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Post Office Tracking Data Can Result in Tax Disputes

Post Office Tracking Data Can Result in Tax Disputes

There have been a number of tax cases involving disputes as to when tax documents are mailed to the government. In Tildon v. Commissioner, No. 15-3838 (7th Cir. 2017), the court considered a dispute that turned on whether U.S. Postal Service tracking data is a “postmark made by the U.S. Postal Service.”

The Facts and Procedural History

In Tildon, the taxpayer hired a tax law firm to prepare and file a petition with the U.S. Tax Court. The law firm prepared the petition, but did not obtain a postmark from the U.S. Postal Service when it mailed the petition to the U.S. Tax Court. Instead, the law firm put a self-printed label on the envelope and hand-delivered the envelope to the post office. It did so on the last day for filing the petition with the U.S. Tax Court. Two days later, at a facility that was 10 miles away from the post office, the U.S. Postal Service entered the tracking information for the envelope into its computer system. The U.S. Tax Court received the envelope several days later and deemed the petition to be filed late. The taxpayer appealed the decision to the Seventh Circuit Court of Appeals.

The Timely-Mailing, Timely-Filed Rule

In the U.S. Tax Court litigation, the IRS cited the general timely-mailing, timely-filed rule. The timely-mailing, timely-filing rule is found in Sec. 7502. It says tax returns and, as in this case, tax court petitions, are timely filed even if they are received by the IRS after the due date as long as they were mailed on or before the due date. This rule only applies when there is a postmark made by the United States Postal Service (the regulations include similar rules for certain private delivery carriers, such as UPS and FedEx).

To be more specific, the timely-mailing, timely-filed rule says that the tax return or tax court petition is considered timely filed if the IRS actually receives the envelope either by the due date or “the time when a document or payment contained in an envelope that is properly addressed, mailed, and sent by the same class of mail would ordinarily be received if it were postmarked at the same point of origin by the U.S. Postal Service on the last date.” The IRS concluded the language in quotes was not satisfied, as it took the U.S. Postal Service seven days to deliver the envelope from Utah to Washington D.C., which was longer than it would ordinarily take.

The Exception Where There Are Two Postmarks

The U.S. Tax Court did not agree. It applied a different rule, which says that where there is a postmark by a U.S. Postal Service and another postmark that was not made by the U.S. Postal Service, only the postmark by the U.S. Postal Service is to be considered. The U.S. Tax Court treated the U.S. Postal Service tracking information as equivalent to a postmark for purposes of this rule. Because the tracking information was not entered into the U.S. Postal Service’s system for two days after the U.S. Postal Service received the envelope, the U.S. Tax Court concluded that the tax court petition was not timely mailed.

On appeal, the Seventh Circuit Court of Appeals concluded that the rule cited by the U.S. Tax Court did not apply. It noted that the U.S. Postal Service certified mail tracking information was not a postmark and not equivalent to a postmark. The IRS agreed that the general timely-mailing, timely-filed rule applied and was satisfied.

Avoiding these Disputes by Using Certified Mail

The Seventh Circuit had some harsh words for the tax law firm, which serves as a reminder why, even in this day and age of high technology, we take the time to mail correspondence to the IRS via U.S. Postal Service certified mail and retain the hand-stamped postmark as proof of mailing:

Although the taxpayer thus prevails on this appeal, we have to express astonishment that a law firm would wait until the last possible day and then mail an envelope without an official postmark. A petition for review is not a complicated document; it could have been mailed with time to spare. And if the last day turned out to be the only possible day (perhaps the firm was not engaged by the client until the time had almost run), why use a private postmark when an official one would have prevented any controversy? A member of the firm’s staff could have walked the envelope to a post office and asked for hand cancellation. … [The law firm] … was taking an unnecessary risk with Tilden’s money (and its own, in the malpractice claim sure to follow if we had agreed with the Tax Court) by waiting until the last day and then not getting an official postmark or using a delivery service.

The Code even confirms that the certified mail is “deemed the postmark date,” which means that it is equivalent to a postmark.

Transferring Property Owned by Taxpayer With Unpaid Taxes

Transferring Property Owned by Taxpayer With Unpaid Taxes

In United States v. Urioste, No. 4:15-CV-1787-VEH (N.D. Ala 2017), the court considered the situation where a business purchased and improved real estate that was encumbered by an IRS tax lien. The case highlights why it can be more advantageous to structure a transaction as a loan rather than a purchase when dealing with property owned by a taxpayer who has unpaid taxes.

