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Tax Court – Taxpayer’s direction to IRA custodian to purchase stock didn’t result in taxable distribution

McGaugh, TC Memo 2016-28

The Tax Court has ruled that there wasn’t a taxable distribution to the owner of a self-directed IRA who directed the IRA custodian to wire cash to purchase shares of a private company, where certificates for those shares were apparently delivered after the 60-day rollover period in Code Sec. 408(d)(3). The Court found that the IRA owner was acting as the IRA custodian’s agent. The stock certificates for the purchased stock were issued in the name of the IRA, and the taxpayer had neither actual nor constructive receipt of the stock.  Click here for the Opinion of the Court.

Background. Generally, amounts distributed from an IRA are includible in a taxpayer’s gross income as provided in Code Sec. 72. (Code Sec. 408(d)(1)) However, under Code Sec. 408(d)(3), a distribution is not includible in gross income if the entire amount of the distribution an individual receives is paid into an IRA or other eligible retirement plan (“rolled over”) within 60 days of the distribution. (Code Sec. 408(d)(3)(B)) A distribution rolled over after the 60-day period generally will be taxed (and also may be subject to a 10% premature withdrawal penalty tax). (Code Sec. 72(t))

As an alternative to a rollover contribution (and its one-per-year limitation), the owner of an IRA may direct the IRA trustee to transfer funds directly to the trustee of another IRA. (Rev Rul 78-406, 1978-2 CB 157) Because the funds are never paid or distributed to the IRA participant, no rollover contribution or taxable distribution occurs in a direct transfer between trustees.

In Ancira, (2002) 119 TC 135, the Tax Court ruled that there was no distribution to a taxpayer who maintained a self-directed IRA. In order to invest in the stock of a company that the IRA could hold but that the custodian wouldn’t buy because it wasn’t publicly traded, the taxpayer had the custodian issue a check to him. The taxpayer then delivered the check to the company, and the issuing company issued the stock certificate. The certificate stated that the taxpayer’s IRA was the owner of the stock shares, and the taxpayer presumed that the issuing company had sent the stock certificate to the IRA custodian as instructed. However, for unspecified reasons, the certificate was not delivered to the custodian, and the taxpayer did not discover the mistake until after receiving a notice of deficiency from IRS. After learning of the error, the taxpayer directed the issuing company to send the stock certificate to him, and he then delivered it directly to the custodian. The Tax Court found that the taxpayer acted as an agent for the custodian. The Court further held that the fact that the issuing company didn’t send the stock certificate to the IRA custodian was a mere bookkeeping error that didn’t alter the IRA’s ownership of the stock.

Facts. Raymond McGaugh had a self-directed IRA of which Merrill Lynch was the custodian. The IRA held 10,000 shares of stock in First Personal Financial Corp. (FPFC). This investment was not a prohibited investment for the IRA, but when Mr. McGaugh requested that Merrill Lynch purchase stock in FPFC for the IRA, it refused to purchase the stock directly.

In October of 2011, at Mr. McGaugh’s request, Merrill Lynch issued a wire transfer of $50,000 directly to FPFC. On November 28, 2011, FPFC issued the stock certificate, as Mr. McGaugh had requested, in the name of “Raymond McGaugh IRA FBO Raymond McGaugh.” While FPFC claimed that the stock certificate was mailed to Merrill Lynch on or about the same day as the Nov. 28, 2011 issuance date on the certificate, Merrill Lynch stated that it actually didn’t receive the stock certificate until “early 2012.” For purposes of its deliberations, the Tax Court treated the timing of the transmittal of the stock certificate to Merrill Lynch as being in dispute and assumed it was in 2012—more than 60 days after the wire transfer.

Thereafter, Merrill Lynch attempted to mail the stock certificate to Mr. McGaugh, but it was returned by the postal service at least twice. The record did not show where the original stock certificate currently was located, but the Court assumed (as the IRS asserted) that Mr. McGaugh held it (an assertion he denied).

Believing the transaction to be subject to the rollover rules and the transfer to be outside the Code Sec. 408(d)(3) 60-day limit, Merrill Lynch reported the $50,000 transaction as a taxable distribution on Form 1099-R, “Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.” and refused to treat the FPFC stock as an asset of the IRA.

