The following taxpayer has a bigger problem. He is not getting paid by his client. So in a desperate attempt to get paid he try's to borrow from his IRA for 60 days to cover the expenses. The IRS can be very unforgiving of missing a deadline. The taxpayer then argued that his withdrawal was a loan, thank God the court didn't call it a loan or the entire balance of his IRA would become taxable immediately.
David Oase CPA
Court rejects taxpayer argument that custodian was to blame for late IRA rollover
Alexander, TC Summary Opinion 2014-18TC Summary Opinion 2014-18
A taxpayer who had received an IRA distribution, used the proceeds for business, and then applied for a "loan" from the IRA custodian to make a rollover—which wasn't rolled into the IRA until the 66th day after the distribution—was subject to tax and the 10% penalty for early distributions.
Facts. Tom Alexander was owed $130,000 for electrical contracting work he'd completed for a general contractor. Due to financial difficulties, the general contractor couldn't pay Alexander, but proposed a deal to pay Alexander in installments and offered him a promissory note secured by real estate worth $130,000 that the general contractor owned. However, the property was burdened with a past-due mortgage and was subject to imminent foreclosure by Sun Trust Bank (Sun Trust), the lender. To secure the real estate, the general contractor asked Alexander to pay Sun Trust $36,000 to stop the foreclosure. Eager to be paid the outstanding sum for his work, Alexander agreed.
To raise the needed money, Alexander decided to take a distribution from his SEP-IRA (IRA) that he maintained with Charles Schwab (Schwab). To limit income taxation, a Schwab employee suggested that Alexander use the IRA money to halt foreclosure on the property, then get a loan from Schwab and roll the loan proceeds back to his IRA within 60 days. Schwab also told Alexander that the loan would be approved within 30 to 45 days. Alexander followed the instruction, wiring $36,000 from his IRA into his checking account on July 31, 2009 and then paying that amount to Sun Trust.
Alexander, however, didn't receive the loan proceeds until Sept. 30, 2009. On Oct. 1, 2009, Alexander mailed Schwab a personal check for $36,000 for deposit in his IRA account. Schwab deposited the amount in Alexander's IRA account on Oct. 5, 2009, 66 days after Alexander had received the original IRA distribution. And, in January 2010, Alexander received from Schwab a Form 1099-R, reporting a gross distribution of $36,000 from his IRA, coded to indicate an early distribution. However, the Form 1099-R showed no taxable amount. Alexander filed his tax return for 2009 without including the IRA distribution as part of his gross income.
IRS issued a statutory notice of deficiency to Alexander for 2009 in the amount of $14,165, which included a 10% penalty tax for early distribution.
Was there a rollover? Alexander argued that he had effected a rollover of the withdrawn funds, but that Schwab had hindered his compliance with the 60-day deadline.
Rollover contributions, the Tax Court recognized, are an exception to the inclusion of IRA distributions in the income of distributees. But an amount is a rollover contribution only if it satisfies the requirements of Code Sec. 408(d)(3). If an amount is distributed from an IRA to the individual for whom the account is maintained, and some or all of the amount is transferred into another IRA or eligible retirement plan for the benefit of the individual not later than the 60th day after the distributee's receipt of the original distribution, then the amount transferred is a rollover excepted from income inclusion. (Code Sec. 408(d)(3)(A))
Alexander's argument was that, despite his check having been deposited into the IRA 66 days after the original funds had been received, there was nonetheless a valid rollover because Schwab, not Alexander, had caused the loan delay. The Court disagreed.
The Court said that Alexander, by his looking to Schwab, the IRA custodian and lender for the rollover proceeds, appeared to be arguing that the situation was similar to that of the taxpayer in Wood, (1989) 93 TC 11493 TC 114. There, the Tax Court held, where a portion of a profit-sharing plan distribution was properly transferred to an IRA but was not actually credited to the IRA account within the 60-day period because of a bookkeeping error by the IRA custodian, the taxpayer was relieved of the error and the rollover was respected. In Wood, the taxpayer had argued that he had reasonably relied on the custodian's representation and had done everything that could reasonably be expected, and so should not be penalized when the custodian then caused the error. The Court agreed, and said that when bookkeeping entries were at variance with the facts, the decision must rest on the facts.
Here, however, the facts were different, the Tax Court said. The $36,000 had not been deposited within the statutorily-prescribed 60-day period; any error that may have been committed by Schwab was not a bookkeeping error. And, while Alexander argued that his intention was to effect a rollover, his intention could not determine the tax consequences of his transaction. What actually was done would determine the tax treatment.
The Court also noted that Code Sec. 408(d)(3)(I) permits IRS, in its discretion, to waive the 60-day requirement under certain circumstances, following the instructions of Rev Proc 2003-16, 2003-1, C.B. 359. It said that, as a result, Alexander would be free to pursue that relief with IRS, but not in the Tax Court.
Was there a loan? Alexander's second line of defense was that the distribution was a permissible loan from the IRA account, and not a distribution. This the Tax Court found implausible.
The Court also warned Alexander that this argument fell into the realm of "be careful what you wish for." Code Sec. 408(e)(2) provides that if the individual for whom the IRA was created, or his beneficiary, engages in a transaction prohibited by Code Sec. 4975, such as a lending between a disqualified person and the plan, the account will no longer be treated as an IRA as of the first day of the tax year. And, under Code Sec. 408(e)(2)(B), the IRA would be treated as having distributed all of its assets to the distributee in that year.
Thus, while the Court concluded that Alexander had not borrowed from his IRA, had he done so, the Court said, the entire IRA value would have been taxable, not just the distribution.
Additional 10% tax for early withdrawal. Code Sec. 72(t)(1) imposes a penalty tax on an early distribution from a qualified retirement plan, like an IRA, equal to 10% of the portion of the amount that is includable in gross income. The Court determined that IRS had been correct in assessing that tax. None of the enumerated exceptions set forth in Code Sec. 72(t)(1) applied.