No Income Tax Liability for IRA Withdrawals

Taxpayers are not liable for distributions from their IRAs made without their knowledge and without their consent the U.S. Tax Court ruled.

In 2008, three withdrawals were made from two IRA accounts maintained by the petitioner. Petitioner’s wife made the requested withdrawals and forged the husband’s signature on the three checks that were issued by the IRA’s. She deposited the money in a joint account with her husband, but the account was exclusively used by the wife. The petitioner first learned of the withdrawals when he received IRS Form 1099-R entitled, Distributions from IRAs. In 2009 the parties separated. During the divorce proceedings, the petitioner learned that his wife had deposited the IRA funds in the joint bank account the petitioner did not use. Furthermore, in 2009 the wife told the petitioner that she would prepare a joint tax return for the 2008 taxes. However, without the petitioner’s knowledge, the wife prepared a joint tax return for herself, an individual tax return for the petitioner and she under-reported petitioner’s income by $3,000.00, overstated a credit by $3,000.00 and omitted interest income of $74.00. In addition, the wife claimed petitioner was entitled to a refund of $3357.00 and the refund was deposited into her bank account.

The IRS issued a deficiency notice to the petitioner for the IRA distributions.

Distributions from IRA’s are taxable income and, in addition, subject to a 10% early distribution penalty if the taxpayer is under the age of 591/2. Sec. 408 (d)(1) and Sec. (+)(1).

The Tax Court stated that neither the Internal Revenue Code nor the Treasury Regulations define the terms “payee” or “distributee” and the code and applicable regulations do not provide specific guidance on when an amount is to be considered have been paid or distributed to a payee or distributee under Sec. 408 (d) (1).

 
However, the Tax Court said that “distributee” is not necessarily synonymous with recipient. In this case the distributions were unauthorized and completed without petitioner’s knowledge and the petitioner did not receive any benefit, directly or indirectly, from the withdrawal. The petitioner is not liable for the income tax liability and not liable for the 10% early withdrawal penalty

For any questions or concerns, please feel free to contact the law office of Arlington Heights attorney Robert S. Thomas. 

LAW OFFICE OF ROBERT S THOMAS

1655 N Arlington Heights Rd, Suite 300West

Arlington Heights IL 60004

847-392-5893 phone
info@attorneyrobertthomas.com

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Deducting Mortgage Interest Payments Made by a Third Person

The United States Tax Court ruled that paying a siblings mortgage may not be deductible by the party making the payment unless the payor can establish that the payor has assumed the benefits and burdens of ownership of the property (equitable interest).

In this case, brother and sister lived together. The brother was the legal owner of the house, but the sister made the mortgage payments after the brother became unemployed. The IRS does not allow a deduction of mortgage interest by the sister. The sister claimed she had an equitable interest in the property since she lived on the property.

The IRS does not allow a deduction for mortgage interest where the taxpayer does not establish “legal or equitable” ownership of the mortgaged property. 

1.  Sec. 163 allows a deduction for interest paid or accrued for a mortgage on real estate of which the taxpayer is legal or equitable owner, even though the taxpayer is not directly liable on the bond or note secured by such a mortgage. The U.S. Tax Court stated it disallows a deduction for mortgage interest where the taxpayer does not establish legal or equitable ownership of the property. Legal ownership means the taxpayer’s name is on the deed. Equitable ownership means the taxpayer has assumed the benefits and burdens of owning the property even though the taxpayer may not be on the deed to the property. 
2.  State law determines property rights and Federal law determines the appropriate tax treatment of those rights. 
3.  The property is located in California. Under California property law, the legal owner is presumed to be the owner of full beneficial interest and this presumption may be rebutted by clear and convincing evidence.

Under Federal tax law, certain factors are considered by courts to determine whether a taxpayer has assumed the benefits and burdens of ownership by considering whether a taxpayer had any rights to the property including, but not limited to the following: (1) to possess theproperty and to the use, rent and profits of the property; (2) duty to maintain the property; (3) responsible for insuring the property; (4) assumed the risk of the loss of the property; (5) obligated to pay taxes, assessments, and charges against the property; (6) has the right to improve the property; and, (7) to obtain legal title at any time by paying the balance of the purchase price.

In the case, the sister offered no evidence that she had an agreement with her brother entitling her to any of the above enumerated factors.       

Qualified Domestic Relations Order (QDRO)

A qualified domestic relations order (QDRO) is a court order or judgment that requires that all or a part of a person’s participant retirement benefits be paid to a spouse, former spouse, child or other dependent of the “participant.” The recipient of the retirement benefits is called the “alternate payee.” Administrators of pension, profit sharing, or stock bonus plans (retirement plans) must give their written approval to a proposed QDRO. A QDRO must contain specific language that identifies the retirement plan, names and addresses of the participant and alternate payee, and the amount and total number of payments to the alternate payee under the QDRO.

