IRS Denies Late Rollover Relief Where Taxpayer Used Funds to Start New Business

The IRS appears to be continuing to show its displeasure with attempts to use IRA funds to purchase businesses, most recently in PLR 201547010.  The IRS denied the taxpayer relief for failing to complete a rollover of IRA funds within 60 days.

Generally under Revenue Procedure 2003-16 the IRS will grant late rollover relief where a rollover failed to be completed due bad advice or an error on behalf of a financial institution or adviser.

In this case the taxpayer had wanted to take funds from his IRA and use it to purchase an interest in a partnership.  His adviser prepared the paperwork to use funds in the IRA held by the current custodian to purchase the partnership interest.  The partnership interest was issued and indicated it was held by the IRA of the taxpayer.

However the custodian was not able to hold the partnership and issued a Form 1099-R reporting a distribution.  The adviser apparently did not realize that the interest could not held by the current custodian.  The taxpayer noted that there were other custodians that would have been willing to hold the interest and argued that the adviser should have prepared the paperwork to transfer the partnership interest to a custodian who would hold it.

On paper this looks like a pretty vanilla case of the taxpayer getting bad advice—but the IRS did not respond by granting relief.

Rather the IRS denied the relief, noting:

In this instance, Taxpayer A chose to use the proceeds from IRA B to fund a business venture rather than attempt to roll the proceeds over into an IRA account for retirement purposes.

Therefore, pursuant to section 408(d)(3)(l) of the Code, Taxpayer A's request that the Service waive the 60-day rollover requirement with respect to the distribution of Amount 1 is declined, and Amount 1 and any earnings thereon are therefore includible in Taxpayer A's gross income for the 2012 taxable year.

Previously some letter rulings had implied, but not openly stated, that relief had been denied due to the IRS not being “in favor” of the investment vehicle chosen.  This notice goes further and specifically calls out the fact that the taxpayer was using the funds to start a business venture as the reason relief is denied.

The ruling does not go so far as to state that the IRS position is even had the partnership interest gone to a custodian willing to hold it that the rollover would have effectively failed, but presumably that is why the IRS is taking this position.  That is, it seems likely the IRS has decided that even if a custodian had been in place to receive the funds, the operation of the entity would have triggered full inclusion of the amount due to the application of the prohibited transaction rules found at IRC §4975.

At the very least this serves as a cautionary tale for taxpayers would may still be pushing to use IRA funds for non-traditional investments—they are apparently not going to obtain IRS relief that is available to those investing in more traditional retirement investments should the transfer go awry for any reason.