The Tax Court held that transfers under a subcontracting agreement from a taxpayer's S corporation to a corporation owned by the taxpayer's Roth IRA were excess contributions to the Roth IRA and that the taxpayer was liable for the 6% excise tax on excess contributions under Sec. 4973. The court agreed with the IRS that the transactions were abusive and designed to avoid Roth IRA contribution limits. The court also held that the S corporation had unreported income due to the transfer, additions to tax under Secs. 6651(a)(1) and (a)(2), and an accuracy-related penalty under Sec. 6662.
Facts: The taxpayer, Brian Polowniak, was a business consultant who founded Solution Strategies Inc., an S corporation, in 1997. Polowniak was Solution Strategies' sole shareholder, officer, and director. Furthermore, Polowniak was the only person who provided consulting services on the company's behalf. In 2001, Delphi Automotive Systems awarded a $680,000 contract to Solutions Strategies for Polowniak's consulting services.
In 2001, Polowniak founded a C corporation, Bevco Investments Inc., of which he was the sole officer, director, and employee. Several days later, at the advice of a promoter of "privately owned Roth IRA corporations" (also known as private IRA corporations, or PIRACs), Polowniak opened a Roth IRA and made an initial contribution of $2,000. To facilitate the PIRAC arrangement, the Roth IRA purchased 98% of Bevco's stock, with the remaining 2% subscribed to Polowniak's administrative assistant.
Solution Strategies and Bevco entered into a subcontracting agreement under which Solution Strategies would pay Bevco 75% of the revenue expected for the contract with Delphi. In exchange for the payment, Bevco was to provide specified services by Polowniak. This was the only contract executed between Bevco and Solution Strategies. Delphi was unaware of the subcontracting agreement. Throughout Bevco's existence, its only source of revenue was deposits made by Solution Strategies and returns on investments within its accounts. Bevco never had an address, email account, or phone number assigned to it.
In 2011, the IRS issued notices of deficiency for 2004 and 2005 for income taxes, interest, penalties, and excise taxes on excess contributions to the Roth IRA.
Issues: A taxpayer's total annual contribution to a Roth IRA is limited by Secs. 408A(c)(2) and (c)(3). Sec. 4973 imposes an excise tax of 6% for excess contributions.
In Notice 2004-8, titled "Abusive Roth IRA Transactions," the IRS announced that it was cracking down on transactions described in the notice and those deemed substantially similar, in which an individual attempts to avoid IRA contribution limits. The transactions involve an individual's preexisting business, a Roth IRA, and a corporation substantially all of whose shares are owned or acquired by the Roth IRA.
Issues before the Tax Court included whether Solution Strategies had additional gross receipts of $680,000 for 2004, whether Polowniak was liable for excise tax on excess contributions to a Roth IRA under Sec. 4973 for 2004 and 2005, whether Polowniak was liable for additions to tax under Sec. 6651(a)(1) and Sec. 6651(a)(2) for failure to file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, and whether Polowniak was liable for an enhanced accuracy-related penalty.
Holding: The Tax Court determined that Solution Strategies had additional unreported gross receipts of $680,000 in 2004. Solution Strategies received the 2004 Delphi annual payment pursuant to a written consulting agreement between Solution Strategies and Delphi, and Delphi issued the payment to Solution Strategies under the terms of that contract. Therefore, under the assignment-of-income doctrine, the $680,000 payment was gross income to Solution Strategies for 2004 that it could not assign to Bevco.
With regard to the excess contributions, the court found that the transfers between Solution Strategies and Bevco were, in substance, a mechanism substantially similar to those described in Notice 2004-8 for transferring value into Polowniak's Roth IRA, and, therefore, the transfers should be considered contributions to his Roth IRA that were subject to excise tax under Sec. 4973. The court observed that the arrangement between Solution Strategies and Bevco was devoid of "normal business dealings," with no accounting of specific work Bevco performed on behalf of Solution Strategies, and with Polowniak the only person performing services for Delphi, as he had before Bevco's formation.
Because Polowniak did not argue that he had reasonable cause for his failure to file Form 5329, the court held he was liable for an addition to tax under Sec. 6651(a)(1) and an addition to tax for failure to timely pay the tax under Sec. 6651(a)(2). Finding that the transaction Polowniak executed was the same as or substantially similar to the listed transaction described in Notice 2004-8, the court also upheld the IRS's assessment of a 30% penalty on the amount of an understatement under Sec. 6662A due to Solution Strategies' unreported gross receipts in 2004.
- Polowniak, T.C. Memo. 2016-31
—By Maria M. Pirrone, CPA, LL.M., assistant professor of taxation, St. John's University, New York City.