No, Not a Misprint – The Day of the IRA
Judge Wherry pitches a double-header today, coming off the July 4 layoff, with Ronald V. and Donna-Kay Swanson, 2011 T.C. Mem. 156, filed 7/5/11, and Robert K. and Joan L. Paschall, 2011 T.C. 2, also filed 7/5/11.
The facts in the two cases scarcely differ in any material respect. Both Messrs. Paschall and Swanson are high-priced engineers with major corporations, at or near retirement. Both had traditional IRAs, either self-started or rollovers from 401(k)s. Both faced heavy-duty income taxes on MRDs or earlier withdrawals, and both had heard about converting to Roths. The bad news, even if one could meet the $100K or less MAGI and could convert without limit at that time, was that one would have to pay income tax on whatever portion of the IRA being converted exceeded one’s basis (and basis was basically contributed post-tax dollars; but one couldn’t contribute post-tax dollars if one was a participant in a qualified plan, and both were). What to do?
Enter Jim Patton, financial adviser. He counseled both Messrs. Paschall and Swanson to talk to A. Blair (“Smokey”) Stover, then a partner at Grant Thornton, at the time the fifth largest accounting firm in the country. Smokey had the sorcerer’s stone for converting taxable IRAs into non-taxable Roths, without paying income tax in between. For a mere $120K, payable out of one’s IRA, Smokey would work his magic, and Grant Thornton would defend and indemnify Messrs. Swanson and Paschall from and against interest and penalties.
Sounds too good to be true? It was. Smokey bit the dust in US v. Stover, 731 F. Supp. 2nd 887 (USDC W. Dist. Mo,, St. Joseph Div., 2010), wherein the IRS got a permanent injunction against Smokey’s shennanigans. And Judge Wherry takes judicial notice of Smokey’s crash-and-burn.
What Smokey did was create a pair of shell corporations for each taxpayer, rolled their traditional IRAs into new IRAs in each shell, paid the traditionals into new Roths, merged the shells, and gave taxpayers a “tax-free” distribution out of the “new” Roths. There was no business purpose for the three-card monte game.
Judge Wherry unpacks the transaction, and then disposes of Paschalls’ statute of limitations argument. Paschall filed their 1040s timely, but never filed Form 5329 for any year at issue, and argued that the 5329 was just an addition to the 1040. To demolish this argument, Judge Wherry cites US Supreme Court learning in Com’r v. Lane-Wells Co., 321 U.S. 219, at pp. 223-224 (1944): “[A] taxpayer does not start the statute of limitations running by filing one return when a different return is required if the return filed is insufficient to advise the Commissioner that any liability exists for the tax that should have been disclosed on the other return * * * the relevant inquiry is whether the return filed sets forth the facts establishing liability. * * *”2011 T.C. 2, at pp. 13-1
Paschall’s 1040s made no mention of Smokey’s smoke-and-mirrors IRA game, so no statute of limitations applies. Said Judge Wherry: “Upon review of Mr. Paschall’s Forms 1040, respondent was not reasonably able to discern that Mr. Paschall was potentially liable for a section 4973 excise tax. While a line on each Form 1040, i.e., line 54 for 2000, line 55 for 2001, line 58 for 2002, line 57 for 2003, line 59 for 2004, and line 60 for 2005 and 2006, states “Tax on qualified plans, including IRAs, and other tax-favored accounts. Attach 5329 if required”, Mr. Paschall left these lines blank, giving respondent no indication of his excess contribution.” 2011 T.C. 2, at p. 14.
Swanson did file 5329s, and of course was audited.
Both Swanson and Paschall, seeking to avoid penalties, claimed they relied on Smokey and Grant Thornton. But that avails them nothing, as Smokey and Grant Thornton were promoters of their tax dodge. Reliance on a promoter is not justifiable reliance.
Quoting a favorite of mine, Judge Wherry states: “Courts have repeatedly held that it is unreasonable for a taxpayer to rely on a tax adviser actively involved in planning the transaction and tainted by an inherent conflict of interest. Canal Corp. v. Commissioner, 135 T.C. 199, 218 (2010)….” 2011 T.C. 2, at pp. 23-24.
See also my posting “A Piece of the Action”, 1/9/2011. As I said then: “There are certain pressures against which the better angels of our nature often strive in vain: high on that list is the pecuniary interest of the pressured one.
“In short, tax professional: don’t do it.”