Rolling Over An Inherited IRA

I am not a fan of the 60-day IRA rollover.

I admit that my response is colored by being the tax guy cleaning-up when something goes awry. Unless the administrator just refuses a trustee-to-trustee rollover, I am hard pressed to come up with a persuasive reason why someone should receive a check during a rollover.

Let’s go over a case. I want you to guess whether the rollover did or did not work.

Taxpayer’s mom died in 2008.

Mom had two IRAs. She left them to her daughter, who received two checks: one for $2,828 and a second for $35,358.

The daughter rolled over $35,358 and kept the smaller check.

On her tax return, she reported gross IRA distributions of $38,194 (there is a small difference; I do not know why) and taxable distributions of $2,828.

She did not have an early distribution penalty, as that penalty does not apply to inherited accounts.

The IRS flagged her, saying that the full $38,194 was taxable.

What do you think?

Let’s go over it.

There is no question she was well within the 60-day period.

The money went into an IRA account. This is not a case where monies erroneously went into something other than an IRA.

This was the daughter’s only rollover, so we are not triggering the rule where one can only roll IRA monies in this manner once every twelve months.

The Court decided that the daughter was taxable on the full amount.

Why?

She ran face-first into a sub-rule: one cannot rollover an inherited account, with the exception of a surviving spouse.

The daughter argued that she intended to roll and also substantially complied with the rollover rules.

Here is the Tax Court:

The Code’s lines are arbitrary. Congress has concluded that some lines of this kind are appropriate. The judiciary is not authorized to redraw the boundaries.”

This is a polite way of saying that tax rules sometimes make no sense. They just are. The Tax Court, not being a court of equity, cannot decide a case just because a result might be viewed as unfair.

The Court did not address the point, but there is one more issue at play here.

There are penalties for overfunding an IRA.

Say that you can put away $6,500. You instead put away $10,000. You have overfunded by $3,500.

So what?

You have to get the excess money out of there, that’s what.

Normally I recommend that the $3,500 be moved as a contribution to the following year, nixing the penalty issue.

Let’s say that you do not do that. In fact, you do not even know to do that.

For whatever reason, the IRS examines your return five years later. Say they catch the issue. You now owe a 6% penalty on the overfunding.

That’s not bad, you think. You will pay $210 and move on.

Nope.

It is 6% a year.

And you still have to get the $3,500 out.

Except it is now not $3,500. It is $3,500 plus any earnings thereon for five years.

Say that amount is $5,500, including earnings.

You take out $5,500.

You have five years of 6% penalties. You also have tax on $2,000 (that is, $5,500 minus $3,500).

If you are under 59 ½ you probably have an early-distribution penalty on the $2,000.

Plus penalties and interest on top of that.

I like to think that the Tax Court cut the taxpayer a break by not spotlighting the overfunding penalty issue.

Our case this time was Beech v Commissioner.

A Tax Preparer As A Witness

It is – once again – that time of year. Extensions. The business extensions came due last month. The individual extensions are due this month.

What a crazy thing to do for a living.

I have not had a lot of time to scan my normal sources, but I did see a case that caught my eye.

The taxpayers live in Illinois. They have an S corporation.

They rent a pole-barn garage to the S corporation. The corporation stores tractors, trailers and other equipment there.

Pretty normal.

They used a tax preparer for their 2012 and 2013 individual returns.

On their rental schedule, they deducted (among other expenses) the following:

·      Interest of $5,846 for 2012 and $4,336 for 2013

·      Taxes of $7,058 for 2012 and $10,395 for 2013

They also deducted the personal portion of their interest and taxes as itemized deductions.

I was anticipating that they double-counted the interest and taxes.

Nope.

They never could document the 2012 real estate taxes on their rental schedule.

Seriously?

Then we have 2013. The Court agreed that the taxes were paid, but they were paid by the S corporation.

Folks, to claim the taxes on a personal return one has to pay the taxes personally.

There went the rental real estate tax deduction for both years.

Onward to the 2012 mortgage interest.

Same answer as the 2013 real estate taxes.

Yeeessh.

