IRS Collection Alternatives: Pay Attention To Details

 

I was glancing over recent Tax Court cases when I noticed one that involved a rapper.

I’ll be honest: I do not know who this is. I am told that he used to date Kylie Jenner. There was something in the opinion, however, that caught my eye because it is so common.

Michael Stevenson filed his 2019 tax return showing federal tax liability over $2.1 million.

COMMENT: His stage name is Tyga, and the Court referred to him as “very successful.” Yep, with tax at $2.1-plus million for one year, I would say that he is very successful.

Stevenson had requested a Collection Due Process (CDP) hearing. It must have gone south, as he was now in Tax Court.

Why a CDP hearing, though?

Stevenson had a prior payment plan of $65 grand per month.

COMMENT: You and I could both live well on that.

His income had gone down, and he now needed to decrease his monthly payment.

COMMENT: I have had several of these over the years. Not impossible but not easy.

The Settlement Officer (SO) requested several things:

·      Form 433-A (think the IRS equivalent of personal financial statements)

·      Copies of bank statements

·      Copies of other relevant financial documents

·      Proof of current year estimated tax payments

Standard stuff.

The SO wanted the information on or by November 4, 2021.

Which came and went, but Stevenson had not submitted anything.

Strike One.

The SO was helpful, it appeared, and extended the due date to November 19.

Still nothing.

Strike Two.

Stevenson did send a letter to the SO on December 1.

He proposed payments of $13,000 per month. He also included Form 433-A and copies of bank statements and other documents.

COMMENT: Doing well. There is one more thing ….

The SO called Stevenson’s tax representative. She had researched and learned that Stevenson had not made estimated tax payments for the preceding nine years. She wanted an estimated tax payment for 2021, and she wanted it now.

COMMENT: Well, yes. After nine years people stop believing you.

Stevenson made an estimated tax payment on December 21. It was sizeable enough to cover his first three quarters.

COMMENT: He was learning.

The SO sent the paperwork off to a compliance unit. She requested Stevenson to continue his estimated payments into 2022 while the file was being worked. She also requested that he send her proof of payments.

The compliance unit did not work the file, and in July 2022 the SO restarted the case. She calculated a monthly payment MUCH higher than Stevenson had earlier proposed.

COMMENT: The SO estimated Stevenson’s future gross income by averaging his 2020 and (known) 2021 income. Granted, she needed a number, but this methodology may not work well with inconsistent (or declining) income. She also estimated his expenses, using his numbers when documented and tables or other sources when not.

The SO spoke with the tax representative, explaining her numbers and requesting any additional information or documentation for consideration.

COMMENT: This is code for “give me something to justify getting closer to your number than mine.”

Oh, she also wanted proof of 2022 estimated tax payments by August 22, 2022.

Yeah, you know what happened.

Strike Three.

So, Stevenson was in Tax Court charging the SO with abusing her discretion by rejecting his proposed collection alternatives.

Remember the something that caught my eye?

It is someone not understanding the weight the IRS gives to estimated tax payments while working collection alternatives.   

Hey, I get it: one is seeking collection alternatives because cash is tight. Still, within those limits, you must prioritize sending the IRS … something. I would rather argue that my client sent all he/she could than argue that he/she could not send anything at all.

And the amount of tax debt can be a factor.

How much did Stevenson owe?

$8 million.

The Court decided against Stevenson.

Here is the door closing:

The Commissioner has moved for summary judgement, contending that the undisputed facts establish that Mr. Stevenson was not in compliance with his estimated tax payment obligations and the settlement officer thus was justified in sustaining the notice of intent to levy.”

Our case this time was Stevenson v Commissioner, TC Memo 2023-115.

Another Runaway FBAR Case

 

Let’s talk about the FBAR (Report of Foreign Bank and Financial Accounts). It currently goes by the name “FinCen Form 114.”

This thing has been with us since 1970. It came to life as an effort to identify foreign financial transactions that might indicate money laundering or tax evasion. 

Sounds benign.

The filing requirement applies to a United States person, defined as

·      A citizen or resident of the U.S.

·      A domestic partnership

·      A domestic corporation

·      A domestic trust or estate

 We’ll come back that first one in a moment.

Next, one needs a financial interest or signature authority in a foreign financial account to trigger this thing.

