IRA Excess Contribution Tax for Stock Sale

Published Categorized as Federal Income Tax, Retirement Accounts, Tax

There are a lot of unanswered questions when it comes to the tax rules for IRAs and other qualified plans. IRAs and qualified plans can shelter a significant amount of income from tax.

Defined benefit plans are an example. A business owner can contribute and shelter up to $245,000 in these plans in 2022. This amount can double if the business owner is married and the spouse participates in the business. This is often a centerpiece of many tax plans for business onwers.

It is possible to make excess contributions to qualified plans. There is an excise tax that applies if there is an excess contribution. This is similar to the rescission doctrine, in that the excise tax does not apply to amounts corrected in the same year.

The recent Couturier v. Commissioner, T.C. Memo. 2022-16, considers a fact pattern involving payments to a taxpayer’s qualified plan to terminate the stock owned by the plan. The IRS asserted that this triggered an excess contribution tax. This provides an opportunity to consider the excess contribution tax.

Facts & Procedural History

The taxpayer was the president of a business from 1999 to 2004. The business was a subsidiary of a parent company.

The parent company maintained an employee stock ownership plan (“ESOP”). It also maintained non-qualified deferred compensation (“NQDC”) plans.

The taxpayer owned shares of the company in the ESOP and he was also entitled to payment under the NQDC plans.

The parent company was reorganized. After the reorganization, it desired to buy out the taxpayer’s shares.

Not only did the parent company buy-out the taxpayer’s shares, the taxpayer also agreed to relinquish his interest in the NQDC plans. This resulted in the payment of $26 million to the taxpayer’s IRA for his shares.

On audit by the IRS, the IRS determined that the shares were only worth about $8 million. The extra amounts were for the relinquishment of the taxpayer’s interest in the NQDC plans. Since these amounts were paid into the taxpayer’s IRA, the IRS determined that they were excess contributions. The IRS assessed excise taxes for these excess contributions.

Excise Taxes on Excess Contributions

The excise tax on excess contributions is found in Section 4973 of the Code. This section says that the IRS can impose a six percent tax on “the amount of the excess contributions to such individual’s account.”

It goes on to define “excess contributions” as the excess of (1) the amount contributed to an IRA for the taxable year (other than a “rollover contribution” described in section 408(d)(3)), over (2) the amount allowable as a deduction under section 219 for such contribution. The reference to Section 219 is the amount of the annual deduction for IRA contributions.

This excess contributions tax applies each year until the excess contribution is distributed to the taxpayer and included as income for income tax purposes.

Time Limit for Assessing the Excise Tax

This court case addresses the question of whether the IRS can assert the excess contribution tax when it did not assess any additional income tax.

The IRS did not make an income tax adjustment in this case. It probably did not do so as the time limit or statute of limitations had expired for the income tax adjustment. The taxpayer’s argument was that the IRS was precluded from making an excise tax adjustment in this situation.

The court did not accept the argument. It concluded that there was no requirement that the IRS also impose income tax to be able to impose an excise tax. The court reached this decision as the taxpayer did not cite the statute of limitation rules. The taxpayer did not argue that the excise tax itself has to be assessed by the time periods within the statute of limitation rules. The Form 5329 is used to report excess contributions. It has to be filed with a timely-filed income tax return. Thus, one would think that filing the income tax return would trigger the statute of limitation for assessing excise taxes. If the taxpayer had timely-filed his income tax return and did not include this form with his tax return, that should start the time period for the IRS to assess the excise tax that is reported on that tax return.

Instead of making that argument, the taxpayer argued that the IRS was taking an inconsistent position. The inconsistency is saying that there is an excess contribution for excise tax purposes, but not one for income tax purposes. The court noted that there is case law supporting this argument. The difference between the current case and the prior case law is that the IRS made no determination as to income tax in the current case. Put another way, there was no inconsistent position as the IRS did not take a position on the income tax side of it.

It should be noted that the taxpayer also did not argue that there was no qualified plan to which an excise tax could apply. The facts, in this case, would not have supported such an argument. The IRS determined that there were no prohibited transactions with the IRA in question. Thus, the IRS did not disqualify the plan itself. This is somewhat unusual. In many cases, the IRS will in fact disqualify the plan. Then there is a question of whether you can have an excess contribution to a non-qualified plan. The normal statute of limitation rules for income taxes would clearly seem to apply in that case.

Other Issues in the Case

This case was before the court on the taxpayer’s motion for summary judgment. Even though the taxpayer did not prevail in this court proceeding, there are other issues in the case that have to be considered. One issue relates to the valuation. This includes the valuation of the stock as well as the taxpayer’s interest in the NQDC plans. The IRS determination as to the value may be incorrect. An increase in the value of the stock would limit the amount of the excess contribution.

Because part of the payment to the IRA was in the form of a promissory note that was to be paid overtime, this too will impact the calculations. The note payable over time is worth less than cash today. It would seem that this may trigger a valuation discount that may also reduce the amount of the excess contribution.

There is also the question of whether there was a prohibited transaction. The IRS determined that there was no prohibited transaction. The IRS could change its position on this and try to raise this issue in this case. If it did, there could be a 15 percent tax that would reach the maximum 100 percent tax as it was not corrected within the tax year. This too would raise questions about the statute of limitations for assessing this tax.

These types of issues show how difficult it is to fix many common IRA problems.

The Takeaway

This issue highlights some of the difficulties in working with qualified plans. Taxpayers who have an interest in the business that is sold may have a number of rights and benefits owed by the business. The right to payments under the NQDC plans in this case provides an example of this. Waiving these rights can trigger an excise tax as it did in this case. Taxpayers may be well advised to keep some records to establish the value of the stock they are selling. This may include getting the stock evaluated by a third party or even soliciting bids from third parties. Taxpayers may also want to file Form 5329 with their tax return to start the time period set out in the statute of limitation rules.

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