IRS Gets Called Out In Offer In Compromise Case

 

I am looking at an offer in compromise (OIC) case.

These cases are almost futile for a taxpayer, as the Tax Court extends broad deference to the IRS in its analysis of and determinations on OICs. To win requires one to show that the IRS acted in bad faith.

COMMENT: I have soured on OICs as the years have gone by. Those commercials for “pennies on the dollar” stir unreasonable expectations and do not help. OICs are designed for people who have experienced a reversal of fortune - illness, unemployment, disability, or whatnot – which affect their ability to pay their taxes. It is not meant for someone who is irresponsible or inexplicably unfettered by decency or the responsibilities of the human condition. Not too long ago, for example, one of the clients wanted us to pursue an OIC, as he has racked up impressive tax debt but has no cash. I refused to be involved. Why? Because his cash is going to construct a $2-plus million dollar home. I am very pro-taxpayer, but this is not that. Were it up to me, we would fire him as a client.

Let’s look at the Whittaker case.

Mr. W is a veteran and was a self-employed personal trainer. Mrs. W worked in a local school district and had a side gig as a mall security guard. They were also very close to retirement.

The Ws owed everybody, it seems: a mortgage, student loans, the IRS, the state of Minnesota and so on.

In 2018 the IRS sent a notice of intent to levy.

The Ws requested a collection due process (CDP) hearing.

COMMENT: The Ws were represented by the University of Minnesota tax clinic, giving students a chance to represent clients before the IRS and courts.

The IRS of course wanted numbers: the Form 433 paperwork detailing income, expenses, assets, debt and so forth.

The Ws owed the IRS approximately $33 grand. The clinic calculated their reasonable collection potential as $1,629. They submitted a 20% payment of $325.80, per the rules, along with their OIC.

In the offer, the Ws stressed that their age and difficult financial situation meant that soon they would have to rely on retirement savings as a source of income rather than as a nest egg. Their house was in disrepair and had an unusual mortgage, meaning that it was extremely unlikely it could be refinanced to free up cash.

The IRS has a unit - the Centralized Offer in Compromise unit – that stepped in next. Someone at the unit calculated the Ws’ RCP as $250,000, which is wildly different from $1,629. The unit spoke with representatives at the clinic about the bad news. The clinic in turn emphasized special circumstances that the Ws brought to the table.  

That impasse transferred the OIC file to Appeals.

It was now March 2020.

Remember what happened in March 2020?

COVID.

The two sides finally spoke in September.

Appeals agreed with an RCP of $250 grand. The Settlement Officer (SO) figured that the Ws could draw retirement monies to pay-off the IRS.

Meanwhile Mr. W had retired and Mrs. W was gigging at the mall only two weekends a month.

The SO was not changing her mind. She figured that Mrs. W must have a pension from the school. She also surmised that Mr. W’s military pension must be $2,253 per month rather than $1,394. How did she know all this? Magic, I guess.

The W’s argued that they could not borrow against the house. They had refinanced it under something called the Home Affordability Refinance Program, which helps homeowners owing more than their house is worth. A ballon payment was due in 2034, and refinancing a house that is underwater is nearly impossible.

This did not concern the SO. She saw an assessed value of $243,000 on the internet, subtracted an $85 thousand mortgage, which left plenty of cash. The W’s pointed out that there was deferred maintenance on the house – a LOT of deferred maintenance. Between the impossible mortgage and the deferred maintenance, the house should be valued – they argued – at zero.

Nope, said the SO. The Ws could access their retirement to pay the tax. They did not have to involve the house, so the mortgage and deferred maintenance was a nonfactor. She then cautioned the W’s not to withdraw retirement monies for any reason other than the IRS. If they did so, she would consider the assets as “dissipated.” That is a bad thing.

Off to Tax Court they went. Remember my comment earlier: low chance of success. What choice did the Ws have? At least they were well represented by the tax clinic.

The Court saw three key issues.

