Can the IRS disallow an IRA 60-day rollover if the intent was to take a short-term loan?

[Guest Fishchick]

My colleague insists that the IRS "busted" someone who took a 60-day rollover and temporarily used the $ for a down payment on a home, but still completed the process within the 60-days. Have you heard of such a case? I have been unable to find anything more about the issue, but I think that Pub 590 is pretty clear:

"You can withdraw, tax free, all or part of the assets from one traditional IRA if you reinvest them within 60 days in the same or another traditional IRA. (2002 590 p. 23).

Am I missing something, or is my friend up in the night?

[Kirk Maldonado]

I've not read the ruling, but I have notes stored on my computer that say that the IRS blessed such an arrangement in PLR 9010007.

[david rigby]

Methinks there are some missing facts.

[Kirk Maldonado]

Here it is. I've not read it, so I can't say whether it comports with the summary of it that I had stored on my computer.

Private Letter Ruling 9010007

Date: December 14, 1989

Taxpayer's Name: ***

Taxpayer's Address: ***

Taxpayer's Identification Number: ***

Years Involved: 1986 and 1987

Date of Conference: None

ISSUES

(1) Is the $1500 to be treated as a premature distribution subject to early withdrawal penalty?

(2) Would the redeposit be considered as an excess contribution subject to penalty?

(3) Can an individual withdraw funds from his Individual Retirement Arrangement (IRA) for personal use and this be considered a rollover as long as he redeposits it back into the same account or into another account at the same bank within 60 days?

1. Facts

On April 11, 1986, the taxpayer deposited $2000 into his IRA for the taxable year of 1985. On May 1, 1986, the taxpayer withdrew $1500 of this amount for his personal use. On June 27, 1986, the taxpayer redeposited the $1500 to the same IRA. The bank issued a 1099-R showing the distribution of $1500. A letter from the bank indicates that the 1099-R was issued in error.

In 1987 the taxpayer made a similar withdrawal. A withdrawal of $1500 was made on October 21, 1987 and the same amount was redeposited on November 4, 1987. The taxpayer showed on the deposit slip “replacement of temporary withdrawal”. The bank deposited this into a certificate of deposit (CD) under the same customer number but into a new separate CD. They treated this as a rollover and apparently did not issue a 1099-R. For purposes of our response, we are assuming that this separate CD funds the original IRA.

2. Applicable Law

Section 72(t) of the Internal Revenue Code provides for a ten percent additional tax on early distributions from qualified retirement plans, including IRAs. Section 72(t)(1) provides that if any taxpayer receives any amount from an IRA, the taxpayer's tax for the taxable year in which such amount is received shall be increased by an amount equal to ten percent of the portion of such amount which is includible in gross income.

Section 4973(a) of the Code provides for a tax on excess contributions to IRAs. In general, in the case of an IRA, there is imposed for each taxable year a tax in an amount equal to 6 percent of the amount of the excess contributions to such individual's IRA (determined as of the close of the taxable year).

Section 4973(b) of the Code provides, in pertinent part, that in the case of IRAs, the term “excess contributions” means the sum of the excess (if any) of (1) the amount contributed for the taxable year to the IRA (other than a rollover contribution described in section 408(d)(3)), over (2) the amount allowable as a deduction under section 219 for such contributions, and the amount determined under this subsection for the preceding taxable year, reduced by the sum of (1) the distributions out of the IRA for the taxable year which were included in the gross income of the payee under section 408(d)(1), (2) the distributions out of the IRA for the taxable year to which section 408(d)(5) applies (certain distributions of excess contributions after the due date for the taxable year), and (3) the excess (if any) of tee maximum amount allowable as a deduction under section 219 for the taxable year over the amount contributed to the IRA for the taxable year.

Section 408(d)(1) of the Code provides general rules for the tax treatment of distributions from an IRA. Generally, any amount distributed out of an individual retirement plan is included in gross income by the payee or distributee as provided under section 72.

Section 408(d)(3)(A)(i) of the Code provides, in general, that the general rule described in section 408(d)(1) does not apply to any amount paid or distributed from an IRA, to the individual for whose benefit the IRA is maintained, if the entire amount received is paid into an IRA for the benefit of such individual not later than the 60th day after the day on which the individual receives the payment or distribution. The individual may make such a rollover of a distribution only once a year.

ANALYSIS

In both cases the taxpayer returned the funds to his IRA within the 60 day time period provided for in section 408(d)(3)(A) of the Code, meeting the rules for a tax-free rollover.

Pursuant to section 72(t) of the Code, the early distribution penalty applies to the portion of a distribution which is includible in gross income. Since the taxpayer's distribution will not be includible in gross income for the taxable years covered in this analysis, such distribution would not be subject to the early withdrawal penalty.

Since section 4973(b) of the Code provides that rollover contributions described in section 408(d)(3) are not included in the definition of the term “excess contributions”, the taxpayer's rolled over amounts are not considered part of an excess contribution to which a penalty applies.

Finally, IRA distributions are tax-free in the year of distribution if the rollover rule under section 408(d)(3) are met. As long as the IRA distribution is redeposited into the same or another qualifying IRA within 60 days of receipt of the distribution, such distribution would constitute a qualified rollover.

