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Individual Who Directed IRA to Purchase Stock Did Not Receive Taxable IRA Distribution

(Parker Tax Publishing July 2017)

The Seventh Circuit held that an individual did not receive a taxable distribution from his individual retirement account (IRA) when he directed his IRA custodian to purchase stock on his behalf but the custodian did not accept the resulting share certificate. The individual did not actually or constructively receive any cash or assets from his IRA for the year at issue, but simply bought stock, which was a permissible IRA transaction. McGaugh v. Comm'r, 2017 PTC 299 (7th Cir. 2017).

Raymond McGaugh opened a self-directed individual retirement account (IRA) with Merrill Lynch, Pierce, Fenner & Smith, Inc. (Merrill Lynch) in 2002. McGaugh's IRA held stock in First Personal Financial Corp. (FPFC) , a privately held company. In 2011, he requested that Merrill Lynch use money from his IRA to buy an additional 7,500 shares of FPFC. When Merrill Lynch declined to make the purchase on McGaugh's behalf, McGaugh called Merrill Lynch and initiated a wire transfer of $50,000 from his IRA directly to FPFC. The transfer occurred in October 2011.

In November 2011, FPFC issued a stock certificate in the name of "Raymond McGaugh IRA FBO Raymond McGaugh" and mailed it to Merrill Lynch. Merrill Lynch claimed to have received the certificate in early 2012. Merrill Lynch did not retain the certificate because it believed the transaction impermissibly exceeded the 60 day window for rollovers of IRA assets under Code Sec. 408(d)(3). Merrill Lynch attempted to send the certificate to McGaugh twice in February 2012, but the post office returned it both times; McGaugh claimed it was mailed to the wrong address. On the second attempt, the envelope was marked as refused. Merrill Lynch then sent the certificate by FedEx and it was not returned. The shares were never deposited into McGaugh's IRA. The location of the certificate was unknown; the IRS contended that McGaugh possessed it, but McGaugh denied that allegation.

Merrill Lynch characterized the wire transfer as a taxable distribution and issued a Form 1099-R, which McGaugh claimed he never received. In 2014, the IRS issued a notice of deficiency indicating that McGaugh had failed to report a $50,000 distribution for 2011. It assessed approximately $13,500 in taxes and a substantial understatement penalty of approximately $2,700. McGaugh filed a Tax Court petition and the Tax Court granted summary judgment in his favor. In doing so, the court noted that the stock certificate bore the name of the IRA, not McGaugh, as its owner. The IRS appealed that decision to the Seventh Circuit.

The IRS argued that even though McGaugh never physically received any cash or other assets from his IRA, he nevertheless took a distribution because he constructively received the proceeds. The IRS's primary argument was that McGaugh constructively received funds from his IRA when he directed Merrill Lynch to wire the money at his discretion to FPFC. McGaugh could not circumvent the rules on taxable income simply by directing a distribution to a third party, the IRS said.

The Seventh Circuit held that McGaugh did not have actual or constructive receipt of any assets from his IRA during 2011, and therefore did not receive a taxable IRA distribution during that time. In the court's view, it was clear that the share certificate was never in McGaugh's physical possession during 2011, nor was there evidence that he had any control over the shares or the rights associated with them that could give rise to a finding of constructive receipt. The Seventh Circuit determined that McGaugh did not direct a distribution to a third party; he bought stock, and such a purchase is a prototypical permissible IRA transaction. Further, there was no indication that McGaugh orchestrated the purchase for the benefit of FPFC or for any reason other than because he wished to obtain stock to be held in his IRA. There was thus no evidence that McGaugh constructively received funds, either in ordering Merrill Lynch to wire funds to FPFC or in any other respect.

For a discussion of taxable distributions from IRAs, see Parker Tax ¶134,535.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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