Retirement Account

The W’s led off with a great argument:

 

  

This is Internal Revenue Manual 5.8.5.10, which states that a taxpayer within one year of retirement may have his/her retirement account(s) treated as income rather than as an asset. This is critical, as it means the IRS should not force someone to empty their 401(k) to pay off tax debt.

The SO was unmoved. The IRM says that the IRS “may” but does not say “must.”

Yep, that is the warm and fuzzy we expect from the IRS.

The Court acknowledged:

We see no erroneous view of the law and no clearly erroneous assessment of facts.”

But the Court was not pleased with the IRS:

But there may be a problem for the Commissioner – this reasoning didn’t make it into the notice of determination …”

The “notice of determination” comment is the Court saying the files were sloppy. The IRS must do certain things in a certain order, especially with OICs. Sloppy won’t cut it.

Home Equity

The W’s had offered to provide additional information on the loan terms, the deferred repairs to the house, the unwillingness of the banks to refinance.

The IRS worked from assessed values.

It is like the two were talking past each other.

Here is the Court:

The IRS does need to take problems with possible refinancing a home seriously.”

The Whittakers have a point – there’s nothing in the administrative record that states or even suggests that the examiner at the Unit or the settlement officer during the CDP hearing asked for any information in addition to the appraised value.”

There is no evidence in the record of any consideration of the Whittakers’ arguments on this point.”

Oh, oh.

Here is the first slam:

We therefore find that the settlement officer’s conclusion about the Whittaker’s ability to tap the equity in their home was clearly erroneous on this record. This makes her reliance on that equity in her RCP calculations an abuse of discretion.”

COVID

The W’s had alerted the IRS that Mr. W had completely retired and Mrs. W was working only two weekends a month. The SO disregarded the matter, reasoning that the W’s had enough pension income to compensate.

Which pension, you ask? Would that include the pension the SO unilaterally increased from $1,394 to $2,253 monthly?

The Commissioner now concedes that the settlement officer was mistaken, and that Mr. Whittaker had a military pension of only $1,394 per month.”

Oops.

There was the second slam.

The IRS – perhaps embarrassed – went on to note that the Mall of America opened after being COVID-closed for three months. Speaking of COVID, the lockdown had inspired a nationwide surge in demand for fitness equipment. Say …, wasn’t Mr. W a personal fitness trainer?

The Court erupted:

Upholding the rejection of the Whittakers’ offer because Mrs. Whittaker’s mall job may have resumed or Mr. Whittaker might be able to run a training business using potential clients’ possible pandemic purchases is entirely speculative.”

True that.

The settlement officer ‘did not think that the loss of the Whittaker’s wage income or self-employment income … sufficiently mattered to justify reworking the Offer Worksheet.’”

The Court was getting heated.

The settlement officer’s explicit refusal to rework the worksheet despite the very considerable discrepancy in the calculation before and after the pandemic is a clear error and thus an abuse of discretion.”

The Court remanded the matter back to IRS Appeals with clear instructions to get it right. It explicitly told the IRS to consider the material change in the Ws’ circumstances – changes that happened during the CDP hearing itself - and their ability to pay.

We said earlier “almost futile.” We did not say futile. The Ws won and are headed back to IRS Appeals to revisit the OIC.

Our case this time was Whittaker v Commissioner, T.C. Memo 2023-59.

The Augusta Rule And Renting To Yourself

I came across the Augusta rule recently.

This is Code section 280A(g), the tax provision that allows one to rent their home for less than 15 days per year without paying tax on the income. It got its name from the famous Augusta National Golf Club in Georgia. There would not be sufficient housing during the Masters without participation by local homeowners. The section has been with us since the 1970s.

There are requirements, of course:

(1)  The property must be in the U.S.

(2)  The property needs to be a residence. Mind you, it does not need to be your primary residence. It can be a second home. Or a third home, if you are so fortunate.

(3)  The house cannot be a place of business.

a.    The Augusta rule does not work well with an office-in-home, for example.

(4)  Rental expenses (excluding expenses such as mortgage interest and taxes which are deductible irrespective of any rental) become nondeductible.

