Broker Check

Ruling to Remember: The Funds Are Still Taxable to You

By The Slott Report Staff

From 1984-2002, the petitioner served as a plan administrator with the United Public Workers (UPW) Mutual Aid Trust Fund, but in 2003, he was convicted in the U.S. District Court of Hawaii of mail fraud, health care fraud and a multitude of other crimes.

He was sentenced to 64 months in prison and ordered to pay a $50,000 fine to the Discount Court and $378,103.63 in restitution to the United Public Workers (UPW). He, however, had no liquid assets to satisfy the judgment. The government attempted to collect his fine and restitution by garnishing his pension benefits.

Legal counsel and the presiding judge expressed concern over the tax consequences of the potential garnishment order. To avoid immediate taxation and buy time in hopes of finding an alternative source of payment, an IRA was established to accept the rollover of his pension funds.

The petitioner eventually won an appeal of his conviction, and in 2008, the District Court ordered the return of the disbursed funds that satisfied the petitioner's fine and restitution. Later that year, UPW pursued civil action against the petitioner and obtained a judgment for $850,000. In order to collect the judgment, UPW filed a motion to garnish the gains and interest that had accrued in the petitioner's IRA. The petitioner objected, arguing that the gains and interest were exempt from garnishment under law. The judge disagreed, ruling that the pension benefits "lost their character" as retirement plan assets when they were transferred into the IRA.

And now the second half of the issue.

The petitioner filed his 2009 federal income tax return and did not fully pay the assessed tax liability. IRS filed a Notice of Federal Tax Lien Filing. After a lot of back and forth, the court ruled that the entire IRA distribution was taxable to the petitioner and that the petitioner cannot escape taxation on the basis that the funds were disbursed to third parties.

You can read about the entire court case here.

You can read about the entire court case here.

Moral of the story:
If funds from your IRA are used to satisfy a debt or other obligation on your behalf, the distribution is still taxable to you – even if you did not actually receive the funds.