In Uncategorized on 06/15/2012 at 17:05

Old-time movie fans will remember S. J. Perelman’s witty rejoinder from the cigar-laden lips of Groucho Marx, in the 1932 classic “Horsefeathers”:

Receptionist: The Dean is furious! He’s waxing wroth!

Groucho: Is Roth out there, too? Tell Roth to wax the Dean for a while.

Well, a couple who wanted their Roths to wax great found themselves on the wrong end of an excise tax for excess contributions to their Roth IRAs in Steven W. Repetto and Gayle F. Repetto, et al., 2012 T.C.Mem.168, filed 6/14/12, with Judge Marvel doing the waxing with a hefty tax.

This was one of the Notice 2004-8, 2004-1 C.B. 333, Abusive Roth IRA Transactions. The taxpayer takes a pre-existing business (here the Repettos were homebuilders), creates sibling entities under common ownership and control (here corporations supposedly providing back-office services), puts the corporate stock into their Roths, and sends down the dividends.

Mr R needed a pastime after retiring from Big Blue, and Mrs R was an engineer looking for new horizons. So they teamed up with a homebuilder, learned the business, and started running it themselves when their mentor became ill.

Their mentor turned them onto an accountant and a tax lawyer, who set up the corporate structure. The Rs already had a corporation in place for asset protection purposes. When the attorney told them that the siblings could be owned by their Roths and channel the dividends to the Roths, Mr R cogently e-mailed said attorney: “We do not meet the rules for a ROTH IRA as our Adjusted Gross Income is to [sic] high. I understand that we can pay a fine as you explained but would our IRA be fraudulent?” Mr. X replied “No”. 2012 T.C. Mem. 168, at p. 10. (Name omitted.)

Well, that e-mail was enough to torpedo the Rs’ defense to the Section 6662A reportable transaction understatement penalties.

Before that, Rs try a Section 7491 burden-of-proof shift, but that fails, since the excise tax is a Subtitle D, and the shift only works for Subtitle A (income) or Subtitle B (estate and gift) taxes. And as usual, Judge Marvel does the preponderance-of-evidence dodge and claims burden of proof irrelevant as to the Subtitle A income tax issues (namely, deductions that Rs’ corporations took and their corporate medical reimbursement plan).

Now a Roth IRA can own C Corp stock, and many do. But the C Corps have to have a substantial business purpose (note that the business activity test of Moline Props., Inc. v. Commissioner, 319 U.S. 436 (1943) isn’t invoked here, and doesn’t help, because the Rs did exactly what they did before the C Corps were created, and ignored whatever contractual arrangements were in place; see my blogpost “Even a Little Substance Matters”, 5/19/11). And the only purpose the sibling C Corps served was to funnel money into the Roths, above the AGI limit, which the Rs clearly exceeded.

Rs tried to argue, relying on Hellweg and Ohsman (see my blogpost “Foolish Consistency,” 5/5/11), that IRS was inconsistent in income tax and excise tax treatments, and therefore the excise tax must fall. No, says Judge Marvel, while IRS didn’t do a Section 482 reallocation among relateds, IRS did knock out the deductions Rs took for payments from its parent to the sibs, and that’s enough to be consistent.

But IRS went too far in assessing penalties, throwing in every item it could find, and not all fit. For details, read the decision.

Takeaway: Let your Roth wax, but keep to the rules.

  1. […] say “seems” because the Legislature has waxed roth before and then settled for half measures.   It is likely that the governing board of the State […]


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