banking finance money kentoh/iStock/Thinkstock

Transfer of IRA Funds Not a Distribution

Taxpayer didn’t make taxable withdrawal, says Seventh Circuit

The U.S. Court of Appeals for the Seventh Circuit recently issued a ruling on whether a taxable distribution occurs when an individual directs his individual retirement account custodian to wire funds directly from his IRA to purchase securities, but his custodian doesn’t accept the resulting share certificate.

Generally, any amount paid or distributed out of an IRA is included in gross income by the payee or distributee.1 In addition, any amount distributed from an IRA must be transferred to an eligible retirement plan no later than the 60th day following the day of receipt to avoid inclusion in the distributee’s gross income.2 

Shares Purchased for IRA, but Rejected by Custodian

In McGaugh v. Commissioner, No. 16-2987 (7th Cir. 2017), Raymond McGaugh had a Merrill Lynch IRA.  In mid-2011, he requested that Merrill Lynch use money from his IRA to buy shares of stock issued by FPFC, a privately held company. For reasons that weren’t clear from the record, Merrill Lynch wouldn’t purchase those shares on McGaugh’s behalf. Because of this, McGaugh called Merrill Lynch and initiated a wire transfer of $50,000 from his IRA directly to FPFC to purchase stock. The stock purchase occurred on Oct. 7, 2011.

On Nov. 28, 2011, FPFC issued a stock certificate titled “Raymond McGaugh IRA FBO Raymond McGaugh,” which was mailed to Merrill Lynch. When Merrill Lynch received the stock certificate in early 2012, however, the company didn’t retain it because it determined the transfer to be outside of the 60‐day IRA rollover deadline. Instead, Merrill Lynch tried unsuccessfully to mail the certificate to McGaugh on two occasions, but each time the correspondence was returned to sender. Merrill Lynch eventually sent the certificate to McGaugh via FedEx, and it wasn’t returned. Merrill Lynch never deposited the shares into McGaugh’s IRA. At the time the case was heard, the location of the share certificate was unknown, and McGaugh denied having it in his possession.

Taxable Distribution?

Merrill Lynch subsequently characterized the Oct. 7, 2011 $50,000 wire transfer as a taxable distribution and issued a Form 1099‐R, which McGaugh claims he never received. The Internal Revenue Service issued a notice of deficiency for McGaugh’s failure to report a $50,000 IRA distribution for 2011. McGaugh then filed suit. The Tax Court sided with McGaugh and held on summary judgment that McGaugh didn’t 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. The Tax Court stated that the timing of the mailing of the shares (that is, more than 60 days after the wire transfer) didn’t alter its conclusion that there was no distribution from the IRA. 

No Taxable Withdrawal

The main issue for the Seventh Circuit was whether McGaugh made a taxable withdrawal from his IRA. While McGaugh never physically received any assets from his IRA, the IRS argued that he took a distribution because he constructively received IRA proceeds in 2011.

Under the doctrine of constructive receipt, a person receives income “not only when paid in hand but also when the economic value is within the taxpayer’s control.”3 Accordingly, constructive receipt occurs when income is credited to a taxpayer’s account, set apart for him or otherwise made available so that he can draw on it at any time. However, there isn’t constructive receipt if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.

The court found that there was no evidence that McGaugh was in constructive receipt of IRA assets. First, the record was clear that McGaugh didn’t constructively receive stock because the share certificate was never in his physical possession. The court also stated that there was no evidence that McGaugh had any control over the shares or the rights associated with the shares. In fact, the court noted that the share certificate was issued in the name of the IRA, rather than in the name of the taxpayer personally. In addition, when McGaugh requested a replacement certificate, FPFC refused to issue one without first receiving indemnification from Merrill Lynch.

The IRS argued that McGaugh constructively received funds from his IRA when he directed Merrill Lynch to wire them to FPFC. The IRS asserted that a taxpayer can’t circumvent the rules on taxable income by directing a distribution to a third party. While the court agreed with this general proposition, it found it inapplicable in this case because McGaugh didn’t direct a distribution to a third party but, rather, he bought stock, which is a permissible IRA transaction. The court further stated that there was no indication that McGaugh orchestrated the purchase for any reason other than because he wanted to invest a portion of his IRA in the stock.

The court concluded that the evidence didn’t support a finding that McGaugh was in actual or constructive receipt of funds from his IRA; therefore, he didn’t take a distribution from his IRA in 2011. Accordingly, the judgment of the Tax Court that no taxable IRA distribution occurred was affirmed.

Endnotes

1. Internal Revenue Code  Section 408(d)(1).

2. IRC Section 408(d)(3).

3. United States v. Fletcher, 562 F.3d 839, 843 (7th Cir. 2009).

 

Hide comments

Comments

  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.
Publish