Sonny Corleone’s IRA

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.

         (3)  Rollover contribution.

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.

IRAs and Nonqualified Compensation Plans

Can an erroneous Form 1099 save you from tax and penalties?

It’s an oddball question, methinks. I anticipate the other side of that see-saw is whether one knew, or should have known, better.

Let’s look at the Clair Couturier case.

Clair is a man, by the way. His wife’s is named Vicki.

Clair used to be the president of Noll Manufacturing (Noll).

Clair and Noll had varieties of deferred compensation going on: 

(1)   He owned shares in the company employee stock ownership program (ESOP).

(2)   He had a deferred compensation arrangement (his “Compensation Continuation Agreement”) wherein he would receive monthly payments of $30 grand when he retired.

(3)   He participated in an incentive stock option plan.

(4)   He also participated in another that sounds like a phantom stock arrangement or its cousin. The plan flavor doesn’t matter; no matter what flavor you select Clair is being served nonqualified deferred compensation in a cone.

Sounds to me like Noll was taking care of Clair.

There was a corporate reorganization in 2004.

Someone wanted Clair out.

COMMENT: Let’s talk about an ESOP briefly, as it is germane to what happened here. AN ESOP is a retirement plan. Think of it as 401(k), except that you own stock in the company sponsoring the ESOP and not mutual funds at Fidelity or Vanguard. In this case, Noll sponsored the ESOP, so the ESOP would own Noll stock. How much Noll stock would it own? It can vary. It doesn’t have to be 100%, but it might be. Let’s say that it was 100% for this conversation. In that case, Clair would not own any Noll stock directly, but he would own a ton of stock indirectly through the ESOP.

If someone wanted him out, they would have to buy him out through the ESOP.

Somebody bought out Clair for $26 million.

COMMENT: I wish.

The ESOP sent Clair a Form 1099 reporting a distribution of $26 million. The 1099 indicated that he rolled-over this amount to an IRA.

Clair reported the roll-over on his 2004 tax return. It was just reporting; there is no tax on a roll-over unless someone blows it.

QUESTION: Did someone blow it?

Let’s go back. Clair had four pieces to his deferred compensation, of which the ESOP was but one. What happened to the other three?

Well, I suppose the deal might have been altered. Maybe Clair forfeited the other three. If you pay me enough, I will go away.

Problem:

         § 409 Qualifications for tax credit employee stock ownership plans

So?

        (p)  Prohibited allocations of securities in an S corporation

                      (4)  Disqualified person

Clair was a disqualified person to the ESOP. He couldn’t just make-up whatever deal he wanted. Well, technically he could, but the government reserved the right to drop the hammer.

The government dropped the hammer.

The Department of Labor got involved. The DOL referred the case to the IRS Employee Plan Division. The IRS was looking for prohibited transactions.

Found something close enough.

Clair was paid $26 million for his stock.

The IRS determined that the stock was worth less than a million.

QUESTION: What about that 1099 for the rollover?

ANSWER: You mean the 1099 that apparently was never sent to the IRS?

What was the remaining $25 million about?

It was about those three nonqualified compensation plans.

Oh, oh.

This is going to cost.

Why?

Because only funds in a qualified plan can be rolled to an IRA.

Funds in a nonqualified plan cannot.

Clair rolled $26 million. He should have rolled less than a million.

Wait. In what year did the IRS drop the hammer?

In 2016.

Wasn’t that outside the three-year window for auditing Clair’s return?

Yep.

So Clair was scot-free?

Nope.

The IRS could not adjust Clair’s income tax for 2004. It could however tag him with a penalty for overfunding his IRA by $25 million.

Potato, poetawtoe. Both would clock out under the statute of limitations, right?

Nope.

There is an excise tax (normal folk call it a “penalty”) in the Code for overfunding an IRA. The tax is 6 percent. That doesn’t sound so bad, until you realize that the tax is 6 percent per year until you take the excess contribution out of the IRA.

Clair never took anything out of his IRA.

This thing has been compounding at 6 percent per year for … how many years?

The IRS wanted around $8.5 million.

The Tax Court agreed.

Clair owed.

Big.

Our case this time was Couturier v Commissioner, T.C. Memo 2022-69.

Wiping Out An Inherited IRA

I came across an unfortunate tax situation this week.

It has to do with IRAs and trusts.

More specifically, naming a trust as a beneficiary of an IRA.

