Retired Police Officer Granted Hardship Waiver for Late Retirement Rollover; Major Depression Was a Condition Qualifying for a Waiver

(Parker Tax Publishing May 2017)

The Tax Court granted a hardship waiver to a retired police officer who, due to a major depressive disorder, failed to roll over his pension distributions to a qualified retirement account within 60 days. Because the distributions were nontaxable, the additional 10 percent tax on early distributions did not apply. Trimmer v. Comm'r, 148 T.C. No. 14 (2017).

Background

In 2011, John Trimmer retired from the New York Police Department at age 47 after 20 years of service. Before retiring, he found a job as a security guard to supplement his pension income and to help finance his sons' college educations. His security guard job fell through shortly after he retired and he was unable to find another position. Three weeks after retiring, Trimmer began experiencing symptoms relating to a major depressive disorder. He became antisocial, irritable, and uncommunicative; he rarely left the house, had trouble sleeping, lost weight, and neglected his hygiene and grooming. He stopped coaching his sons' sporting events and stopped attending their school events. He did little with his days, although he did occasionally write checks from his and his wife's joint checking account.

In May and June 2011, after his depression had set in, Trimmer received two retirement account distribution checks, one for approximately $99,000 and the other for approximately $1,700. The checks lay on his dresser for over a month until he deposited them into a bank account in July 2011. In April 2012, on the advice of his tax return preparer, Trimmer opened an IRA and rolled the funds over from the account where the two checks had been deposited. Trimmer and his wife made no use of any of the funds before they were rolled over to the IRA. They reported the distributions as nontaxable on their 2011 tax return.

The Trimmers received an IRS Notice CP2000, Proposed Changes to Your 2011 Form 1040, in December 2013 indicating that they had failed to report approximately $100,000 of taxable retirement income, and that they were also liable under Code Sec. 72(t) for an additional 10 percent tax on early distributions from a qualified plan. According to the IRS, the Trimmers owed almost $40,000 in additional taxes. The notice advised that if the Trimmers disagreed, they should complete an attached response form and send it to the IRS. Trimmer replied to the notice with a letter contesting the assessment. He explained his condition and noted that none of the retirement funds had been spent and that the funds had already been rolled over to an IRA. Trimmer said that such a large tax bill would cripple his family and that no harm was done by the late rollover. He asked the IRS to consider the facts and come to a fair decision.

The IRS responded with a letter telling Trimmer that he did not need to do anything else at that time, and that they would tell him what action they would take within 60 days. Three days later, an IRS operations manager denied the request for relief. No mention was made in the denial letter of the IRS's authority to grant a hardship waiver or of the procedure for applying for one. The letter also did not acknowledge any of Trimmer's particular circumstances. It stated that if Trimmer disagreed, he should respond and explain why. In August 2014, the IRS issued a notice of deficiency, and the Trimmers took their case to the Tax Court.

Analysis

Under Code Sec. 402(a), a distribution from a retirement plan is generally taxable. However, the recipient can, under Code Sec. 402(c)(1), exclude from income any portion of a distribution that is rolled over within 60 days to an eligible retirement plan. The rollover exclusion is generally not available after 60 days, but the IRS can waive the 60-day requirement under a hardship exception provided in Code Sec. 402(c)(3)(B). Under that provision, a hardship waiver may be granted by the IRS where the failure to do so would be against equity or good conscience.

Rev. Proc. 2003-16 provides guidance about applying for hardship waivers under Code Sec. 402(c)(3)(B) and states that a taxpayer must apply for a hardship exception to the 60-day rollover requirement by submitting a private letter ruling (PLR) request under the procedures outlined in Rev. Proc. 2003-4 and include a user fee with the application. The IRS subsequently issued Rev. Proc. 2016-47, which modified Rev. Proc. 2003-16 and had an effective date of August 24, 2016. Rev. Proc. 2016-47 authorizes "additional" hardship waivers where, during an audit, the IRS determines that the taxpayer qualifies for a waiver of the 60-day rollover requirement under Code Sec. 402(c)(3)(B).

Before the Tax Court, the Trimmers argued that the hardship exception should apply because the failure to timely rollover the retirement amounts was caused by Trimmer's major depressive disorder. The IRS contended that the Trimmers failed to apply for relief by requesting a PLR and paying a fee as required in Rev. Proc. 2003-16. The IRS contended that its Examination Division lacked the authority to consider a hardship waiver under Code Sec. 402(c)(3)(B) and that, in any event, the IRS's exercise of discretion in denying a hardship waiver was not subject to judicial review. The IRS also said that, because Rev. Proc. 2016-47 had not been issued as of the time when the Trimmers' 2011 return was under audit, the IRS's Examination Division did not have the authority to determine whether the Trimmers qualified for a waiver. Finally, according to the IRS, there was no abuse of discretion in denying a hardship waiver because Trimmer failed to establish that he was unable to complete the rollovers within 60 days of the distributions.

The Tax Court held that Trimmer was entitled to a hardship waiver under Code Sec. 402(c)(3)(B) and that the 10 percent additional tax on early distributions under Code Sec. 72(t) did not apply.

According to the Tax Court, the IRS had the authority to consider Trimmer's request for a hardship waiver in the course of auditing his tax return. Nothing in Rev. Proc. 2003-16, the court said, prevented the IRS's ability to consider a hardship waiver in the course of auditing a return. Nor was there any such constraint in Code Sec. 402(c)(3)(B). Moreover, the court noted, the Internal Revenue Manual gives examiners the authority to recommend the proper disposition of all issues, including those raised by the taxpayer. Regarding Rev. Proc. 2016-47, the Tax Court reasoned that the purpose and effect of the 2016 modification of Rev. Proc. 2003-16 was not to create some new authority that had not previously existed for IRS examiners to consider hardship waivers during audits, but rather to make clear the existence of that authority.

Having determined that the IRS could consider a hardship waiver request during an examination, the Tax Court also found that Trimmer's letter in response to the IRS's notice constituted a waiver request. In response to that request, the IRS did not decline to consider the issue, nor did it advise Trimmer that he was required to submit a PLR request. Their response, the court noted, was that Trimmer need not do anything else at that point, and that the IRS would notify Trimmer of its decision. When the IRS denied Trimmer's request, the court observed, it did not say the reason for the denial was that Trimmer had made the request in the wrong manner.

Next, the Tax Court held that it had jurisdiction to consider the IRS's denial of Trimmer's waiver request. According to the court, reviewing the waiver denial was necessary in order to determine the merits of the deficiency determination.

Considering the merits of Trimmer's hardship waiver request, the Tax Court held that Trimmer's depression was a disability that significantly impaired his ability to perform day-to-day activities, and that his failure to meet the 60-day rollover requirement was attributable to his disability. The court found that Rev. Proc. 2003-16 specifies the factors for the IRS to consider in deciding whether to grant the waiver, one of which is the inability to complete a timely rollover due to disability. Reviewing Trimmer's symptoms during the relevant period, the court concluded that Trimmer's depression satisfied the disability requirements as provided in Rev. Proc. 2003-16.

Finally, the court also held that the additional 10 percent tax on early distributions under Code Sec. 72(t) did not apply since none of the distributions were taxable.

For a discussion of hardship waivers under Code Sec. 402(c)(3)(B), see Parker Tax ¶131,550.

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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