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December 11, 2012

Lessons from Recent Tax Related Rulings on IRAs


As the tax season approaches, many taxpayers are diligently gathering documents in preparation for filing their tax returns. However, as we know, even painstaking preparation can be for naught if the rules are not followed. For IRAs and other retirement accounts, the ramifications are often compounded by early distribution penalties, loss of tax deferred status and unintended tax consequences. As such, extreme care must be taken to ensure that your retirement accounts are operated as required by governing rules and regulations.

The following are highlights of cases in which income tax and penalties were assessed, because of mishandling of retirement assets and misunderstanding of the governing rules (Details will be provided in the next issue of The IRA Authority)

  • Interest on Unintended Distributions Were Taxable

A taxpayer moved amounts from IRAs to certificate of deposits (CD) at other financial institutions, by withdrawing the amounts from the IRAs and subsequently depositing said amounts to the newly opened CDs.

The CDs were opened as ‘regular ‘(non-IRA, non-retirement accounts), which resulted in the earnings being reported as taxable income. According to the details of the case, he thought the CDs were IRAs. As a result, he did not include the income on his tax return, resulting in the IRS issuing a notice of deficiency.

He disagreed with the IRS’ position and the matter was referred to the Tax Court.

After reviewing the facts of the case, the Tax Court agreed with the IRS and provided explanations that supported their position. This included explanation and examples of circumstances under which exceptions can be made, and why such exceptions could not be applied to this particular case.

Lesson: Intention means naught if not supported by action

  •  Earnings Accrued in IRAs are Not Capital Gains

A taxpayer made several withdrawals from her IRAs, and the amounts were included on her (joint) tax return as capital gains and proceeds of sale from securities. As you know, withdrawals from IRAs are required to be treated as ordinary income.

  • When the IRS compared the amounts reported on the 1099-Rs issued for the distributions with the amount reported as IRA distributions on the tax return, they issued a notice of deficiency. The taxpayers challenged the notice and the matter was referred to the Tax Court. The Tax Court determined that there was no authority to support their position, which include their argument that capital gains within the IRAs “increased the cost basis” of the shares of securities. As a result, they were required to pay a penalty of $8,179, in addition to income tax of $44,643.

Lesson: Misunderstanding of the rules governing the taxation of IRAs can be costly

  •  Rollovers After Death

As they say, “every cloud has a silver lining”, and this summary of “Lessons from Recent Tax Related Rulings on IRAs” is no different. Our silver lining is the IRS allowing a rollover to be completed to an IRA, after the IRA owner’s death.

In this case, the IRA owner took the necessary (and proper) steps to complete a rollover. However, due to an error made by the financial institution, the amount was deposited to a regular (non-IRA/nonqualified) account. The amount remained in the nonqualified account until after the 60-day deadline for completing rollovers (we will discuss why the 60-day deadline should not have been an issue in the next issue of The IRA Authority ). The financial institution accepted responsibility for the error.

  • A private letter ruling (PLR) request was filed, requesting a waiver of the 60-day limitation. The IRS approved the request.

Lesson: Intention means everything if supported by action

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Subscribe to The IRA Authority to get details of these cases, and explanations of these and other IRA/employer plan rules/regulations. Where possible, copies of cases and PLRs discussed are included.

By Appleby Retirement Consulting Inc. Theory means more when it is accompanied by practical experience. We excel at explaining IRA and employer plan rules and regulations, because we know and understand the regulations, and we have extensive practical experience.

Written By

Denise Appleby

Denise is CEO of Appleby Retirement Consulting Inc., a firm that provides IRA resources for financial/ tax/legal professionals. She has over 20 years of experience in the retirement plans field, which includes training and technical consultation.

Denise writes and publishes educational /marketing tools for advisors; available at Denise co-authored several books on IRAs

Denise is a graduate of The John Marshall Law School, where she obtained a Masters of Jurisprudence in Employee Benefits, and has earned 5 professional retirement designations.
She has appeared on numerous media programs, sharing her insights on retirement tax laws.


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