The client owned a self-directed IRA that invested $150,000 in his employer’s promissory notes. After the promissory notes became worthless, the IRA custodian assigned the promissory notes to the client individually and issued an erroneous Form 1099-R to the client for $150,000.
The IRS filed a substitute for return including $150,000 in taxable income and assessing a $15,000 penalty for early withdrawal. This substitute for return also included the client’s business income, but none of his expenses, thereby overstating the client’s taxable income by $216,358. Client filed his tax return three years later reporting the Schedule C and 1099-R distribution but also deducting the $150,000 as a loss due to the worthlessness of the investment.
Upon appeal we were able to prove the worthlessness of the underlying promissory notes and validity of his Schedule C, thereby reducing taxable income by $216,358 and obtain the non-assertion of the $15,000 penalty for early withdrawal.