1099-R for $160,000 Worthless Promissory Note from 2009
I was notified by the IRS that they were going to levy my income and bank accounts for taxes and penalties of approximately $90,000. I had failed to file returns for 2009 through 2014; and found out that an IRA custodian of worthless promissory notes had reported a 1099-R at $160,000 (full value) as an early distribution in 2009.
I ran into financial difficulties in 2008 and my personal and LLC Chapter 11 was converted to a 7 by the court. I was discharged in August, 2009… and now find myself against the wall trying to undo this 1099-R… as the notes have no value.
I just found this out… as I “checked out” after losing everything in 2008 and 2009… now these purported taxes owed are throwing a monkey wrench into my financial comeback.
How do I correct this? As this incident presumably came before IRA custodians were required to provide a year-end value. Did the bankruptcy toll this issuance of 1099-R in 2009? This IRA custodian had threatened to close my account and make an early distribution for my lack of payment of fees at that time… but I am not sure what actually triggered the distribution, as I of course, did not request it.
HELP!
Permalink Submitted by Alan - IRA critic on Tue, 2015-10-27 19:03
Permalink Submitted by Jose Morales on Tue, 2015-10-27 19:43
What do you mean by “correct?” If you are disputing the amount shown on the 1099-R then your dispute is primarily with the IRA Custodian that issued the 1099-R. Being that it was issued in 2009 and you are only now getting around to disputing the amount shown will make your chances of having them easily make a 1099-R correction very slim. They would have provided you with a fair market value statement and the 1099-R for that year and the appropriate time to question the value of whatever was distributed would have been shortly after receiving those documents. If you want to plead your case with the IRS that these promissory notes were worthless and the 1099-R is wrong, you will need to gather all the evidence you can to prove beyond a doubt that the notes were in fact worthless. There is on tax court case that comes to mind where a couple tried to make this exact same arguement and they were not successful in convincing either the IRS or the US Tax Court. Both the IRS and US Tax Court saw it as very self serving to claim the value of the distribution is worthless being that it would allow the couple to avoid paying tax on the distribution from their IRA.
Permalink Submitted by Jose Morales on Tue, 2015-10-27 20:23
http://ustaxcourt.gov/UstcInOp/OpinionViewer.aspx?ID=353 http://ustaxcourt.gov/UstcInOp/OpinionViewer.aspx?ID=354
Permalink Submitted by Joe Luby on Tue, 2015-10-27 20:47
1) Based on the information provided in your post, it is most likely a case where the IRA custodian carried out its action of closing your account, distributing the assets, and issuing the 1099-R to report the distribution in response to your failing to pay the custodial fees demanded. That is a normal and customary business practice in the industry as IRA custodians are under no obligation to continue providing custodial and reporting services to non-paying customers. 2) The key question is this: What was the fair market value of the notes as of the date of distribution from the IRA? If they were indeed worthless on that date, then the IRA custodian should have reported them as such on the Form 1099-R. However, if the fair market value of the notes on that date was $160,000, and the notes only became worthless sometime after the fact, then the 1099-R valuation was correct. 3) If the notes were worthless on the date of distribution, then your IRA custodian violated the tax law by misreporting their value on the Form 1099-R. Nonetheless, the IRA custodian is highly unlikely to issue a corrected 1099-R, even if you were to provide irrefutable proof of their error, in part because said corrected 1099-R may be viewed as a tacit admission of wrongdoing by them in the first place. That doesn’t mean that you should not attempt to get them to issue a corrected 1099-R if you have the proof described. I’m just being realistic so that you understand it will be a very steep uphill battle. 4) Your other avenue is to attempt to use the same irrefutable proof that the notes were actually worthless on the date of distribution to persuade the IRS that the Form 1099-R valuation is incorrect. If successful, then the IRS would have to reassess any tax, penalties, and interest owed based on the updated valuation. Again, from a “setting proper expectations” standpoint, this is also a very steep uphill battle. The IRS is in possession of a mandatory reporting form prepared and issued by a (presumably) lawfully recognized IRA custodian which states that the taxable value of the assets was $160,000 on the date of distribution. As they have done in prior cases, the IRS is likely to stick to their assessment and force you to take the issue to court if you want to pursue it. They know that with many taxpayers, especially ones with limited financial means, this will not be a viable option and the IRS’ assessment will not be successfully challenged. 5) If you can prove the notes were worthless on the date of distribution and that the IRA custodian falsely valued them at $160,000, then you may have a valid legal claim against the IRA custodian. Emphasis on the word “may.” There are many variables involved, not the least of which is the applicable statute of limitations for bringing suit, etc.
