Take-Away: To start the statute of limitations running on the excise tax that arises with an excess contribution to a qualified retirement account, it is imperative that a Form 5329 be filed for the tax year in question. Even if the statute of limitations runs on the individual’s Form 1040 income tax return, that will not prevent the IRS from pursuing the excise tax for an excess contribution to a retirement account if no separate Form 5329 is not filed.

Background: The Tax Code contains several provisions with regard to ‘Miscellaneous Excise Taxes.’ IRC 4973(a) provides that in the case of any IRA, there is imposed for each taxable year an excise tax in an amount that is equal to 6% of the amount of the excess contributions to such individual’s retirement account. An ‘excess contribution’ is defined as the excess of the amount contributed to an IRA for the taxable year (other than a rollover contribution, per IRC 408(d)(3)) over the amount that is allowable as a tax deduction. [IRC 4973(b)(1).] This 6% excise tax continues to apply to all future tax years until such time as the original excess contribution is distributed to the retirement account owner and that amount is then included in the account  owner’s taxable income. [IRC 4973(b)(2).]

No Conditions to Assessing the Excise Tax: Equally important,  IRC 4973 does not condition the imposition of the 6% excise tax on whether the individual has an income tax liability, whether the individual has filed a tax return, whether the IRS has examined an income tax return, or whether the IRS has issued to the account owner a Notice of Deficiency regarding  their income tax liability. Rather, IRC 4973(a) simply provides that there is imposed for each taxable year an excise tax in an amount equal to 6% of the amount of the excess contributions to the individual’s retirement account. Consequently, the failure of the IRS to examine an income tax return or to challenge a particular position reported on an income tax return does not constitute a concession or admission that the account owner’s position is correctly reported. While the IRS may be legally precluded by an explicit concession, it cannot be precluded by inaction, inattention, or silence.

Form 5329: The Instructions to a Form 1040 (line 59) indicate that if the account owner has made excess contributions to his IRA, then he must consult with IRS publications to determine whether he was required to file Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax Favored Accounts. An important distinction is that Form 5329 is a separate tax return separate from Form 1040.

Recently the Tax Court affirmed this interpretation that even when the statute of limitations has run out on an account owner’s Form 1040 income tax return, so that no additional assessments of income taxes can be made by the IRS, the failure of the account owner to also file a Form 5329 with regard to the individual’s retirement plan contribution permits the IRS to later assess the 6% excise tax, for each year that the excess contribution fails to be corrected. This led to a 9-figure tax liability.

Courturier v. Commissioner, Tax Court Memo, No. 19714-16 (July 6, 2022)

Facts: In 2004, Mr. Courturier received funds from  the sale of his stock held in an ESOP account. Mr. Courturier also, at the same time, received payment from the stock purchaser for the surrender of his corporate nonqualified deferred compensation plan ($30,000 a month), an Incentive Stock Option plan,  and a synthetic equity interest that he held in the same corporation. Consequently, Mr. Courturier received a single purchase price from the purchaser of $26 million for his ESOP interest, deferred compensation, and his interest in an Incentive Stock Option (ISO) and synthetic equity plans; he was paid $12 million in cash and the remaining $14 million was in the form of a promissory note. Mr. Courturier rolled the cash and promissory note into his IRA. Mr. Courturier was issued a Form 1099-R in 2004 by his employer. Mr. Courturier then reported the $26 million payment on his 2004 Form 1040  income tax return as ‘non-taxable income.’ However, Mr. Courturier did not contemporaneously file Form 5329 with respect to his claimed IRA rollover contribution.