(5)  A proprietorship (or disregarded single-member LLC) does not qualify. Mind you, a corporation you wholly own will qualify, but your proprietorship will not.

a.    Another way to say this is that both the rental income and expense cannot show up on the same tax return.

(6)  The rent must be reasonable.

(7)  There must be a business purpose for the rental.

Tax advisors long ago realized that they could leverage the Augusta rule if the homeowner also owned a business. How? Have the business rent the house from the homeowner for less than 15 days over a rolling 12-month period.

Can it work?

Sure.

Will the IRS challenge it?

Let’s look at a recent case to see a common IRS challenge to Augusta-rule rentals.

Two anesthesiologists and an orthopedic representative owned Planet LA, LLC (Planet). Planet in turn owned several Planet Fitness franchises in Louisiana. It opened its first one in 2013 and was up to five by 2017 when it sold all its franchises.

The three shareholders had issues with regular business meetings because of work schedules and distance. Beginning in 2015 they decided to have regular meetings at their residences. Planet would pay rent (of course), which varied in amount until it eventually settled on $3,000 per month to each shareholder.

One of the advantages of having three shareholders was being able to apply the Augusta rule to three houses. If you think about it, this allowed Planet to have up to 42 meetings annually without voiding the day count for any one residence.

Let’s do some quick math.

$3,000 x 3 shareholders x 14 meetings = $126,000

Planet could deduct up to $126,000 and the shareholders would report no rental income.

Sweet.

The IRS wanted to look at this.

Of course.

The first IRS challenge: show us agendas and notes for each meeting.

Here is the Court:

Petitioners failed to produce any credible evidence of what business was conducted at such meetings, and their testimony was vague and unconvincing regarding the meetings.”

Oh, oh.

The second challenge: the revenue agent researched local rental rates for meeting space. He determined that one could rent space accommodating up to 1,200 people for $500 per day.

The shareholders could not prove otherwise.

Here is the Court:

While petitioners argue that the $500 rent determined by … was not reasonable, we disagree and find to the contrary that $500 allowed per month is actually generous.”

This was almost too easy for the IRS.

·      Prove the number of meetings.

·      Multiply that number by $500.

The IRS allowed Planet rent deductions as follows:

          2017           none, as no meetings were proven

          2018           12 meetings times $500 = $6,000

          2019           9 meetings times $500 = $4,500

The shareholders had deducted $290,900 over three years.

The IRS allowed $10,500.

Yep, that is an IRS adjustment of over $280 grand over three years, with minimal effort by the IRS.

And that is how the IRS goes after the Augusta rule in a self-rental context.

The takeaway?

The Augusta rule can work, but you want to document and substantiate everything.

You want to have agendas for every meeting, perhaps followed up with minutes of the same.

Be careful (and reasonable) with the rental rate. This is not VRBO. You are renting a portion of a house, not the full house. You are renting for a portion of a day, not for days or weeks. You cannot just look up weekly house rentals online and divide them by seven. Those rental rates are for a different use and not necessarily comparable to business use of the residence.

You may want to formally invoice the business.

You want to pay the rent from the business bank account.

Our case this time was Sinopoli et al v Commissioner, T.C. Memo 2023-105.

Renting a Home Office To An Employer

A client asked about the home office deduction last week.

This deduction has lost much of its punch with the Tax Cuts and Jobs Act of 2017. The reason is that employee home office deductions are a miscellaneous itemized deduction, and most miscellaneous itemized deductions have been banned for the next two-plus years. 

The deduction still exists for self-employeds, however, including partners in a partnership or members in an LLC. Technically there is one more hoop for partners and members, but let’s skip that for now.

Say you are working from home. You have a home office, and it seems to pass all the bells-and-whistles required for a tax deduction. Can you deduct it?

Depends. On what? On how you are compensated.

(1) If you are a W-2 employee, then you have no deduction.

(2) If you receive a 1099 (think gig worker), then you have a deduction.

Seems unfair.

