Recently, the tax court held that early distributions from an IRA are subject to a 10% early distribution penalty and ordinary income tax despite the taxpayer’s financial hardship. James T. Colegrove, et. ux. v. Commissioner, U.S. Tax Court Summary Opinion 2010-44 (April 13, 2010).

Mr. Colegrove, a real estate broker and under the age of 59½, withdrewover $50,000 from his IRA in 2006 after the Florida real estate recession left him unable to meet his business and family expenses. The IRS argued that the withdrawals were early distributions subject to the 10%penalty. Mr. Colegrove, representing himself, argued that the distributions were loans from his IRA.

Fortunately forMr. Colegrove, both the IRS and the tax court characterized the withdrawals as early distributions, rather than loans. Tax-free loans from an IRA are prohibited transactions that result in the loss of the IRA’s tax exempt status and cause all assets of the IRA to be deemed as distributed on the first day of the year the loan is made. Though sympathetic to Mr. Colegrove’s situation, the tax court held that the 10% penalty applied and that there is no “economic hardship” exception to the early distribution penalty. Had Mr. Colegrove consulted a tax attorney, he could have saved both time and money. The law is clear in this area, and his case was a losing one from the beginning. Clients should consult with their advisors before removing funds from retirement vehicles. Also, clients should be wary of representing themselves in tax matters and should, at a minimum, consult an attorney regarding the merits of their cases before proceeding.

The Court of Appeals for the Second Circuit upheld the imposition of fines on a law firm for its failure to comply with IRS levies on a partner’s draws. U.S. v. Moskowitz, Passman & Edelman, 105 AFTR 2d ¶ 2010-828. The court held that the partner’s draws were akin to salary that the IRS could levy pursuant to Section 6331(e) of the Internal Revenue Code (the “Code”).

The managing partner of the firm, A. Sheldon Edelman, was entitled to 60% of the firm’s profits and regularly wrote checks to himself that were characterized as draws taken against the firm’s profits. In 1996, the IRS sent the firm a Form 668-W(c) Notice of Levy on Wages, Salary, and Other Income in an attempt to collect Edelman’s unpaid taxes from previous years and followed up with a Form 668-C Final Demand letter. After receiving no response to either, in 1997, the IRS sent the firm a Form 668-A(c) Notice of Levy on Property and followed up with a another Final Demand letter. When the firmagain failed to respond, the IRS commenced proceedings to enforce both levies under Section 6332(d) of the Code.

The court held in favor of the IRS, finding that the draws were a form of compensation for services similar to fees, commissions, or bonuses under the regulations. It also imposed penalties on the firm under Section 6332(d)(2) of the Code for its failure to comply with the levies because the firm had not demonstrated reasonable cause for failing to comply. If your firm receives a salary or property levy from the IRS against one of the partners, then contact your tax advisor. If that partner’s draws are not used to satisfy the levy, then the firm and, thus, its other partners, could be subject to penalties.

It is important to inform the IRS if your address changes. Taxpayers are held to have knowledge of all correspondence sent to their “last known address” on record with the IRS. However, a taxpayer is not held responsible for correspondence sent to an old address if the taxpayer has properly informed the IRS of a change in address. In Estate of Paul Rule et al. v. Comm’r, T.C. Memo 2005-309, the IRS was unable to collect over $500,000 in deficiencies and penalties against an estate because the IRS sent correspondence to an old address even though the estate’s administrator had notified the IRS of its newaddress.

Rev. Proc. 2010-16, effective June 1, 2010, explains how taxpayersmust informthe IRS of a change of address and supersedes earlier procedures. The IRS uses the address listed on the most recently filed and processed return as the address of record. The address of record is automatically updated when taxpayers update their addresses with the postal service. Additionally, taxpayers can change their address of record by sending the IRS clear and concise notification of the change. Such notification can be written, oral, or electronic. Oral notification must be made in person or on the telephone to an IRS employee with access to the Service Master File. Electronic notificationmust be submitted through an application on the IRS’s website; email is not sufficient. Always keep the IRS informed of your current mailing address to avoid missing communications, which could lead to penalties. When dealing with estates and trusts, always send the Form 56 - Notice Concerning Fiduciary Relationship.