The Art of Borrowing from Your IRA and Rolling Back in Time to Avoid Income Taxation and Penalties

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By Kathleen Ford Bay, Esq.

Lippincott Phelan Veidt PLLC, Austin, TX

 

Background

 

As a general rule, any amount distributed from an individual retirement account (IRA) is includible in gross income of the taxpayer for whose benefit the account is maintained.1 However, a taxpayer may exclude the distribution from gross income if that distribution is returned to an IRA ("rolled over") "not later than the 60th day after the day on which he receives the payment or distribution."2 Even if the taxpayer does not place the entire amount into an IRA by the 60th day, to the extent a partial amount is rolled over, that part is excluded.3 However, if the taxpayer has used the 60-day exception to exclude another distribution within one year prior to the date of the current distribution, then no exception will apply.4

 

Case

 

The Eighth Circuit, in Haury v. Commissioner,5 reversed the Tax Court's rather simplistic denial of the taxpayer's partial rollover of distributions he had taken from IRAs in order to lend the monies, on what hopefully would be a very short-term basis, to two companies which were bidding on a governmental contract and which relied on the taxpayer's software in order to conduct their businesses.

 

To fund these loans, the taxpayer had taken the following distributions: February 15, 2007: $120,000; April 9, 2007: $168,000; May 14, 2007: $100,000; July 6, 2007, $46.933.06; and October 25, 2007: $31.32. Additionally, on April 30, 2007, the taxpayer made a transfer to the IRA of $120,000. The Tax Court concluded that since more than 60 days had passed between February 15 and a transfer to the IRA on April 30, no offset on IRA income was allowed and 100% of the withdrawals were included in taxable income: nearly $435,000. The taxpayer appeared pro se at the Tax Court.

 

The Eighth Circuit was more inclusive than the Tax Court and treated the $120,000 transfer as being a partial rollover of the April 9, 2007 withdrawal. The taxpayer was represented by counsel at the Eighth Circuit.

 

On appeal, the IRS argued that this should not be allowed because the taxpayer had not met his burden of proving in the Tax Court that he had not taken any IRA distributions in the year before the distribution of April 30 and that since this issue had not been raised in the Tax Court, the taxpayer should lose. However, the Eighth Circuit, citing Hormel v. Helvering, responded that "[t]hough we generally do not consider issues not raised below, as the Supreme Court said in a tax case many years ago, we should `where injustice might otherwise result.'" The Eighth Circuit further responded that "the Commissioner argues that we cannot grant relief on the basis of a qualifying partial rollover because Haury failed to prove that he had not made a prior rollover contribution within one year of April 30, 2007. This contention is factually without merit, if not downright silly. As government counsel conceded at oral argument, the IRS had access to the transactions in Haury's IRA account during the year prior to April 30, 2007. Had there been a prior rollover contribution, it would have been a complete defense to Haury's rollover contention, because the one-year limitation in §408(d)(3)(B) applies to all rollover contribution claims, whether complete or partial. Had the IRS's exhaustive review of the transactions in Haury's IRA account revealed a disqualifying prior rollover contribution during the prior year, the Commissioner would have asserted this defense before the Tax Court, making the 60-day limit the Commissioner in fact asserted unnecessary. As the Commissioner did not raise the one-year issue, Haury had no need to address it at trial." [Emphasis added.]

 

Note: There is definitely an art to borrowing short-term from an IRA through the use of the 60-day rollover. Taxpayers should not borrow from IRAs without prior planning and preferably with advice of counsel as the strict timing rules make the technique fraught with dangers.

 

For more information, in the Tax Management Portfolios, see Kennedy, 367 T.M., IRAs,  Mezzullo, 814 T.M., Estate and Gift Tax Issues for Employee Benefit Plans, and in Tax Practice Series, see ¶5610, IRAs, ¶6350, Estate Planning.

 


 

 1 §408(d)(1). Unless otherwise specified, all "Section" or "§" references refer to the Internal Revenue Code of 1986, as amended, and the regulations thereunder.

 2 §408(d)(3)(A)(i).

 3 §408(d)(3)(D).

 4 §408(d)(3)(B).

 5 751 F.3d 867 (8th Cir. 2014).