Can we shift those deductions to the W-2 employer? Would charging rent be enough to transform the issue from being an employee to being a landlord?

There was a Tax Court case back in the 1980s involving the tax director of a public accounting firm in Phoenix (Feldman). His position involved considerable administrative work, a responsibility difficult to square with being accessible to staff at work while also maintaining confidentiality on private firm matters.

Feldman built a house, including a dedicated office.  He worked out an above-market lease with his firm. He then deducted an allocable share of everything he could against that rent, including maid service.

No surprise, Feldman and the IRS went to Tax Court.

Let’s look at the Code section under dispute:

Sec 280A Disallowance of certain expenses in connection with business use of home, rental of vacation homes, etc.

(a)  General rule.

Except as otherwise provided in this section, in the case of a taxpayer who is an individual or an S corporation, no deduction otherwise allowable under this chapter shall be allowed with respect to the use of a dwelling unit which is used by the taxpayer during the taxable year as a residence.

Thanks for the warm-up, said Feldman., but let’s continue reading:

      Sec 280A(c)(3) Rental use.

Subsection (a) shall not apply to any item which is attributable to the rental of the dwelling unit or portion thereof (determined after the application of subsection (e).

I am renting space to the firm, he argued. Why are we even debating this?

The lease is bogus, said the IRS (the “respondent”).

Respondent does not deny that under section 280A a taxpayer may offset income attributable to the rental of a portion of his home with the costs of producing that rental income. He contends, however, that the rental arrangement here is an artifice arranged to disguise compensation as rental income in order to enable petitioner to avoid the strict requirements of section 280A(c)(1) for deducting home office expenses. Because there was no actual rental of a portion of the home, argues respondent, petitioner must qualify under section 280A(c)(1) before he may deduct the home office expenses.

Notice that the IRS conceded that Feldman was reading the Code correctly. They instead were arguing that he was violating the spirit of the law, and they insisted the Court should observe the spirit and not the text.

The IRS was concerned that the above-market rent was disguised compensation (which it was BTW). Much of tax practice is follow-the-leader, so green-lighting this arrangement could encourage other employers and employees to shift a portion of their salaries to rent. This would in turn free-up additional tax deductions to the employee - at no additional cost to the employer but at a cost to the fisc.

The IRS had a point. As a tax practitioner, I would use this technique - once blessed by the Court – whenever I could.

The Court adjusted for certain issues – such as the excess rent – but decided the case mostly in Feldman’s favor.

The win for practitioners was short-lived. In response Congress added the following to the Code:

      (6)  Treatment of rental to employer.

Paragraphs (1) and (3) shall not apply to any item which is attributable to the rental of the dwelling unit (or any portion thereof) by the taxpayer to his employer during any period in which the taxpayer uses the dwelling unit (or portion) in performing services as an employee of the employer.

An employer can pay rent for an employee’s office in home, said Congress, but we are disallowing deductions against that rental income.

Our case this time was Feldman v Commissioner, 84 T.C. 1 (U.S.T.C. 1985).

 

A House And A Specialized Trust

I saw a QPRT here at Galactic Command recently,

It had been a while. These things are not as common in a low interest rate environment.

A QPRT (pronounced “cue-pert”) is a specialized trust. It holds a primary or secondary residence and – usually – that is it.

Why in the world would someone do this?

 I’ll give you a common example: to own a second home.

Let’s say that you have a second home, perhaps a lake or mountain home. The children and grandchildren congregate there every year (say summer for a lake home or the holidays for a mountain home), and you would like for this routine and its memories to continue after you are gone.

A couple of alternatives come immediately to mind:  

(1)  You can bequeath the property under will when you die.

(2)  You can gift the property now.

Each has it pros and cons.

(1) The property could continue to appreciate. If you have significant other assets, this appreciation could cause or exacerbate potential estate taxes down the road.

(2) You enjoy having and using the property and are not quite ready to part with it. You might be ready years from now - you know: when you are “older.”

