PLR 200904029: Assets mistakenly placed in an IRA counted as investment in the contract

Plain-English summary

A taxpayer directed a bank to return non-IRA assets that had secured a loan to two non-IRA accounts. The bank mistakenly transferred the assets into the taxpayer's traditional IRA, and the taxpayer did not discover the error until after the period for withdrawing excess contributions without penalty had expired. The amount exceeded the limit for nondeductible traditional IRA contributions, and the taxpayer planned to withdraw it. The IRS ruled that the mistakenly contributed amount was investment in the contract under section 72(e)(6) because it was consideration paid for the IRA and no deduction had been taken for it. That basis would be considered when determining how much of a distribution from the IRA had to be included in gross income. The ruling assumed that the IRA otherwise satisfied section 408.

Ruling snapshot

• Question: Did non-IRA assets mistakenly deposited into a traditional IRA count as investment in the contract when later distributed?
• Outcome: Approved. The mistaken contribution was treated as investment in the contract
• Key authorities: IRC §§ 72(e), 219, and 408(d)

Full text (IRS public release)

200904029

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

OCT 30 2008

U.I.L. 408.03-00

XXXXX

XXXXX

XXXXX

SE:T:EP:RA:T2

LEGEND:

Taxpayer A = xxxxx

Company M = xxxxx

IRA X = xxxxx
Account Y = xxxxx
Account Z = xxxxx
Bank B = xxxxx
Account C = xxxxx
Amount N = xxxxx
Year 1 = xxxxx
Year 4 = xxxxx

Year 6 = xxxxx

Page 2

Dear

This is in response to your letter ruling request as submitted, supplemented and amended on your behalf by your authorized representative, in correspondence dated July 2, 2007, and February 25, March 31 and April 8, 2008, as to whether certain after-tax amounts transferred erroneously into a traditional individual retirement arrangement (IRA) represent investment in the contract within the meaning of section 72(e)(6) of the Internal Revenue Code (the “Code”) and, as such, can be excluded from gross income in the taxable year in which such amounts are distributed from the IRA.

The following facts and representations are made under penalties of perjury in support of your ruling request.

In Year 1, Taxpayer A maintained IRA X and Accounts Y and Z with Company M, and he maintained Account C with Bank B. IRA X is a traditional individual retirement arrangement described in section 408(a). Accounts C, Y and Z are not IRAs of any type.

In Year 1, Taxpayer A entered into an agreement with Bank B under which assets from Accounts Y and Z totaling Amount N were transferred to Bank B and held in Account C as collateral for a loan.

In Year 4, Bank B released the collateral for the loan and Taxpayer A directed that the assets be transferred to Accounts Y and Z. Instead, Bank transferred the funds to IRA X.

Amount N exceeds the limit on nondeductible contributions to a traditional IRA set forth in section 408(o)(2) of the Code.

Taxpayer A did not discover the error until Year 6, when it was brought to his attention by his tax advisor. By this time, the period for withdrawing excess contributions without penalty had expired. Taxpayer A intends to withdraw Amount N from IRA X in order to avoid further penalty.

Based on the foregoing, you request a ruling that, upon the distribution of Amount N from IRA X, Taxpayer A will be entitled to exclude Amount N from gross income for the taxable year to the extent that Amount N represents an investment in the contract within the meaning of section 72(e)(6) of the Code.

Section 408(d) of the Code deals with the tax treatment of distributions from individual retirement arrangements.

Section 408(d)(1) of the Code provides generally that any amount paid or distributed out of an individual retirement plan shall be included in gross income

200904029

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by the payee or distributee, as the case may be, in the manner provided under section 72.

Section 408(d)(2) of the Code provides, in pertinent part, that for purposes of applying section 72 to any amount described in section 408(d)(1), all distributions during any taxable year are treated as one distribution, and the value of the contract, income on the contract, and investment in the contract shall be computed as of the close of the calendar year in which the taxable year begins.

Section 72(a) of the Code provides that gross income generally includes any amount received as an annuity under an annuity, endowment or life insurance contract.

Section 72(e)(2) (B) of the Code provides that when an amount received under an annuity, endowment or life insurance contract is not received as an annuity, and the amount is received before the annuity starting date, the amount is included in gross income to the extent it is allocable to income on the contract, but it is excludable to the extent it is allocable to investment in the contract.

Section 72(e)(6) of the Code provides that investment in the contract as of any date is (A) the aggregate amount of premiums or other consideration paid for the contract before such date, minus (B) the aggregate amount received under the contract before such date, to the extent that such amount was excludable from gross income.

Generally, the investment in the contract includes contributions for which no deduction has been taken under section 219 of the Code but does not include contributions for which a deduction has been taken under section 219 of the Code.

Based on the information provided and the representations submitted, Amount N was erroneously contributed to IRA X. However, regardless of the reason for the contribution, Amount N represents an amount of premiums or other consideration paid for IRA X for which no deduction was taken. Accordingly, we rule that, for purposes of determining the amount of any distribution from IRA X that must be included in Taxpayer A’s gross income, Amount N is considered “investment in the contract” within the meaning of section 72(e)(6) of the Code, with respect to IRA X.

This ruling assumes that IRA X satisfies the qualification requirements of section 408 of the Code at all times relevant to this transaction.

No opinion is expressed as to the tax treatment of the transaction described herein under the provisions of any other section of either the Code or regulations which may be applicable thereto.

200904029

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This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

If you wish to inquire about this ruling, please contact xxxx, I.D. # xxxxx, by telephone at xxxxx, or by fax at xxxxx. Please address all correspondence to SE:T:EP:RA:T4.

Sincerely yours,

Donzell H. Littlejohn, Manager
Employee Plans Technical Group 4

CC:

xxxxx
xxxxx
xxxxx

Enclosures:
Deleted copy of ruling letter
Notice of Intention to Disclose