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Houston Tax Attorney
Early distributions from IRAs are subject to a 10 percent additional tax. The 10 percent additional tax does not apply if the distribution is taken when the IRA owner is disabled. The recent Gillette v. Commissioner, T.C. Memo. 2018-195, case addresses whether medically-induced compulsive gambling qualifies as a disability.
The Facts & Procedural History
The taxpayer-wife is a firefighter. She also managed rental properties the taxpayers owned. She suffered from restless leg syndrome and was taking medication for this condition. The medication led to severe compulsive behavior, including compulsive gambling. This was a known side effect of the medication she was taking.
The court described her gambling as follows:
She began traveling hours from her home to play live casino games, increasing her bets to upwards of $500 on a single play at a slot machine and betting thousands of dollars on a single hand of blackjack. She opened credit lines at various casinos and many were soon in default.
But Ms. Gillette also won big. On one occasion she won roughly $162,000. She left the casino with less, having played and lost a portion of her winnings. She went immediately to another casino that had closed one of her many credit lines and paid off her debt to that casino; the casino then extended her further credit. Days later, without much sleep and without leaving the casino, Ms. Gillette gambled away all of her winnings.
After her son discovered the taxpayer’s financial difficulties and gambling, the taxpayer-wife consulted with her doctor and was taken off of the medication over time. She stopped gambling once she stopped taking the medication. Prior to this time, she had taken out money from her IRA.
On her tax return, the taxpayer reported approximately $10,000 for additional tax owed on the premature IRA distribution. She challenged the additional tax as part of the IRS’s collection efforts, which is the subject of the tax litigation. The question for the court was whether the premature IRA distribution was subject to additional tax given the taxpayer-wife’s medically-induced compulsive gambling.
The Additional Tax on Early IRA Distributions
Distributions from IRA accounts are subject to Federal income tax. If the taxpayer is under 59 1/2 years old at the time of the distribution, the distribution is also subject to a 10 percent additional tax.
There are several exceptions to the 10 percent additional tax, which includes an exception for distributions “attributable to the employee’s being disabled.”
The term “disabled” is defined as follows:
an individual shall be considered to be disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. An individual shall not be considered to be disabled unless he furnishes proof of the existence thereof in such form and manner as the Secretary may require.
The regulations provide further clarification:
Whether or not the impairment in a particular case constitutes a disability is to be determined with reference to all the facts in the case. The following are examples of impairments which would ordinarily be considered as preventing substantial gainful activity:
(i) Loss of use of two limbs;
(ii) Certain progressive diseases which have resulted in the physical loss or atrophy of a limb, such as diabetes, multiple sclerosis, or Buerger’s disease;
(iii) Diseases of the heart, lungs, or blood vessels which have resulted in major loss of heart or lung reserve as evidenced by X-ray, electrocardiogram, or other objective findings, so that despite medical treatment breathlessness, pain, or fatigue is produced on slight exertion, such as walking several blocks, using public transportation, or doing small chores;
(iv) Cancer which is inoperable and progressive;
(v) Damage to the brain or brain abnormality which has resulted in severe loss of judgment, intellect, orientation, or memory;
(vi) Mental diseases (e.g. psychosis or severe psychoneurosis) requiring continued institutionalization or constant supervision of the individual;
(vii) Loss or diminution of vision to the extent that the affected individual has a central visual acuity of no better than 20/200 in the better eye after best correction, or has a limitation in the fields of vision such that the widest diameter of the visual fields subtends an angle no greater than 20 degrees;
(viii) Permanent and total loss of speech;
(ix) Total deafness uncorrectible by a hearing aid.
The existence of one or more of the impairments described in this subparagraph (or of an impairment of greater severity) will not, however, in and of itself always permit a finding that an individual is disabled as defined in section 72(m)(7). Any impairment, whether of lesser or greater severity, must be evaluated in terms of whether it does in fact prevent the individual from engaging in his customary or any comparable substantial gainful activity.
