Recent cases and rulings. (Tax Trends).

IN THIS DEPARTMENT

Employee Benefits & Pensions

* IRA owner can act as conduit for IRA investments: Ancira, TC; p. 798.

Procedure & Administration

* IRS did not prove six-year limitations period: Hoffman, TC; p. 799.

The reports of cases, rulings, etc., herein, except for the Reflections, are edited versions of the relevant court opinion, published ruling, etc.

* This development, concerning related matters, is covered in the Reflections to the report of the principal item.

EMPLOYEE BENEFITS & PENSIONS

IRA Owner Can Act as Conduit for IRA Investments

During 1998, M maintained a self-directed IRA. P was the IRA custodian; H was the investment adviser. M could request that the IRA funds be invested in specific assets (specific mutual funds, stocks, etc.). These requests were typically made by telephone to H; P would then execute them.

In September 1998, M requested that his IRA invest $40,000 in the stock of S Corp. H informed M that P would not purchase the stock because it was not publicly traded. M contacted S and was informed that its stock was available for direct purchase. M and H then determined that the IRA could invest in S if P issued a check payable directly to S. H gave M a" Distribution Request Form" from P to facilitate issuance of the check. The form stated that its use would result in a distribution reportable to the IRS. On Sept. 14, 1998, M executed the form and P issued a $40,000 check payable to S, drawn on M's IRA account. P sent the check to M, who forwarded it directly to S.

On Dec. 1, 1998, S issued a stock certificate stating that M was the owner of 714.28 shares. For reasons that are not clear, the stock was not immediately transferred to P or to M, who was unaware that P did not have the stock until much later. When M learned that the stock had not been transferred to P (after a deficiency notice was issued), he contacted S and had the certificate sent to him. M then delivered the stock to P; the stock was placed in M's IRA account. P issued M a Form 1099-R, indicating that a $40,000 distribution had been made to M, but M did not report this $40,000 transaction on his 1998 return.

The IRS determined that the $40,000 check issued by P to M was an IRA distribution includible in income under Secs. 408(d) and 72, and imposed a Sec. 72(t) 10% penalty tax.

Analysis

Sec. 408(d)(1) provides that "any amount paid or distributed out of an individual retirement plan shall be included in gross income by the ... distributee ... in the manner provided under Section 72." Neither the Code nor the regulations specify whether an amount is considered to have been "paid or distributed out of an individual retirement plan" in the circumstances here. If, on M's instructions, P had paid the $40,000 to S (or a broker) for its stock, there simply would have been an investment in an asset of the IRA, with no question about whether a distribution had occurred. The question is whether M received a distribution when P delivered the check made out to S to M, who in turn delivered it to S to purchase the stock for the IRA account.

The soundest view of this case is that M acted as a conduit for P by both arranging the stock purchase and ensuring that the check was delivered to S. No provisions of the Code, applicable regulations or case law bar a taxpayer from acting as a conduit for an IRA trustee under the circumstances presented here. In addition, it cannot be argued cogently that M was in constructive receipt of the assets represented by the transaction. Specifically, under Louisiana law, M was not a holder of and could not negotiate the check. M's actions as a conduit for the IRA trustee in these limited circumstances violated no prohibition on a taxpayer's relationship to his IRA and, thus, did not result in a distribution.

The IRS argues that the transaction is controlled by Lerhishow, 110 TC 110 (1998). In Lemishow, the taxpayer made withdrawals from retirement accounts, invested the distributions in stock and contributed the stock to a new IRA. That transaction did not qualify as a tax-free rollover of qualified plan assets, because the character of the property transferred to the new IRA was different from the character of the property distributed to the taxpayer. But, in this case, M received no cash.

The fact that S did not immediately deliver the shares to P is insignificant. At all times, the IRA, not M, was the owner of the shares even though it may not have been in physical possession of the stock certificate. The failure to deliver the stock certificate would not invalidate the transaction.

ROBERT ANCIRA, 119 TC No. 6

PROCEDURE & ADMINISTRATION

IRS Did Not Prove Six-Year Limitations Period

After two extensions, P and L filed a joint Federal return for 1990, received by the IRS on Sept. 10, 1991. The original return reported that either P or L held limited and general partner interests in six partnerships, but that neither had "materially participated" under Sec. 469. The IRS no longer has copies of any of the six partnerships' 1990 returns, and the Schedules K-1 are not in the record. The record does not indicate the six partnerships' gross income.

On Sept. 8, 1997, P and L filed an amended 1990 return prepared by their accountant and remitted payment. The amended return shows an additional tax liability of $218,152 (without statutory additions) based on $779,114 of gross income omitted from the original return. The amount omitted from the original return relates to unreported cancellation of debt income. The IRS assessed the additional tax shown on the amended return on Nov. 6, 1997.

P and L dispute any balance due and request a refund of $218,152 paid in error. They claim the amended return was invalid and the assessment of penalties and interest is incorrect because the amended return was filed after expiration of the three-year statute of limitations (SOL).

Analysis

Sec. 6501(e) generally provides that a six-year SOL applies when a taxpayer omits from gross income an amount greater than 25% of the gross income stated in the return. P and L established that the general three-year SOL has expired, so the IRS bears the burden of establishing that the amount P and L omitted exceeds 25% of the gross income reported in their return. To satisfy the burden of going forward, the IRS must show the amounts of gross income reported on the partnership and S corporation returns or that no such returns were filed. The IRS provided none of the income tax returns for the six partnerships in which P and L were partners and has not alleged that any of the six partnerships failed to file returns for 1990. Instead, the IRS alleges that the burden of going forward does not include the production of the partnership returns.

The amount petitioners omitted, the numerator in the calculation, is not in dispute in this case; it is $779,114. The parties disagree, however, as to the amount of gross income stated in P and L's return. Gross income is not defined in Sec. 6501. However, the Code's general definition of gross income applies to Sec. 6501(e), except for the modification provided in Sec. 6501(e)(1)(A)(i). That section provides that as applied to a trade or business, "gross income" includes the total of the amounts received or accrued from the sale of goods or services before diminution by the cost of those sales or services. As to a taxpayer-partner, we have interpreted this provision as requiring that a taxpayer's gross income include his or her share of the partnership's gross receipts from the sale of goods or services.

We have not previously addressed whether Sec. 6501(e)(1)(A) applies only to situations in which a taxpayer-partner did materially or actively participate in the partnership. In general, a general partner may be deemed to be conducting the trade or business activity of the partnership of which he or she is a member. Moreover, the wade or business of the partnership may be imputed to a general partner, regardless of the fact that the partner did not actively or materially participate in the partnership; see Bauschard, 279 F 2d 115 (6th Cir. 1960). It is also possible for the trade or business activity of a limited partnership to be imputed to a limited partner; Newhall Unitrust, 105 F 3d 482 (9th Cir. 1997).

Sec. 6501(e)(1)(A)(i) does not indicate that a partner must materially or actively participate in the wade or business. We hold that Sec. 6051(e)(1)(A)(i) does not require that a partner materially participate (as defined by Sec. 469) in the trade or business activity. Thus, the IRS failed to meet its burden of production as to establishing the amount of gross income stated on the 1990 tax return. Because the IRS failed to show that the six-year SOL applies, the general three-year SOL applies.

PETER M. HOFFMAN, 119 TC NO. 7