On November 10, 2020, the Tax Court issued a Memorandum Opinion in the case Ball v. Commissioner (T.C. Memo. 2020-152). The primary issues before the court in Ball were whether distributions from an IRA constituted items of gross income, whether the petitioner was liable for the 10% addition to tax under IRC § 72(t), and whether the petitioner was liable for the accuracy related penalty under IRC § 6662(a).
In 2012 and 2013, the petitioner participated in an IRA, the custodian of which was J.P. Morgan Chase, N.A. in 2012, the petitioner requested and received distributions of nearly $210,000. The petitioner, perhaps not thinking about his future (tax court case), checked the box on the IRA distribution request that the withdrawal was an early distribution (he was not yet 59-1/2) with no known exceptions to being taxable. To add a bit of a wrinkle, the petitioner instructed Chase to make the distribution into a Chase business checking account that he had opened in the name of a Nevada limited liability company, The Ball Investment Account, LLC. The Ball Account was not a retirement account, and the petitioner was the sole owner and managing member of the Ball Account, LLC.
Immediately upon the distribution of the first $170,000 into the Ball Account in June 2012, the petitioner wired a like amount from the account to a Nevada title company to fund a real estate loan. The loan was repaid in April 2013, and the petitioner immediately deposited the payoff check into the SEP-IRA account. His account statement shows the deposit as “rollover contribution.” The petitioner treated the second distribution similarly, though funding a separate real estate loan.
Chase Narcs on Petitioner (read: Issues a Form 1099-R)
Chase issued to petitioner Form 1099-R (Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.) for 2012 reporting that he had received taxable distributions from the IRA of $210,000, indicating an early distribution with no known exceptions to being taxable. Chase also issued to petitioner Form 5498 (IRA Contribution Information) for 2012, which, among other things, reported that the fair market value of the account was $57,507. The values of the outstanding loans were not reflected in that principal balance.
The IRS Tells Tchaikovsky to Move
The petitioner filed a timely 2012 Form 1040 on which he reported (a) that he had received $210,000 in distributions from the IRA, and (b) that none of the distributions constituted gross income to him. The IRS’s Automated Underreporter Program (AUR) begged to differ. The AUR sent the petitioner a Notice CP2000, informing him that his 1040 did not match the 1099-R.
The Tax Court observes that “[t]he notice invited petitioner to respond” to the notice if he disagreed with the proposed changes. This makes it sound like the computer generated notice also invited the petitioner to an afternoon tea, where finger sandwiches and light (controlled) frivolity would ensue, response cordially requested. Alas, the petitioner did not respond, missed the AUR’s fete, and, subsequently, the IRS determined a deficiency, additional tax, and penalty.
Although it is true that an IRA is administered by a trustee or custodian (Chase, here), which custodian may invest IRA property as it sees fit, the fiduciary alone is responsible for the investment and disposition of property held in the IRA. See McGaugh v. Commissioner, T.C. Memo. 2016-28, at *8 (citing Treas. Reg. § 1.408-2(e)), aff’d, 860 F.3d 1014 (7th Cir. 2017). The record contains no evidence that Chase had any knowledge of, or control over, the use that Ball LLC made of the $210,000 Chase deposited into the Ball Account or that Chase had any fiduciary responsibility with respect to Ball LLC’s disposition or investment of those funds.
A “Conduit Agency Arrangement”
The petitioner argued that the movement from the IRA to the loans and back to the IRA constituted a “conduit agency arrangement.” Under that theory, Ball LLC acted as a mere facilitator, transferring funds between the IRA and the two other LLCs (lenders).
Before you dismiss the cockamamie argument as just that, I would be loath to not note that the Tax Court has previously found in certain circumstances that an otherwise taxable IRA distribution was not includible in a taxpayer’s gross income when the taxpayer was acting as an agent or conduit on behalf of the IRA’s custodian to carry out an investment. See, e.g., Ancira v. Commissioner, 119 T.C. 135, 138 (2002); McGaugh v. Commissioner, T.C. Memo. 2016-28.
However, and it’s a big however, the Tax Court has also held that when a distributee has “unfettered control” over an IRA distribution, he could not claim that he was acting as a mere conduit or an agent for the IRA custodian with respect to the distributed funds. Vandenbosch v. Commissioner, T.C. Memo. 2016-29.
The Tax Court’s “Difficulty”
The Tax Court noted that it had some “difficulty with the petitioner’s argument,” which is to say, the Tax Court called bullshit. The Tax Court could not conclude that Ball LLC was acting as an agent or conduit on behalf of Chase (as custodian of the IRA) when Ball LLC received and made use of the distributions. To begin with, Chase had no knowledge of the disposition of the $210,000 that it deposited into the Ball Account other than that it made the deposits at petitioner’s direction. The petitioner controlled Ball LLC, and nothing in the record convinced the Tax Court that the petitioner did not have unfettered control over the $210,000 Ball LLC received from Chase.
Although, it is true that the petitioner caused his LLC to lend the distributions nominally for the benefit the Ball Account, the Tax Court found that he could have just as easily have made the loans in his own name.
But, But, the LLC
Alternatively, the petitioner argues that the funds were deposited into an LLC, not into his own checking account. Amounts paid or distributed out of an IRA are included in gross income by the payee or distributee in the manner provided under IRC § 72. See IRC § 408(d)(1). While neither the statute nor the regulations define the terms “payee or distributee,” the Tax Court has held that generally, the payee or distributee of an IRA is the participant or beneficiary who is eligible to receive funds from the IRA. Roberts v. Commissioner, 141 T.C. 569, 576 (2013). In some cases, the general rule is inapplicable. Id. at 582 (holding that a taxpayer is not a payee or distributee within meaning of IRC § 408(d)(1) with respect to improper withdrawals from his IRA account without his knowledge by his soon-to-be divorced spouse). However, the mere fact that the distribution is made by the plan administrator to A rather than to B does not, ipso facto, make A the distributee. Darby v. Commissioner, 97 T.C. 51, 58 (1991).
Sadly (for the petitioner) the Tax Court concluded that the IRA distribution (which the petitioner requested) into the petitioner’s LLC’s account (over which he had full control) was actually made to the petitioner (which is 100% correct). Because he was under 59-1/2, the 10% “early withdrawal penalty” of IRC § 72 applied. Because he was completely full of it and failed to report any taxes, the accuracy related penalty of IRC § 6662(a) and (b)(2) (substantial understatement) applied as well.
Interesting Note on IRC § 6751(b)(1) Approval vis-à-vis the AUR Program
The IRS’s burden of production under IRC § 7491(c) includes making a prima facie case that IRC § 6751(b)(1)’s requirement for written supervisory approval has been met. See Kestin v. Commissioner, 153 T.C. 14, 28 (2019); Graev v. Commissioner, 149 T.C. 485, 493 (2017), supplementing and overruling in part 147 T.C. 460 (2016). Nevertheless, IRC § 6751(b)(2)(B) provides an exception from the requirement for penalty approval for a “penalty automatically calculated through electronic means.”
The examination of petitioner’s return was processed through the AUR program. That software program automatically calculated the substantial understatement of income tax penalty through electronic means. Thus, the penalty is within the exception provided under IRC § 6751(b)(2)(B), and the IRS was not required to establish that written supervisory approval had been obtained. See Walquist v. Commissioner, 152 T.C. 61, 73-74 (2019).Add to favorites