Distributions to wife do not result in income for husband

Most of the distributions a wife, with a power of attorney (POA) from her incarcerated husband, took from his individual retirement account (IRA) and insurance policies were taxable to the wife instead of the husband because the POA did not give her authority to take the distributions.

Background

Joseph Balint was incarcerated from Dec. 17, 2013, through Jan. 6, 2015. During 2014, Balint owned a retirement account with Pershing LLC (Pershing), and a life insurance policy with Pruco Life Insurance Co. (Pruco).

While incarcerated, Joseph remained married to his wife, Jacqueline. At this point, Joseph was trying to save his marriage, which was under what appeared to be considerable stress due to his criminal activity, his incarceration, and the fact that Jacqueline had no money. In 2014, Joseph sent Jacqueline a letter telling her to contact his attorney to get a POA. The letter stated, “Tell [the lawyer] I want to give you everything! House, cars, motorcycles & my bank accounts — all of them in your name, making me beneficiary!” The letter also said that the purpose of doing this was so Jacqueline would not “lose anything” and would “have access to everything.” In a second letter that month to Jacqueline, Joseph wrote: “Have to get my name off the house title, car & motorcycle titles & trailer too! All that stuff is yours.”

In a March 2014 telephone call, because his $1,200 monthly Social Security payments had been suspended, Joseph also instructed Jacqueline to go to his attorney to obtain a POA that would allow her to receive $1,200 per month from his financial planner until he returned home.

Jacqueline contacted Joseph’s lawyer, who, as instructed, sent Joseph a POA, governed by Florida law, which appointed Jacqueline as his agent. The POA granted Jacqueline “full power and authority to perform any act, power, or duty that I may now or hereafter have and to exercise any right that I now have or may hereafter acquire.” It also granted her power to “withdraw … money or property deposited with or left in the custody of a financial institution” and to “withdraw benefits from” any retirement plan. According to the Tax Court, Joseph signed the POA while he was incarcerated because he wanted to take care of Jacqueline and was trying to save his marriage.

In April 2014, Jacqueline used her authority under the POA to withdraw $25,000 from the cash value of Joseph’s life insurance policy with Pruco. The next week, she used the POA to take a distribution of $51,300 from Joseph’s Pershing IRA account.

in August 2014, she took a distribution of an additional $34,650 from the Pershing IRA.

In September 2014, Jacqueline used the POA to withdraw an additional $22,592 from the cash value of Joseph’s Pruco life insurance policy. In October 2014, she took another $3,927 distribution from the Pershing IRA account. The amounts Jacqueline withdrew from the life insurance policy and IRA account in 2014 totaled $137,469. Of these amounts, she immediately transferred $130,908 to her own individual accounts for her own use, leaving a difference of $6,561 between the withdrawals and transfers.

Unfortunately for Joseph, his generosity did not have the desired effect. Jacqueline used the amounts taken from his IRA and life insurance policy to decamp from the couple’s residence in Florida to Kentucky, and she filed for divorce in September 2014. Joseph did not learn of Jacqueline’s actions until he was served with divorce papers while still incarcerated in October 2014.

Joseph was released from prison on probation in January 2015. He filed a timely return with a married-filingseparately status for 2014 on which, among other things, he reported taxable IRA distributions of $154,477 and taxable distributions from pensions and annuities of $67,078. He did not believe that these amounts were properly taxable to him, but he was afraid that his failure report them on his return would be a parole violation, and he hoped to work things out with the IRS. After withholding, Joseph reported he owed $34,614 on his return.

The IRS assessed the amount he reported was due and subsequently sent him a notice of intent to levy. Joseph requested a collection due process (CDP) hearing. On his hearing request form, he did not indicate that he wished to pursue a collection alternative but did indicate he wanted to make a claim for innocent spouse relief.

As requested by the Appeals settlement officer (SO), before the hearing, Joseph submitted a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, along with supporting financial information and an explanatory letter emphasizing his claim that Jacqueline had taken “everything [he] had” and that he had not received any money when she did so. Joseph participated in the CDP hearing by telephone as scheduled. Nonetheless, the SO, after conducting the hearing, sent Joseph a notice of determination sustaining the proposed levy.

