As printed by Journal of Accountancy

A taxpayer’s physical possession of gold coins purchased with her individual retirement account (IRA) caused her to have taxable distributions from the IRA, the Tax Court held.

Facts: In 2015, Donna McNulty purchased IRA services through the website of Check Book IRA by which she established a self-directed IRA that was the sole member of Green Hill Holdings LLC. Check Book advertised on its website that such an LLC could invest in American Eagle gold coins that the IRA’s owner could then hold at his or her home without tax consequences or penalties so long as the coins were titled to the LLC. American Eagle gold, silver, platinum, and palladium coins are produced by the U.S. Mint and sold by authorized dealers.

McNulty named Kingdom Trust Co., an independent qualified custodian, as the IRA’s custodian. Green Hill’s articles of incorporation named McNulty and her husband as its managers and their personal residence as its principal place of business. The couple also both had signatory authority over Green Hill’s bank account.

McNulty authorized direct transfers to her IRA of $378,487 from an individual retirement annuity in 2015 and of $48,375 from a Sec. 401(k) plan in 2016 and directed Kingdom Trust to use those funds to purchase membership interests in Green Hill. She then had Green Hill use most of the funds to purchase American Eagle coins from an authorized dealer. The coins’ invoices listed Green Hill as the purchaser, but the shipping labels identified McNulty and/or her IRA as the recipient. The coins were shipped to McNulty’s home, where she stored them in a safe along with coins purchased by her husband’s self-directed IRA and coins she and her husband purchased directly.

McNulty’s joint returns with her husband for the two years were prepared by a CPA, but they did not consult the CPA about the tax reporting of their IRAs or physical possession of the coins. In 2018, the IRS issued the McNultys a notice of deficiency, determining in part that McNulty had distributions equal to her American Eagle coins’ cost of $374,000 in 2015 and $37,380 in 2016, resulting in deficiencies of $250,558 and $18,094, respectively. The IRS further proposed accuracy-related penalties under Sec. 6662 based on these deficiencies.

Law and regulations: Under Sec. 408(h), a custodial account is treated as a trust that can qualify as an IRA under Sec. 408(a) if its assets are held by a bank (as defined by Sec. 408(n)) or another person who demonstrates to the IRS’s satisfaction that the person will administer the account consistently with Sec. 408’s requirements, in which case the custodian can be treated as the account’s trustee, as further delineated in Regs. Sec. 1.408-2(e). IRA assets cannot be commingled with other property except in a common trust fund or common investment fund (Sec. 408(a)(5)).

Sec. 408(m) forbids IRAs from investing in certain items designated as collectibles, including at Sec. 408(m)(2)(D) “any stamp or coin,” with an exception under Sec. 408(m)(3) for certain gold, silver, or platinum coins or bullion “if such bullion is in the physical possession of a trustee” of the IRA (Sec. 408(m)(3)(B)).

Issues: The IRS contended that McNulty’s receipt of the American Eagle coins constituted taxable distributions equal to their purchase price, finding that McNulty possessed the coins despite their purported ownership by Green Hill. McNulty argued that the coins were assets of Green Hill and that she did not use them, so her physical receipt of them did not constitute taxable IRA distributions.

The Service further contended that McNulty violated the statute’s prohibition against commingling IRA assets, which caused taxable distributions of the coins when they were stored in the home safe, even if the Tax Court were to conclude McNulty’s physical possession of the coins did not. McNulty countered that because she labeled the coins as purchased with IRA funds before putting them in the home safe, she did not commingle them with other coins in the safe.

Alternatively, McNulty argued that because Sec. 408(m)(3)(B) specifies that bullion must remain in the physical possession of an IRA’s trustee, that requirement does not apply to coins described in Sec. 408(m)(3)(A), including the American Eagle coins. This, too, the IRS disputed.

As for the penalties, the McNultys argued that their research of the IRA/LLC structure and their use of Check Book’s advice and service in setting it up, along with unclear IRS guidance respecting physical possession of coins, demonstrated they attempted to comply with the law, constituting a reasonable-cause defense.

Holding: McNulty’s physical custody of the American Eagle coins gave her unfettered control over them, resulting in taxable IRA distributions, the Tax Court held. Despite the LLC’s formal interposition and although she did not use the coins, she was free to do so however she might have chosen. The court found that McNulty’s arguments to the contrary would create a situation “ripe for abuse” that would subvert Sec. 408’s fiduciary requirements. “Personal control over the IRA assets by the IRA owner is against the very nature of an IRA,” the court stated. Having determined that McNulty’s physical possession of the coins caused a taxable distribution, the court said it need not address the commingling arguments, although it noted that labeling assets alone probably does not prevent their commingling. The court also denied McNulty’s argument that the trustee custody requirement for bullion means there is no such requirement for coins.

The court also upheld the penalties, stating that Check Book’s “questionable internet scheme” did not constitute professional advice upon which taxpayers could rely for a reasonable-cause defense. Furthermore, McNulty and her husband did not divulge the arrangement to the CPA who prepared their returns, the court noted.

Observations: Coins as IRA assets under Sec. 408(m)(3)(A) are limited to certain gold, silver, and platinum coins described in 31 U.S.C. Section 5112(a), (e), or (k), which are Treasury-minted coins in specified sizes and currency denominations and/or weights, or a “coin issued under the laws of any State.” The bullion allowed under Sec. 408(m)(3)(B)is gold, silver, platinum, or palladium of at least as pure fineness as required in satisfaction of a regulated futures contract under the Commodity Exchange Act (7 U.S.C. Chapter 1).

While not binding guidance, a frequently asked question on the IRS website asks, “If my IRA invests in gold or other bullion, can I store the bullion in my home?” The IRS answers that bullion must be in the physical possession of a bank or an IRS-approved nonbank trustee. This rule also applies where an IRA-owned LLC buys the bullion, the IRS advises. The IRS publishes a list of its approved nonbank trustees. Regs. Sec. 1.408-2(e) lays out general fiduciary and fitness requirements for nonbank trustees, including that assets requiring safekeeping must be deposited in an “adequate vault” (Regs. Sec. 1.408-2(e)(5)(v)(B)).

Thus, taxpayers wishing to have IRA investments in approved coins can avoid having physical or constructive receipt of them by having them held, like bullion, by a bank or approved nonbank trustee, in an adequate vault, which clearly would not include a safe deposit box to which the owner (or, likely, anyone but the trustee) has access.

Custody issues aside, many financial advisers question whether physical coins or precious metals are a good IRA investment in the first place (see, e.g., “How Investors Can Protect Against Inflation,” JofA, Oct. 28, 2021). If an account owner must take a required minimum distribution or other distribution, the coins or metal must first be liquidated at the current price, which can be volatile.

“There’s nothing wrong with collecting gold coins, but I see it more as a hobby or speculation than an investment,” said Chris Benson, CPA/PFS, with L.K. Benson & Co. in Baltimore. Self-directed IRA owners desiring some exposure to gold could get it through shares in an exchange-traded fund that in turn invests in bullion, Benson said, “but even then, it should be a small percentage of the overall portfolio.”