An additional tax of 10 percent is charged on premature withdrawals from a qualified retirement plan, SIMPLE plan or IRA. The additional tax is 10 percent of amounts withdrawn that are includible in gross income. The rules and exceptions are intricate enough that they don’t need to be complicated by things like fraudulent withdrawals by a soon-to-be former spouse. But that’s what happened to Andrew Roberts, whose wife withdrew funds from his IRAs without his knowledge.
Although Roberts did not make any request for withdrawals from his AIG SunAmerica or ING accounts during 2008, requests for withdrawals were faxed from his wife’s place of business to both institutions. The resulting withdrawals were deposited in an account controlled by Roberts’ wife, Cristie Smith, and subsequently spent by her during the period of the couple’s divorce proceedings.
The IRS determined a deficiency in Roberts’s 2008 return, asserting he must include in taxable income withdrawals from his IRAs of $37,020 that his former wife took without his knowledge despite the fact that he did not receive any benefit from the withdrawals.
The Tax Court, in Roberts v. Commissioner, 141 T.C. No. 19, held that the $37,020 was not includible in Roberts’s gross income, and was not subject to the additional tax of 10 percent.
Surprisingly, the issue hasn’t been litigated before, according to the Tax Court.
“These facts present an issue of first impression under section 408(d)(1)—whether IRA withdrawals made pursuant to forged withdrawal requests that are not received by the purported distribute or used by the purported distributee for his or her economic benefit are distributions includible in the gross income of the purported distributee under section 408(d)(1),” it stated. “Common sense dictates that the answer must be no, and our findings of fact and analysis support that answer.”
Under the court’s analysis, because Roberts did not request, receive or benefit from the IRA distributions, he was not a payee or distribute within the meaning of section 408(d)(1). However, the IRS said that Roberts had one year to discover and report the unauthorized signatures and that his failure to do so precludes any remedies under Washington law, thus making the distributions taxable to him. In other words, state law would not require ING and SunAmerica to restore any amounts paid from his IRA accounts since he did not report the unauthorized signatures within one year, and therefore he received a distribution within the meaning of section 408(d)(1).
The Tax Court disagreed. “Accordingly, any failure by [Roberts] to exercise his rights under Washington law and any purported benefit he received in the divorce does not affect our conclusion that he was not a payee or distribute within the meaning of section 408(d)(1) in 2008, the year for which [the IRS] determined the deficiency at issue,” it stated.
“We hold that [Roberts] is not a distribute or payee within the meaning of section 408(d)(1) because the IRA distribution requests were unauthorized, the endorsements on the checks that were issued pursuant to the requests were forged, he did not receive the economic benefit of the IRA distributions, and the IRA distributions were not made to discharge any legal obligation of his,” the court said. “Accordingly, we conclude that [Roberts] did not fail to report any income attributable to distributions from his Sun America and ING IRAs in 2008.”
Nevertheless, the court did find Roberts liable for the 20 percent section 6662(a) accuracy-related penalty for a substantial understatement of income tax. Although the return was prepared by and filed by his former wife, he did not disavow the return, nor did he file a different return for 2008.
The takeaway is that the absence of economic benefit to Roberts insulated him, in part, from the consequences of the premature withdrawal.
The non-tax takeaway, if there is one, is that if your marriage is falling apart, keep a close watch on any accounts in which your spouse might attempt to prematurely procure a share.
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