Regarding his eligibility for innocent spouse relief, the SO found that because Joseph had not filed joint returns with Jacqueline for the years at issue and had provided insufficient information about the legal action he had taken with respect to Jacqueline’s withdrawals from his accounts, he was not entitled to innocent spouse relief. As Joseph had not provided a collection alternative, the SO further found that the proposed levy was appropriate.

Joseph then timely petitioned the Tax Court to review the notice of determination. After filing his Tax Court petition, he filed for divorce from Jacqueline in Florida. The divorce court (a state court of Florida) found that Joseph had authorized Jacqueline to withdraw a total of $10,800 from his IRA, which had “directly benefited” him, and therefore he should be liable for tax on that income.

The state court also found, on the other hand, that Jacqueline should be liable for the tax due on an additional $179,296 of income ($89,320 of IRA distributions and $89,976 of life insurance distributions) because Joseph did not receive any financial benefit from those funds and Jacqueline had taken the distributions without his knowledge or consent.

Before his trial in Tax Court, Joseph conceded that $42,259 of the IRA distributions he reported on his return (including the $10,800 distribution from the Pershing IRA that the state court had held he had authorized) were taxable to him but continued to argue that none of the pension and annuity amounts reported on the return were taxable, leaving disputed amounts of $112,218 of IRA distributions and $67,078 of pensions and annuities.

The Tax Court’s decision

The Tax Court held that the disputed amounts were not includible in Joseph’s gross income. Therefore, for 2014, it sustained the determination to proceed with the proposed levy only to the extent of any unpaid tax liability that remained due after those amounts were removed from the liability calculation.

State court order: The Tax Court first addressed whether the state court order in the Balints’ divorce had any bearing on its own decision. The IRS argued that the doctrines of res judicata and collateral estoppel did not apply to give preclusive effect to the fact findings or legal conclusions of that order in Joseph’s case.

Under the doctrine of res judicata, a second suit cannot be brought involving a cause of action on which a final judgment previously has been rendered by a court of competent jurisdiction. For the doctrine to apply, the identity of the parties in the case in which res judicata is invoked must be the same as the parties in the case on which the claimed application of the doctrine is based.

Collateral estoppel is a more narrow doctrine that “precludes litigation of issues in a second cause of action if those issues were actually litigated and necessary to the outcome of the first action.” For collateral estoppel to apply, except in certain narrow circumstances, the party against whom the doctrine is invoked must have been a party (or in privity to a party) to the prior judgment upon which the claim of collateral estoppel is based.

It was undisputed that the IRS was not a party (nor in privity with a party) to the state court divorce proceeding. Thus, the court held that to the extent the state court’s order would benefit Joseph, neither res judicata nor collateral estoppel should apply based on an order issued in the divorce proceeding.

Inclusion of disputed amounts: Per Sec. 408(d)(1), amounts distributed from IRAs to a taxpayer are generally includible in his or her gross income and taxed as provided under Sec. 72. Amounts that a taxpayer receives under a life insurance contract that are not paid as an annuity are includible in the taxpayer’s gross income to the extent that they exceed the amount he or she has invested in the contract.

However, as the Tax Court explained, it has sometimes held that funds misappropriated from a taxpayer were not includible in his or her gross income because the taxpayer was not the payee, distributee, or recipient of the misappropriated funds. In Roberts, 141 T.C. 569 (2013), the court held that a taxpayer’s gross income did not include amounts that his wife fraudulently withdrew from his IRAs without his knowledge, noting that “[w]hether there is an economic benefit accruing to the taxpayer is the crucial factor in determining whether there is gross income.”

Similarly, under the court’s holding in Grant, T.C. Memo. 1995-29, a taxpayer in an agent/principal relationship is not required to include funds in gross income “where the agent receives and misappropriates funds for his own use, where the principal had no knowledge of such misappropriation, and where the principal received no economic benefit from the misappropriated funds.” Relatedly, it held in Wilkinson, T.C. Memo. 1993-336, that where an agent appointed under a POA made withdrawals for her own benefit from the principal’s accounts, and the POA had not authorized the agent to make gifts to herself, the withdrawn funds were not includible in the principal’s gross income.

