was when he took the funds from the retirement account), he offered no medical evidence showing the severity of the disability he had at that time. 

Under §72(m) a taxpayer is disabled if “unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration.”  The related regulations require the taxpayer to demonstrate this in the form required by the IRS—but Mr. Trainto offered no such evidence of his condition at the time of the distribution.  And it was his condition at the time of the distribution, and not just at some point during the year, that was the key issue.

The taxpayer claimed to be depressed to such an extent that he was disabled pursuant to IRC §72(m)(7), but here he solely offered his own testimony with no medical evidence whatsoever.  The taxpayer’s own uncorroborated testimony is almost never going to be sufficient to carry this issue—in fact, it’s probably more correct to say it simply is not going to ever be sufficient.

The same problem dogged his claim of being insolvent—he did not provide evidence of his insolvency. 

Certainly it’s very possible that Mr. Trainito suffered consequences from his diabetes that rendered him unable to engage in any gainful activity—he had left his job because he claimed was unable to meet its requirements any longer.  As well, his financial condition may very well have placed him with more debts than assets by the time Wells Fargo cancelled the debt.

But the problem is that the burden is on the taxpayer to demonstrate the right to claim a benefit—something Mr. Trainito failed to do.  Thus he was denied the benefits that he may very well have been entitled to.