Charlotte and Charles T. Gee v. Commissioner of Internal Revenue
127 T.C. 1; 2006 U.S. Tax Ct. LEXIS 20; 127 T.C. No. 1 (2006)
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Rule of Law:
When a surviving spouse rolls over funds from a deceased spouse's Individual Retirement Account (IRA) into their own, pre-existing IRA, the funds lose their character as assets received 'on or after the death of the employee.' Consequently, any subsequent distribution to the surviving spouse from their own IRA before they reach age 59.5 is subject to the 10-percent additional tax on early distributions under I.R.C. § 72(t).
Facts:
- In 1993, Charlotte Gee and her husband, Ray A. Campbell, Jr., each established separate Individual Retirement Accounts (IRAs).
- Mr. Campbell died in June 1998, at age 73, naming Gee as the primary beneficiary of his IRA.
- In July 1998, when she was 51 years old, Gee directed that the entire balance of Mr. Campbell's IRA, over $1 million, be directly rolled over into her own pre-existing IRA.
- In 2000, Gee transferred the combined funds in her IRA, then totaling over $2.6 million, to a new custodian, SEI Private Trust Co.
- In 2002, while still under the age of 59.5, Gee received a distribution of $977,887.79 from her IRA.
- On their 2002 joint tax return, petitioners reported the distribution but did not report or pay the 10-percent additional tax, claiming the funds originated from her deceased husband's IRA.
Procedural Posture:
- Petitioners filed a joint Federal income tax return for 2002, reporting an IRA distribution but not the associated 10-percent additional tax.
- The Internal Revenue Service (Respondent) issued a notice of deficiency for $97,789, representing the unpaid additional tax, and assessed an accuracy-related penalty.
- Petitioners filed a timely petition with the U.S. Tax Court to contest both the tax deficiency and the penalty.
- The case was submitted to the Tax Court fully stipulated, meaning both parties agreed on the facts and asked the court to rule on the legal issues.
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Issue:
Does a distribution from a surviving spouse's own IRA, which contains funds rolled over from a deceased spouse's IRA, qualify for the death exception to the 10-percent early distribution penalty under I.R.C. § 72(t)?
Opinions:
Majority - Kroupa, J.
Yes, a distribution from a surviving spouse's own IRA containing funds rolled over from a deceased spouse's IRA is subject to the 10-percent early distribution penalty under I.R.C. § 72(t). The exception for distributions made 'on or after the death of the employee' does not apply once a surviving spouse elects to treat the inherited funds as their own by rolling them into their personal IRA. The court reasoned that the distribution came from an IRA owned solely by petitioner Gee, not from an account of which she was merely a beneficiary. Once Gee chose to roll the funds over, they became her own 'for all purposes of the Code,' and the source of the funds became irrelevant. The distribution was not occasioned by her husband's death but by her own decision to withdraw funds from her own account, frustrating the policy of § 72(t) to discourage premature distributions intended for retirement. Therefore, she lost the ability to claim the death exception.
Analysis:
This decision clarifies a critical election for surviving spouses who inherit IRA assets. It establishes that the act of rolling over a deceased spouse's IRA into one's own IRA is an irrevocable choice that changes the legal character of the funds. This holding serves as a bright-line rule for financial and estate planning, emphasizing that a surviving spouse cannot simultaneously treat the funds as their own for purposes of continued tax-deferred growth and as inherited for purposes of avoiding early withdrawal penalties. The case underscores the importance of carefully considering the tax consequences of how inherited retirement assets are handled.
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