This carried a bit more punch before the tax law change of the SECURE Act, effective for 2020. Prior to the change, best planning for an inherited IRA frequently included a much younger beneficiary. This would reset the required distribution table, with the result that the monies could stay in the IRA for decades longer than if the original owner had lived. This was referred to as the “stretch” IRA. The SECURE Act changed that result for most beneficiaries, and now IRAs have to distribute – in general – over no longer than 10 years. 

Trusts created a problem for stretch IRAs, as trusts do not have an age or life expectancy like people do. This led to something called the “look-through” or “conduit” trust, allowing one to look-through the trust to its beneficiary in arriving at an age and life expectancy to make the stretch work.

The steam has gone out of the conduit trust.

One might still want to use a trust as an IRA beneficiary, though. Why? Here is an example:

The individual beneficiary has special needs. There may be income and/or asset restrictions in order to obtain government benefits.

What is the point, you ask? Doesn’t the IRA have to distribute to the individual over no more than 10 years?

Well … not quite. The IRA has to distribute to the trust (which is the IRA beneficiary) over no more than 10 years. The trust, in turn, does not have to distribute anything to its individual beneficiary.

This is referred to as an accumulation trust. Yes, it gets expensive because the trust tax rates are unreasonably compressed. Still, the nontax objectives may well outweigh the taxes involved in accumulating.

There is something about an inherited IRA that can go wrong, however. Do you remember something called a “60-day rollover?” This is when you receive a check from your IRA and put the money back within 60 days. I am not a fan, and I can think of very few cases where I would use or recommend it.

Why?

Because of Murphy’s Law, what I do and have done for over 35 years.

You know who can do a 60-day rollover?

Only a surviving spouse can use a 60-day rollover on an inherited IRA.  

You know who cannot do a 60-day rollover on an inherited IRA?

Anyone other than a surviving spouse.

It is pretty clear-cut.  

I am looking at someone who did not get the memo.

Here are the highlights:

·      Husband died.

·      The wife rolled the IRA into her own name (this is a special rule only for surviving spouses).

·      The wife died.

·      A trust for the kids inherited the IRA.

No harm, no foul so far.

·      The kids wanted to trade stocks within the IRA.

So it begins.

·      The IRA custodian told the kids that they would have to transfer the money someplace else if they wanted to trade.

No prob. The kids should have the IRA custodian transfer the money directly to the custodian of a new IRA that will let them trade to their heart’s content.

·      The kids had the IRA custodian transfer the money to a non-IRA account owned by the trust.

And so it ends.

The kids were hosed. They tried a Hail Mary by filing a private letter request with the IRS, asking for permission to put the money back in the IRA. The IRS looked at the tax law for a split second … and said “No.”

The IRS was right.

And, as usual, I wonder what happened with calling the tax advisor before moving around not-insignificant amounts of money.  

One can point out that taxes would have been payable as the kids withdrew money, and an inherited IRA has to distribute. If mom died in 2020 or later, the IRA would have to be distributed over no more than 10 years anyway.

Still, 10 years is 10 years. If nothing else, it would have given the kids the opportunity to avoid bunching all IRA income into one taxable year.

Not to mention paying for a private letter ruling, which is not cheap.

I hope they enjoy their stock trading.

The cite for the home gamers is PLR 202125007.

Another IRA-As-A-Business Story Gone Wrong

 

I am not a fan.

We are talking about using your IRA to start or own a business. We are not talking about buying stock in Tesla or Microsoft; rather we are talking about opening a car dealership or rock-climbing facility with monies originating in your retirement account. The area even has its own lingo – ROBS (Rollover for Business Start Ups), for example - of which we have spoken before.

Can it be done correctly and safely?

Probably.

What are the odds that it will not be done – or subsequently maintained - correctly?

I would say astronomical.

For the average person there are simply too many pitfalls.

Let’s look at the Ball case. It is not a standard ROBS, and it presents yet another way how using an IRA in this manner can blow up.

During 2012 Mr Ball had JP Morgan Chase (the custodian of his SEP-IRA) distribute money.

COMMENT: You have to be careful. The custodian can send the money to another IRA. You do not want to receive the money personally.

Mr Ball initiated disbursements requests indicating that each withdrawal was an early disbursement ….

         COMMENT: No!!!

He further instructed Chase to transfer the monies to a checking account he had opened in the name of a Nevada limited liability company.

         COMMENT: That LLC better be owned by the SEP-IRA.

Mr Ball was the sole owner of the LLC.

         COMMENT: We are watching suicide here.

Mr Ball had the LLC loan the funds for a couple of real estate deals. He made a profit, which were deposited back into the LLC.