Facts & Procedural History

The facts and procedural history are as follows:

  • The case relates to the tax liabilities of Mr. Urioste (the “Taxpayer”), who was deceased, and his single member LLC.
  • On April 21, 2006, the Taxpayer purchased real property that was the subject of the court case. The property was purchased using proceeds from a bank mortgage and the bank filed its mortgage the same day the real estate was purchased.
  • On April 25, 2006, the Taxpayer’s son formed an LLC.
  • On May 22, 2006, the IRS filed a notice of Federal tax lien against the Taxpayer.
  • On November 8, 2006, the Taxpayer requested an installment agreement with the IRS.
  • On November 13, 2006, the Taxpayer transferred the property to his son’s newly-formed LLC. The deed transferring the property excepted the IRS’s lien. The only consideration for the transfer was the son’s LLC assumed the bank’s mortgage on the property.
  • On November 2, 2007, the IRS rejected the Taxpayer’s installment agreement request.
  • On May 19, 2011, the son’s LLC paid off the bank’s mortgage on the property.
  • The son’s LLC had made $140,000 of improvements to the property.
  • On October 13, 2015, the government brought suit against the Taxpayer’s personal representatives and the son’s LLC to seize the property.
  • Neither the son nor the son’s LLC were aware of the IRS lien notice prior to the time the government brought suit.

In the case, the court looked to state law (i.e., Alabama law) to determine what rights the parties had to the property. The Taxpayer cited several judicial doctrines to argue that it had a superior right to the property than the IRS did.

Equitable Subrogation

The doctrine of equitable subrogation applies where one party advances funds to pays off the debt secured by another lien. This doctrine allows the new lender to step into the shoes of the prior lender and avoid another lien that would have priority. The doctrine does not apply if the new lender is aware of or should be aware of the other lien that would have priority.

So in this case, the Taxpayer argued that the son’s LLC stepped into the shoes of the bank, whose mortgage had priority over the IRS’s tax lien, and the IRS was not entitled to enforce its inferior lien.

The court did not agree, as it concluded that the son’s LLC was not a lender but rather a purchaser.

Unjust Enrichment

Unjust enrichment is an equitable argument whereby one party asserts that it is unfair for another party to benefit given the facts. In this case, the Taxpayer argued that it would be unfair for the government to benefit from the expenses the son’s LLC incurred in improving the property. The Taxpayer asked the court to find that there was an equitable lien, with priority, in the son’s LLC’s favor equal to the amount of the improvements.

The court considered Alabama law, which essentially says that unjust enrichment can only be invoked where there was some wrongdoing by the other party or some mistake. The court concluded that the government did not do anything wrong and that the expenditures were not made by mistake, but rather, they were made in furtherance of the son’s LLC’s business operations.

Marshaling of the Assets

The marshaling of the assets is another equitable argument. It applies where a debtor has two or more creditors and assets, and says that the creditor with priority cannot choose the asset that will result in the other creditor not being entitled to anything.

In this case, the Taxpayer argued that the government should foreclose on the Taxpayer’s other property first, before it forecloses on the property at issue in the case.

The court concluded that the son’s LLC was not a creditor, but rather a party that acquired the property. The Taxpayer argued that it was an equitable creditor because it paid off the bank mortgage. The court did not agree, and noted that prior courts have refused to require the government to marshall the assets when satisfying IRS tax liens.


While the Taxpayer was not successful in this case, the arguments show the distinction between being a lender and a purchaser when it comes to IRS liens. The parties are free to structure their affairs as they see fit (absent fraudulent transfers or other transfers for less than fair market value), which should be considered when dealing with property that could be subject to an IRS tax lien.

Deducting Pre-Acquisition Stock Compensation

Deducting Pre-Acquisition Stock Compensation

In Qinetiq US Holdings, Inc. v. Commissioner, No. 15-2192 (4th Cir. 2017), the court addresses the situation where a taxpayer acquired a target corporation and then claimed a substantial tax deduction for expenses the target corporation had paid prior to the acquisition. There are rules intended to prevent taxpayers from being able to deduct pre-acquisition expenses. The stock compensation rules can be an exception to these rules, which is addressed in the case.