A foreign financial account includes a bank account, which is easy enough to understand. It would also include a broker account (think Charles Schwab, but overseas). Some are not so intuitive, though.

·      A foreign insurance policy with cash value is reportable.

·      A foreign hedge fund is not.

·      A foreign annuity policy is reportable.

·      A foreign private equity fund is not.

·      A foreign cryptocurrency account is not reportable.

Some require a google search to understand what is being said.

·      A Canadian registered retirement savings plan is reportable.

·      A Mexican fondo para retiro is reportable.

Next, the foreign financial account has to exceed a certain dollar balance ($10,000) at some point during the year.

That $10,000 balance has been there for as long as I can remember. You will have a hard time persuading me that $10,000 in 1986 is the same as $10,000 now, but that number is apparently eternal and unchanging.

The $10,000 is tested across all foreign financial accounts. If it takes your fourth foreign account to put you over $10 grand, then you are over. Testing is done. All your accounts are reportable on a FBAR.

Like so many things, the FBAR started with reasonable intentions but has morphed into something near unrecognizable.

Fail to file an FBAR and the standard penalty is $10 grand. Fail to file for two years and the penalty is $20 grand. Have two foreign accounts and fail to file for two years and the penalty is $40 grand.

And that is assuming the error is unintentional. Do it on purpose and I presume they will execute you.

I exaggerate, of course. They will just bankrupt you.

It puts a lot of pressure on defining “on purpose.”

Let’s look at Osamu Kurotaki (OK).

OK was born in Japan and lives in Japan. He obtained a U.S. green card, making him a U.S. permanent resident. One of the pleasures of being a permanent resident is filing an annual tax return with the United States, irrespective of whether you live in the U.S. or not. One can talk about a foreign income exclusion or foreign tax credit – which is fine – but that annual filing makes sense only if someone intends to eventually return to the U.S. It does not make as much sense if someone does not intend to return, someone like OK.

OK paid someone to prepare his annual U.S. tax return. He found a CPA who was bilingual.

In 2021 the U.S. Treasury assessed civil penalties against OK for more than $10 million. His footfall? He failed to file FBARs. Treasury also upped the ante by saying that his failure was “willful.”

Huh?

Treasury is requesting summary judgement that OK willfully failed to file FBARs, prefers waffle over sugar cones and rooted for the Diamondbacks in the World Series. 

The Court wanted to know how Treasury climbed the ladder to get to that “willful” step.

So do I.

Here is what the Court saw:

·      OK is a Japanese speaker and does not speak English “at all.”

·      OK relied on his bilingual CPA to make sense of U.S. tax filing obligations.

·      His CPA provided annual tax questionnaires in both English and Japanese. The English was for theater, I suppose, as OK could not read English.

·      The CPA’s translation now becomes critical. Here are instructions to the FBAR in English:

U.S. taxpayers are required to report their worldwide income; that is, income from both U.S. and foreign sources.”

·      Here is the Japanese translation:

U.S. resident taxpayers are required to report their worldwide income, that is, income from both US. and foreign sources."

OK told the Court that he did not think he had a filing obligation because he was not a “U.S. resident.”

I get it. He lives in Japan. He works in Japan. His kids go to school in Japan. He is as much a “U.S. resident” as I am a Nepalese Sherpa.

Except …

OK was green card – that is, a “permanent” resident of the U.S.

Technically …

The Court cut OK some slack. Technically - and in a law school vacuum - he was a “resident.” Meanwhile - in the real world – no one would think that. Furthermore, OK hired a CPA who made a mistake. Even a trained professional erred interpreting the Treasury’s word salad. 

The Court said “no” to summary judgement.

Treasury will have to argue its $10 million-plus proposed penalty.

And I believe the Court just outlined reasonable cause.

Perhaps OK should consider turning in that green card. 

Our case this time was Osamu Kurotaki v United States, U.S. District Court, District of Hawaii.

 

A Penalty Against A Tax Preparer

 

Did you know that the IRS can assess penalties against a tax preparer as well as a taxpayer?

I am looking at an IRS Chief Counsel Memorandum recommending a preparer be penalized for a deduction on a client return.

You do not see that every day.

Let’s talk about it.

As is our way, we will streamline the issue so that it is something you might want to read and something I might want to write.

A taxpayer accrued expenses on its books for customer early payment discounts and estimated write-offs for disputed billing and shipping charges.

