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By Kathleen Ford Bay, Esq.
Lippincott Phelan Veidt PLLC, Austin, TX
In Fish v. Commissioner,1 the Tax Court held that a taxpayer was not entitled to a deduction for stock portfolio losses realized inside his individual retirement account (IRA). In reaching its decision, the Tax Court rejected the taxpayer's assertion that an IRA was analogous to a grantor trust whose income and loss items were reportable on his individual return. Instead, the Tax Court concluded that the IRA was tax exempt and that transactions internal to the IRA did not have income tax consequences to the account holder except upon distribution.
Taxpayer claimed a deduction on his 2009 income tax return for losses of approximately $89,000 on the stock portfolio held in his traditional IRA, which reduced his income tax liability by approximately $15,500. Taxpayer's IRA had received K-1s showing these losses. Taxpayer, a semi-retired patent attorney, had also received distributions from his IRA of about $40,500 (whether this was a voluntary withdrawal or a required minimum distribution is not indicated).
The IRS challenged the deduction on the grounds that per §72,2 §408(d), and §7701(a)(37), a loss from investments in an IRA can be recognized only when the IRA has been completely distributed and the basis of assets in the IRA is greater than the total of what has been distributed. Conversely, Taxpayer asserted that an IRA was like a grantor trust and, therefore, a "passthrough entity." From a policy perspective, Taxpayer argued that restraining the ability to deduct losses in the IRA "thwarts Congressional intent to encourage individuals to save for retirement." Additionally, Taxpayer contended that forcing a retiree to liquidate his IRA in order to claim the losses on his income tax return was "unreasonable, arbitrary, capricious and completely unworkable for savers dependent upon IRA/SEP income for their retirement."
Tax Court Analysis
In reaching its decision, the Tax Court noted that an IRA is a tax-exempt entity, not a pass-through entity.3 As such, the Tax Court concluded that it was clear that no losses could be taken by an account holder for assets in an IRA that was still in place. The Tax Court further noted that it must decide "cases on the basis of the law enacted by Congress rather than a taxpayer's policy arguments on how the law should have been written."
In addition to disallowing the loss deduction, the Tax Court upheld the imposition of an accuracy-related penalty under §6662(a). A 20% accuracy-related penalty is imposed on any portion of an underpayment of tax attributable to: (1) negligence or disregard of rules and regulations; or (2) a substantial understatement of income tax.4 Negligence includes any failure to make a reasonable attempt to comply with the Code.5 Disregard includes any careless, reckless or intentional disregard.6 An understatement of tax is deemed to be substantial if it exceeds the greater of (1) 10% of the tax required to be shown on the return or (2) $5,000.7
The Tax Court concluded that the understatement of income tax for 2009 was substantial because it resulted in a deficiency of $15,439, which exceeded the greater of $5,000 or $2,307, which was 10% of the amount that should have been shown on the return. Additionally, the Tax Court concluded that the position the Taxpayer had taken on the return was not supported by the law and/or regulations, only by a tax policy argument, and that a "seasoned attorney would not have taken the position petitioner took on his return," thereby implying that the understatement was also due to a disregard of the rules and regulations.
Here, the cleverness of taxpayer's argument that an IRA was like a grantor trust did not resonate with the Tax Court. Although Taxpayer was a semi-retired patent attorney, not a tax attorney, as a "seasoned" attorney, Taxpayer should have known better than to make an argument that had no support in the Code, Treasury regulations, or case law, no matter how clever.
This commentary also appears in the January 2016 issue of the Estates, Gifts and Trusts Journal. For more information, in the Tax Management Portfolios, see Kennedy, 367 T.M., IRAs, and in Tax Practice Series, see ¶5610, IRAs.
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