At year-end Chase issued Forms 1099 showing $209,600 of distributions to Mr Ball.

         COMMENT: Well, that is literally what happened.

Mr Ball did not report the $209,600 on his tax return.

COMMENT: He wouldn’t have to, had he done it correctly.  

The IRS computers caught this and sent out a notice of tax due.

COMMENT: All is not lost. There is a fallback position. As long as the $209,600 was transferred back into an IRA withing 60 days, Mr Ball is OK.

ADDITIONAL COMMENT: BTW, if you go the 60-day route – and I discourage it – it is not unusual to receive an IRS notice. The IRS does not necessarily know that you rolled the money back into an IRA within the 60-day window.

This matter wound up in Tax Court. Mr Ball had an uphill climb. Why? Let’s go through some of technicalities of an IRA.

(1) An IRA is a trust account. That means it requires a trustee. The trustee is responsible for the assets in the IRA.

Chase was the trustee. Guess what Chase did not know about? The LLC owned by Mr Ball himself.

Know what else Chase did not know about? The real estate loans made by the LLC upon receipt of funds from Chase.

If Chase was the trustee for the LLC, it had to be among the worst trustees ever. 

(2)  Assets owned by the IRA should be named or titled in the name of the IRA.

Who owned the LLC?

Not the IRA.

Mr Ball’s back was to the wall. What argument did he have?

Answer: Mr Ball argued that the LLC was an “agent” of his IRA.

The Tax Court did not see an “agency” relationship. The reason: if the principal did not know there was an agent, then there was no agency.

Mr Ball took monies out of an IRA and put it somewhere that was not an IRA. Once that happened, there was no restriction on what he could do with the money. Granted, he put the profits back into the LLC wanna-be-IRA, but he was not required to. The technical term for this is “taxable income.”

And – in the spirit of bayoneting the dead – the Court also upheld a substantial underpayment penalty.

Worst. Case. Scenario.

Is there something Mr Ball could have done?

Yes: Find a trustee that would allow nontraditional assets in the IRA. Transfer the retirement funds from Chase to the new trustee. Request the new trustee to open an LLC. Present the real estate loans to the new trustee as investment options for the LLC and with a recommendation to invest. The new trustee – presumably more comfortable with nontraditional investments – would accept the recommendation and make the loans.

Note however that everything I described would take place within the protective wrapper of the IRA-trust.

Why do I disapprove of these arrangements?

Because – in my experience – almost no one gets it right. The only reason we do not have more horror stories like this is because the IRS has not had the resources to chase down these deals. Perhaps some day they will, and the results will probably not be pretty. Then again, chasing down IRA monies in a backdrop of social security bankruptcy might draw the disapproval of Congress.

Our case this time was Ball v Commissioner, TC Memo 2020-152.

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.

Blowing Up An IRA

I am not a fan of using retirement funds to address day-to-day financial stresses.

That is not to downplay financial stresses; it is instead to point out that using retirement funds too easily can open yet another set of problems.

Those who have followed me for a while know that I disapprove of using retirement funds to start a business: the so-called Rollovers as Business Startups, whose humorous acronym is ROBS. I know that – in a seminar setting – it is possible to mitigate the tax risks that ROBS pose. I do not however practice in a seminar setting. Heck, I am lucky if a client calls in advance to discuss whatever he/she is getting ready to do.

Let me give you a couple of ROBS pitfalls:

(1) You have your IRA buy a fourplex. You spend time cleaning, doing maintenance and repairs and routinely running to Home Depot.

Question: Is there a tax risk here?

(2) You have your IRA buy a business. You have your son and daughter run the business. You work there part-time and draw a paycheck.

Question: Is there a tax risk here?

The answer to both is yes. Consider:

(1) You are buying stuff at Home Depot, stuff that the IRA should have been buying - as the IRA owns the fourplex, not you. If you are over age 50, you can contribute $6,500 to the IRA annually. Say that you have already written that check for the year. You are now overfunding the IRA every time you go to Home Depot. Granted, one trip is not a big deal, but make routine trips – or incur a major repair – and the facts change. That triggers a 6% penalty – every year - until you take the money back out.

(2) There are restrictions on direct and indirect benefits from an IRA. You are receiving a paycheck from an asset the IRA owns. While arguable, I am confident that your paycheck is a prohibited benefit.

I am looking a Tax Court case where the taxpayer had her IRA lend $40,000 to her dad in 2005. A few years went by and she had the IRA lend $60,000 to a friend.

