Judge: Taxpayers get advice from IRS 'at their own peril'
In a tax case, a US judge ruled that the agency's published guidelines don't hold up in court.
This post comes from Janet Novack at partner site Forbes.com.
Before filing your 2013 tax return, did you consult an Internal Revenue Service publication for clarification of some confusing point?
That's living dangerously.
Or so a U.S. Tax Court Judge declared this week. "Taxpayers rely on IRS guidance at their own peril," Judge Joseph W. Nega wrote in an order entered on April 15th -- an order denying a motion that he reconsider his earlier decision to penalize tax lawyer Alvan L. Bobrow for making an IRA rollover move that IRS Publication 590, Individual Retirement Arrangements (IRAs), says is allowed.
Technically, Nega denied the motion as moot, since Bobrow and his wife Elisa had reached a settlement with the government. But the judge wrote in his order that IRS guidance isn't "binding precedent" or even sufficient "substantial authority" to get a taxpayer excused from penalties if he follows that guidance and the IRS’s interpretation of the tax law turns out to be wrong.
Huh? Sound unfair? Some of the nation’s most prominent tax lawyers sure think so.
In a friend of the court brief urging Nega to reconsider his original decision, the Board of Regents of the American College of Tax Counsel had argued that it undermines public confidence in the tax system to tell taxpayers who have followed the IRS's own guidance that they "have made an error with potentially catastrophic financial consequences."
Nega was unimpressed. He cited in his order Tax Court and Appeals Court decisions holding that IRS published guidance doesn’t count in court and added that he had been well aware of what Pub 590 said before his original ruling.
At issue in the Bobrows’ case is a decades old provision of the tax code -- 408(d)(3) -- that allows IRA owners, once a year, to withdraw funds from an IRA without having the money taxed or subjected to the 10 percent early withdrawal penalty so long as they redeposit the cash, or roll it over to a different IRA, within 60 days after the date of withdrawal.
In proposed (but never finalized) regulations issued in 1981 and in editions of Publication 590 since 1984, the IRS has told taxpayers that the one-a-year restriction applies separately to each IRA. (The restriction doesn’t apply at all to IRA rollovers done in an IRA custodian to IRA custodian transfer—say, when JPMorgan Chase JPM transfers money directly to Fidelity Investments , only to those transfers in which the taxpayer takes possession of the funds, however briefly.)
Alvan Bobrow, a leader of Mayer Brown’s tax practice and former General Tax Counsel for CBS Inc., took $65,064 out of two separate IRAs in 2008 and redeposited the same sum in each IRA within the 60 day window. On the Bobrows' joint 2008 1040, Alvan treated both withdrawals as qualified rollovers and not taxable distributions. (A fuller explanation of the case is here.)
In his original January decision, Nega ruled that Alva Bobrow's second 2008 withdrawal wasn't a qualified rollover because the “plain language” of the law makes it clear that the once a-year rollover restriction applies to all of a taxpayer’s IRAs combined. He also found the Bobrows liable for a 20 percent substantial underpayment penalty on the extra taxes that resulted from the failed second rollover.
Last month, the IRS issued a notice stating that it intends to adopt Nega's Bobrow decision and limit 60-day rollovers to one per taxpayer a year, but only beginning on Jan. 1, 2015, to give IRA custodians (and presumably the IRS itself) time to change their materials. In settling the case with the Bobrows, the government agreed to give them the same benefit of a prospective (rather than retrospective) policy change, and to treat both of Alvan’s 2008 rollovers as qualified.
The Bobrows, for their part, agreed to pay an extra $28,681 in taxes (including a 10 percent penalty for an early withdrawal before age 59 1/2) and a 20 percent substantial underpayment penalty of $5,736 for not treating as taxable income yet another2008 $65,064 distribution from Elisa Bobrow’s IRA -- one the IRS alleged they failed to repay within 60 days. According to Nega's original decision, the couple put some of the money back in Elisa’s IRA, but on day 61.
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If Congress allows this Tax Court judge's comment to stand--and they probably will, since anything important is beyond their ken--this will erode any remaining remnant of the idea of tax fairness. What it says is a huge boon for tax lawyers everywhere, since just reading and following the published documents is useless. And of course Congress will never do anything to rein in lawyers, one of their biggest cash cows.
Yeah, I know the guy was doing all kind of stupid and unnecessary shenanigans, but the judge's comment is still potentially explosive. They should have changed the documents and said that the new rules apply from the day the changes were published.
For years even fools have known it is playing with weird fire to ever, ever, ever take actual receipt of IRA funds. Even 401(k)-to-an-IRA funds need to be done via custodial transfer ONLY. Period!
But that aside, reread what the Bobrows were doing. What the heck were they doing!? The best I can make of it is, the guy thought he was a sharp operator: Transfer large IRA funds into very short-term cash instruments such as CDs, perhaps at a special teaser rate, and then stuff the funds back into the IRA(s).
It seems obvious his game was strange -- witness his failure on one of the takes-possession-of-IRA funds plays -- he tried to keep it out not for 59 days, but for the full 60 . . . and blew it. My verdict on the guy? Too clever by half.
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