Sure, easy for a CPA to say.

Let’s clarify. The company sold stuff. It allowed discounts if a customer paid early. It also had routine billing disputes – for quantity, quality, price, damage and so on. As part of its general accounting, it estimated these charges and recorded them as expenses when the related sale was recorded.

Makes sense to me. Generally accepted accounting wants one to record all related expenses when the sale is recorded. This is called the “timing principle,” and the idea is to present net profit from a sales transaction as well as reasonably possible. What if all the expenses are not known at that precise moment - say, for example - the amount of product that will be returned because of damage in shipping? Generally accepted accounting will allow one to estimate that number, normally by statistical analysis of historical experience.

BTW you better do this if you expect to have your financial statements audited. Part of an audit is a review of your accounting method, and the “estimate that number” described above is considered a best-of-breed.

Generally accepted accounting might not work when you get to your tax return, however. Why? Well, generally accepted accounting is trying to get to the “best” number in an economic sense. Tax accounting is not trying to get to the “best” number; rather, it is trying to measure your ability to pay. Pay what? Taxes, of course.

Let’s go back to our taxpayer. They estimated a bunch of expenses when they recorded a sale. They included those numbers on their financial statements. They then wanted to deduct those same numbers on their tax return.

Problem:

The taxpayer utilized statistics to record the expenses for the two items. The courts held that statistics were not a valid method to record the amounts.”

Their CPA firm had to review the accounting method and decide whether it was acceptable for tax purposes.

There is even a Code section and Regulations:

           Reg § 1.461-1. General rules for taxable year of deduction

(a)(2) Taxpayer using an accrual method.

(i) In general. Under an accrual method of accounting, a liability (as defined in §1.446-1(c)(1)(ii)(B)) is incurred, and generally is taken into account for Federal income tax purposes, in the taxable year in which all the events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability. 

 

You see that last sentence and its reference to “economic performance?”

 

For generally accepted accounting, one must:

        

·      Establish the fact of the liability.

·      Measure the amount of the liability with reasonable accuracy.

 

Tax then adds one more requirement:

        

·      Economic performance on the liability must have occurred.

 

That third requirement is what slows down the tax deduction.

 

What is an example of economic performance?

 

Say that you record expenses for services related to the sale. Economic performance wants to see those services performed before allowing the deduction. What if you know - because it has happened millions of times before and can be calculated with near-arithmetic certainty – that the services will occur? Tax doesn’t care.  

 

But the auditors signed-off on the financial statements, you say. Doesn’t that mean that experts agreed that the accounting method was valid?      

A taxpayer’s conformity with its accrual method used for financial accounting purposes does not create a presumption that its tax accrual method clearly reflects income.”

And there you have a brief introduction to why a company’s financial statements and its tax return might show different numbers. Financial statement accounting and tax accounting serve different purposes, and those differences have real-world consequences.

 

In this situation, I side with the IRS. Work in a CPA firm for any meaningful period and you will see tax people repetitively “tweak” the audit people’s numbers. It happens so often it has a term: “M-1.” Schedule M-1 is a tax schedule that reconciles the profit per the financial statements to the profit per the tax return. The possible list of differences is near endless:

 

·      Entertainment

·      Depreciation

·      Allowance for uncollectible receivables

·      Accrued bonuses

·      Reserve for warranties

·      Deferred rent

·      Controlled foreign corporation income

·      Opportunity zone income

 

And on and on. Knowing these differences is part of being a tax pro.

 

The Chief Counsel wanted to know why the tax pros at this particular CPA firm did not know that this generally accepted accounting method would not work for purposes of the tax return.

 

To be fair, methinks, because it is complicated …?

 

No dice, said the Counsel’s office. The preparer should have known.

 

The items deducted constituted a substantial part of the return. 

TRANSLATION: It was a big deduction.

And therefore the preparer penalty is appropriate.  

TRANSLATION: Someone has to pay.

Mind you, a Chief Counsel memorandum is internal to the IRS. The taxpayer – and by extension, its CPA firm – might appeal the matter to the Tax Court. I would expect them to, frankly. The memorandum is just the IRS’ side.

For the home gamers, today we have been discussing Chief Counsel Memorandum 20223301F.