In 2013 she changed IRA custodians. The new custodian saw those two loans, and she had problems. Perhaps the custodian could not transfer the promissory notes. Perhaps there were no notes. Perhaps the custodian realized that a loan to one’s dad is not allowed. This part of the case is not clear.

COMMENT: It is possible to have an IRA lend money. I have a client who does so on a regular basis. Think however of acting like a bank, with due diligence, promissory notes, periodic interest and lending to nonrelated independent third-parties.

The IRS saw easy money:

(1)  There was a taxable distribution in 2013;

(2)  … and a 10% penalty for early distribution;

(3)  … and the “substantial understatement” penalty because the tax numbers changed enough to rise to the level of “substantial.”

How do you think it turned out for our tax protagonist?

Go back to the dates.

She loaned money to her dad in 2005.

Let’s glance over IRC Section 408(e)(2)

 (2)  Loss of exemption of account where employee engages in prohibited transaction.

(A)  In general. If, during any taxable year of the individual for whose benefit any individual retirement account is established, that individual or his beneficiary engages in any transaction prohibited by section 4975 with respect to such account, such account ceases to be an individual retirement account as of the first day of such taxable year.

The loan was a prohibited transaction. She blew up her IRA as of January 1, 2005. This means that she should have reported ALL of her IRA as taxable income in 2005, of which we can be quite sure she did not.

Can the IRS assess taxes for 2005?

Nope. Too many years have gone by. The standard statute of limitations for assessments is three years.

So, the IRS will tag her in 2013, right?

Nope, they cannot. For one thing, the prohibited transaction did not occur in 2013, and the IRS is not allowed to time-travel just because it serves their purpose.

But there is a bigger reason. Read the last part of Sec 408(e)(2) again.

There was no IRA in 2013. There could be no distribution, no 10% penalty, none of that, as “that” would require the existence of an IRA.

And there was no IRA.

The name of the case for the home gamers is Marks v Commissioner.

Being Unemployed, Depressed And Owing The IRS

The case is 55 pages long.

Even a tax guy gets tired of marathon reading.

The story got me fired up, however, so let’s talk about it.

A frequent area of taxpayer request for IRS relief from penalties is rollovers of retirement monies, especially IRAs. Used to be that one filed for a Private Letter Ruling to obtain official absolution. Those bad boys are not cheap, as you will pay a tax CPA or attorney to draft the PLR, as well as pay the IRS filing fee. The filing fee alone can run you $10,000.

In 2016 the IRS published Revenue Procedure 2016-47 allowing for alternate means of absolution without requesting a PLR. Even the IRS got tired of taking your money.

Mr Trimmer was a retired cop with the New York Police Department. He was moving on after 20 years with the NPD, taking a security job with the New York Stock Exchange. He needed the job to supplement his pension, as he had two sons going through college. The new job however fell through. He was hosed, as the NYPD does not rehire.

And Trimmer went major depressive. He was antisocial, rarely left the house, neglected his hygiene and grooming – all the classic symptoms.

Somewhere in there he received two retirement checks: one for $99,990 and a second for $710. They lay on his dresser for weeks until he finally got around to depositing them into … his checking account.

COMMENT: If you were thinking a rollover, he flubbed because the roll did not go into an IRA account.

Months later Trimmer and his wife met with their accountant for their taxes. The accountant advised that he transfer the monies to an IRA immediately.

COMMENT: Trimmer was well outside the 60-day window at that point.

The IRS sent him a notice asserting that he failed to report over $100,000 of income and demanded taxes, penalties, interest, a Weimaraner puppy and a month’s pass to Planet Fitness.

It added up close to $40.000.

Yipes!

Trimmer wrote back to the IRS: 

    Dear Sirs:

I am contesting the amount of money said to be owed. Please allow me to explain the situation. In April 2011 I retired from my job and took a pension loan. After my retirement I went through a period of depression and was not managing my affairs. I received my check for the loan and deposited it into Santander bank on July 5, 2011. The money remained in this account until April of 2012 when it was switched to an I.R.A. in the same bank where it remains to this day.

A few points

- There was no deception or spending, investing of the money at all. I received the check and deposited it into the bank.

- My wife and I have been paying taxes for a combined 60 years and NEVER had the least bit a problem.

- There was no harm done to anyone with the money staying in the bank except me (I was receiving 0.25% interest.)

- I switched the money to an I.R.A. before I was notified by the I.R.S.