Discovery: This sale transaction with regard to the ESOP was later discovered by the Department of Labor (DOL) when it audited the ESOP transaction (concerned that a prohibited transaction of self-dealing had occurred.) The DOL then referred the transaction to the IRS for further investigation whether the ESOP had engaged in a prohibited transaction. The IRS concluded after its examination that no prohibited transaction occurred with the ESOP and the sale of the corporate stock.  However, the IRS concluded that Mr. Courturier’s stock was worth far less than $26 million reported as the rollover amount.  The IRS concluded that Mr. Courturier’s ESOP stock was worth $830,392, thus leading to an excess contribution to Mr. Courturier’s IRA back in 2004.  In  2016, long after Mr. Courturier filed his 2004 Form 1040, the IRS issued a Notice of Deficiency of $8,476,705. $830,392 was treated as a correct rollover of the value of Mr. Courturier’s ESOP stock to his IRA. The amount paid for Mr. Courturier’s deferred compensation benefit, his ISO,  and his synthetic equity rights in the corporation were classified as interests in a non-qualified plans. In short,  the balance of the $26 million contribution to Mr. Courturier’s IRA, or over $25.1 million, was an excess contribution to an IRA under IRC 4973(a)(1) and (b)(2) generating an excise tax of 6% on that amount for 11 years.

Dispute: Mr. Courturier filed a petition with the Tax Court in which he claimed that the IRS’s Notice of Deficiency was untimely because it was issued after the expiration of the normal 3-year period of limitations [IRC 6501(a)] as well as the 6-year period of limitations. [IRC 6501(e)(3).] He argued that the IRS is legally precluded from asserting any tax deficiencies against him for any of the tax years at issue because the IRS did not assert any income tax deficiency against him in 2004. The IRS responded that excise taxes could be assessed at any time [under IRC 6501(c)(3)] because Mr. Courturier had failed to report his excess IRA contributions on Form 5329, which itself constitutes a separate ‘tax return.’ [IRC 6011.]

Tax Court: In addressing Mr. Courturier’s argument of ‘legal preclusion’ premised on the fact that the IRS did not assert any income tax deficiency against him for 2004, the year of the alleged excess contribution to his IRA, the Court found:

“There is nothing in section 4973 , the Treasury regulations, or any other IRS authority that makes the assertion of an income tax deficiency a precondition for determining an excise tax deficiency for the same year. There are many reasons why the IRS might do the latter without having done the former. The taxpayer may have filed an income tax return, but that return may have eluded scrutiny through the “audit lottery.” The taxpayer may have made an excess contribution but claimed no deduction under [IRC] section 219; there would then be no deduction to disallow and no deficiency to assert. The taxpayer may have failed to file a return, and the IRS may have received no-third-party reports suggesting the need to prepare a substitute for return. Or, the taxpayer may have had no obligation to file a Form 1040 because his gross income was below the filing threshold.”

Nor did the Tax Court find that the IRS had taken an ‘inconsistent position’ as Mr. Courturier claimed. It noted that the IRS had taken ‘no position’ with regard to Mr. Courturier’s 2004 income tax liability. At no point did the IRS examine the Form 1040 for 2004 or make any determination with regard to his income tax liability for 2004.

“But the law is well established: The IRS’s failure to examine a return, or its failure to challenge a particular position that a taxpayer took on a return, does not constitute a concession or admission that the taxpayer’s position was correct…The bedrock principle underlies the well-known maxim that every tax year stands on its own.”

Observation: The Courturier decision raises an interesting question. When should an individual file a Form 5329? If the account owner does not know he/she has made an excess contribution to their IRA, why would they file Form 5329? Many advisors after reading Courturier may simply advise their clients to always file a protective Form 5329 whenever there is an IRA rollover during the year, or if there is any doubt there could be an excess contribution to the IRA. A protective Form 5329 would report zero excise tax, but that would start the 3-year statute of limitations running. Conversely, filing a Form 5329 reporting $0.00 tax due might be the equivalent of raising a red flag with the IRS and thus increase the chance of an IRS audit. As the IRS anticipates a dramatic influx in operating revenues and personnel resulting from the Inflation Reduction Act, the likelihood of triggering an IRS audit in the coming years seems to be greater.

Conclusion: Forms 1040 and 5329 are separate tax returns, each with their own statute of limitations. The failure to file Form 5329 means that the ability of the IRS to audit in search of a 6% excise tax remains open, for each year Form 5329 is not filed and the excess contribution remains in the IRA. Most folks will not encounter an $8.4 million excise tax, but it is a reminder just how punitive the 6% excise tax can be if overlooked.