3. Conclusion

(1) The $1500 is to be treated as a tax-free rollover not subject to the early withdrawal penalty.

(2) The redeposit is not considered as an excess contribution subject to penalty.

(3) An individual may withdraw funds from his IRA for personal use and this may be considered a rollover as long as he redeposits it back into the same IRA or into another qualified IRA within 60 days.

[Guest Fishchick]

Thanks for the reference. I KNEW I was right about this one.

[Kirk Maldonado]

One caveat. I just had some notes on my computer that I stored some time ago.

I didn't do any research. That being said, my guess is that if the IRS had reversed courses, I would have heard about it or somebody else would have posted a correction. But don't bet the house on this one cite that I don't even know where I got.

[Appleby]

I agree with pax- there seems to be something missing.

As is evidenced by the PLR referenced above, and many other cites including 408(d)(3)(B),an IRA owner may withdraw an amount from an IRA, and the amount will be tax and penalty free if it is rolled over within 60-days of receipt. However, there are cases when this rollover is not allowed----including:

If a distribution occurs from the same IRA within 1 year after the first distribution is received form the IRA (1-year limitation not applicable to distributions used towards the purchase of a first time home)

If the distribution is attributed to an RMD and so on…

If the IRS “busted” someone, then that someone must have conducted a rollover of assets not considered rollover eligible.

Could your friend provide any additional information ?

[Kirk Maldonado]

Could this be the case?

Albert Lemishow v. Commissioner, 110 TC 110, 1993.

TANNENWALD, Judge:

OPINION

P received distributions from individual retirements accounts (IRA's) and Keogh accounts consisting solely of money. P purchased stock with a portion of the distributions. Thereafter, P opened a new IRA and placed the stock in that IRA within 60 days of receipt of the distributions.

[1] Held, secs. 408(d)(3) and 402©, I.R.C., both require that a rollover contribution, from a distribution of money, consist only of money. Thus, P's reinvestments of his IRA and Keogh distributions do not constitute rollover contributions and such distributions are includable in income.

[2] Held, further, the portion of the distributions not invested in the stock, including the amounts for taxes withheld, are includable in P's income.

Respondent determined a deficiency in petitioner's Federal income tax in the amount of $170,968 and an accuracy-related penalty under section 6662(a) 1 in the amount of $34,194 for the taxable year 1993. The issues for decision are:

(1) Whether petitioner's use of distributions from Keogh and individual retirement accounts (IRA's) to purchase stock which was contributed to an IRA constitutes a tax-free rollover contribution;

(2) whether petitioner received a taxable distribution of money not contributed to an IRA; and

(3) whether petitioner is liable for the accuracy-related penalty under section 6662(a).

This case was submitted fully stipulated under Rule 122. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioner resided in Flushing, New York, at the time he filed the petition in this case. During 1993, petitioner was a self-employed accountant.

On December 13, 1993, petitioner completed a subscription agreement to purchase 30,000 shares of GP Financial Corp. stock at $15 a share for a total purchase price of $450,000. The Green Point Savings Bank (Green Point) was responsible for taking the stock orders and payments for the subscription offering.

As of December 1993, petitioner maintained Keogh accounts and IRA's with Green Point and Apple Bank for Savings (Apple). On December 14, 1993, petitioner's account balances in the Keogh accounts and IRA's at Green Point totaled $327,252 and those at Apple totaled $165,695. On December 14, 1993, petitioner made the following withdrawals from his Keogh and IRA accounts (amounts rounded down to the nearest whole dollar):

Type of

Bank Amount Account

---- ------ -------

Green Point $250,651 Keogh

Green Point 50,130 Keogh

Green Point 13,939 IRA

Apple 153,828 Keogh

Apple 6,377 IRA

Apple 5,489 IRA

-------

Total $480,414

Green Point and Apple withheld Federal income tax from the distributions of $50,130.00 and $153,828.00, respectively, in the amounts of $12,532.58 and $30,765.62, respectively.

Petitioner used the net Keogh and IRA distributions ($437,117) plus $12,883 of his own funds to pay the $450,000 purchase price of the GP Financial Corp. stock. On January 28, 1994, petitioner received 25,193 shares of GP Financial Corp. stock, not the 30,000 shares as per the subscription agreement. The 25,193 shares (the stock) at $15 per share cost $377,895. On January 29, 1984, petitioner received a stock purchase refund of $72,105 plus interest from Green Point.

On February 11, 1994, petitioner opened an IRA with Smith Barney Shearson (the Smith Barney IRA). On[pg. 112] February 11, 1994, petitioner deposited the stock into the Smith Barney IRA.

Petitioner did not report any of the Keogh and IRA distributions on his 1993 Federal income tax return. Petitioner claimed a credit for the $43,298.20 in Federal income tax withheld by Green Point and Apple. Respondent determined that all $480,414 of the 1993 distributions (the net amount distributed plus withholding) from petitioner's Green Point and Apple and Keogh accounts were includable in petitioner's 1993 income.