I am now employed again and am driving a school bus and have a son in college and another a year away. To pay $40,000 in taxes for money that is in an I.R.A. would absolutely cripple my family as it would be 3 years of my salary. Sir no harm was done to anyone. I went through a rough time upon separation from my job, causing me emotional hard times that caused this situation. Penalizing me and my family would not benefit anybody, only cause extreme duress and punish my children who played no part in this situation. I ask you to consider these facts and please come to a fair decision. Please contact me if you need at [phone number redacted].

Thank You,

John Trimmer

I feel sorry for the guy.

Here is the IRS reply:

“The law requires you to roll over your distribution within 60 days of the distribution date. If the roll over exceeds the time frame it becomes fully taxable.”

Nice folk over there.

Here is the tax issue: The IRS can issue waivers for this penalty, but they did not mention such fact to Mr Trimmer or how to apply for a waiver. Heck, they did not even reference Trimmer’s unfortunate circumstances. A reasonable person could question whether anyone even read his letter.

The IRS sent a Statutory Notice of Deficiency, also known as a 90-day letter.

Trimmer filed with the Tax Court.

The IRS went right for the throat:

•  Trimmer did not follow procedures (Rev Proc 2013-16 for the nerds).
• This made the hardship waiver provision “inapplicable.”
•  Since Trimmer had not pressed the point, there technically had been no “final administrative determination.”
• Without that “final,” the Tax Court had no authority over the case.
• In any event, Trimmer had never explained why he was unable to accomplish the two rollovers within 60 days.
• And where is that puppy?

Well, thank you Darth.

The Tax Court seemed to like Trimmer:

(1) OK, so he did not follow procedures.

(2) Not so quick, Sith Lord. How does the IRS reconcile 2003-16 with the following from the Internal Revenue Manual:

Examiners are given the authority to recommend the proper disposition of all identified issues, as well as any issued raised by the taxpayer.”

(3) The examiner’s authority to consider a hardship waiver “strongly implies” that the taxpayer may request the waiver.

COMMENT: 

(4) From the Court:

As might be expected from a self-represented taxpayer unversed in the technicalities of the tax law, he did not expressly cite section 402(c)(3)(B). But his letter leaves little doubt that he was seeking a hardship waiver of the 60-day rollover requirement….”

(5) The Court points out that the examiner 

… did not decline to consider Mr. Trimmer’ request, did not request that petitioners provide any additional information, and did not advise them that they were required to submit a private letter request or do anything else in particular to have their request considered.”

(6) If anything, the examiner wrote Mr. Trimmer that

… you do not need to do anything else for now. We will contact you within 60 days to let you know what action we are taking.”

(7) And 3 days later the examiner

… wrote petitioners again, denying requested relief, not on the basis that petitioners had requested it in the wrong manner or had provided insufficient information, but on the basis of cursory and incomplete legal analysis that failed to take into account the provision for hardship waivers under section 402(c)(3)(B).”

The Tax Court found in favor of Trimmer. He could do a late rollover. He was not subject to tax or penalty and could keep his Weimaraner puppy.

Good.

But it should not have gone this far. We are not in unexplored tax country here.

One could argue that our tax system is near-to breaking when you have to hire a professional to resolve near-routine tax problems. This man did not roll-over his money within 60 days. He was clinically depressed for a while. I can see requesting a doctor’s letter attesting to the taxpayer’s condition, but this is not cutting-edge tax practice.  

So why the HBO-level drama?

Here is one commentator’s remark:

We have a lazy revenue agent who probably just glances over the response. Is it the revenue agent’s fault? No, I don’t blame the revenue agent. With budget cuts, the caseloads of revenue agents are insane.”

I was listening until the “overworked” card. Seriously? I recommend this revenue agent not consider a career as a tax CPA, although – as a positive – it would probably be a short one.  

I do think our case highlights a disturbingly under-skilled IRS employee.

I also think it shows a trigger-happy IRS assessing penalties on anyone for anything. That examiners are throwing them around like sugar packets from a McDonalds drive-through indicates that they are under pressure to sweeten the take, irrespective of whether penalties are appropriate. Those penalties are under-the-table income to an IRS already facing a tight budget.

We have spoken before of a goose-and-gander bill, requiring the IRS to pay a taxpayer when the agency acts recklessly. The IRS already has people on payroll to pin your ears back, whereas you have to hire someone like me to fend them off. Their incremental cost to chase you is minimal, but your incremental cost to defend yourself can be significant if not ruinous.

Our goose-and-gander bill might or might not have protected Trimmer specifically, but eventually the IRS would lose enough cases to reconsider the automatic-tax-and-penalty-no-reasonable-cause-raised-middle-finger policy it has adopted. Cutting a check really focuses one’s attention.