Taxpayer Misunderstood Relief Provision for Taking Excess Contribution Distribution By Due Date of Return

The taxpayers in the case of Wu v. United States, 118 AFTR 2d ¶2016-5154, CA 7 the taxpayers recognized they had made an error and made excess contributions to their IRAs in 2007, failed to grasp the error of their position for a number of years, and then withdrew the excess funds and earnings in 2010.  The taxpayers recognized that they owed an excess contribution tax of 6% (IRC §4973) for each year there remained an excess contribution.

But what they disputed was whether that excess contributions tax of 6% should apply to 2009 since they had withdrawn the funds by the unextended due date of their 2009 income tax return.  IRC §4973(b) provides that “any contribution which is distributed from the individual retirement account or the individual retirement annuity in a distribution to which section 408(d)(4) applies shall be treated as an amount not contributed.”

IRC §408(d)(4) is the section related to taking a repayment of excess contributions and earnings prior to the due date of a taxpayer’s tax return.  That section provides:

(4) Contributions returned before due date of return

Paragraph (1) does not apply to the distribution of any contribution paid during a taxable year to an individual retirement account or for an individual retirement annuity if—

(A) such distribution is received on or before the day prescribed by law (including extensions of time) for filing such individual’s return for such taxable year,

(B) no deduction is allowed under section 219 with respect to such contribution, and

(C) such distribution is accompanied by the amount of net income attributable to such contribution.

In the case of such a distribution, for purposes of section 61, any net income described in subparagraph (C) shall be deemed to have been earned and receivable in the taxable year in which such contribution is made.

The taxpayer’s view was that since they took the funds out before April 15, 2010, the 6% additional tax would not apply to 2009.

The appellate panel, agreeing with the trial court, found that the Wu’s interpretation was not correct.

The panel holds:

That provision, as we have noted, literally applies when a contribution paid into an IRA “during a taxable year” is distributed “on or before the day prescribed by law (including extensions of time) for filing such individual's return for such taxable year.” As the government points out, the phrase “such taxable year” refers to the taxable year in which the contribution was made to the account. The Wus made their excess contributions in 2007, so for that tax year they could have avoided incurring the annual tax on excess contributions by withdrawing the excess before the return-filing deadline for that taxable year, i.e., April 15, 2008. But for any later year the Wus could avoid the annual tax only by taking the distribution before the taxable year ended.

The position advocated by the Wus ignores the language in § 408(d)(4) and also is an ill fit with the text of § 4973(b). Under § 4973(b), the consequence of taking a qualifying distribution under § 408(d)(4) is that the amount of the withdrawal “shall be treated as an amount not contributed.” But the Wus are not asking that their 2007 contributions be treated as if they were never contributed (after all, they conceded liability for tax years 2007 and 2008); they are asking that those contributions be eliminated from the calculation for 2009 alone.