Facts & Procedural History

The facts and procedural history of the case are as follows:

  • Thomas Hume (“Hume”) formed a corporation in 2002 and elected to have it treated as a Subchapter S corporation.
  • He admitted Julian Chin (“Chin”) as a shareholder of the corporation later in 2002.
  • As part of this, the corporation issued two shares of stock–Class A voting stock and Class B non-voting stock.
  • The corporate records included a consent that authorized the corporation to offer to sell the shares of the Class A voting stock to Hume and Chin.
  • The consent also authorized the corporation to enter into shareholder and employment agreements with Hume and Chin.
  • The consent did not authorize the corporation to enter into restrictive stock agreements with Hume and Chin.
  • The shareholder agreement with Hume and Chin included terms restricting the sale or transfer of stock and for returning stock to the corporation in the event of either Hume’s or Chin’s death, disability, or termination of employment with the corporation.
  • The employment agreements with Hume and Chin did not have any reference to stock issued as compensation.
  • Hume and Chin purchased the Class A voting stock.
  • In 2008, the corporation was acquired by the Taxpayer.
  • In 2009, the Taxpayer reported a $117,777,501 deduction for the stock Hume and Chin received in 2002.
  • The tax court ruled that the Taxpayer had not demonstrated entitlement to the deduction on two independent bases, namely, that the stock was not property “transferred in connection with the performance of services” and was not “subject to a substantial risk of forfeiture” at the time Chin acquired the shares.
  • The Taxpayer appealed the decision, which brings us to the current case.

The question for the appeals court was whether the Taxpayer was entitled to a deduction in 2009 for the stock Hume and Chin received in 2002.

Substantial Risk of Forfeiture

Compensation for services is usually deductible to the employer in the year it is paid and reported as income to the recipient in the same year. There is an exception for compensation for services that are subject to a substantial risk of forfeiture. This compensation is deductible and taxable in the year that it is no longer subject to forfeiture. The regulations include a number of rules that explain when compensation is subject to a substantial risk of forfeiture.

The appeals court cited two of these rules, namely, that there is no substantial risk of forfeiture if (1) the employer is required to pay the fair market value of such property to the employee upon the return of such property and, (2) at the time of the transfer, the facts and circumstances demonstrate that the forfeiture condition is unlikely to be enforced.

Restrictions that are Not Substantial

The appeals court noted that the shareholder agreement obligated the corporation to pay the fair market value of such property to the employee upon the return of such property upon Chin’s death, disability, or termination without cause. These restrictions failed the fair market value rule cited by the court.

The other restrictions in the shareholder agreement showed that the only circumstances in which Chin would be required to forfeit his stock at a below-market price would be if he voluntarily resigned before 20 years of employment, if he voluntarily resigned and entered into competition with the Taxpayer, or if he was terminated for cause.

The regulations say that termination for cause does not apply, so the court focused on the restriction imposed if Chin voluntarily resigned. This is the crux of the case. The tax court concluded that this risk was not “substantial” given its conclusion that Hume would have been unlikely to enforce the shareholder restrictions on the stock in the event Chin voluntary resigned. The tax court based this decision on Chin’s early role in the company and the close relationship between Hume and Chin. The appeals court accepted this conclusion.

Structuring Stock Compensation

The takeaway is that stock restrictions have to be carefully considered in determining whether it is subject to a substantial risk of forfeiture. The regulations should be reviewed as they contain detailed rules that help clarify these rules. But the regulations (and case law) cannot be relied on in isolation. For restrictions such as voluntary resignation terms, facts, such as the close relationship identified in this case, should be considered in determining whether the risk is substantial.

It should also be noted that the appeals court did not have to address the investor vs. employee compensation issue in this case. This is yet another hurdle that taxpayers seeking to deduct this type of expense from a prior year have to overcome. This is especially true where the employees pay for their stock rather than being awarded stock pursuant to an established plan or arrangement based on some pre-defined criteria.

Taxpayer Retains Right to Tax Refund Claims Despite Bankruptcy Discharge

Taxpayer Retains Right to Tax Refund Claims Despite Bankruptcy Discharge

The bankruptcy-tax rules can present a number of opportunities. In Martin v. United States, Case No. 3:13-CV-03130 (C.D. Ill 2017), the court concludes that the taxpayers retained the right to sue the IRS for substantial tax refunds for taxes that were overpaid prior to their bankruptcy, despite having discharged the their debts in bankruptcy.

