Criminally forfeited IRA distribution was constructively received and taxable

The Tax Court held that a criminally forfeited individual retirement account (IRA) distribution transferred directly to the United States was constructively received by the taxpayer and therefore was taxable. The court also upheld additions to tax for the taxpayer’s failure to timely file a return for 2017 reporting the distribution and failure to timely pay taxes on it.

Facts: Lonnie Hubbard was a pharmacist in Kentucky. Hubbard was indicted and tried for crimes related to the distribution of controlled substances and listed chemicals, and a jury found him guilty on most counts in the indictment. He was sentenced to 360 months of imprisonment, three years of supervised release, and a criminal monetary penalty. In addition, his property listed in the indictment, including an IRA, was condemned and criminally forfeited to the federal government. Hubbard was incarcerated on Feb. 16, 2017, and remained so during all relevant times during his Tax Court case.

In accordance with the judgment, T. Rowe Price made an involuntary distribution from Hubbard’s IRA to the United States of $427,518. Following the distribution, T. Rowe Price sent Hubbard a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for the 2017 tax year, reporting an early taxable distribution of $427,518. Hubbard alleged that he never received the Form 1099-R because it was mailed to the address that he had shared with his now divorced wife and that she was not communicating with him or forwarding his mail. Hubbard did not file a federal income tax return or make any payments for the 2017 tax year.

The IRS prepared a substitute for return, as authorized by Sec. 6020(b), for Hubbard’s 2017 tax year and notified him that the IRA distribution resulted in a tax liability for 2017. In February 2020, the IRS sent Hubbard a Notice 2566, indicating that, despite prior notices, the IRS still had not received his delinquent 2017 Form 1040, U.S. Individual Income Tax Return, and warned that it would assess tax should he fail to file by March 19, 2020.

Having still not heard from Hubbard, the IRS issued a notice of deficiency on Nov. 16, 2020, indicating a deficiency of $165,353, an addition to tax under Sec. 6651(a)(1) for failure to timely file of $37,204, and an addition to tax under Sec. 6651(a)(2) for failure to timely pay of $28,937.

On Feb. 10, 2021, Hubbard timely petitioned the Tax Court, contesting the deficiency. On March 3, 2023, the IRS moved for summary judgment on the issues of the deficiency and the additions to tax. Hubbard objected to the motion in his response on April 3, 2023.

Issues: Under Sec. 61, gross income includes “all income from whatever source derived” including income that the taxpayer has constructively received. With certain exceptions, pension (Sec. 61(a)(10)) and IRA (Sec. 408(d)(1)) distributions are specifically mentioned as items included in gross income. If Hubbard had received a voluntary distribution that was paid directly to him from his T. Rowe Price IRA account, there would be little doubt that this amount would be included in his gross income. Hubbard, however, argued that because the funds from his IRA were directly transferred to the United States, he never constructively received them and, therefore, they were not includible in his gross income. Additionally, given his incarceration, he asserted, he had reasonable cause for his failure to timely file a return and failure to timely pay the tax shown on the 2017 substitute for return.

Addressing the issue of constructive receipt, the court noted that, under the constructive receipt doctrine, “funds [or other property] which are subject to a taxpayer’s unfettered command and which he is free to enjoy at his option are constructively received by him whether he sees fit to enjoy them or not” (Estate of Brooks, 50 T.C. 585, 592 (1968)). Furthermore, citing its own precedent in Gambina, 91 T.C. 826 (1988), the court found that when “a taxpayer’s funds are criminally forfeited to the USA to satisfy a forfeiture judgment, [the taxpayer is] not relieved of the income tax consequences that would have attached to the funds without said forfeiture.” The court stated that “by forfeiting the funds, the taxpayer has realized the benefits of them and must recognize the funds as gross income to the same extent as if the taxpayer had physically received them” (see Carione, T. C. Memo. 2008-262).

Additionally, in the specific situation where IRA funds have been involuntarily distributed to a third party in a forfeiture, the Tax Court has previously held that these amounts constituted gross income (Rodrigues, T.C. Memo. 2015-178). Ultimately, the court determined that the funds from the IRA that were forfeited to the United States as an involuntary distribution were includible in Hubbard’s 2017 tax year gross income because he “constructively received the funds by having received the economic benefit of the funds through satisfaction of his forfeiture liability to the USA.”

Addressing the issue of the additions to tax for failure to timely file and pay, the court concluded that the IRS had met this burden of production by attaching Hubbard’s IRS account transcript for the 2017 tax year and a valid substitute for return.

Although Hubbard attempted to argue that he had reasonable cause for his failure to file and pay due to incarceration, lack of income since December 2015, and that he did not receive the Form 1099-R, the court was not persuaded. It noted nonreceipt of tax information forms is not an excuse for not reporting income (see Du Poux, T.C. Memo. 1994-448). Similarly, citing its decisions in Llorente, 74 T.C. 260 (1980), and George, T.C. Memo. 2019-128, the court rejected the notion that incarceration is reasonable cause for the failure to file or pay tax. Ultimately, the court found that Hubbard had failed to establish reasonable cause for his failure to file his 2017 tax return or timely pay his tax due.

Holding: The Tax Court held that Hubbard was liable for the 2017 deficiency and additions to tax because he constructively received a taxable distribution from his IRA and failed to prove that he had reasonable cause for his failure to timely file and failure to timely pay. As a result, it granted the IRS’s motion for summary judgment in the case.

■ Hubbard, T.C. Memo. 2024-16

— Matthew Geiszler, Ph.D., is a lecturer in accounting in the Brooks School of Public Policy; John McKinley, CPA, CGMA, J.D., LL.M., is a professor of the practice in accounting and taxation in the SC Johnson College of Business; and Isaac Chasen is a recent graduate of the SC Johnson College of Business, all at Cornell University in Ithaca, N.Y. To comment on this column, contact Paul Bonner, the JofA’s tax editor.