Generally, any amount paid or distributed out of an IRA is included in gross income by the payee or distributee, as the case may be, in the manner provided in section 72. Sec. 408(d)(1). Rollover contributions, however, are not includable in gross income. Sec. 408(d)(3)(A). One type of rollover contribution consists of any amount paid or distributed out of an IRA to the individual for whose benefit the IRA is maintained if “the entire amount received (including money and any other property) is paid into an individual retirement account or individual retirement annuity *** for the benefit of such individual not later than the 60th day after *** [the individual] receives the payment or distribution”. Sec. 408(d)(3)(A)(i). If any amount would meet these requirements except that the entire amount was not rolled over into the new IRA, the portion rolled over within the time limit will be considered as a rollover contribution. Sec. 408(d)(3)(D).

As with IRA distributions, amounts distributed out of Keogh accounts generally are taxable in the year received under section 72. Sec. 402(a). However, to the extent the distribution meets the following requirements, such distribution is not includable in gross income:

(A) any portion of the balance to the credit of an employee in a qualified trust is paid to the employee in an eligible rollover distribution,

(B) the distributee transfers any portion of the property received in such distribution to an eligible retirement plan, and

© in the case of a distribution of property other than money, the amount so transferred consists of the property distributed, [sec. 402©(1).]

Respondent concedes that petitioner's IRA and Keogh distributions were eligible to be rolled over and that the Smith Barney IRA was an eligible plan. [pg. 113]

It is clear from the above provisions that to the extent that petitioner did not reinvest the IRA and Keogh distributions ($480,414 received less $377,895 in stock, or $102,519), those portions are taxable, and we so hold. Whether the portions of the IRA and Keogh distributions used to purchase the stock are excludable from income turns on whether the respective rollover provisions of sections 408(d)(3) and 402© require, since the distributions consisted of money, that petitioner transfer money to the Smith Barney IRA.

Both rollover provisions were enacted as part of the Employee Retirement Income Security Act of 1974, Pub. L. 93-406, sec. 2002(b), (g)(5), 88 Stat. 829, 959-964, 968-969. 2 The purpose of allowing a tax- free rollover from a retirement plan to an IRA was to facilitate portability of pensions. Conf. Rept. 93-1280 (1974), 1974-3 C.B. 415, 502; H. Rept. 93-807 (1974), 1974-3 C.B. (Supp.) 236, 265. The purpose of the IRA-to-IRA transfers was to permit flexibility with respect to the investment of an IRA. H. Rept. 93-807, supra, 1974-3 C.B. (Supp.) at 374; S. Rept. 93-383 (1973), 1974-3 C.B. (Supp.) 80, 214. With respect to rollovers, the legislative history repeatedly speaks in terms of “this same money or property” and “the same amount of money (or the same property)”, both for distributions from an IRA and from a qualified plan. H. Rept. 93-807, supra, 1974-3 C.B. (Supp.) at 374-375; Conf. Rept. 93-1280, supra, 1974-3 C.B. at 502. Section 1.408-4(b), Income Tax Regs., describing rollovers from IRA to IRA, uses the language “if the entire amount received (including the same amount of money and any other property) is paid into an” IRA.

Based on the language of the statutory provisions and the legislative histories of those provisions, we hold that petitioner's use of the distributions from his Keogh and IRA's to purchase stock which he then contributed to the Smith Barney IRA does not constitute a tax-free rollover contribution under section 402© or 408(d)(3), respectively. 3[pg. 114]

Section 6662(a) imposes a penalty of 20 percent of the underpayment due to negligence or disregard of rules and regulations. “Negligence” includes any failure to make a reasonable attempt to comply with the provision of the internal revenue laws; “disregard” includes any careless, reckless, or intentional disregard. Sec. 6662©. The negligence penalty is inappropriate where an issue to be resolved by the Court is one of first impression involving unclear statutory language. Hitchins v. Commissioner, 103 T.C. 711, 720 (1994).

Since this is the first time we have considered the rollover requirements as to the specific character of the property to be transferred, we find for petitioner as to the negligence penalty imposed on the portion of the underpayment attributable to the distributions used to purchase the stock. The record contains no facts pertaining to petitioner's failure to report any portion of the distributions. Thus, we find petitioner liable for the negligence penalty imposed on the portion of the underpayment attributable to the $102,519 not used to purchase the stock.

In keeping with the above holdings,

Decision will be entered under Rule 155.

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1

Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable year at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

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2

These provisions enacted sec. 402(a)(5), which is the predecessor of sec. 402©.

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3

We note that a limited exception to the requirement of a tax-free rollover, that the same property distributed be contributed by the recipient to a qualified plan, was enacted in 1978. See sec. 402(a)(6)(D)(now sec. 402©(6)), added by the Revenue Act of 1978, Pub. L. 95- 600, sec. 157(f)(1), 92 Stat. 2763, 2806. This exception permitted property distributed to be sold and the proceeds contributed during the 60- day period. The narrow scope of this section is reflected in Staff of Joint Comm. on Taxation, General Explanation of the Revenue Act of 1978, Pub. L. 95-600, at 110 (J. Comm. Print 1979). See also Rev. Rul. 87-77, 1987-2 C.B. 115.