You'll Want To Read

[Snaggletooth]

Or at least I THINK you will...

I am facing a situation that I will be forthright among you to post NOW. I will not wait until it's over before choosing to post so
I can pick the winner/loser after the game is over.

The reason for this is there has been considerable discussion about cites and how we align our positions accordingly. Remember the
thread "Don't need no stinkin' cite" recently?

The issue is taking a penalty exception for death on a 1099-R coded "1". This refers to a thread I started on 03/20/13 titled "Commingled
Death Benefit." The numbers are fictitious but the situation is real and the true numbers are even larger than what I portrayed. After
much consideration and reseaching what the code, regs, and TTB had to say, I decided that the taxpayer was entitled to the penalty
exception. The death amount had been commingled with her own IRA, which she totally emptied in 2012 at age 38. Furthermore, I
consulted this forum about the particular issue and most of our best and brightest admonished me that I would be wrong. In fact,
I did not receive a single vote of support.

It is important for me to state that I never claimed exclusion from claiming the income -- only an exclusion for the penalty. I may be wrong, but at this point it remains to be seen. For those of you who are interested, I will keep you informed as the situation unfolds.

Withholding on the amount cashed in was a whopping 40%, so there was a refund. The IRS has not issued the refund and has sent my client an
audit letter. They announced they would be looking at "certain items" but there IS no other item that will be of much concern to them.

I will add that I went through a similar situation with not-for-profit reporting a couple years ago. When I consulted this forum, one of you
told me I was so wrong that I should be punished for perpetrating a fraud. The result was the auditor agreed with me and my client was
off the hook. I'll admit it could have gone either way. But taking your client's position is not equivalent to "fraud."

I'll keep you informed. For those of you so inclined, please wish me the best.

[DaveO]

Good luck with this Snag.

I recall one my big concerns a few years back when I had returns for a few "Drive away" truckers who move and/or deliver new semi tractors around the country. They tow a vehicle, usually a small pickup, behind the semi tractor that they drive after they drop the semi to their next job. We used standard mileage for the small vehicle while they were driving it and 1/2 standard mileage while they were towing it on the premise of the wear and tear on the tires and drive train as well as the fact the miles still record on the odometer. I was assured by my group of drivers this was standard industry practice and IRS approved. Despite all my searching I could find no guidence on the issue. As fate would have it one of the drivers got audited. I went to the audit and went thorough my explanation of the process expecting the worst. The auditor listened thought about it for a moment and said "Sounds reasonable to me" and went to the next item.

I hope you do as well.

[Gretel]

For those of you so inclined, please wish me the best.

Yes, Snag, I wish you the best and sorry for your frustration.

[JohnH]

Snags: Fraud? That's a highly loaded word and one I use very sparingly. Surely no one would be that crass & disrespectful on this professional forum would they?

[Snaggletooth]

Fraud Indeed John H

Yeah, I know but it did actually happen. It would be even more crass to call out this person by name, but (s)he was so vocal that I'm sure (s)he remembers doing so.

Aside from that, this person is one of our most frequent people. Very sharp with a storehouse of knowledge and actually quite helpful. It was quite out-of-character.

[JohnH]

OK.
That makes me feel better.

[Black Bart]

Cuts 'n' kudos

For those of you so inclined, please wish me the best.

Yes, Snag, I wish you the best and sorry for your frustration.

Me too, Snag.

...this person is...Very sharp with a storehouse of knowledge...

Well, that rules out about 2/3 of us. But yeah, I know whatcha mean -- some nit-picking nerds around here (you know who you are) can be downright nasty and spiteful. But hang in there -- I think most of us know you're one of the best of the the "good guys" (always helping others) around this board and I'm confident you'll work it out to a satisfactory conclusion.

P.S. I wonder if Brad could have the dirty, rotten, low-down, #$@&* rat waterboarded.

[Burke]

Surely you're not talking about HTT?

[Snaggletooth]

It was a mistake...

to mention the "fraud" accusation because it seems the attention has turned to "who dunnit" and away from the critical issue at hand. After discussion with my client and research of what cites exist, I exempted over $20K from the penalty on a 1099-R Code "1". IRS is now calling our hand, and we will be called upon to defend the position.

