A taxpayer who purchased American Eagle coins through a self-directed IRA, had the coins delivered to her, and stored the coins in a safe in her home received taxable distributions from the IRA equal to the coins' cost.
Donna McNulty wished to invest her retirement savings in American Eagle (AE) coins through a self-directed IRA. To this end, in 2015 she engaged the services of Check Book IRA LLC, which advertised that a limited liability company owned by an IRA could invest in AE coins and IRA owners could hold the coins at their homes without tax consequences or penalties so long as the coins were "titled" to an LLC.
With the assistance of Check Book, McNulty established a self-directed IRA with Kingdom Trust Co. as custodian and set up Green Hill Holdings LLC, a single-member LLC with the IRA as the sole initial member and McNulty and her husband as managers. McNulty transferred funds to the IRA by purchasing Green Hill membership interests. The IRA then purchased AE coins using the funds from those purchases.
McNulty, who exercised sole control over her IRA's investment decisions, funded the IRA through direct transfers from two qualified retirement accounts she owned: an individual retirement annuity and a 401(k) account. She transferred $378,487 from the annuity to her IRA during 2015 and $48,375 from the 401(k) during 2016 to purchase membership interests in Green Hill. McNulty did not report any part of these transfers as gross income.
After the IRA purchased the interests, McNulty, as Green Hill's manager, had the LLC use almost all of the funds from the membership interest sale to purchase AE coins from Miles Franklin Ltd., an authorized coin dealer. The money to purchase the coins was transferred to Miles Franklin from Green Hill's bank account, and the invoices for them showed Green Hill as the purchaser. However, the shipping labels for the coins purchased identified McNulty individually or along with her IRA as the recipient of the shipments. In 2015, the IRA purchased 320 AE one-ounce gold coins for $374,000, and in 2016 it purchased 2,000 AE one-ounce silver coins, four one-ounce AE gold coins, two one-quarter-ounce AE gold coins, and one one-tenth-ounce AE gold coin for a total of $37,380.
McNulty had the coins shipped to her home and stored them in a safe there. Although the safe also contained AE coins purchased with funds from sources other than McNulty's IRA, the coins purchased with her IRA funds through Green Hill were labeled as belonging to the IRA.
For 2015 and 2016, McNulty and her husband had their joint income tax returns prepared by a CPA. The couple did not seek or receive advice from the CPA about the tax reporting for their self-directed IRAs or the tax ramifications of the physical possession of AE coins purchased using funds from the IRAs or the LLC and did not disclose to the CPA that they had physical possession of the AE coins purportedly purchased by McNulty's IRA at their residence.
The IRS, on audit, found that McNulty's receipt of the AE coins constituted taxable distributions equal to their value (here the cost of the coins because they were shipped to McNulty upon purchase) that were includible in McNulty's gross income under Sec. 408(d)(1). Accordingly, the IRS issued the McNultys a notice of deficiency for 2015 and 2016 in which it determined that McNulty had received taxable distributions in coins equal to their cost of $374,000 for 2015 and $37,380 for 2016.
The McNultys challenged the IRS's determination in Tax Court, asserting that the AE coins were assets of Green Hill and that McNulty's physical receipt of them did not constitute taxable distributions from her IRA.
The Tax Court's decision
The Tax Court held that McNulty's receipt of the AE coins was a taxable distribution equal to the cost of the coins. While the court based its decision on McNulty's physical possession of the AE coins, it also discussed McNulty's argument that Sec. 408(m)(3) created an exception to the prohibition on physical possession of IRA assets and the IRS's argument that McNulty had improperly commingled the coins she bought through the IRA with other coins.
Prohibition on physical possession: Citing a number of its prior cases, the Tax Court explained that an owner of a self-directed IRA is entitled to direct how his or her IRA assets are invested without losing the tax benefits of an IRA. However, the owner will lose those benefits if the owner has unfettered control over the assets.
Related to this rule regarding the owner's control over IRA assets, the IRA must have a qualified custodian or trustee that maintains custody of the assets, maintains required records, and processes transactions that involve the assets. This independent oversight by a third-party fiduciary to track and monitor investment activities is one of the key aspects of the statutory scheme and works to ensure that the intended purposes of IRAs, to encourage retirement savings and to prevent the savings from being used before the owner's retirement, are preserved.