Bankruptcy & Tax Refunds, Generally

Typically, a taxpayer will want to include unpaid tax debts in their bankruptcy case. With a Chapter 7 bankruptcy, this may allow the unpaid taxes to be discharged. With a Chapter 13 case, this will allow the unpaid taxes to be paid through the bankruptcy rather than surviving the bankruptcy.

The motivations for tax overpayments or refunds may be different. If the tax refund is included in the bankruptcy, it is part of the bankruptcy estate that is available to pay creditors. Pre-petition tax refunds received before the bankruptcy petition may be used to pay the secured creditors before the bankruptcy petition, with the aim of ensuring that it does to pay off the secured creditors first. Tax refunds received after the bankruptcy filing can be more problematic.

Taxpayers cannot simply fail to include a tax refund claim for taxes paid prior to the bankruptcy in their bankruptcy. To the extent the refund claim was not known at the time the bankruptcy was filed, the unreported tax refund claim remains an asset of the bankruptcy estate. The bankruptcy trustee is the party who has the ability to file the refund claim and to receive the proceeds. If the bankruptcy is already closed at the time the refund claims are discovered, the bankruptcy trustee has to re-open the bankruptcy to try to collect on the refund claims.

Martin v. United States

In Martin v. United States, the bankruptcy trustee did not file the taxpayers’ amended returns or tax refund claims. The taxpayers did. They did so before the bankruptcy case had been closed (they also filed corrected amended returns after the bankruptcy case had been closed). The IRS audited the refund claims and denied the claims (it appears that one of the tax years may have been allowed by the IRS, but this is not addressed in the court case). The IRS Office of Appeals also denied the claims. The taxpayers, not the bankruptcy trustee, then filed a lawsuit against the IRS to recoup the refunds. The bankruptcy trustee re-opened the bankruptcy case at that point. This was required given the undisclosed tax refund claims. The bankruptcy trustee then abandoned the tax refund claims (after giving creditors notice, etc.).

Can Taxpayers File Tax Returns and Bring Suit

The government moved to dismiss the taxpayers’ lawsuit, asserting that the taxpayers did not have standing to bring suit. This turned on whether the taxpayers, not the bankruptcy trustee, had the authority to file a refund claim, as the law requires taxpayers to file a refund claim prior to bringing a lawsuit to recoup the refund.

The law is not clear on this point. In reviewing this law, the court noted that once the bankruptcy trustee abandoned the refund claim, the refund claim reverted back to the taxpayers as if the bankruptcy case did not exist. Based on this, the court concluded that the taxpayers had the right to file the refund claims and to bring the lawsuit to collect on the claims.

The takeaway is that taxpayers who discover tax refunds during or after a bankruptcy case should file the refund claims, even if the bankruptcy trustee will not do so. It may help if timing wise, as in Martin, the claims are disallowed by the IRS at the administrative level. This may encourage the bankruptcy trustee to abandon the claims, rather than incur the costs to pursue them. The abandoment will cause the refund claims to revert back to the taxpayer, rather than the bankruptcy estate.

Cease-and-Desist Order Not Sufficient Evidence for Bad Debt Deduction

Cease-and-Desist Order Not Sufficient Evidence for Bad Debt Deduction

In Sensenig v. Commissioner,T.C. Memo. 2017-1, the court considers whether an investment fund is entitled to a bad debt deduction for cash-hungry start-up companies the fund had invested in when securities regulators barred the investment fund from raising money needed to sustain the start-up companies. The court considers whether the receipt of a cease-and-desist order from the state regulator is a triggering event that establishes that the start-up companies were worthless in the year the order was received.

The Facts & Procedural History

The facts and procedural history are as follows:

  • The taxpayer operated a business that raised money to invest in start-up companies.
  • In return for the money his business invested, the taxpayer would acquire an equity interest in the start-up companies and he acquired financial control over each of the companies by becoming a director, a bank account signatory, the chief financial officer, and the tax return preparer.
  • The taxpayer had raised $50 million from third parties to invest in these start-up companies.
  • The taxpayer’s business invested in 15-20 start-up companies.
  • The Pennsylvania Securities Commission (“PSC”) determined that the practice of issuing demand notes to investors in return for receipt of borrowed funds constituted the sale of unregistered securities.
  • In June of 2005, the PSC issued the taxpayer an order to cease and desist the offering and sale of unregistered securities.
  • In January 2006 the PSC accepted the taxpayer’s offer of settlement and rescinded the summary order to cease and desist.
  • The taxpayer and his fund were permanently barred from offering or selling securities in Pennsylvania unless he received a valid registration statement.
  • The taxpayer took steps to try to register with the U.S. Securities and Exchange Commission, but it proved too costly and he abandoned the effort.
  • The taxpayer claimed a $10,695,581 bad debt loss on his 2005 tax return for three of these start-up companies.
  • The IRS audited the taxpayer’s return and disallowed the loss.