 

Requesting A Payment Plan With Over $7 Million In The Bank

Sometimes I wonder how people get themselves into situations.

Let’s take a look at a recent Tax Court case. It does not break new ground, but it does remind us that – sometimes – you need common sense when dealing with the IRS.

The Strashny’s filed their 2017 tax return on time but did not pay the tax due.

COMMENT: In and of itself, that does not concern me. The penalty for failing to file a tax return is 10 ten times more severe than filing but not paying. If the Strashny’s were my client and had no money, I would have advised the same.

The 2017 return had tax due, including interest, of over $1.1 million.

COMMENT: Where did the money go? I am curious now.

In June, 2018 the IRS assessed the tax along with a failure-to-pay penalty.

In July, 2018 the Strashny’s sent an installment payment request. Because of the amount of money involved, they had to disclose personal financial information (Form 433-A). They wanted to stretch the payments over 72 months.

COMMENT: Standard procedure so far.

Meanwhile the IRS sent out a Notice of Intent to Levy letter (CP90), which seemed to have upset the Strashny’s.

A collection appeal goes before an IRS officer settlement officer (or “SO,” in this context). In April, 2019 she sent a letter requesting a conference in May.

COMMENT: Notice the lapsed time – July, 2018 to April, 2019. Yep, it takes that long. It also explains while the IRS sent that CP90 (Notice of Intent to Levy): they know the process is going to take a while.

The taxpayers sent and the SO received a copy of their 2018 tax return. They showed wages of over $200,000.

OK, so they had cash flow.

All that personal financial information they had sent earlier showed cryptocurrency holdings of over $7 million. Heck, they were even drawing over $19,000 per month on the account.

More cash flow.

COMMENT: Folks, there are technical issues in this case, such as checking or not checking a certain box when requesting a collection hearing. I am a tax nerd, so I get it. However, all that is side noise. Just about anyone is going to look at you skeptically if you cite cash issues when you have $7 million in the bank.

The SO said no to the payment plan.

The Strashny’s petitioned the Tax Court.

COMMENT: Notice that this case does not deal with tax law. It deals, rather, with tax procedure. Procedure established by the IRS to deal with the day-to-day of tax administration. There is a very difficult standard that a taxpayer has to meet in cases like this: the taxpayer has to show that the IRS abused its authority.

The Strashny’s apparently thought that the IRS had to approve their request for a payment plan.

The Court made short work of the matter. It reasoned that the IRS has (with limited exceptions) the right to accept or reject a payment plan. To bring some predictability to the process, the IRS has published criteria for its decision process. For example, economic hardship, ill health, old age and so on are all fair considerations when reviewing a payment plan.

What is not fair consideration is a taxpayer’s refusal to liquidate an asset.

Mind you, we are not talking a house (you have to live somewhere) or a car (you have to get to work). There are criteria for those. We are talking about an investment portfolio worth over $7 million.

The Court agreed with the IRS SO.

So do I.

Was there middle ground? Yes, I think so. Perhaps the Strashny’s could have gotten 12 or 24 months, citing the market swings of cryptocurrency and their concern with initiating a downward price run. Perhaps there was margin on the account, so they had to be mindful of paying off debt as they liquidated positions. Maybe the portfolio was pledged on some other debt – such as business debt – and its rash liquidation would have triggered negative consequences. That approach would have, however, required common sense – and perhaps a drop of empathy for the person on the other side of the table – traits not immediately apparent here.

They got greedy. They got nothing.

Our case this time was Strashny v Commissioner.

Marijuana And Tax-Exempt Status

I am not surprised.

I am looking at a Private Letter Ruling on a tax -exempt application for an entity involved with marijuana and CBD.

I doubt the CBD plays any role here. It is all about marijuana.

I have become sensitive to the issue as I have two friends who are dealing with chronic pain. The pain has risen to the level that it is injuring both their careers. The two have chosen different ways to manage: one does so through prescriptions and the other through marijuana.

Through one I have seen the debilitating effect of prescription painkillers.

The other friend wants me to establish a marijuana specialization here at Command Center.

I am not. I am looking to reduce, not expand, my work load.

What sets up the tax issue?

Federal tax law. More specifically, this Code section:

        § 280E Expenditures in connection with the illegal sale of drugs.

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

Marijuana is a Schedule I substance, so it runs full-face into Section 280E. There is “no deduction or credit” allowed on that tax return.

