Retirement Plan Distributions Are Taxed – Even when You Don’t Actually Receive them

Take-Away: An incapacitated retiree who had her IRA deposited to her bank account was taxed even though she never actually received them.

Reported Decision: Nice v United States, (U.S. District Court, Eastern District of Louisiana) No. 18:7362 (October 16, 2019)

Facts: Mary Ellen Nice (Mary) was the widow after 61 years of marriage. Her husband had died in 2002. Mary’s husband left her with considerable wealth. Their son Chip was named as personal representative of Mary’s late husband’s estate, probably due, in part, to Mary’s age. In 2007 Mary was diagnosed with the initial onset of dementia. Chip moved in with his mother. Shortly after moving in with his mother, Chip began to financially exploit her. Part of the claim regarding Chip’s financial exploitation was that he fraudulently gained access to his mother’s retirement accounts, he caused distributions to be made from those accounts, and he then diverted those distributions for his own personal use. In 2011 Mary’s daughter Julianne got wind of Chips behavior. Julianne claimed that Chip fraudulently had his mother sign a financial durable power of attorney to assist in his financial abuse of her. Julianne sued to remove Chip from Mary’s home and to stop his access to, and control of, Mary’s finances. A temporary restraining order was issued by the court against Chip in 2014. Chip died in 2015. (Divine justice?) On her mother’s behalf, Julianne then filed amended income tax returns for Mary going back to 2006, all of which tax refund requests were denied. Julianne then filed the lawsuit seeking a tax refund of $519,502 (plus penalties and interest) claiming that Mary never received the income because of Chip’s fraudulent diversion of her funds for his own use.  Julianne claimed that these filed tax returns had over-stated Mary’s real income, resulting in her overpayment of income taxes.

Issue: The District Court initially was asked to determine as a matter of law that Mary did not actually, or constructively, receive the funds that were disbursed into her bank account. Later the litigants agreed that constructive receipt was not applicable to the facts. Thus, the focus of the litigants, and the federal judge, was on the whether Mary actually received as income disbursed into her personal bank account and reported on her income tax returns. Mary (presumably through her daughter) argued that she never actually received the distributions because: (i) she was unaware of the funds; (ii) she could not and did not exercise control over the distributed funds; (iii) she was substantially restricted from access to, or using, the funds due to Chip’s control over them; and (iv) she did not in any way benefit from the funds.

Court Decision: It should not come as much of a surprise that the District Judge found that Mary had received these taxable funds from her IRAs, and what Chip did with Mary’s funds was technically irrelevant to the question that they were taxable. The reasons provided by the Judge follow:

• Received is What Counts: Gross income is taxable income from whatever source derived. An item of income is included in the taxpayer’s taxable gross income for the taxable year in which it is received by the taxpayer. [IRC 451] Actual receipt of income occurs when it is reduced to the taxpayer’s possession. [Treasury Regulation 1.451-2(a).]
• Sole Owner of the Account: Mary was the sole owner of the checking account into which the IRA distributions were made. At all times she was the owner of the account. In fact, Mary had the checkbook for and actually wrote checks on that account. In addition, Mary periodically made withdrawals from the checking account.
• Knowledge of the Funds: While technically not the issue before the Court, the judge acknowledges legal precedent exists that knowledge of the fund’s receipt is necessary for the court to apply the constructive receipt doctrine. However, the parties had stipulated that constructive receipt did not apply to Mary’s situation. Nonetheless, the court pointed out that Mary obviously had knowledge because she had access to the account as indicated by the fact that she took withdrawals, wrote checks against the account, and “most importantly, [she] knew that it existed.”
• Let’s Ignore Chip’s Bad Behavior: With regard to Mary’s dementia and her frail condition, and Chip’s willingness to take full advantage of his mother’s condition, the Judge said:

“At its core, Plaintiff requests this Court find as a matter of law that Mrs. Nice [Mary] did not receive income as defined by the Code because once the funds ‘were received’, they were used by Chip without valid authorization. This argument fails simply because the Plaintiff must concede that the funds were received before they were misappropriated. The plaintiff’s argument that Mrs. Niece [Mary] suffered from dementia and was financially defrauded by her son does not in and of itself result in a finding that she did not actually receive income as defined by the Code….The substantive issue, in this case, is whether Mrs. Nice [Mary] received the income for which she was taxed. Mrs. Nice’s ability to manage her financial affairs has no bearing on her ability to receive taxable income, and the Plaintiff provides the Court with no law to support such a contention.”

Forgery: Much of the Judge’s decision in Nice was an attempt to distinguish a prior court decision where the Tax Court had found that the distributions from a retirement account were not received income by the IRA owner. Mary had argued that this earlier court decision, Roberts v Commissioner, 141 Tax Court 569 (2013), was dispositive of her claim that she had not received the distributions from the IRA. In Roberts, Mr. Roberts and his wife had separated. Mr. Roberts and his wife maintained two checking accounts. On their separation, each spouse maintained exclusive use and control of only one of the checking accounts. Mr. Roberts did not have possession of the checkbook for, nor did he write checks on, nor did he make withdrawals from, the checking account that Mrs. Roberts maintained exclusive control over. In addition, Mr. Roberts did not receive any bank statements that would have shown deposits into that joint account that his estranged wife controlled. In 2008, Mrs. Roberts caused distributions to be made from Mr. Robert’s several IRA accounts, without his knowledge, directing the distribution into this joint checking account, over which she had exclusive access and control. Apparently Mrs. Robert forged these IRA disbursement requests. The Tax Court in Roberts found that the forged IRA disbursement requests into the joint checking account on which Mr. Robert’s name appeared, but over which he had no control, were not received by Mr. Roberts- neither the withdrawal requests, nor the checks written against those IRA withdrawals were made with Mr. Robert’s authorization. Splitting hairs a bit, the Roberts Tax Court also found that the checking account into which the IRA disbursements were deposited, “was joint in name only…[and that he, Mr. Roberts] was generally unaware of the use of the account.”  Roberts was distinguished by the Judge in Nice because Chip had his mother’s IRA distributions deposited into a checking account that “was in her name alone.”

Conclusion: There is not a lot to be learned from this decision, despite its sad facts, other than it stands as a stark reminder that elder financial abuse is rampant and that victims of dementia still have to pay their income taxes. What the Nice decision does not fully describe is whether Chip used the durable power of attorney that his mother gave to him to pull off his misappropriation of her funds.

Nice should prompt some folks to consider embedding in their financial durable powers of attorney, where they name their adult children as agents,  some sort of ‘check-and-balance’ safety mechanisms that require the agent to periodically report to third-parties any transactions that are undertaken on the principal’s behalf using the durable power of attorney, where the failure to adhere to such reporting obligation would be deemed under the instrument a forgery. I am not sure if the IRS would accept a deemed forgery classification under a financial durable power of attorney to fall under Roberts ‘not received’ defense to taxation, but it might be worth a shot.

The whole topic of elder abuse and elder financial abuse is soon going to get a shot in the arm with all of the proposed legislation currently percolating in Lansing, including a possible amendment to Michigan’s slayer statute that would automatically disinherit an individual who is found guilty of elder abuse. More to come on this hot topic.