I remember him as Sonny Corleone in The Godfather. He is James Caan, and he passed away in July 2022.
I am reading a Tax Court case involving his (more correctly: his estate’s) IRA.
There is a hedge
fund involved.
For the most
part, we are comfortable with “traditional” investments: money markets, CDs,
stocks, bonds, mutual funds holding stocks and bonds and the mutual fund’s
updated sibling: an ETF holding stocks and bonds.
Well, there
are also nontraditional investments: gold, real estate, cryptocurrency, private
equity, hedge funds. I get it: one is seeking additional diversification, low
correlation to existing investments, enhanced protection against inflation and
so forth.
For the most
part, I consider nontraditional investments as more appropriate for wealthier
individuals. Most people I know have not accumulated sufficient wealth to need nontraditional
assets.
There are
also tax traps with nontraditional assets in an IRA. We’ve talked before about
gold. This time let’s talk about hedge funds.
James Caan
had his cousin (Paul Caan) manage two IRAs at Credit Suisse. Paul wanted to
take his career in a different direction, and he transferred management of the
IRAs to Michael Margiotta. Margiotta left Credit Suisse in 2004, eventually
winding up at UBS.
The wealthy
are not like us. Caan, for example, utilized Philpott, Bills, Stoll and Meeks
(PBSM) as his business manager. PBSM would:
· Receive all Caan’s mail
· Pay his bills
· Send correspondence
· Prepare his tax returns
· Act as liaison with his financial
advisors, attorneys, and accountants
I wish.
Caan had 2
IRAs at UBS. One was a regular, traditional, Mayberry-style IRA.
The second
one owned a hedge fund.
The tax Code
requires the IRA trustee or custodian to file reports every year. You probably
have seen them: how much you contributed over the last year, or the balance in
the IRA at year-end. Innocuous enough, except possibly for that year-end thing.
Think nontraditional asset. How do you put a value on it? It depends, I suppose.
It is easy enough to look up the price of gold. What if the asset is trickier:
undeveloped land outside Huntsville, Alabama – or a hedge fund?
UBS had Caan
sign an agreement for the IRA and its hedge fund.
The Client must
furnish to the Custodian in writing the fair market value of each Investment
annually by the 15th day of each January, valued as of the preceding December
31st, and within twenty days of any other written request from the Custodian,
valued as of the date specified in such request. The Client acknowledges,
understands and agrees that a statement that the fair market value is
undeterminable, or that cost basis should be used is not acceptable and the
Client agrees that the fair market value furnished to the Custodian will be
obtained from the issuer of the Investment (which includes the general partner
or managing member thereof). The Client acknowledges, understands and agrees
that if the issuer is unable or unwilling to provide a fair market value, the
Client shall obtain the fair market value from an independent, qualified
appraiser and the valuation shall be furnished on the letterhead of the person
providing the valuation.
Got it. You
have to provide a number by January 15 following year-end. If it is a hassle,
you have to obtain (and you pay for) an appraisal.
What if you
don’t?
The Client
acknowledges, understands and agrees that the Custodian shall rely upon the
Client’s continuing attention, and timely performance, of this responsibility.
The Client acknowledges, understands and agrees that if the Custodian does not
receive a fair market value as of the preceding December 31, the Custodian
shall distribute the Investment to the Client and issue an IRS Form 1099–R for
the last available value of the Investment.
Isn’t that a
peach? Hassle UBS and they will distribute the IRA and send you a 1099-R.
Unless that IRA is rolled over correctly, that “distribution” is going to cost
you “taxes.”
Let’s start
the calendar.
March 2015 |
UBS contacted the hedge
fund for a value. |
|
June 2015 |
Margiotta left UBS for
Merrill Lynch. |
|
August 2015 |
Striking out, UBS
contacted PBSM for a value. |
|
October 2015 |
Hearing nothing, UBS
sent PBSM a letter saying UBS was going to resign as IRA custodian in
November. |
|
October 2015 |
Margiotta had Caan sign
paperwork to transfer the IRAs from UBS to Merrill Lynch. |
|
There was a problem: all
the assets were transferred except for the hedge fund. |
||
December 2015 |
UBS sent PBSM a letter
saying that it had distributed the hedge fund to Caan. |
|
January 2016 |
UBS sent a 1099-R. |
|
March 2016 |
Caan’s accountant at
PBSM sent an e-mail to Merrill Lynch asking why the hedge fund still showed
UBS as custodian. |
|
December 2016 |
Margiotta requested the
hedge fund liquidate the investment and send the cash to Merrill Lynch. |
|
November 2017 |
The IRS sent the
computer matching letter wanting tax on the IRA distribution. How did the IRS
know about it? Because UBS sent that 1099-R. |
The IRS wanted taxes of almost $780 grand, with penalties over $155 grand.
