Taxpayer wins partial IRA rollover contribution issue on appeal

Partially reversing the Tax Court, the Eighth Circuit holds that a taxpayer made a timely partial rollover contribution to his IRA.

The Eighth Circuit held that the IRS and Tax Court improperly denied a taxpayer’s claim of a partial qualifying rollover contribution to his individual retirement account (IRA) by ignoring a partial repayment of a distribution made less than 60 days earlier.

Facts: Harry Haury was a software engineer and owner of two businesses developing a national alert warning system for the U.S. Department of Homeland Security. The businesses incurred nearly $4 million in development costs and lacked sufficient cash flow from their operations. In 2007, when he was under the age of 59½, Haury transferred $434,933 to the companies from his IRA in four distributions. Each transfer was matched with an interest-bearing promissory note from the companies under which they were required to repay the IRA trustee on behalf of Haury’s IRA account upon demand.

On April 30, 2007, Haury’s IRA trustee received and deposited into Haury’s account a $120,000 check from one of the businesses. Near the end of the year, Haury demanded repayment of the notes, which an officer of the businesses refused.

Haury did not file a tax return for 2007. The IRS prepared a substitute return and issued a notice of deficiency saying he owed more than $250,000 in unpaid taxes, penalties, and interest, based partly on the IRA distributions and a 10% additional tax under Sec. 72(t). After petitioning the Tax Court, Haury filed a 2007 return claiming a bad-debt deduction for the portion of the loans not repaid to him.

Issues: Before the Tax Court, Haury argued pro se that the April 30, 2007, deposit to his IRA was a qualifying rollover contribution. The IRS, however, pointed out that the contribution amount matched a $120,000 distribution made on Feb. 15, 2007, and argued that it was not a qualifying contribution because it was not made within the 60-day time limit in Sec. 408(d)(3)(A)(i). The Tax Court agreed with the IRS. The court, citing Generes, 405 U.S. 93 (1972), also held that although the loans were bona fide and became worthless during the tax year, Haury’s dominant motivation for making the loans was the protection of his investments in the companies, so the loans were nonbusiness debt under Sec. 166(d) and not deductible.

Before the Eighth Circuit, Haury, now represented by counsel, argued that the $120,000 IRA contribution on April 30 was a qualifying partial rollover of a $168,000 IRA distribution made on April 9, less than 60 days before the contribution. The IRS now argued that Haury had forfeited the partial rollover issue by failing to raise it in the Tax Court and alternatively argued that Haury was not entitled to treat the repayment as a partial rollover because he had not proved that he did not make a prior rollover contribution in the year before the repayment. Haury also again argued the loan balances were deductible business bad debts.

Holding: The Eighth Circuit reversed the Tax Court’s decision regarding the IRA rollover, affirmed its decision regarding the bad-debt deduction, and remanded the case to the Tax Court for a redetermination of the deficiency. The Eighth Circuit stated that it was “appalled by the unfairness” of the IRS’s contention that Haury had forfeited the partial rollover issue and dismissed the IRS’s alternative argument as “factually without merit, if not downright silly.” However, the Eighth Circuit found the Tax Court did not clearly err in determining that the debt was nonbusiness.

– Haury, No. 13-1780 (8th Cir. 5/12/14), rev’g in part T.C. Memo. 2012-215

By Laura Jean Kreissl, Ph.D., associate professor of accounting, the School of Business Economics, Thompson Rivers University, Kamloops, British Columbia, Canada, and Darlene Pulliam, CPA, Ph.D., Regents Professor and McCray Professor of Accounting, the College of Business, West Texas A&M University, Canyon, Texas.