Permalink Submitted by John Eng on Tue, 2015-10-27 20:55
I spoke with the IRA custodian. My account was closed due to non-payment of fees that were due in 2006,2007, and 2008; I filed Chapter 11 in June, 2008 (personally), and it was converted to a Chapter 7 by the Court in October, 2008. The IRA custodian billed me personally for the IRA fees as no cash was in the account. They distributed the notes to me “in-kind” (apparently…not physically received by me) on March 31, 2009 during the period where assets were still in the bankruptcy estate….Would these assets then be considered in the bankruptcy estate at that time (March 31, 2009)?Would the Custodian even be able to take action on non-payment while the stay was in place?Would these fees billed to me personally be discharged in my discharge August 2009 5 months after the account closing for lack of payment (individually) of my IRA fees? Should I object to the closure for lack of payment while in bankruptcy and on this basis ask the custodian who perhaps inproperly took collection action to file a “Corrected 1099R” and then square up in fees now to re-instate my account? Rather than tackle the FMV proof problem… ?
Permalink Submitted by Jose Morales on Tue, 2015-10-27 23:55
They resigned as custodian due to your lack of paying fees, they didn’t take any collection action that can be demonstrated. If they had sold the assets in your IRA to cover their fee and then distributed the rest to you, you might have been able to go down that road. Having the custodian take back the closure (how?) and reinstating your account is tremendously more impossible than the task you have before you, which is to convince the IRS that the value of the assets at the time of distribution was $0. If you read the two US Tax Court cases that I linked to with circumstances exactly like yours you would see that neither the IRS nor the tax court will simply take your word that the promissory notes are worthless. Gather any hard evidence that they were worthless (in the cases above the noted that the IRA holders hadn’t done any research to confirm that their promissory notes were in fact worthless and they were not going to take the word of the “investment manager” that issued the promissorry notes either).
Permalink Submitted by Joe Luby on Wed, 2015-10-28 14:58
Many of your questions require the knowledge and expertise of a good bankruptcy attorney. He/She can guide you as to whether the IRA custodian engaged in a “collection action” that should have been subject to the bankruptcy rules, how the distributed notes should have been handled at that time (i.e., bankruptcy trustee notified of their distributed status, etc.) and so on. As to your question about the possibility of paying all of the old fees and having the account reinstated, that is a dead end, probably (never say never). First, the IRA custodian will have no interest in doing so. Second, the IRA distribution occurred several years ago. The only way to negate that taxable event and have the IRA recognized by the IRS dating from 2009 to present is to submit a request for a private letter ruling (PLR) to the IRS. You would be asking for a ruling to essentially waive the 60-day rollover rule allowing you to replace the assets back into the IRA based on some error by the IRA custodian. This is a costly procedure with a very limited chance of success given the facts described. The only shred of hope may be if your bankruptcy attorney determines without question that the acts of the IRA custodian were somehow in violation of the bankruptcy rules and that they should not have closed your account. Even then, the PLR request will be an uphill battle. Based on your comments regarding the notes themselves (i.e. problems with the notes, missed payments over 6 years, etc), your best option may be to retain a qualified appraiser to have the notes valued as of their date of distribution. If such valuation confirms your claim that they were worthless on the date of distribution, then you may be able to pursue the suggestions from my prior post above. Unfortunately, there is no “clever solution” because it is now six years after the fact. The best opportunity to successfully deal with a misvalued IRA asset distribution, if that is in fact what occurred here, is at the time of distribution. The second best time is when the incorrect Form 1099-R is received from the IRA custodian.