Refusal to grant 60-day IRA rollover waiver upheld

The Tax Court held it could review, under the abuse-of-discretion standard, the IRS’s refusal to issue a private letter ruling granting a waiver of the Sec. 408(d)(3)(l) 60-day limit for rolling over an IRA distribution. The court further held that the IRS’s refusal to grant a waiver for actor James Caan’s distribution of a partnership interest from an IRA was not an abuse of its discretion.

Background

Caan was best known for playing Sonny Corleone in “The Godfather,” released in 1972, for which he received an Oscar nomination. Over his long acting career, from 1961 until his death in 2022, he had roles in over 100 films and television series.

In 2015, Caan held two IRAs with the Swiss bank UBS. Both IRAs were governed by a custodial agreement between Caan and UBS. Under that agreement, every year by a certain date, Caan was required to provide UBS with the year-end fair market value (FMV) of any non-publicly traded investment that UBS allowed Caan to hold in the IRAs. If Caan did not provide the information, UBS would distribute the investment to Caan and issue an IRS Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for the investment’s last available value.

One of the IRAs held a partnership interest (P&A interest) in the P&A Fund, a hedge fund. Caan did not provide UBS the FMV for tax year 2015 as required by the custodial agreement, so UBS distributed the P&A interest from the IRA and notified Caan and his financial advisers of the distribution under the relevant terms of the custodial agreement.

In June 2015, Caan’s investment adviser, Michael Margiotta, who initially worked for UBS, resigned from the company and began working for Merrill Lynch. In October 2015, Caan transferred the UBS IRAs to Merrill Lynch under Margiotta’s management.

All assets in both IRAs were transferred to a single IRA at Merrill Lynch, except for the P&A interest. In 2016, UBS issued a Form 1099-R to Caan, reporting that the P&A interest was valued at $1,910,903, which was its 2013 FMV and the last FMV known to UBS. More than a year after the notification from UBS, Margiotta, acting on Caan’s behalf, liquidated the P&A interest and contributed the cash proceeds from the liquidation to Caan’s IRA at Merrill Lynch.

On his 2015 income tax return, Caan reported the IRA distribution but claimed that it was nontaxable as a rollover contribution under Sec. 408(d)(3). The IRS disagreed with this treatment of the distribution and issued a notice of deficiency to Caan, determining that there was a taxable distribution and an income tax deficiency of $779,915, and it imposed an accuracy-related penalty of $155,983.

In response, Caan filed a private letter ruling request asking the IRS to waive the 60-day period for IRA rollover contributions for the distribution of the P&A interest. Caan also petitioned the Tax Court for a redetermination of his 2015 income tax deficiency.

During the pendency of Caan’s case, the IRS declined to issue the private letter ruling, on the grounds that waiving the 60-day rollover period would be inconsequential because Caan was required to contribute the P&A interest (not cash) to Merrill Lynch for the transaction to be a nontaxable rollover contribution.

After concessions by Caan and the IRS in his Tax Court case, the court was required to decide five issues:

1. Whether UBS distributed the P&A interest to Caan in tax year 2015.
2. If the P&A interest was distributed, whether that distribution was nontaxable because it was rolled over into another IRA within the Sec. 408(d) (3)(I) 60-day rollover period.
3. If the P&A interest was distributed, what its value was at the time of the distribution.
4. If the P&A interest was distributed, whether the court could review the IRS’s refusal to issue a letter ruling waiving the 60-day rollover period and what the standard of review should be.
5. If it could review the IRS’s refusal to issue the letter ruling, whether it should uphold the IRS’s refusal to issue Caan the letter ruling. Caan would not live to pursue those issues in the Tax Court, dying at the age of 82 in 2022. His estate, however, continued the litigation.

The Tax Court’s decision

The Tax Court held that the P&A interest was distributed to Caan in 2015; the interest was not contributed to the Merrill Lynch IRA in a manner that would qualify as a rollover contribution; Caan was taxable for 2015 on the interest’s value at the time of the distribution; the interest’s value at that time was $1,548,010; the Tax Court had jurisdiction under Sec. 6213(a) to review the IRS’s denial of Caan’s request for a waiver of the 60-day period for rollover contributions; the standard of review was abuse of discretion; and the IRS did not abuse its discretion in denying Caan a waiver.

Distribution of the P&A interest: After reviewing UBS’s actions before the distribution of the P&A interest, the Tax Court found that the company went above and beyond what the custodial agreement required of it in trying to determine the year-end FMV of the interest, and, having failed to do so, UBS acted well within its rights under the custodial agreement by resigning as the P&A interest’s custodian and distributing the P&A interest in kind to Caan. Thus, the court determined that UBS distributed the P&A interest to Caan in 2015.

Caan’s estate argued that UBS’s distribution of the P&A interest was a “phantom distribution,” alleging that UBS resigned as the interest’s custodian — and purported to distribute the interest — without notifying Caan or his advisers. The estate relied heavily on the trial testimony of Margiotta and another of Caan’s advisers to bolster this argument. Both Margiotta and the other adviser testified that they had never seen the relevant letters from UBS until the litigation had begun and had not known about UBS’s making the distribution. However, the Tax Court did not find the advisers’ testimony credible and rejected this argument.

