Rulings to Remember: The $425K IRA Mistake

Client Should Have Realized CPA Firm’s Tax Deal “To Good to be True”

Robert K and Joan L. Paschall V. Commissioner of Internal Revenue
(No. 2: Nos. 10478-08, 25825-08, Decided July 5, 2011

IRA Mistake results in taxesRobert Paschall, a married resident of California and an MIT graduate, worked for Rockwell International for his entire career until he retired in 1996.  Early in 2000, Paschall paid Grant Thorton, a national accounting firm, $120,000 for advice on his regular IRA that had a value of $1,391,942.  They presented Paschall with a plan, which he accepted, to “restructure” his regular IRA into a Roth IRA – the $425K IRA Mistake.

Under Grant Thorton’s guidance, Paschall rolled his IRA over into a self-directed traditional IRA.  He also opened a self-directed Roth IRA, funding it with $2,000, and created two corporations.  The Roth IRA purchased all the stock of one corporation for $2,000, and the traditional IRA purchased all the stock of the second corporation for close to the traditional IRA’s balance. The second corporation transferred the purchase amount (plus $120,000 paid as consideration in a merger) to the fi rst corporation.  The fi rst corporation then transferred the proceeds ($1,272,802) to the Roth IRA, which then transferred the funds into a second Roth IRA.

He was caught by IRS and got hit with penalties for excess Roth contributions, late filing and negligence penalties for multiple years.  He essentially made a $1.4 million excess contribution to a Roth IRA in a year when the contribution limit was $2,000.  The IRS assessed deficiencies against Paschall and his wife totaling more than $425,000 for tax years 2002 to 2006 for the excise tax on the excess contribution and assessed penalties of more than $103,000 for the same years for failure to file Form 5329.

In 2008, Paschall and his wife petitioned the Tax Court for relief.

What happened?

The Paschalls argued that the statute of limitation barred the assessment of the excise tax for 2002-2004, since they had filed Form 1040 for those years.  The taxpayers also argued that the penalty for Paschall’s failure to fi le Form 5329 should not apply, since his failure to file was due to reasonable cause –specifically, his reliance on the certified public accountant.

The court ruled on July 5, 2011 that the IRS was right and that it was unreasonable for Paschall to rely on the opinion of a tax advisor who was actively involved in the planning of the transaction in question and was tainted by an inherent conflict of interest.

The Paschalls owed income tax on their Roth conversion.  Interest was owed on the late tax. They owed accuracy-related penalties.  They owed failure to file penalties for not filing Form 8606.

The court stated, “Mr. Paschall should have realized that the deal was too good to be true.”  Despite his doubts during the process, Paschall never asked for advice from an independent advisor, the court said.

What you can do

If you have doubts about advice you are receiving, get a second opinion!  IRS holds the tapayer responsible for taxes, interest, and penalties.

Work with someone you trust and don’t fall for “too good to be true.”

Copyright 2016 Ed Slott and Company LLC
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