There is one exception, and that has to do with the cost of the marijuana itself. Accountants refer to this as “cost of sales,” and it would include more than just the cost of the product. It would include costs associated with buying the product or storing it, for example. Still, the big bucks would be with the cost of the product itself.

There is a Court decision which defines taxable revenues as revenues after deduction for cost of goods sold. The decision applies to all businesses, not just marijuana.

What it leaves out is everything other than cost of sales, such as rent, utilities or the wages required to staff and run the business.

That gets expensive. One is paying taxes on business profit, without being allowed to deduct all the costs and expenses normally allowed in calculating business profit. That is not really “profit” in the common usage of the word.

I am reading that someone applied for tax exempt status. They argued that their exempt purpose was:

·      To aid financially disadvantaged patients and families affected by the cost of THC and CBD medical treatment

·      To educate health providers about THC and CBD medical treatments

·      To support research into said THC and CBD medical treatments

The entity anticipated the usual stuff:

·      It will be supported by contributions and gifts

·      It will develop a website, which will give it another venue to educate about its mission as well as fundraise

·      It will develop relevant medical and treatment literature

·      It will conduct relevant seminars and classes

·      It will organize support groups for patients and their families

·      It will track and publish relevant medical data

The IRS led with:

You were formed to aid financially disadvantaged patients and patient’s families who are affected by the costs of THC and CBD medical treatment by providing financial support to cover costs of living and other expenses that the patients may incur.”

It continued:

… you are providing funding to the users of these substances who may be struggling to pay living and/or travel expenses because of their use of these illegal substances. Furthermore, your financial assistance is only available to users of these substances.”

In response the entity argued that it did not directly provide THC or CBD to individuals nor did it provide direct funding for the same.

The IRS was unmoved:

You were formed for the purpose of providing financial assistance to individuals who are engaged [in] an illegal activity which is contrary to public policy.”

The IRS rejected the tax-exempt application.

There are numerous tax-exempts throughout the nation that counsel, research, educate and proselytize concerning their mission. A substance abuse clinic can provide methadone, for example. What it cannot do is provide the heroin.

The entity could, I suppose, withdraw the financial support platform from its mission statement, greatly increasing the likelihood for tax-exempt status.

If its core mission was to provide such financial support, however, this alternative might be unacceptable.

If I were advising, I might consider qualifying the entity as a supporting organization for a pain clinic. The clinic would likely address more than marijuana therapy (it would have to, otherwise we are just circling the block), which represents a dilution of the original mission. In addition, a supporting organization transfers some of its governance and authority to the supported organization. It may be that either or both of these factors could be deal-breakers.

It has been interesting to see the continuing push on this area of tax law.

Owing A Million Dollar Penalty

What caught my attention was the size of the penalty.

The story involves Letantia Russell, a dermatologist from California who has been in the professional literature way too much over too many years. The story started with her attorneys reorganizing her medical practice into a three-tiered structure and concealing ownership through use of nominees. Then there was the offshore bank account.

Let’s talk about that offshore account.

Back when I came out of school, one had to report foreign accounts above a certain dollar balance. The form was called the “TD 90-22.1.” I remember accountants who had never heard of it. It just wasn’t a thing.

The requirement hasn’t changed, but the times have.

If you have an overseas bank account, you are supposed to disclose it. The IRS has a question on Schedule B (where you report interest and dividends) whether you have a foreign bank account. If you answer yes, you are required to file that TD 90-22.1. The form does not go to the IRS; it instead goes to the Treasury Department. Mind you, the IRS is part of Treasury, but there are arcane rules about information sharing between government agencies and whatnot. Send to Treasury: good. Send to IRS: bad.

The rules were fairly straightforward: bank account, balance over $10 grand, own or able to sign on the account, required to file. There was no rocket science here.

Don’t play games with account types, either. A checking account is the same as a savings account which is the same as a money market and so on. Leave that hair-splitting stuff to the lawyers.

About a decade or so ago, the government decided to pursue people who were hiding money overseas. Think the traditional Swiss bank account, where the banker would risk jail rather than provide information on the ownership of an account. That Swiss quirk developed before the Second World War and was in response to the unstable Third Republic of France and Weimar government of Germany. Monies were moving fast and furious to Switzerland, and Swiss bankers made it a criminal offense to break a strict confidentiality requirement.

