I am looking at a Tax Court case (Dunn v Commissioner) for $1,460 in tax and $292 in penalties. It seemed a low dollar amount to take to Tax Court, which in turn prompted me to think that Dunn was either an attorney or CPA. He would then represent himself, skipping the professional fees.
Dunn is an attorney.
Then I read what landed in him in hot water.
Folks, sometimes we have to pay attention to the details.
We have talked in past articles about shiny objects like real estate investment trusts, charitable remainder trusts, private foundations and so forth. Hopefully we have told the story in an entertaining way, as tax literature does not tend to be riveting reading. For most of us, however, our finances and taxes are quite humdrum. Odds are our tax troubles are going to come from not attending to the details.
Let’s tell the story.
Stephen Dunn is a tax attorney in Michigan. In 2008 he was working for a law firm. He finished 2008 as self-employed and continued as such through 2010. He participated in the law firm’s retirement plan – presumably a 401(k) - for the part of 2008 he was there.
He made the following IRA contributions:
2010 $ 800
The IRS took a look and disallowed his 2008 IRA contribution.
Because he was covered by a retirement plan at work.
There is no income “test” for an IRA contribution if one (or one’s spouse) does not have another available retirement plan. Have a plan at work, however, and the rule changes. The tax Code will disallow your IRA deduction if you make too much money.
What is too much?
If you are a single filer, it starts at $61,000. If you are a married filer, it starts at $98,000.
For what it is worth, I consider these income limits to be idiocy. I cringe when someone thinks that $61,000 is “too much money.” Perhaps it was back in the 1950s, but nowadays $61,000 will not rock you a Thurston Howell lifestyle anywhere across the fruited plain. Remember also that a maximum IRA is $5,500 ($6,500 if one is age 50 and above). If taxes on $5,500 are a fiscal threat to the Treasury, we have much more serious problems than any discussion about IRAs.
Dunn got caught-up in the rules and made too much money for a deductible IRA contribution in 2008.
No problem, thought Dunn the attorney. He rolled the $6,000 forward and deducted it in 2010. Mind you, he wrote checks for only $800 in 2010. The $6,000 was a “carryforward,” so to speak.
So, what is the problem?
Generally speaking, individuals report their taxes on the cash basis of accounting. This means that they report income in the year they receive a check, and they report deductions in the year they write a check. The tax Code does allow some latitude with IRAs, as one can fund a previous-year IRA through April 15th of the following year. That is a special case, however. The tax Code however does not automatically “carryover” an excess contribution from one year to the next. In fact, overfund an IRA and the tax Code will assess a 6% penalty for every year you leave the excess in the IRA.
How do tax professionals handle this in practice?
Easy enough: you have the IRA custodian move it to the following year. Say that you are age 58 and put $7,000 in your 2014 IRA. You have overfunded $500, no matter what the results of the income test are. You would call the custodian (Dunn’s custodian was Vanguard), explain your situation and ask them to move the $500.
Now there is a detail here that has to be clarified. Say that you contributed $1,000 of the $7,000 in March, 2015 (for your 2014 tax year). You could ask Vanguard to move $500 of that $1,000 to 2015. They probably would, as they received it in 2015.
Let’s change the facts. You contributed all of the $7,000 in 2014. Vanguard now will likely not move any of the money because none of it was received in 2015. The best Vanguard can do is send you a $500 check, which you will deposit and send back to Vanguard as a 2015 contribution.
What did Dunn not do?
He never called Vanguard and had them move the money. In his case it would have been a bit frustrating, as he had to get from 2008 to 2010. He would be calling Vanguard a lot. He would have to refund 2008 and fund 2009; then refund 2009 and fund 2010. Vanguard may have not wanted him as a customer by that point, but that is a different issue.
Dunn tried. He even requested the equivalent of mercy, pointing out:
"…Congress’ policy of encouraging retirement savings supports the deduction they seek.”
Here is the Tax Court:
"These arguments are addressed to the wrong forum.”
Dunn did not pay attention to the details. He lost his case and also got smacked with a penalty. I am not a fan of IRS-automatically-hitting-people-in-the-face-with-a-penalty, but in this case I understand.
After all, Dunn is a tax attorney.
About the author
Steven D. Hamilton is a career CPA, with extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.