A QPRT might work. Here is what happens:

(1) You create an irrevocable trust.

a.    Irrevocable means that you cannot undo the trust. There are no backsies.

(2) You transfer a residence to the trust.

a.    The technique works better if there is no mortgage on the property. For one thing, if there is a mortgage, you must get money into the trust to make the mortgage payment. Hint: it can be a mess.

(3) You reserve the right to use the property for a period of years.

a.    This is where the fancy planning comes in.

b.    It starts off with the acknowledgement that a dollar today is more valuable than a dollar a year (or years) from now. This is the “time value of money.”

c.    At some point in time the property is going to the kids and grandkids, but … not … right …now.     

d.    If the property is worth a million dollars today, the time value of money tells us that the gift (that is, when the property goes to the kids and grandkids) must be less than a million dollars.  

e.    There is a calculation here to figure out the amount of the gift. There are three key variables:

                                               i.     The age of the person making the gift

                                             ii.     The trust term

                                           iii.     An interest rate

A critical requirement of a QPRT is that you must outlive the trust term. The world doesn’t end if you do not (well, it does end for you), but the trust itself goes “poof.” Taxwise, it would be as if you never created a trust at all.

(4) There is a mortality consideration implicit here. The math is not the same for someone aged 50 compared to someone aged 90.

(5) Your retained right of use is the same thing as the trust term. You probably lean toward this period being as long as possible (if a dollar a year from now is worth less than a dollar today, imagine a dollar ten years from now!). That reduces the amount of the gift, which is good, but remember that you must outlive the trust term. There is push-and-pull here, and trust terms of 10 to 15 years are common.

We also need an interest rate to pull this sled. The government fortunately provides this rate.

But let’s go sidebar for a moment.

Let’s say you need to put away enough money today to have $5 a year from now. You put it in a bank CD, so the only help coming is the interest the CD will pay. Let’s say the CD pays 2%. How much do you have to put away today?

·      $5 divided by (100% + 2%) = $4.90

OK.

How much do you have to put away if the CD pays 6%?

·      $5 divided by (100% + 6%) = $4.72

It makes sense if you think about it. If the interest rate increases, then it is doing more of the heavy lifting to get you to $5. Another way to say this is that you need to put less away today, because the higher interest is picking up the slack.

Let’s flip this.

Say the money you are putting in the CD constitutes a gift. How much is your gift in the first example?

$4.90

How much is your gift in the second example?

$4.72

Your gift is less in the second example.

The amount of your gift goes down as interest rates go up.

What have interest rates been doing recently?

Rising, of course.

That makes certain interest-sensitive tax strategies more attractive.

Strategies like a QPRT.

Which explains why I had not seen any for a while.

Let me point out something subtle about this type of trust.

·      What did we say was the amount of the gift in the above examples?

·      Either $4.90 or $4.72, depending.

·      When did the gift occur?

·      When the trust was funded.

·      When do the kids and grandkids take over the property?

·      Years down the road.

·      How can you have a gift now when the property doesn’t transfer until years from now?

·      It’s tax magic.

But what it does is freeze the value of that house for purposes of the gift. The house could double or triple in value before it passes to the kids and grandkids without affecting the amount of your gift. That math was done upfront and will not change.

A couple of more nerd notes:

(6) We are also going to make the QPRT a “grantor” trust. This means that we have introduced language somewhere in the trust document so that the IRS does not consider the QPRT to be a “real” trust, at least for income tax purposes. Since it is not a “real” trust, it does not file a “real” income tax return. If so, how and where do the trust numbers get reported to the IRS? They will be reported on the grantor’s tax return (hence “grantor trust”). In this case, the grantor is the person who created the QPRT.

(7)  What happens after 10 (or 15 or whatever) years? Will the trust just kick you out of the house?

Nah, but you will have to pay fair-market rent when you use the place. It is not worst case.

There are other considerations with QPRTs – like selling the place, qualifying for the home sale exclusion, and forfeiting the step-up upon the grantor’s death. We’ll leave those topics for another day, though.