The Court was a little more lenient in 2013, sort of. While they disallowed any interest on the rental schedule, the Court did allow substantiated mortgage interest in excess of claimed interest as an itemized deduction.

The IRS next went in to bayonet the wounded and dead: it wanted a 20% accuracy-related penalty.

Of course they did.

A common defense to this penalty is reliance on a tax professional.

Taxpayers used a tax preparer for 2013 and 2013.

Seems to me they have a potential defense.

The Court then drops this:

Although their returns were prepared by a paid income tax preparer, the return preparer used income and expense amounts petitioner provided. Apparently, no source documents underlying the deductions were provided to the return preparer; according to the return preparer, petitioners had ‘horrible books and records.’”

And this is a witness for the taxpayers?

Because petitioners did not furnish the return preparer with complete and accurate information, they failed to establish that their reliance upon the return preparer constitutes ‘reasonable cause’ and ‘good faith’ with respect to the underpayments of tax.”

Wow.

I get it. The preparer might have gotten them out of a penalty on a technical issue, but given the poor quality of the records the preparer could not get them out of a penalty for the numbers themselves.

The taxpayers probably would have done better by not bringing their preparer to testify.

And then I noticed: it was a “pro se” case.

Which means that the taxpayers represented themselves.

COMMENT: Pro se does not mean that your preparer is not there. I for example can appear before the Tax Court as part of a pro se. I would then be there as a witness, and I would not considered to be “practicing.”

In this case the taxpayers made a bad call by bringing in their preparer.

The case for the home gamers is Lawson v Commissioner.

A Twist On A Penalty

I am looking at a tax case. There is no suspense or twist, but there was something at the end that caught my attention.

The case involves an Uber driver.

He deducted the following:

(1)  Vehicle expenses of $44,729

(2)  Travel expenses of $6,915

(3)  Repairs and maintenance of $5,345

(4)  Insurance of $3,349

(5)  Cleaning expenses of $751

I am not seeing a whole lot of technical here. Hopefully he kept documentation and receipts. Just sort, label, copy and provide to the IRS.

But the story goes chippy.

(1) The travel expenses were for trips to Florida seeking medical treatment.

COMMENT: So this is not a business deduction. It instead is a medical deduction, which he might not be able to use if he doesn’t have enough to itemize.

               He provided no documentation for these trips.

(2)  He had nothing to support the repairs and maintenance.

Odd. One would have thought he had a primary garage, and that garage could provide a printout. It might not account for every dollar deducted, but it should be a good chunk.

(3)  He did not provide documentation for the insurance, not even the name of the insurance company.

This is getting strange. I am beginning to wonder if he is a protester.

(4)  It turns out that the cleaning was dry cleaning. That may or may not be deductible, hinging on whether he was dry-cleaning a uniform. I am, for example, unable to deduct my dry cleaning, but then I do not wear a uniform.

Again, he offered no documentation.

(5)  I am curious about the vehicle expenses. Forty-four grand is a lot.

Turns out he deducted approximately 70,000 miles.

Problem is, he drove only 9,439 miles as an Uber driver.

Oh, oh.

On top of that he deducted both actual expenses and mileage.

No can do.

The IRS wanted almost $18,000 in tax.

I am not surprised, considering that the disallowance of the deductions swelled both his income tax and self-employment tax simultaneously.

The IRS also wanted a substantial-understatement penalty of almost $3,600.

COMMENT: This penalty applies when the additional tax due is more than the larger of $5,000 or 10% of the corrected tax liability (before any payments). The penalty is 20%, and it hurts.

Frankly, I am thinking he is doomed. He does not have a prayer, having provided no documentation for his expenses, even the easy documentation.

Twist: this penalty has to be approved by an IRS supervisor.

Happens all the time.

But the IRS failed to submit evidence to the Court that it was approved.

The IRS tried to reopen the record to submit said evidence.

Too late. The taxpayer had the right to object.

What would you do?

Of course. You object.

So did the taxpayer.

Without the evidence the Tax Court bounced the substantial accuracy penalty.

Mind you, he still owed tax of almost $18,000, but he did not owe the penalty.

The case for the home gamers is Semere Misgina Hagos v Commissioner.