Interaction of criminal forfeiture & tax laws; Seizure of an Individual Retirement Account (IRA); Whether the forfeiture triggered tax obligations; Whether the IRS qualified as the “payee or distributee” of the funds; 26 USC § 408(d)(1); Old Colony Trust Co v Commissioner

The court reversed the tax court’s ruling that plaintiff-Hubbard was responsible for income taxes owed on an IRA seized under the criminal-forfeiture laws. It held that because “the IRS owned and controlled the IRA and received the funds, it qualified as the payee or distribute[,]” not Hubbard. He was convicted of running a “pill mill,” and his sentence included prison and extensive criminal forfeiture. The government seized his home, boat, and financial accounts, including his IRA (seized in 2017). It later “sent him a notice of deficiency suggesting that he owed $274,979.91 for his failure to pay taxes in 2017. That total included three components: (1) $122,601 for the income taxes owed on the withdrawal in 2017; (2) $42,752 for the 10% penalty that arose because the IRA funds were withdrawn before Hubbard turned 59 and a half; and (3) $109,626.91 in interest and penalties because [he] failed to file a tax return and pay the required taxes on time.” The IRS conceded in the tax court that he “should not have to pay either the 10% penalty for withdrawing the IRA funds early or a small part of the penalties” but it otherwise successfully moved for summary judgment. The tax court found that under its precedent, “IRA funds qualify as income even when forfeited through an ‘involuntary distribution’ to a third party” and it determined “that this rule applied to Hubbard’s IRA.” On appeal, the court found that the tax court’s conclusion that “the transfer of the IRA funds qualified as Hubbard’s income because it discharged an ‘obligation’ that [he] owed . . . misunderstood the type of forfeiture at issue. When courts impose a forfeiture, they can either grant the government ownership of a specific asset or enter a money judgment that allows the government to collect on any of the defendant’s property.” The forfeiture order here “granted the IRS ownership of his IRA; it did not enter a money judgment against him. So when the IRS withdrew the funds from the IRA, it was not taking Hubbard’s money to discharge a debt. It was simply transferring its own money.” Thus, the court held that this “forfeiture does not trigger tax obligations for Hubbard.”