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WHAT PART OF '60 DAYS' DON'T YOU UNDERSTAND?

June 11, 2004

One of the hazards of a professional education may be the temptation to be too clever. Consider the case of James Dirks, a research attorney employed by the California court system.

Mr. Dirk had the winning bid on a house that was up for auction. He withdrew money from IRA accounts to pay for the house. He knew that the tax law allows such withdrawals to be tax-free if they are put back in an IRA within 60 days. He withdrew $118,000 from the IRAs on January 19, 2000; he planned to restore the funds to the IRA when he closed on a mortgage for the new house. The 60-day grace period was to expire March 19, 2000.

The mortgage didn't close until April 3, 2000. On April 4, Mr. Dirk put $118,000 back into his IRAs. Even though the 60-day period had expired, he didn't report the IRA withdrawals as taxable income on his 2000 return.

"SUBSTANTIAL" COMPLIANCE?

This is where Mr. Dirks may have gotten too clever. He told the Tax Court that even though he missed the 60-day deadline, he really met it under the “equitable doctrine of substantial compliance.” (That would have come in handy when we got home at 1 a.m. after telling our parents we'd be in by 10.)

Unfortunately for Mr. Dirks, the Tax Court doesn't seem to believe in equitable doctrine. The judge quoted another court:

   All fixed deadlines seem harsh because all 
   can be missed by a whisker--by a day, or
   for that matter by an hour or a minute. They 
   are arbitrary by nature. * * * The legal 
   system lives on fixed deadlines; their 
   occasional harshness is redeemed by the 
   clarity which they impart to legal obligation.
   * * * There is no general judicial power to 
   relieve from deadlines fixed by legislatures.

                              (Citations omitted)

ANOTHER PITFALL OF PROFESSIONAL TRAINING

The IRS assessed Mr. Dirks "substantial understatement" penalties of $8,819 for failing to report the $118,000 in IRA income. The law allows the penalties to be waived if the taxpayer acts "reasonably and in good faith" to comply with the tax law. Here the Tax Court held Mr. Dirks's professional background against him:

   We disagree with petitioner’s argument that 
   he acted reasonably and in good faith with
   respect to the subject matter of the 
   deficiency. Petitioner is a seasoned attorney 
   who filed his 2000 tax return with the 
   knowledge and understanding of the
   relevant provisions of section 408. The fact 
   that he may have intended earnestly to 
   meet the 60-day rule did not excuse him
   from not reporting the withdrawals as income 
   when he failed to meet that rule.  Nor do we 
   believe that reasonableness and good faith
   may be found in petitioner’s litigating 
   position that he substantially complied with 
   the 60-day rule by paying the amount of 
   withdrawals into the second IRA 
   contemporaneously with the closing of his 
   escrow.

AN EXPENSIVE SOURCE OF FUNDS

Considering only federal taxes and penalties, Mr. Dirks will pay $52,916 for the use of $118,000 for 76 days. That works out to an effective interest rate of 215.37%.

The moral? There are at least two:

- IRAs can be an expensive source of interim financing, and
- 60 days means 60 days.

Link: James Dirks vs. Commissioner, T.C. Memo. 2004-138 (pdf format)

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