Take-Away: Whenever an IRA owner engages in a rollover transaction it would be wise to file a ‘protective’ Form 5329 to start the 3-year statute of limitations running on the transaction if an excise tax is later asserted by the IRS.

Background: Distributions from an IRA are generally taxed as ordinary income under IRC 71. [IRC 408(d)(1).] Any part of the distribution that represents a return of basis is excluded from income. [IRC 72(b).] If, however, the individual rolls the distribution from one IRA into a second IRA within 60 days of receiving the distribution, then the distribution is ignored for tax purposes. [IRC 408(d)(3)(A).]

Excise Taxes: When the 60-day deadline is missed, then the distribution is taxed as ordinary income, and if the individual is under age 59 1/2, then a 10% excise tax is imposed for that ‘early distribution.’ An annual 6% excise tax is also imposed if an excess contribution is made to an IRA which is not timely corrected, i.e. removed from the IRA. [IRC 4973(a).] This 6% excise tax is imposed each year until the excess contribution, plus earnings, is eliminated.

Form 5329: Each year where the IRA owner has an excess contribution, the owner must file IRS Form 5329. Only when a Form 5329 is filed will the three year limitation period on assessments of the excise tax start to run. [IRC 6501(a).]

IRA owners often get confused- the income tax on an early IRA distribution is not the same thing as an imposed excise tax. Even when the statute of limitations has run on the rollover distribution that should have been reported by the IRA owner as ordinary income, that same limitations period does not run when the IRA owner failed to file Form 5329 with regard to a corresponding excise tax. A recent Tax Court decision reinforces this distinction.

Clair R. Couturier, Jr. v. Commissioner, Tax Court Memo, 2022-69 (July 6, 2022)

Facts: Mr. Courturier was the president of a company owned by TEOHC. Through TEOHC Mr. Couturier participated in 4 separate deferred compensation plans: an ESOP, a non-qualified deferred comp plan, an incentive stock ownership plan, and something called a Value Enhancement Incentive. In 2004 as part of a corporate reorganization, Mr. Couturier negotiated a buyout, whereby TEOHC would contribute $26 million to Mr. Couturier’s IRA in exchange for his interest in his ESOP and the other three deferred compensation plans. On his 2004 income tax return, Mr. Courturier did not report the $26 million as income; rather, while he reported the distribution he indicated that it was a nontaxable rollover contribution to his IRA. Neither did Mr. Courturier report any amount of excise tax due nor did he file a Form 5329 (ever.)

Excise Tax: The IRS did not get around to asserting any tax deficiency until 2016, long after the 3-year statute of limitations had run on the taxable distribution Mr. Courturier received. The IRS claimed that the ESOP shares were worth about $830,000, which could be rolled over into the IRA. However, the rest of the $26 million represented the three deferred compensation plans; unfortunately, those three deferred comp plans were not ‘qualified plans’ and thus they could not be validly rolled over into the IRA. The upshot was that close to $25 million deposited into the IRA in 2004 was a taxable distribution to Mr. Couturier, resulting in an annual excise tax imposed of 6% going back to 2004 and continuing each year through 2016. In short, the IRS asserted a deficiency for the non-payment of the 6% excise tax of $8.5 million.

Issue: Mr. Couturier claimed that the IRS was precluded from asserting the excise tax liabilities because it had failed to assert the income tax liabilities arising from the same transaction. Restated, Mr. Couturier argued that due to the interplay between the excise tax and the income tax on the 2004 ‘erroneous’ rollovers were inextricably intertwined so that the IRS could not assert the excise tax without also asserting the income tax which it was barred from doing.

Tax Court: The Tax Court Judge found that excise taxes are not income taxes, and because Mr. Couturier had failed to file any Form 5329s the statute of limitations never ran on his failure to pay the annual 6% excise tax on the excess contributed amount to his age IRA.

Nothing in the statute, regulations or even internal IRS guidance makes the assertion of an income tax deficiency a precondition for determining an excise tax deficiency for the same year.”

“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.” 

Observation: One of the problems with an excise tax is that the individual IRA owner seldom knows that he/she has made an excess contribution.  IRA owners who mess up their IRA rollovers will not always know that they screwed up. Accordingly, if the IRA owner sees no reason why they screwed up, they have no reason to file a Form 5329. Thus, the failure to file a Form 5329 means that an IRA owner leaves himself/herself open forever to potential excise tax liability.

Conclusion: A sensible practice would be to always file a Form 5329 whenever there is a rollover in a given year, even if the amount of the excise tax that is reported on that Form is $0.00. Filing a Form 5329 will at least start the 3-year IRS limitations clock running under IRC 6501.