The court followed its reasoning in these cases in its analysis of the withdrawals Jacqueline made from Joseph’s account. The court noted that it interprets POAs under state law, and thus it interpreted the POA Joseph gave to Jacqueline in accordance with Florida law.

Under Fla. Stat. §709.2201(1), generally, “an agent may only exercise authority specifically granted to the agent in the power of attorney and any authority reasonably necessary to give effect to that express grant of specific authority.” Case law has held that POAs are strictly construed and will be closely examined to ascertain the principal’s intent. Consequently, a general grant of authority to an agent normally must yield to a more specific limitation of the agent’s authority so that the specific limitation is not made superfluous.

The court pointed out that the POA specifically allowed Jacqueline to make gifts of Joseph’s property and to take actions that could otherwise be considered to be prohibited self-dealing. However, a sentence in the POA authorizing Jacqueline, as Joseph’s agent, “to take actions … that may benefit the agent … by providing for health, education, maintenance or support,” limited that authority by stating that “in other words, actions that might otherwise be considered prohibited as self-dealing are specifically authorized … for the purpose of tax, financial or estate planning, for [Joseph’s] benefit, or for qualifying for public assistance … for which [Joseph] may be eligible.”

Strictly construing this sentence, the Tax Court found that the POA did not give Jacqueline an open-ended authorization to exercise her power for her own benefit. Instead, the clear implication was that she was authorized to take actions that would benefit herself only if the benefit to her was incidental to planning undertaken primarily to benefit Joseph or to ensure that Joseph would qualify for public assistance. Construing the sentence to grant any broader authority to engage in selfdealing would render superfluous the clarifying restatement of the grant of authority following the phrase “in other words.”

Jacqueline testified at trial that she withdrew money from Joseph’s accounts and used it to move, establish a separate household, and pay her living expenses. Statements for the couple’s joint checking account confirmed that she took distributions of at least $89,877 from Joseph’s Pershing IRA and $47,592 from his Pruco life insurance policy, and she took all but $6,561 for her own use. Furthermore, these transactions took place while Joseph was incarcerated, and he was unaware of them until he was released and returned home.

Because the POA authorized Jacqueline to engage in self-dealing only in connection with specified activities undertaken for Joseph’s benefit, the court found her use of the bulk of the withdrawn funds for her own benefit constituted unauthorized self-dealing and was a breach of her fiduciary duty. It therefore concluded that Joseph did not authorize the withdrawals other than the $10,800 distribution and that Jacqueline was, more likely than not, the economic beneficiary of the distributions of $79,077 ($89,877 minus the $10,800 distribution Joseph had authorized) from the Pershing IRA and $47,592 from the Pruco life insurance policy and that these were taxable to her as the distributee of the funds.

Propriety of the levy: The Tax Court then considered whether the SO had abused her discretion. Its review of the administrative record showed that the SO properly verified that all requirements of applicable law and administrative procedure were satisfied. Joseph did not dispute these findings and stipulated that he did not seek a collection alternative during the CDP hearing. Accordingly, the court held the levy was not an abuse of discretion. The only error made by the SO was in the amount of Joseph’s underlying tax liability, so the court sustained the levy to the extent that any unpaid balance remained due after adjusting Joseph’s underlying tax liability for the IRA and life insurance distributions that the court had determined were not includible in his gross income.

Reflections

In a footnote, the Tax Court observed that Joseph’s letters to Jacqueline suggested that he wanted to “give her” his property. However, the court put a greater weight on his statements in the letters that he wanted her to make him “beneficiary” of the property and to “use [the property] wisely” and “be careful” because his savings could not be replaced. Further, he directed her to withdraw $1,200 a month to replace his Social Security benefits, which had been suspended. The court stated, “In view of these circumstances, which were known to Jacqueline, we do not think she could have concluded that [Joseph] reasonably expected her to liquidate his accounts and use all of the proceeds for her sole benefit.”

Balint, T.C. Memo. 2023-118

Contributor

James A. Beavers, CPA, CGMA, J.D., LL.M., is The Tax Adviser’s tax technical content manager. For more information about this column, contact thetaxadviser@aicpa.org.