The "fraud" source should not be tarred and feathered. And on that particular issue the IRS could have gone in either direction, so I might have been just plain lucky. (S)he is a frequent and helpful presence to all of us.

Thanks for everyone's interest, and I'll keep the forum posted as the weeks go by.

[Snaggletooth]

Progress Report

I promised to keep you informed on the progress of this situation. The client received a letter around Apr 1 saying their refund was being withheld and for them to "stand by" and be prepared for an audit. (Don't know whether this will be the electronic version or the old-fashioned kind).

Client and I agreed to wait until June 1 and if IRS hadn't done anything, we would follow-up by correspondence. It's June 1 and we haven't heard anything.

So...no real news on this, but several weeks have elapsed and we've reached a datemark. Nothing else to report. Thanks for your interest...

The ongoing saga will continue, so if you are interested enough to keep up with this, it will be like a TV Soap Opera.

[New York Enrolled Agent]

I promised to keep you informed on the progress of this situation. The client received a letter around Apr 1 saying their refund was being withheld and for them to "stand by" and be prepared for an audit.

Anything is possible in an audit situation. However, if you win, I'm afraid it will be strictly a case of luck.

I just read your March post and fail to see any difference in the fact pattern (substitute 401K for IRA) than a case decided in the Tax Court.

A regular case (full precedent) Gee 127 TC No. 1 [underlines added] - I would suggest you read the whole case but here is the headnote.

P rolled over a distribution from her deceased husband’s individual retirement account (IRA) into her separate IRA upon her husband’s death. Four years later, P received a distribution from her IRA. She claims that the distribution was an amount received from her deceased husband’s IRA and therefore exempt from the 10-percent additional tax on early distributions under sec. 72(t)(2)(A)(ii), I.R.C., as a distribution to a beneficiary upon a decedent’s death.

1. Held: P received an early distribution from her own IRA subject to the sec. 72(t), I.R.C.,additional tax. The amount received from P’s deceased husband’s IRA lost its character as a distribution made to a beneficiary upon a decedent’s death once P transferred the funds to her separately owned IRA.

[Snaggletooth]

Thanks for Court Case NYEA

Before taking my position, I thoroughly read the Code and Regs §72(t). These clearly outline a penalty exemption for death benefit, but they do not incubate the amount as a penalty-free status if the recipient comingles the benefit with their own IRA. The ability of the recipient to preserve a penalty-free death amount is not guaranteed by the code/regs, but neither is it penalized by statute.

Had I known how to research for a court case without reading literally thousands of cases, I would have done so. I would like to be able to strip away the non-relevant cases with a research tool specific enough to get down to the heart of the issue. Thanks for providing this case for reference, and at this point I agree I've probably got a loser. The court has ruled in favor of the Service on this case, although clearly there was no guidance from the code/regs in the event of comingling the funds. In my opinion they ruled on a coin-flip.

I do have an ace-up-my-sleeve, not that the IRS is compelled to honor it. If a "Code 1" distribution cannot have a portion attributable to death, then why do they publish relief under "exception 4 - death"? If the court case is right, then treatment under exception 4 would be unavailable, and the proper treatment would exist only under a "Code 4" distribution. The exceptions are listed for use when a "Code 1" is encountered, and exception 4 would not be available unless some portion could be excluded from penalty.

I don't believe the IRS will be able to successfully explain the redundancy of "exception 4", but that doesn't necessarily mean I will prevail.

Thanks, NYEA

[New York Enrolled Agent]

Before taking my position, I thoroughly read the Code and Regs §72(t). These clearly outline a penalty exemption for death benefit, but they do not incubate the amount as a penalty-free status if the recipient comingles the benefit with their own IRA. The ability of the recipient to preserve a penalty-free death amount is not guaranteed by the code/regs, but neither is it penalized by statute.