Thurston Howell III joked about it on Gilligan’s Island.

Travel forward to the aughts and the UBS scandal and the U.S. government was not laughing.

Swiss banks eventually agreed to disclose.

The IRS thundered that those who had … ahem, “underreported” … their foreign income in the past might want to clean-up their affairs.

The government dusted-off that old 90-22.1 and gave it a new name: FinCen 114 Report of Foreign Bank and Financial Accounts.

The IRS was still miffed about that government-agency-sharing thing, so it came up with its own form: Form 8938 Statement of Foreign Financial Assets.

So you had to report that bank account to Treasury on the FinCen and to the IRS on Form 8938.  Trust me, even the accountants were trying to understand that curveball.

Resistance is futile, roared the IRS.

Many practitioners, me included, believed then and now that the IRS went fishing with dynamite. The IRS seemed unwilling to distinguish someone who inherited his/her mom’s bank account in India from a gazillionaire hedge-fund manager who knew exactly what he/she was doing when hiding the money overseas.

And you always have … those people.

Letantia Russell is one of those people.

The penalties can hurt. Fail to fail by mistake and the penalty begins at $10,000. Willfully fail to file and the penalty can be the greater of

·      $100,000 or

·      ½ the balance in the account

Letantia dew a $1.2 million penalty on her 2006 tax return. I normally sympathize with the taxpayer, but I do not here. One has to be a taxpayer before we can have that conversation.

It went to District Court. It then went to Appeals, where her attorneys lobbed every possible objection, including the unfortunate trade of Jimmy Garappolo from the New England Patriots to the San Francisco 49ers.

It was to no avail. She gets to pay a penalty that would make a nice retirement account for many of us.

When Hardship Is Not Enough

Let’s talk a bit about hardship distributions from your retirement plan – perhaps your 401(k).

You may know that you are not supposed to touch this money before a certain age. If you do, not only will there be income taxes to pay, but also a 10% early withdrawal penalty. These are two moving pieces here: one is the income tax on the distribution and another for the 10% penalty.

Here is a question for you:

Let’s say you can withdraw money from your plan for hardship reasons. Does that mean that the penalty does not apply?

The answer is no. One would think that the two Code sections move in tandem, but they do not.

Candace Elaine ran into this in a recent Tax Court decision.

Candace lived in California, and in 2012 she withdrew $84,000 from her retirement plan. She had lost her job in 2009, and she was trying to support herself and family.

The tax Code applies two requirements to the income taxation of hardship withdrawals:

·        On account of an immediate and heavy financial need, and

·        Any amount withdrawn is limited to actual need

An “immediate and heavy financial need” would include monies needed for medical expenses or to avoid foreclosure. In addition, one is not allowed to withdraw $20,000 if the need is only $12,000, with the intention of using the excess for other purposes. 

The plan custodian is the watchman for these two requirements. The custodian is to obtain reasonable assurance of need and inquire whether other financial resources exist. This is a role above and beyond routine administration, and consequently many plans simply do not offer hardship withdrawals.

Candace met those requirements and her plan allowed withdrawals. She reported and paid income tax on the $84,000, but she did not pay the 10% penalty.

The IRS bounced her return. Off to Tax Court they went, where Candace represented herself.

Her argument was simple: I received a hardship distribution. There is an exemption for hardship.

The IRS said that there was not. And in the spirit of unemployed taxpayers trying to support their family, the IRS assessed a penalty on top of the 10% chop.

The Court pointed several exceptions to the 10% early withdrawal penalty, including:

·        Separation from service

·        Disability

·        Deductible medical expenses

·        Health insurance premiums while unemployed

·        Higher education

·        First time purchase of a principal residence

There isn’t one for hardship, though.

Meaning that Candace owed the 10% penalty.

The Court did note that the misunderstanding on the 10% is widespread and refused to assess the IRS’ second penalty.

Why did Candace not just borrow the money from her 401(k) and avoid the issue? Because she had been let go, and you have to be employed in order to take a plan loan.

What if she had rolled the money into an IRA?

IRAs are not allowed to make loans, even to you. The only way you can get money out of an IRA is to take a distribution. This is what sets up the ROBs (Roll-Over as Business Start-Up) as a tax issue, for example.

Candace was stuck with the penalty.