Unexpected Tax Due: California IRA Owners Beware

The IRS will not bail you out of adverse tax consequences resulting from your mistake when it comes to IRA withdrawals no matter how unintentional. Although the taxpayer did not live in California, the ruling impacts those who do live throughout the State of California. The IRS, in a Private Letter Ruling (defined as taxpayer-specific written decisions by the Internal Revenue Service in response to a taxpayer’s request which sometimes applies to unpaid taxes), denied a taxpayer’s request for permission to do a late rollover of an IRA distribution. Here was the situation:

The taxpayer’s daughter had a durable power of attorney to act on her father’s behalf because he suffered from a mental impairment disease.

In order to provide for her father’s future nursing home care, the daughter used that power and withdrew an amount from her father’s IRA.

It was only later, after the expiration of the 60 day rollover period, that the daughter realized the tax consequences of the IRA withdrawal.

The private letter ruling was requested based upon the daughter not realizing the tax consequence of the withdrawal.

The IRS denied the request to do a late rollover because there was never any intention to do a rollover at the time of the IRA withdrawal.

The applicable rule, generally speaking, is that the amount withdrawn is not subject to income tax if the amount withdrawn from an IRA is re-deposited within 60 days of the withdrawal. If you fail to re-deposit the amount withdrawn within 60 days you may request a waiver from the IRS that would permit you to do a late rollover and avoid taxation.

In Revenue Procedure 2003-16 the IRS listed certain circumstances that they would consider in determining whether or not to grant permission for a late rollover. These include:

errors committed by a financial institution;

inability to complete a rollover due to death, disability, hospitalization, incarceration, restrictions imposed by a foreign country or postal error;

the use of the amount distributed (for example, in the case of payment by check, whether the check was cashed); and

the time elapsed since the distribution occurred.

In this private letter ruling, the IRS stated that none of the factors described in Revenue Procedure 2003-16 were met since the daughter, using her power of attorney, withdrew the money from the IRA to provide future nursing home care for her father. Apparently, she did not consult with any professional as to whether this course of action was tax-wise.

Consult with a tax lawyer when you are about to take action with tax consequences.