On audit, IRS determined that the wire transfer issued by Merrill Lynch was a distribution from Mr. McGaugh’s IRA and was includible in gross income under Code Sec. 408(d) and Code Sec. 72. And, because he had not yet reached age 59 1/2, it was an “early distribution” subject to the 10% additional tax of Code Sec. 72(t). IRS issued a notice of deficiency for the tax year, determining a $13,538 deficiency in tax, as well as an accuracy-related penalty of $2,708.

The issue. Whether a transaction involving the removal of $50,000 from Mr. McGaugh’s IRA to purchase stock for his IRA constituted a distribution that was not rolled over within the 60-day period allowed in Code Sec. 408(d)(3), and so was taxable income.

Tax Court’s conclusion. The Tax Court held that Mr. McGaugh did not receive a distribution when Merrill Lynch made the wire transfer to FPFC, and, to the extent that he had control over the wired funds, he at most acted as a conduit for the IRA custodian. Accordingly, the 60-day limitation on a rollover under Code Sec. 408(d)(3) did not come into play. The timing of the mailing of the shares (i.e., more than 60 days after the wire transfer) did not alter the Court’s conclusion that there was no distribution from the IRA to Mr. McGaugh.

The Tax Court determined that there was no distribution from the IRA to Mr. McGaugh. No cash, check, or wire transfer ever passed through Mr. McGaugh’s hands, and he was therefore not a literal “payee or distributee” of any amount. Even if the Court adopted IRS’s interpretation of the transaction—that Merrill Lynch’s wiring of the funds at Mr. McGaugh’s instruction put the funds at Mr. McGaugh’s discretion—and even if the Court acknowledged Mr. McGaugh as the director of the transaction, the outcome didn’t change. The owner of an IRA was entitled to direct the investment of the funds without forfeiting the tax benefits of an IRA. Even acknowledging that Mr. McGaugh “pulled all the strings,” it remained true that the funds the IRA released went straight to the investment and resulted in the stock shares being issued straight to the IRA.

When the Court analyzed the situation for possible “constructive receipt” of the funds from Merrill Lynch by Mr. McGaugh (and constructive transfer of the funds by him to FPFC), the Tax Court, relying on Ancira, found that there was no distribution because Mr. McGaugh acted as a conduit to or an agent of the IRA fiduciary and custodian, Merrill Lynch. Moreover, the facts here were even more convincing than those in Ancira because unlike the taxpayer in Ancira, who received a check from the IRA and delivered it to the issuing company, Mr. McGaugh never personally handled any check by which the IRA funds were transmitted to FPFC. Instead, he requested that Merrill Lynch transfer the funds via wire transfer directly to the issuing company, and that transfer was duly made without Mr. McGaugh’s interposition. And unlike the stock in Ancira, the FPFC stock certificate was sent directly to the custodian.

The Court dismissed IRS’s argument that there was constructive receipt because it appeared that Mr. McGaugh was in possession of the purported stock certificate. The Court determined that even if the taxpayer had physical possession of the stock certificate, he was not in constructive receipt of the asset. The essence of constructive receipt is that funds which are subject to a taxpayer’s unfettered command and which he is free to enjoy at his option are constructively received by him whether he sees fit to enjoy them or not. Here, the stock was issued not in Mr. McGaugh’s name but in the name “Raymond McGaugh IRA FBO Raymond McGaugh.” Mr. McGaugh could not have realized any practical utility or benefit from the certificate in the name of the IRA.

The Court also noted that if Merrill Lynch’s attempts to mail the IRA’s stock certificates to Mr. McGaugh in 2012—contrary to his instructions and intention—gave him ownership of the shares, then that was a distinct 2012 transaction that would not affect his 2011 income tax liability.

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Meet Paul Raymond

Meet Paul Raymond

Mr. Raymond is a sought after speaker in tax controversy law by many attorney, accountant, and business groups and at the request of the Internal Revenue Service, has presented programs at the IRS Nationwide Tax Forum, attended by tax professionals throughout the United States.

Additionally, he continues to be an active member in the Section of Taxation, American Bar Association, where he was the Past Chair of the Employment Taxes Committee.

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