Self-Directed IRA Owner Wins Appeal and Avoids Account Distribution for Common Mistake
Mat Sorensen


July 3, 2017

Photo of a courtroom in the U.S. Tax Court in Washington, D.C.

Every year, there is at least one case when the IRS attempts to distribute a self-directed IRA for failing to meet a single technical requirement. This common situation arises when an IRA owner uses their standard, non-self-directed IRA to purchase assets that only self-directed IRA custodians allow. This was the case of McGaugh v. Commissioner, as Mr. McGaugh owned a Merrill Lynch IRA, and requested Merrill Lynch acquire FPFC shares for his IRA. Merrill Lynch sent the funds for the purchase to FPFC, but unfortunately considered the purchase a distribution from Mr. McGaugh’s IRA, and sent him a 1099-R.

TIP: When buying non-publicly traded assets, such as private stock or LLC units, make sure that you use a self-directed IRA custodian who allows such assets to be held by an IRA.

Mr. McGaugh intended for the shares to be owned by his IRA, and in fact had them titled as “Raymond McGaugh FBO Raymond McGaugh IRA.” The shares were sent to Merrill Lynch, who refused them and attempted to send the shares to Mr. McGaugh. In the end, Merrill Lynch did not recognize the shares as assets of Mr. McGaugh’s IRA, and Mr. McGaugh was forced to dispute the 1099-R with the IRS in Tax Court. The IRS alleged that the assets were distributed from Mr. McGaugh’s IRA since Merrill Lynch, his custodian, refused the shares and sent them to Mr. McGaugh. The 7th Circuit Court of Appeals ruled against the IRS, and in favor of Mr. McGaugh. The Court ruled that Mr. McGaugh never took personal possession of the FPFC private stock, and stated that the shares were not in his personal name. Consequently, he never had constructive possession of his IRA assets and they were not considered distributed. It is important to note that had the shares been titled to his personal name (not FBO his IRA), the case likely would’ve gone the other way. Also, it is important to note that shares should never be titled in the IRA owner’s name FBO their IRA. This was presumably done by FPFC or requested by Mr. McGaugh, since Merrill Lynch refused the shares.

TIP: Make sure that self-directed assets (e.g. real estate, private stock, LLC units) are owned in the name of your IRA. The typical titling of a self-directed IRA is as follows, “ABC Trust Co. FBO Mat Sorensen IRA.”

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