Debt vs. Capital Contribution

The court started by considering whether the monies advanced to the start-up companies were even a debt. The court considered the factors that indicate whether an advance is a loan or a capital investment:

(1) the intent of the parties;
(2) the identity between creditors and shareholders;
(3) the extent of participation in management by the holder of the instrument;
(4) the ability of the corporation to obtain funds from outside sources;
(5) the thinness of the capital structure in relation to debt;
(6) the risk involved;
(7) the formal indicia of the arrangement;
(8) the relative position of the obligees as to other creditors regarding the payment of interest and principal;
(9) the voting power of the holder of the instrument;
(10) the provision of a fixed rate of interest;
(11) a contingency on the obligation to repay;
(12) the source of the interest payments;
(13) the presence or absence of a fixed maturity date;
(14) a provision for redemption by the corporation;
(15) a provision for redemption at the option of the holder; and
(16) the timing of the advance with reference to the organization of the corporation.

Weighing these factors, the court concluded that the money advanced by the investment fund were capital investments. This precluded from taking a bad debt deduction.

Whether the Cease-and-Desist Order Establishes Worthlessness

The court then assumes that the advances were debt, to consider whether the loans were worthless if the advances were debt.

The taxpayer argued that the securities regulators shut down his investment activity with the June 2005 cease-and-desist order and he lacked additional funds with which he could keep the companies going. According to the taxpayer, it was obvious that the companies were therefore doomed and that the loans from the investment funds to them became worthless.

The court noted that the receipt of the cease-and-desist order was significant, but that this fact alone was not sufficient to establish that the debt was worthless. The court asked the taxpayer to provide evidence of the companies finances as of 2005. The taxpayer failed to do this, which resulted in the court concluding that the debt was not worthless.

It should be noted that the taxpayer could also be entitled to take a deduction for worthless securities for its investment in the start-up companies. It does not seem that this worthless securities deduction would have been available in 2005 either, as the start-up companies were still operating in 2005.

The Takeaway

Bad debt and worthless securities deductions are often timing issues. The question is what year is the deduction allowable. For investment funds, the takeaway from this case is that the receipt of a cease-and-desist order from a state regulator alone is not a sufficient triggering even to establish worthlessness. The taxpayer also needs to show financial records to prove that the start-up companies were worthless in the same year that the cease-and-desist order was received.

S Corporation Owner Subject to Self-Employment Tax

S Corporation Owner Subject to Self-Employment Tax

Taxpayers often establish Subchapter S corporations to avoid Social Security and Medicare taxes on a portion of their earnings. This is a very common arrangement. In Fleischer v. Commissioner, T.C. Memo. 2016-238, the taxpayer was not able to avoid these taxes using a Subchapter S corporation. The case provides an example of how the Subchapter S corporation must be structured to avoid these taxes.

Facts & Procedural History

In Fleisher, the taxpayer was a financial planner. He entered into an agreement with a broker and an insurance company to sell their products to his clients. He signed the agreements in his individual capacity. The taxpayer had also formed a legal entity. He chose to have the entity be taxed as a Subchapter S corporation. The taxpayer entered into an employment agreement with the business. The taxpayer reported his earnings on the S corporation tax return (the Form 1120S) and he reported the flow through wages and distribution on his personal tax return (the Form 1040). The taxpayer did not report any self-employment tax on his personal tax return. The IRS audited the taxpayer and concluded that his income and expenses should have been reported on his personal tax return, and not on the legal entity’s tax return. If the IRS’s position was correct, this would subject a large portion of the business income to self-employment tax.

Subchapter S Corporations and Income and Self-Employment Taxes

Subchapter S corporations are not subject to income tax. Rather, they file an information return and report their income, expense, etc. which flow through to, and are reported on, the shareholder’s personal tax returns. The shareholder also reports any wages that are paid to him by the corporation.

The shareholder can classify a portion of the S corporation’s income as wages and a portion as a distribution. The wage portion is subject to self-employment tax, which includes both Social Security and Medicare taxes. The distribution portion is not.

