At first blush, Chief Counsel Advice Memorandum CCA 201313025, may seem overly harsh. After all, the taxpayer was relying on information provided to her from her employer when she took her lump sum distribution and rolled it over into an IRA. However, the government was simply following the statute and regulations in refusing to refund the excess contribution penalty.
Here, the taxpayer’s former employer was overly generous to the taxpayer and, in making the lump sum distribution to her, distributed more to her than was in her qualified plan, and reported to her on a 1099R that the entire amount of the distribution was an eligible rollover distribution. Believing that she was entitled to the entire distribution and that it was entirely an eligible rollover distribution, the taxpayer rolled over this entire distribution including the over-payment to her rollover IRA and reported the lump sum distribution and rollover as a tax-free rollover on her income tax return that year.
About a year later, the taxpayer’s former employer informed her of the error and the taxpayer then withdrew the excess contribution from her IRA, presumably to return it to the employer. At the time she was over age 59½ so there was no 10% early withdrawal penalty, but there was a 6% excess contribution penalty because the time for curing the excess contribution (the due date for filing her return for the year of the rollover) had already passed. The taxpayer took the position on her return that the withdrawal qualified for the exception to taxation as a withdrawal of an excess contribution under IRC § 408(d)(5)(B), under which an excess rollover contribution to an IRA as a result of reasonable reliance on erroneous information can be withdrawn from the IRA tax-free. Although the taxpayer did not include the withdrawal amount in her taxable income for the year, she did pay the 6% excess contribution penalty for the excess rollover contribution she had now withdrawn.
The government challenged her failure to include the withdrawal in her taxable income for the year of withdrawal and assessed a deficiency. By that time, the statute of limitations had run on the income tax return for the year of the rollover, so the government could not assess a tax on the over-payment from the qualified plan that was not an eligible rollover distribution and ineligible for tax deferral as a rollover. The government instead taxed the withdrawal of the excess contribution, which would otherwise have qualified for the exception to taxation under IRC § 408(d)(5)(B), applying the “duty of consistency” doctrine. This doctrine applies whenever (1) the taxpayer makes a representation as to the taxation of an item in one year, (2) the Service relies on that representation, and (3) after the statute of limitations bars adjustment to the tax in the prior year, the taxpayer seeks to change that representation as it relates to taxation of an item in a subsequent year. Because the taxpayer had entirely excluded the over-payment from income in the prior year and the government could no longer tax that over-payment due to the expiration of the statute of limitations on the tax year in which the rollover occurred, the withdrawal did not meet the requirements for the exception to taxation of the withdrawal.
The taxpayer then sought a refund of the excess contribution penalty on the basis of the duty of consistency doctrine. Chief Counsel, however, stated that it was the taxpayer and not the Service that had changed her position. An excess contribution penalty is due whenever an excess contribution is made to an IRA regardless of fault. That 6% excess contribution penalty is due each year that the excess contribution remains in the IRA until it is either “absorbed” into the IRA as authorized contributions of the annual contribution amount or is withdrawn.
For example, Alice receives an over-payment in year 2010 of $10,000 and, based on incorrect information from her former employer, rolls over that ineligible contribution amount into an IRA. Then in 2013, Alice’s former employer provides her with new information that it had inadvertently made an over-payment making the lump sum distribution to her. Her former employer then requests a return of the $10,000, which Alice obtains principally through a withdrawal from her IRA into which she had rolled over the ineligible contribution. Since the error was not corrected by the due date of her 2010 return, a 6% excess contribution penalty is due under §4973 of the Code on the amount of the excess contribution in 2010, or $600 for 2010. If Alice was eligible to make a regular contribution to her IRA in 2011, but did not make any such contribution, the excess contribution amount would be reduced by the amount of the eligible 2011 regular annual contribution amount, and the 6% penalty for 2011 would be due on the balance. But if Alice was not eligible to make a regular annual contribution to an IRA, the 6% penalty would continue to be charged for each year in which the excess contribution remained in the IRA.