Tax or Penalty?

Tax or Penalty?

An executive owned shares in an ESOP and had a nonqualified deferred compensation arrangement. After a corporate reorganization and his termination, the executive agreed to accept a payment of $26 million to his IRA in satisfaction of his claims. The transfer was reported on his income tax return as an IRA rollover contribution.

The IRS didn’t see it that way, as payments from the deferred comp were not eligible to be rolled over. Some $25 million was held to be an excess IRA contribution, subject to a payment of 6% to the government every year until the amount was disgorged from the IRA to be fully taxed as ordinary income.

Is the 6% payment an additional tax, or is it a penalty for the “bad behavior” of making an excess contribution?  The distinction is important, because the taxpayer in this case claimed that the IRS had not followed its own required procedures for imposing penalties. Unfortunately for him, the Tax Court held that the 6% is an excise tax, so those procedures are not required.

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