The regulations also say that: “In order to meet the requirements …, an impairment must be expected either to continue for a long and indefinite period or to result in death” and “An impairment which is remediable does not constitute a disability.”
Is Medically-Induced Compulsive Gambling a Disability?
The taxpayers argued that the medically-induced compulsive gambling satisfied these two conditions:
- Damage to the brain or brain abnormality which has resulted in severe loss of judgment, intellect, orientation, or memory.
- Mental diseases (e.g. psychosis or severe psychoneurosis) requiring continued institutionalization or constant supervision of the individual.
The court did not address whether the taxpayer-wife’s condition fitwithin these two conditions. Rather, it cites the final language in the regulations that says that an impairment that can be remedied is not a disability and that this precluded the taxpayer-wife from being disabled:
Even accepting that Ms. Gillette suffered an impairment in 2012, we nonetheless find that any impairment was remediable and not a disability under section 72(m)(7). Ms. Gillette was treated in a reasonable and safe manner with the help of her family and medical professionals. She was able to return to managing her rental properties and financial affairs and has not gambled since 2015. Any impairment that affected Ms. Gillette during the year at issue was remediable; she was not disabled…
This ruling is consistent with the prior cases where the court considered the disability exception, which provide the context for understanding the case.
The Court’s Strict Reading of the Regulations
There are a number of prior cases where the court considered the disability exception. None of these cases have been found in the taxpayer’s favor.
Most of these cases are decided based on the lack of evidence supporting the disability. For example, in Trainito v. Commissioner, T.C. Summary Opinion 2015-37, the taxpayer suffered a diabetic coma two months after taking an early IRA distribution. The court concluded that the taxpayer’s diabetes did not qualify, as the taxpayer failed to prove up his medical condition two months prior, at the time of the IRA distribution.
The court in Trainito cites Kopty v. Commissioner, T.C. Memo. 2007-343, which is another case that considered the disability exception. In Kopty, the taxpayer’s heart condition was not diagnosed until after he received his IRA distribution. The court in Trainito noted that “[a] taxpayer may not escape the 10% early withdrawal penalty by suffering a disability at just any point during the tax year; rather the disability must be present at the time the distribution is made.” The court also considered the taxpayer’s depression-as-a-disability argument. The court also concluded that the taxpayer failed to present evidence that he suffered from depression.
Even where taxpayers present evidence, the court has still generally concluded that the facts are not sufficient to establish the existence of a disability. For example, in Dwyer v. Commissioner, 106 T.C. 337 (1996) the court concluded that a taxpayer who suffered from severe depression was not disabled. The court noted that the taxpayer “continued to function as an active stock trader in the face of his clinical depression and in fact withdrew his IRA funds to further that activity.” The court did not accept the taxpayer’s arguments that his sizeable loss from his stock trading activity showed that it was not a gainful activity and contributed to his depression. The court concluded that a profit making activity, not that a profit was made, is all that matters. That the taxpayer continued to engage in this activity negated a finding of a disability.
The Pamela v. Commissioner, 64 T.C.M. 1076 (1992), court case is similar. In Pamela, the taxpayer suffered from clinical depression and presented evidence of this in court. The court concluded that the taxpayer was not disabled as the “evidence presented … at trial leads to the conclusion that he did not require continued institutionalization or constant supervision.”
Cases Decided on the Facts
This brings us back to the Gillette case. The taxpayer in Gillette presented sufficient evidence of her disability, which allowed the court to address whether there was a disability. The case fits within the second group of cases where the court concludes that the medical condition did not rise to the level of a disability.
That the taxpayer’s compulsive gambling was medically-induced helped, but there wasn’t sufficient evidence that the disability was permanent. The evidence showed that it was possible to simply stop taking the medication. If the taxpayer brought the suit before reducing her medication and the court did not have evidence that this was even possible, the court may have reached a different conclusion.
Perhaps the take away is that these disputes should be resolved at the administrative level or, if litigation is necessary, litigated in a forum other than the U.S. Tax Court.