Caan’s estate also contended that no distribution occurred because Caan was never placed in actual or constructive receipt of the P&A interest. The Tax Court held in Estate of Brooks, 50 T.C. 585 (1968), that under the constructive-receipt doctrine “funds [or other property] which are subject to a taxpayer’s unfettered command and which he is free to enjoy at his option are constructively received by him whether he sees fit to enjoy them or not.” The court found that Caan could have had the P&A Fund re-register the P&A interest in his name without needing any further involvement from UBS, or he could have rolled over the P&A interest into another IRA. These options meant, in the court’s view, that Caan had unfettered control over the P&A interest and was therefore in constructive receipt of it.

Finally, Caan’s estate claimed UBS had not resigned as custodian because no resignation or distribution had occurred under California trust law. The court rejected this argument because Caan’s relationship with UBS was custodial, not a trust relationship, and the custodial agreement stated that it was governed by New York law, not California law.

Tax-free rollover of the P&A interest: After reviewing the text of Sec. 408(d)(3)(A)(i), the legislative history behind Sec. 408(d)(3), its own case law, and the regulations, the Tax Court found that it was clear that Caan was required to contribute the P&A interest, not cash, to the Merrill Lynch IRA to preserve the interest’s tax-deferred status. Caan had contributed the proceeds from the liquidation of the P&A interest, and, accordingly, the court held that the contribution to the Merrill Lynch IRA was not a nontaxable rollover contribution under Sec.408(d) (3)(A)(i).

FMV of the P&A interest: UBS reported on the Form 1099-R that the value of the P&A interest was $1,910,903, which was its 2013 year-end FMV. The estate generally argued that the form was incorrect because UBS did not distribute the P&A interest and it reported an incorrect value.

The IRS agreed with the estate that the P&A interest was misvalued and it should be valued at $1,548,010, which was the ending capital account balance reported by the P&A Fund on Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., for tax year 2015.

The IRS reasoned that the 2015 ending capital account balance was the best approximation of the interest’s value when UBS distributed it because the distribution occurred on Nov. 25, 2015, and the ending capital account balance was Caan’s capital account balance as of Dec. 31, 2015.

In its briefs, the estate did not argue against the IRS’s valuation proposal, focusing instead on the ways in which the Form 1099-R was a deficient document. The Tax Court found that the IRS’s proposed value of $1,548,010 for the interest closely matched its 2017 liquidation amount of $1,532,605, and because the estate did not propose a different value, the court held that the value of the P&A interest was the IRS’s proposed value.

Tax Court review of refusal to issue a letter ruling and the standard of review: Both were questions of first impression for the Tax Court. To answer them, the court referred to its decision in Trimmer, 148 T.C. 334 (2017), in which it held that it had jurisdiction to review the IRS’s denial of a hardship waiver under Sec. 402(c) (3)(B) to the 60-day rollover period for rollover contributions from an employee’s trust in Sec. 402(c)(3)(A).

The court in Trimmer concluded that nothing in Sec. 402(c)(3) expressly precluded judicial review of such a waiver, and the legislative history did not reveal a congressional intent to preclude review. Therefore the court could review the IRS’s refusal to waive the 60-day requirement under the well-established Tax Court precedent that its jurisdiction to redetermine deficiencies under Sec. 6213(a) includes jurisdiction to review any discretionary agency actions that would affect the deficiency amount.

The Tax Court found its reasoning in Trimmer applied to the 60-day rollover requirement for IRA distributions as well. The court noted that Secs. 402(c)(3)(B) and 408(d)(3)(I) are worded identically, neither the text of Sec. 408(d)(3) nor its legislative history precludes judicial review, and whether the IRS grants a waiver under Sec. 408(d)(3)(I) is a discretionary determination that would affect a taxpayer’s deficiency.

With regard to the standard of review, the Tax Court, having determined based on its holding in Trimmer that it had jurisdiction to review the denial of a waiver, determined that the correct standard of review was the same as in that case. In Trimmer, the court, citing Mailman, 91 T.C. 1079 (1988), held that the appropriate standard of review is whether the IRS has abused its discretionary authority by exercising it arbitrarily, capriciously, or without sound basis in law or fact (i.e., abuse of discretion).

Did the IRS abuse its discretion?: The IRS declined to issue a private letter ruling with a waiver of the 60-day rollover requirement to Caan under Sec. 408(d)(3)(I) because he liquidated the P&A interest after the distribution from UBS, and therefore the rollover would fail under the property requirement in Sec. 408(d) (3)(A)(i) even if the waiver were granted. The Tax Court held that denying a waiver on this basis was not an abuse of discretion, because “[i]t cannot be an abuse of discretion for the IRS to deny a waiver where granting the waiver would not have helped the taxpayer in any way.”

Reflections

The Tax Court noted that Caan’s estate also urged the court to adopt an equitable resolution to this case, which it refused to do as well. As all taxpayers would be wise to remember, the Tax Court, as it noted while citing its own and Supreme Court precedent, is “not a court of equity, and we [the court] cannot ignore the statutory law to achieve an equitable end.”

Estate of Caan, 161 T.C. No. 6 (2023)

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.