Snags

I think you're hung up on an incorrect assumption. The Court has now basically ruled there is no such thing as a "comingled" IRA. IRA (or 401K) accounts are individual accounts. With all due respect, to suggest the ruling was the result of a coin-flip really is silly. Regular Court decisions are those the Chief Judge has determined to have significant legal importance. This case was a case of first impression. Before that decision was released to the public, every judge on the Tax Court would have had an opportunity to disagree with the ruling.

I don't know if you read the case but the decision makes sense to me. Whether the company acted in the best interest of your taxpayer by having her do a rollover of her husband's account is questionable. But once it was done, the die was cast.

Some text from the decision: (underlines added)

[start] The parties agree that the only relevant exception is section 72(t)(2)(A)(ii), which provides that distributions "made to a beneficiary (or to the estate of the employee) on or after the death of the employee" are not subject to the 10-percent additional tax. Petitioner argues that the entire distribution she received from her IRA was an amount received on or after the death of Mr. Campbell.4 We note that this Court has not previously decided whether an IRA distribution retains its character as a distribution to a beneficiary "on or after the death of an employee" if the distribution is of funds that were rolled over to the IRA upon the employee's death.

Respondent argues that once petitioner as surviving spouse decided to maintain the funds in an account in her own name as owner of the IRA, she became the owner of the IRA "for all purposes of the Code," relying upon section 1.408-8, Q&A-5 and 7, Income Tax Regs. Petitioner counters that the funds from her deceased husband's IRA did not lose their character as funds from her deceased husband's IRA. ...

We find that petitioner received the distribution from her own IRA, not from an IRA of which she was a beneficiary on or after the death of an employee. We further find that the source of the amount received, whether originating from her deceased husband's IRA or petitioner's own contributions, is irrelevant. ...

Petitioner rolled over the entire amount received from her deceased husband's IRA into her own IRA. Petitioner is and was the sole owner of her separately created IRA. The distribution petitioner received was not occasioned by the death of her deceased husband nor made to her in her capacity as beneficiary of his IRA.

Petitioner cannot have it both ways. She cannot choose to roll the funds over into her own IRA and then later withdraw funds from her IRA without additional tax liability because the funds were originally from her deceased husband's IRA. Accordingly, once petitioner chose to roll the funds over into her own IRA, she lost the ability to qualify for the exception from the 10-percent additional tax on early distributions. The funds became petitioner's own and were no longer from her deceased husband's IRA once petitioner rolled them over into her own IRA. The funds therefore no longer qualify for the exception. ...

To avoid the section 72(t) additional tax, petitioner must show that the IRA distribution falls within one of the exceptions provided under section 72(t)(2). She has not done so. ...[end]

Say a prayer that your auditor is unaware of Gee.

[Snaggletooth]

Here's the Latest

I went out on a limb and told all my comrades "up front" of this situation, and that I would let everyone know regardless of how the chips fell.

More of the chips have fallen. My client has received ALL of the refund, including $20K which was reported as penalty-exempt because of deceased husband's portion. However, there was no explanation or affirmation of the position from the IRS, just a refund of the money. This means the money is not safe for another 3 years.

In the foregoing, you will no doubt see the admonition from NYEA describing a disallowance that went to court in the Gee case, and the taxpayer lost. Had I been aware of the case at the time of preparation I would have not filed exempting the penalty. So the Gee case is hanging over our heads, and "winning" this for my client is tainted. It's like scoring a winning touchdown on a bad call by the referees, and being afraid of what the videotape will reveal.

I'm not going to amend the return, simply because the code and regs clearly do not spell out the penalty. At least I did research the matter to the extent of code and regs, although fell short of knowing about the Gee case. The Gee case is similar to my client, although not exactly the same.

[Bees Knees]

As long as the client is informed of the new information you have learned and you took an honest position based on information you had available at the time, you are not required to file an amended return if the client does not want to file an amended return.

Court cases are helpful and do provide instruction, but I read court cases all the time where the same issue keeps coming up and the taxpayers keep losing. The worst that happens is the taxpayer gets hit with negligence penalties for not having substantial authority for the position (a Tax Court decision is substantial authority). Even with court decision after court decision saying you can’t do that, nobody gets hit with fraud allegations unless there is a willful attempt to conceal income.