According to the Tax Court, if coins or bullion are in the physical possession of the IRA owner (in whatever capacity), independent oversight that could prevent the owner from invading her retirement funds is absent, which "is clearly inconsistent with the statutory scheme." The court further stated: "Personal control over the IRA assets by the IRA owner is against the very nature of an IRA." Moreover, the court reasoned that the inclusion of the value of IRA physical assets in the owner's gross income when the owner takes possession of the assets was consistent with the "basic axiom of tax law that taxpayers have income when they exercise complete dominion over it."
In McNulty's case, the Tax Court found that she had "complete, unfettered control" over the AE coins and could use them any way she chose, notwithstanding Green Hill's purported ownership of the coins and her status as the LLC's manager.
The court noted that although an IRA owner may act as a conduit or agent of the IRA custodian, this is allowed only if the owner is not in constructive or actual receipt of the IRA assets. Citing its opinion in Ancira, 119 T.C. 135 (2002), the court stated that constructive receipt occurs where funds are subject to the taxpayer's unfettered command and the taxpayer is free to enjoy them as he or she sees fit. Because McNulty, by being in possession of the AE coins, had complete and unfettered control over them, she was not acting as a conduit or agent of the IRA custodian, and thus the value of the coins was includible in her gross income.
Sec. 408(m): Alternatively, McNulty argued that Sec. 408(m) provides an exception to the Sec. 408 custodial requirements for the AE coins, allowing McNulty to take physical possession of them. Generally, under Sec. 408(m), IRAs cannot invest in collectible assets, which generally includes coins. However, certain gold and silver coins described in Sec. 408(m)(3)(A) are not considered collectibles, as well as gold, silver, platinum, or palladium bullion described in Sec. 408(m)(3)(B), if the bullion is in the physical possession of the IRA trustee (Sec. 408(m)(3), flush language).
McNulty argued, based on this statutory language, that the flush language of Sec. 408(m)(3) makes physical possession by a trustee a condition of an IRA's ownership of bullion. She further argued that because the flush text applies only to bullion described in Sec. 408(m)(3)(B) and AE coins are not bullion, a trustee is not required to have physical possession of AE coins. The IRS countered that McNulty was misinterpreting the plain text of the statute and that the flush language did not eliminate the physical possession requirement of Sec. 408(a).
The Tax Court analyzed the language of Sec. 408(m)(3) to determine its meaning. The court found that under the plain text of the statute, an IRA's bullion that is not in the physical possession of a trustee is a collectible. Furthermore, it did not address the fiduciary or custodial requirements of Sec. 408(a). The court refused to interpret the flush language as creating an exception to the Sec. 408(a) requirements in the absence of express language in the statute, because, as the Supreme Court has held, a court should assume that Congress is aware of existing law when it passes new legislation.
The court also concluded that McNulty's argument negated the Sec. 408(a) requirement that there be a trustee that acts as a fiduciary and administers IRA assets. The court refused to "apply such a negative inference to override the basic fiduciary and custodial requirements of section 408(a) that are fundamental to the retirement savings scheme, particularly in the absence of clear statutory text."
Prohibition against commingling: The IRS argued in the alternative that even if the court sanctioned McNulty's physical possession of the AE coins, McNulty had violated Sec. 408(a)(5). This section prohibits IRA assets from being commingled with other property except in a common trust fund or common investment fund. The IRS claimed she violated the statute by storing her coins in the safe with non-IRA assets, but McNulty claimed that the labeling of the coins she purchased before they were put in the safe prevented commingling.
The Tax Court did not reach the issue because it had already held that McNulty had violated the Sec. 408(a) physical custody requirements. It did state, however, that it questioned "whether labeling is sufficient to satisfy the Code's prohibition against commingling or whether storage in a safe satisfies the requirement that assets requiring safekeeping be kept in an adequate vault."
McNulty's husband had also set up a self-directed IRA to purchase AE coins, and he was penalized for engaging in prohibited transactions (i.e., certain transactions between a disqualified person and a qualified employee benefits plan, including an IRA) under Sec. 4975 with his IRAs. Because the issues with his IRA were settled before trial, the Tax Court did not discuss them in its opinion. The court, in a footnote, stated without explanation that the IRS conceded that McNulty had not engaged in any Sec. 4975 prohibited transactions.
McNulty, 157 T.C. No. 10 (2021)