Compare this to a sole proprietorship or single-member limited liability company. These businesses are disregarded for federal income tax purposes. The items of income, expense, etc. are reported on the taxpayer’s individual tax returns. The business income is subject to self-employment tax, which, again, includes both Social Security and Medicare taxes.

Whether the Income and Expense Belong to the Subchapter S Corporation

The question for the court was whether the taxpayer’s income and expenses should be reported by the legal entity, resulting in less self-employment tax, or reported by the taxpayer on his personal tax return.

The court noted that there are two factors to consider in answering this question:

  • the individual providing the services must be an employee of the corporation whom the corporation can direct and control in a meaningful sense and
  • there must exist between the corporation and the person or entity using the services a contract or similar indicium recognizing the corporation’s controlling position.

The court determined that neither element was satisfied in this case. It based this decision on the fact that the taxpayer signed the brokerage and insurance contracts in his personal capacity. He did not sign the contracts on behalf of the business. This meant that the brokerage and insurance companies were paying the taxpayer, not his legal entity. They also reported the income to the IRS in the taxpayer’s name, not in the business’ name. To the court, this meant that the business did not control the taxpayer. Accordingly, the court determined that the income and expenses should have been reported on the taxpayer’s personal tax return.

The takeaway is that business owners need to ensure that their contracts are entered into in the name of the busienss,the income is paid to the business and not the individual owner, and the income is reported to the IRS as having been paid to the business and not the individual owner.

Using IRA Funds to Settle a Probate Dispute

IRA Funds to Settle a Probate Dispute

Inherited IRAs can present a number of challenges. In Ozimkoski v. Commissioner, T.C. Memo. 2016-228, the court considered the tax implications of a withdraw from an inherited IRA that was used to settle a probate dispute with the couple’s son. The case shows what not to do when using IRA funds to settle a probate dispute.

Facts & Procedural History

The facts and procedural history of the case are as follows:

  • The taxpayer’s husband died and his will left all of his assets to the taxpayer.
  • The couple’s son contested the husband’s will.
  • The bank that held the husband’s IRA froze the account pending the outcome of the litigation.
  • The taxpayer eventually entered into a settlement agreement whereby her son was to be paid $110 thousand.
  • The bank transferred $235 thousand of the husband’s IRA into the taxpayer’s IRA.
  • The taxpayer then took at $141 distribution from her IRA and wrote a check to her son for $110 thousand settlement payment.
  • The taxpayer reported the $141 thousand distribution and paid tax on it. She did not report a 10 percent addition to tax on the $141 thousand distribution.
  • The IRS assessed a 10 percent additional tax on the $141 distribution from the taxpayer’s IRA.

The Tax and Addition to Tax for Early Withdrals

Taxpayers must pay tax on distributions they receive from IRAs. Taxpayers are also subject to a 10 percent additional tax on withdraws from IRAs if the withdraws are taken before the taxpayer reaches age 59-1/2. There is an exception to the 10 percent additional tax for withdraws by a surviving spouse from the deceased spouse’s IRA if the distributions are made due to the decedent’s death. The taxpayer argued that this exception applied and that she was not subject to the 10 percent additional tax. This was the primary issue addressed by the court.

As noted in the case, the courts have previously concluded that:

once the assets in the decedent’s IRA were transferred into the taxpayer’s IRA, any subsequent distributions were no longer occasioned by the decedent’s death and were not made to the taxpayer as a beneficiary of the decedent; therefore, the exception … did not apply.

In applying this rule, the court determined that the taxpayer was liable for the 10 percent additional tax.

Avoiding the Tax and 10 Percent Addition to Tax

With a little foresight, the taxpayer could have avoided the tax and the 10 percent addition to tax altogether. Had the taxpayer not transferred the $235 thousand to her account, but had instead left it in her husband’s IRA and paid the $110 thousand to her son directly from her husband’s IRA, she would not be subject to tax on the distribtion and the 10 percent penalty would not have applied.

The taxpayer could have rolled part of her husband’s IRA into an inherited IRA for her son. With this arrangement, the son would have had to start taking distributions from the IRA immediately or within 5 years and the distributions would be subject to tax. It appears that the taxpayer’s son was aware of this rule, as the son had told the bank that he did not want an inherited IRA. With the settlement, the son was able to receive $110 thousand free of any tax, while shifting the liability for the tax and addition to tax to his mother.

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