Incarcerated Taxpayer Was Not Liable for Misappropriated IRA Distributions

(Parker Tax Publishing October 2023)

The Tax Court held that a taxpayer was not required to include in gross income distributions from his individual retirement account (IRA) and life insurance policy that were made by his wife pursuant to a power of attorney (POA) while the taxpayer was incarcerated because the taxpayer was not the distributee under Code Sec. 408(d)(1). The court found that the taxpayer's wife, whole used the funds to renovate a home in another state and to support herself and her ailing mother, breached her fiduciary duty under the POA by engaging in unauthorized self-dealing. Balint v. Comm'r, T.C. Memo. 2023-118.

Background

Joseph Balint was incarcerated from December 17, 2013, through January 6, 2015. During 2014 Joseph owned a retirement account with Pershing, LLC (Pershing), and a life insurance policy with Pruco Life Insurance Co. (Pruco).

In February 2014, Joseph sent his wife, Jacqueline, a letter asking her to get a power of attorney (POA). Joseph wanted to take care of Jacqueline and was trying to save his marriage. In the POA, which stated that it was governed by Florida law, Joseph appointed Jacqueline as his agent and granted her "full power and authority to perform any act, power or duty that I may now or hereafter have and to exercise any right that I now have or may hereafter acquire." The POA further authorized Jacqueline to "withdraw money or property deposited with or left in the custody of a financial institution" and to "withdraw benefits from" any retirement plan. In addition, Joseph initialed "yes" beside provisions granting Jacqueline the authority to make gifts of his property to or for the benefit of any person and stating that it was his specific intent to authorize her to take certain actions that might otherwise constitute prohibited self-dealing. Specifically, the POA stated that Jacqueline was authorized to engage in such actions "for the purpose of tax, financial or estate planning, for [Joseph's] benefit, or for qualifying for public assistance" programs for which Joseph may be eligible.

During 2014, Jacqueline used the POA to effect distributions from Joseph's IRA account and life insurance policy, which she deposited into the couple's joint checking account and then to her individual account shortly thereafter. The amounts Jacqueline withdrew from Joseph's IRA and life insurance policy in 2014 totaled $137,469, and the amounts she thereafter transferred to her own individual accounts totaled $130,908, a difference of $6,561. Jacqueline used the funds to move from the couple's residence in Florida to Kentucky, to renovate a house there, to care for her ailing mother, and to pay living expenses. In September 2014, Jacqueline commenced a proceeding for divorce while Joseph was still incarcerated. Joseph first learned of Jacqueline's desire for a divorce when he was served with the divorce papers in prison in early October 2014.

Joseph was released from prison in January 2015. In April 2015 he filed a federal income tax return for 2014, which he filed as married filing separately. Joseph included in his gross income the IRA and life insurance distributions, even though he did not believe these amounts were properly taxable to him, because he had received IRS forms reporting them and was concerned that failing to report them could constitute a violation of the terms of his probation. After the IRS assessed the tax and issued a notice of intent to levy, Joseph submitted to the IRS Independent Office of Appeals (Appeals) a Form 8857, Request for Innocent Spouse Relief, in which he alleged that Jacqueline had stolen more than $240,000 from him and that he had not received any of those funds. After Appeals sustained the proposed levy, Joseph took his case to the Tax Court.

Under Code Sec. 408(d)(1), amounts distributed from IRAs are generally includible in the gross income of the "payee" or "distribute" and amounts "received" under a life insurance contract, but not paid as an annuity, are includible in the recipient's gross income to the extent that they exceed the amount invested in the contract.

In some circumstances the Tax Court has concluded that funds misappropriated from a taxpayer's financial accounts were not includible in the taxpayer's gross income because the taxpayer was not the payee, distributee, or recipient of the misappropriated funds. For example, in Roberts v. Comm'r, 141 T.C. 569 (2013), the Tax Court observed that "whether there is an economic benefit accruing to the taxpayer is the crucial factor in determining whether there is gross income" and held that a taxpayer was not required to include in his gross income amounts that his wife fraudulently withdrew from his IRAs without his knowledge. The court reasoned that the taxpayer could not be treated as the payee or distributee of the amounts in question under Code Sec. 408(d)(1) because "the IRA distribution requests were unauthorized, the endorsements on the checks that were issued pursuant to the requests were forged, [the taxpayer] did not receive the economic benefit of the IRA distributions, and the IRA distributions were not made to discharge any legal obligation of his." Instead, the court explained, the taxpayer's wife had benefited from the IRA distributions, which she used for, among other purposes, establishing a separate household.

The Tax Court has reached similar conclusions in cases where a taxpayer's agent has misappropriated the taxpayer's funds while purporting to act on the taxpayer's behalf. In Grant v. Comm'r, T.C. Memo. 1995-29, for instance, the court pointed out that although a taxpayer is generally treated as the recipient of any income received by his or her agent, that rule does not apply "where the agent receives and misappropriates funds for his own use, where the principal had no knowledge of such misappropriation, and where the principal received no economic benefit from the misappropriated funds." The evidence in Grant showed that an agent whom the taxpayers had engaged to help them consolidate and pay personal debts had caused a distribution from one of their pension accounts without their knowledge or authorization, and that their agent (and the debt consolidation company with which he worked) had kept the money instead of using it to pay their debts or otherwise benefit them. Accordingly, the court held that the distribution was not includible in the taxpayer's gross income. Relatedly, in Wilkinson v. Comm'r, T.C. Memo. 1993-336, the Tax Court held that where an agent appointed under a power of attorney made withdrawals for her own benefit from the principal's accounts, and the power of attorney had not authorized the agent to make gifts to herself, the amounts in question were properly characterized as the agent's income.

Analysis

The Tax Court held the funds Jacqueline withdrew from Joseph's IRA and life insurance policy and transferred to her individual account in 2014 were not includible in Joseph's gross income for 2014 because Joseph was not the distributee of the funds under Code Sec. 408(d)(1). The Tax Court found that the reasoning in Roberts, Grant, and Wilkinson applied with equal force in this case, where the withdrawals that Jacqueline made from Joseph's accounts were outside the scope of her authority under the POA, made without his knowledge, and did not result in any economic benefit to him.

The court found that Jacqueline was authorized under the POA to make gifts of Joseph's property and to take actions that could otherwise be understood to constitute prohibited self-dealing. However, the court noted that the POA also limited that authority by explaining that "actions that might otherwise be considered prohibited as self-dealing are specifically authorized ... for the purpose of tax, financial or estate planning for [Joseph's] benefit, or for qualifying for public assistance ... for [Joseph] may be eligible." In the court's view, this sentence did not amount to an open-ended authorization for Jacqueline to exercise her authority under the POA for her own benefit. Instead, the court found that Jacqueline was authorized to take actions that would benefit herself only if the benefit to her was incidental to planning undertaken primarily to benefit Joseph, or to ensuring that Joseph would qualify for public assistance.

The court concluded that Jacqueline engaged in self-dealing for her own benefit and not as an incident to accomplishing any authorized purpose on Joseph's behalf. In the court's view, Joseph did not plausibly benefit from any use of the funds that Jacqueline conceded she withdrew from Joseph's life insurance and IRA account and used for her benefit. Because the POA authorized Jacqueline to engage in self-dealing only in connection with specified activities undertaken for Joseph's benefit, the court found that her use of the remainder of the withdrawn funds for her own benefit constituted unauthorized self-dealing and was a breach of her fiduciary duty. The court concluded that Jacqueline, and not Joseph, was the economic beneficiary and thus the distributee or recipient of those funds.

For a discussion of the taxation of distributions from an IRA, see Parker Tax ¶134,535.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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