A Model Home As A Business

 

What does a tax CPA do a few days after the filing deadline?

This one is reviewing a 17-page Tax Court case.

Yes, I would rather be watching the new Batman movie. There isn’t much time for such things during busy season. Maybe tomorrow.

Back to the case.

There is a mom and dad and daughter. Mom and dad (the Walters) lived in Georgia. They had launched three successful business in Michigan during the 70s and 80s. They thereafter moved to Georgia to continue their winning streak by developing and owning La-Z-Boy stores.

During the 90s dad invested in and subsequently joined the board of an environmentally oriented Florida company. He followed the environmental field and its technology, obtained certifications and even guest lectured at Western Carolina University.

Daughter received an undergraduate degree in environmental science and then a law degree at a school offering a focus on environmental law.

After finishing law school, daughter informed her parents that she was not interested in the furniture business. Mom and dad sold the La-Z-Boy businesses but kept the real estate in an entity called D&J Properties. They were now landlords to La-Z-Boy stores.

The family decided to pivot D&J by entering the green real estate market.

Through the daughter’s connections, mom and dad became aware of a low-density housing development in North Carolina, emphasizing land conservation and the incorporation of geothermal and solar technologies.

You know this caught dad and daughter’s attention.

They bought a lot. They built a house (Balsam Home). They stuck it in D&J Properties. The house received awards. Life was good.

They received an invitation to participate in a “Fall Festival of Color.” Current and potential property owners would tour Balsam Home, meet with members of the team and attend a panel discussion. Word went out to the media, including the Atlanta Journal-Constitution.

Balsam Home became a model home for the development. Awards and certificates were hung on the walls, pamphlets about green technology were placed on coffee tables. A broker showed Balsam Home when mom and dad were back at their regular residence.

Sometimes the line blurred between model home and “home” home. Mom and dad registered cars at the Balsam Home address, for example, and dad availed himself of a golf membership. On the flip side, the green technology required one to be attentive and hands-on, and mom and dad did most of that work themselves.

Where is the tax issue here?

Balsam Home never showed a profit.

The La-Z-Boy stores did.

The IRS challenged D&J Properties, arguing that Balsam Home was not a business activity conducted for profit and therefore its losses could not offset the rental income from the furniture stores.

This “not engaged in for profit” challenge is more common than you may think. I am thinking of the following from my own recent-enough experience:

·      A mom supporting her musically inclined twin sons

·      A young golfer hoping to go pro

·      A model certain to be discovered

·      A dancer determined she would join a professional company

·      A dressage rider meeting “all the right people” for later success

The common thread is that some activity does not make money, seems likely to never make money but is nonetheless pursued and continued, normally by someone having (or subsidized by someone having) enough other income or wealth to do so. It can be, in other words, a tax write-off.

But then again, someone will be the next Bruno Mars, Scottie Scheffler or Stevie Nicks. Is it a long shot? Sure, but there will be someone.

Not surprisingly, there is a grid of questions that the IRS and courts go through to weigh the decision. It is not quite as easy as having more “yes” than “no” answers, but you get the idea.

Here is a (very) quick recap of the grid:

·      Manner in which taxpayer carried on the activity

·      Taxpayer’s expertise

·      Taxpayer’s advisors’ expertise

·      Time and effort expended by the taxpayer

·      Expectation that activity assets will appreciate in value

·      Success of the taxpayer on carrying on similar activities

·      History of activity income and loss

·      Financial status of the taxpayer

·      Elements of personal pleasure or recreation

Let’s review a few.

·      Seems to me that mom, dad and daughter had a fairly strong background in green technology. The IRS disagreed, arguing “yes this but not that.”  The Court disagreed with the IRS.

·      Turns out that mom and dad put a lot of time into Balsam House, and much of that time was as prosaic as fertilizing, weeding and landscaping. The Court gave them this one.

·      Being real estate, it was assumed that the asset involved would appreciate in value.

o  BTW this argument is often used in long-shot race-horse challenges. Win a Kentucky Derby, for example, and all those losses pale in comparison to the future income.