That caught
everyone’s attention.
July 2018 |
Caan requested a private
letter ruling from the IRS. |
Caan wanted mitigation from an IRA rollover that went awry. This would be a moment for PBSM (or Merrill) to throw itself under the bus: taxpayer relied on us as experts to execute the transaction and was materially injured by our error or negligence….
That is not
wanted they requested, though. They requested a waiver of the 60-day
requirement for rollover of an IRA distribution.
I get it:
accept that UBS correctly issued a 1099 for the distribution but argue that fairness
required additional time to transfer the money to Merrill Lynch.
There is a
gigantic technical issue, though.
Before that,
I have a question: where was PBSM during this timeline? Caan was paying them to
open and respond to his mail, including hiring and coordinating experts as
needed. Somebody did a lousy job.
The Court
wondered the same thing.
Both
Margiotta and the PBSM accountant argued they never saw the letters from UBS
until litigation started. Neither had known about UBS making a distribution.
Here is the
Court:
We do not find that portion of either witness’ testimony
credible.
Explain,
please.
We find it highly unlikely that PBSM
received all mail from UBS— statements, the Form 1099–R, and other
correspondence—except for the key letters (which were addressed to PBSM).
Additionally, the March 2016 email between Ms. Cohn and Mr. Margiotta suggests
that both of them knew of UBS’s representations that it had distributed the
P&A Interest. It seems far more likely that there was simply a lack of
communication and coordination between the professionals overseeing Mr. Caan’s
affairs, especially given the timing of UBS’s letters, Mr. Margiotta’s move
from UBS to Merrill Lynch, and the emails between Mr. Margiotta and Ms. Cohn.
If all parties believed that UBS was still the P&A Interest’s custodian,
why did no one follow up with UBS when it ceased to mail account statements for
the IRAs? And why, if everyone was indeed blindsided by the Form 1099–R, did no
one promptly follow up with UBS regarding it? (That followup did not occur
until after the IRS issued its Form CP2000.) The Estate has offered no satisfactory
explanation to fill these holes in its theory.
I agree with
the Court.
I think that
PBSM and/or Merrill Lynch should have thrown themselves under the bus.
But I would
probably still have lost. Why? Look at this word salad:
408(d) Tax
treatment of distributions.
An
amount is described in this paragraph as a rollover contribution if it meets
the requirements of subparagraphs (A) and (B).
(A) In general.
Paragraph (1) does not apply to any amount paid or distributed out of an
individual retirement account or individual retirement annuity to the
individual for whose benefit the account or annuity is maintained if-
(i) the entire
amount received (including money and any other property) is paid into an
individual retirement account or individual retirement annuity (other than an
endowment contract) for the benefit of such individual not later than the 60th
day after the day on which he receives the payment or distribution; or
(ii) the entire
amount received (including money and any other property) is paid into an
eligible retirement plan for the benefit of such individual not later than the
60th day after the date on which the payment or distribution is received,
except that the maximum amount which may be paid into such plan may not exceed
the portion of the amount received which is includible in gross income
(determined without regard to this paragraph).
I highlighted the phrase “including money and any other property.” There is a case (Lemishow) that read a “same property” requirement into that phrase.
What does
that mean in non-gibberish?
It means
that if you took cash and property out of UBS, then the same cash and property
must go into Merrill Lynch.
Isn’t that
what happened?
No.
What came
out of UBS?
Well, one
thing was that hedge fund that caused this ruckus. UBS said it distributed the
hedge fund to Caan. They even issued him a 1099-R for it.
What went
into Merrill Lynch?
Margiotta
requested the hedge fund sell the investment and send the cash to Merrill
Lynch.
Cash went
into Merrill Lynch.
What went
out was not the same as what went in.
Caan (his
estate, actually) was taxable on the hedge fund coming out of the UBS IRA.
Dumb.
Unnecessary. Expensive.
Our case
this time was Estate of James E. Caan v Commissioner, 161 T.C. No. 6,
filed October 18, 2023.
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