When the alternate payee is the spouse or former spouse, then the alternate payee pays income taxes on the QDRO payments. If the alternate payee is a child or other dependent, then the participant pays income taxes on the QDRO payments.

 If the participant under the retirement plan would have been eligible for a rollover, then the alternate payee may make a tax free rollover to a traditional IRA or to a qualified plan. If the plan participant was born before 1936, the distribution may be eligible for special averaging for tax purposes if the distribution meets an IRS lump sum distribution test. If the distribution meets the IRS requirements, the recipient qualifies for a 10 year averaging and 20% capital gains. If the plan participant was born after 1935, the alternate payee is not eligible for the special tax treatment.

For any questions or concerns, please feel free to contact the law office of Arlington Heights attorney Robert S. Thomas. 

LAW OFFICE OF ROBERT S THOMAS

1655 N Arlington Heights Rd, Suite 300West

Arlington Heights IL 60004

847-392-5893 phone
info@attorneyrobertthomas.com

Se Habla Español

The Minimum Interest Rate for Mortgages

The price that a purchaser is willing to pay for property will increase if the purchaser can obtain financing on favorable terms, whether the financing is provided directly by the seller, from a third party, or in the assumption of a mortgage. The latter category includes: the buyer acquires the property “subject to the debt” without taking on personal liability; the buyer and seller are jointly or severally liable for the debt; or, the buyer becomes liable for the debt and the seller is released from liability.

Under the Deficit Reduction Act of 1984 (DEFRA), Congress added Section 7872 to the Internal Revenue Code in 1984 so that interest free loans and below market loans would be taxed in accordance with their economic substance. Section 7872 operates by imputing interest on loans that do not charge a market rate of interest.

A loan is any extension of credit including purchase money mortgage, in which the owner of money permits another person to use the money for a period of time after which the money is to be transferred to the owner or applied accordingly to an express or implied agreement with the owner. Treas. Reg. {1.7872-2(a)}.

A taxpayer’s characterization of a transaction as a prepayment or loan is not conclusive. Transactions will be characterized for tax purposes according to their economic substance rather than the terms used to decide them. Id.

A below market loan is a loan that does not require payment of interest at a rate at least equal to the Applicable Federal Rate (AFR). Treas. Reg. {1.7872-3(a)}.

The AFR is divided into three categories: (1) A short-term rate that applies to loans having a maturity of three years or less; (2) A mid-term rate that applies to loans having maturity of more than three years or less than nine years; and (3) A long-term rate that applies to loans having a maturity of nine years or more from the date of issue. Sec. 1274(d).

The rates are determined by the Treasury Department within 15 days after the close of six month periods ending on September 30 and March 31. The rates determined to reflect the average yield for a six month period ending on September 30 are applicable during the six month period beginning on January 1 of the succeeding calendar year. The rates determined to reflect the average yield for the period beginning on the following July 1. Treas. Reg. {1.7872-3(b)(1)}

Sec. 7872 does not apply to any loan which has sufficient states interest. A loan has sufficient interest if it provides for interest on outstanding loan balance as a rate no lower than the applicable Federal rate based on compound period appropriate for the loan. Treas. Reg. {1.7872-3(3)(c)}.

The term demand loan means any loan which is payable in full at any time on demand of the lender. It includes any loan with an indefinite maturity and any loan if the benefits of the interest arrangements of such loans are not transferable and are conditioned on the future performance of substantial service by an individual. Sec. {(7872(e)}.

The AFR for demand loans is the short term AFR. The demand loan becomes a below market loan if the interest payable on the loan is at a rate less than the applicable AFR. Sec. {7872(e)}.

The amounts of the loan are treated as transferred and re-transferred on a daily basis and the applicable Federal rate for any day is the relevant rate for the six month period in which such day falls. Tax Management Sec. 535 p. B-409.

A term loan is any loan that is not a demand loan. The applicable Federal rate is the rate for the day the loan is made and the relevant rate is determined by the reference to the term of the loan short-term, mid-term or long-term rate. Sec. {7872(e)}. A term loan becomes a below market loan if the amount loaned exceeds the present value of all payments under the loan, determined as of the day the loan is made, using a discount rate equal to the applicable Federal rate in effect on the day of the loan is made. Treas. Reg. {1.7872-3(a)(2)}.

Finally, the amount of loaned means the amount received by the borrower. 

For any questions or concerns, please feel free to contact the law office of Arlington Heights attorney Robert S. Thomas. 

LAW OFFICE OF ROBERT S THOMAS

1655 N Arlington Heights Rd, Suite 300West

Arlington Heights IL 60004

847-392-5893 phone
info@attorneyrobertthomas.com

Se Habla Español