·      I expected financial status to be a strong challenge by the IRS. Mom and dad owned those La-Z-Boy stores, for example. The Court took pains to point out that they had sold the stores but kept the real estate, so the ongoing income was not comparable. The Court called a push on this factor, which I considered quite generous.

The Court decided that the activity was conducted for profit and that losses could be used to offset income from the furniture stores.

A win for the taxpayers.

Could it have gone differently?

You bet. Court decisions in this area can be … quixotic.  

Our case this time was Walters v Commissioner, T.C. Memo 2022-17.

Exceptions to Early Distribution Penalties

 

What caught my eye about the case was the reference to an “oral opinion.”

Something new, methought.

Better known as a “bench opinion.’

Nothing new, methinks.

What happened is that the Tax Court judge rendered his/her opinion orally at the close of the trial.

Consider that a tax case will almost certainly include Code section and case citations, and I find the feat impressive.

Let’s talk about the case, though, as there is a tax gotcha worth discussing.

Molly Wold is a licensed attorney. She was laid-off in 2017. Upon separation, she pulled approximately $86 grand from her 401(k) for the following reasons:

(1)  Pay back a 401(k) loan

(2)  Medical expenses

(3)  Student loans

(4)  Mortgage and other household expenses

You probably know that pulling money from a 401(k) is a taxable event (set aside a Roth 401(k), or we are going to drive ourselves nuts with the “except-fors”).

Alright, she will have income tax.

Here is the question: will she have an early distribution penalty?

This is the 10% penalty for taking money out from a retirement account, whether a company plan (401(k), 403(b), etc) or IRA and IRA-based plans (SIMPLE, SEP, etc). Following are some exceptions to the penalty:

·      Total and permanent disability

·      Death of the account owner

·      Payments over life expectancy; these are sometimes referred to as “Section 72(t)” payments.

·      Unreimbursed medical expenses (up to a point)

·      IRS levy

·      Reservist on active duty

Then it gets messy, as some exceptions apply only to company-based plans:

·      Leaving your job on reaching age 55 (age 50 if a public safety employee)

Is there a similar rule for an IRA?

·      Withdrawals after attaining age 59 ½.

Why age 55 for a 401(k) but 59 ½ for an IRA?

Who knows.

Molly was, by the way, younger than age 55.

There are exceptions that apply only to a company-based plan:

·      A qualified domestic relations order (that is, a divorce)

·      Dividends from an ESOP

There are exceptions that apply only to an IRA and IRA-based plans:

·      Higher education expenses

·      First-time homebuyer (with a maximum of $10,000)

Yes, Congress should align the rules for both company, IRA and IRA-based plans, as this is a disaster waiting to happen.

However, there is one category that all of them exclude.

Ms Wold might have gotten some pop out of the exception for medical expenses, but that exclusion is lame. The excluded amount is one’s medical expenses exceeding 7.5% of adjusted gross income (AGI). I suppose it might amount to something if you are hit by the proverbial bus.

The rest of the $86 grand would have been for general hardship.

Someone falls on hard times. They turn to their retirement account to help them out. They take a distribution. The plan issues a 1099-R at year-end. Said someone says to himself/herself: “surely, there is an exception.”

Nope.

There is no exception for general hardship.

10% penalty.

Let’s go next to the bayonet-the-dead substantial underpayment penalty. This penalty kicks-in when the additional tax is the greater of $5,000 or 10% of the tax that should have been shown on the return.

Folks, considering the years that penalty has been around, you would think Congress could cut us some slack and at least increase the $5 grand to $10 grand, or whatever the inflation-adjusted equivalent would be.

Ms Wold requested abatement of the penalty for reasonable cause.

Reasonable cause would be that this area of the Code is a mess.

You know who doesn’t get reasonable cause?

An attorney.

Here is the Court:

So I will hold her as a lawyer and as a highly intelligent person with a good education to what IRS instructions that year showed.”

Our case this time was Woll v Commissioner, TC Oral Order.