Lawyer Voids Tax Break by Moving Funds to IRA

CHICAGO (CN) - A lawyer who moved his retirement money into a private IRA cannot take advantage of a tax code exception that removes a 10 percent tax on such withdrawals for those between the age of 55 and 59 1/2, the 7th Circuit ruled.

Young Kim left his partner position at Seyfarth Shaw in 2004, at age 56, and enrolled in the London School of Economics. A year later, he moved funds from his Seyfarth Shaw retirement plan into a private IRA. He then withdrew about $240,000 from the private account.

The Internal Revenue Code requires individuals aged 55 to 59 ½ who withdraw from their employer-sponsored retirement accounts to pay income tax, but not an additional ten percent tax that the IRS usually imposes.

Because Kim moved the money into a private IRA before withdrawing it, the Commissioner of Internal Revenue determined that he owed the ten percent tax, as well as the penalty for substantial underpayment.

Kim unsuccessfully took the case to Tax Court, where he was assessed almost $25,000 in back-taxes. Because the ten percent exception only applies to withdrawals from an employer-sponsored fund, the court ruled, Kim was not exempt.

On appeal, Kim argued that the rule makes no sense. "He could have taken the money from the law firm's pension plan without the 10% additional tax; why should it matter that the money went from the law firm's plan to an IRA before being withdrawn? The answer is that the Internal Revenue Code says that it matters," 7th Circuit Chief Judge Frank Easterbrook summarized.

"Many parts of the tax code are compromises, and all parts reflect the need for lines that can't be deduced from first principles."

The ten percent tax, the court explained, is intended to offset the expense to the U.S. Treasury that results from deferring income tax collection on the funds. It also decreases the appeal of using retirement funds as a tax shelter decreases.

"The interaction of these provisions is bound to seem irrational to many affected persons, but Congress has concluded that some lines of this kind are appropriate. The judiciary is not authorized to redraw the boundaries," Easterbrook concluded.

The court also affirmed late payment fines, part of the $25,000 award, reasoning that Kim had forfeited the "reasonable basis exception" that applies when a taxpayer relies on the opinion of a competent tax advisor by missing the deadline for submitting expert evidence.

Kim, also a former Northwestern University School of Law professor, is now a partner at KYZ Law in Northbrook, Illinois.

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