IRA 1099R but money was not received and is lost

[KathyC44]

Client invested 7000 into an IRA in 2011, the IRA Company invested it in a start up company that went bankrupt. In 2022 the IRA Company gave the Client a 1099-R for 7000. However Client never got a dime. IRA company said he should ask Start up company for the money??? How should I report this?  

[BobKamman]

"IRA Company" sounds like they might have been in on the fraud.  IRA's have trustees, and lose the privilege of serving in that capacity if they issue phony 1099R's. And was $7,000 even allowed in 2011?  

[qbteachmt]

This makes no sense.

No, $7,000 was not the possible max contribution in 2011.

Anything gained or lost inside of an IRA is not reported on a 1099-R.

Even if the account went to 0, you don't report that on a 1099-R. It just means that when/if distributions are taken, there is nothing in the account, and the tax forms where you enter the amount is filled in accordingly. For instance, you cannot take an RMD from a account that went to $0, obviously.

And you cannot invest in certain types of activities. If this was a self-directed IRA, then the client took that leap of faith, not the "IRA Company."

I would find someone to consult with, to see if the "IRA Company" was fraudulent and all of this was fraudulent from the beginning, and determine if there is criminal activity here.

[sjrcpa]

I had a similar situation years ago. Within an IRA, an LLC interest was purchased for $30K. LLC went bankrupt. IRA Custodian issued a 1099-R for the $30,000 cost. We reported as -0- taxable on 1040. IRS sends matching notice. We respond. IRS is not moved. Bills for tax, interest and penalty ensue. Went to Taxpayer Advocate. Client's account was levied. Taxpayer Advocate said they couldn't stop it when presented with notice. Client eventually went to his elected representative's office. He finally got his money refunded and case closed. This took about 4 years.

I have no words of wisdom but I wish you luck.

[BobKamman]

It would have cost $60 to file a Tax Court petition, which is what should have been done as soon as the Notice of Deficiency was issued.  Most Tax Court petitions are "pro per" -- no lawyer represents the taxpayer, but most cases settle before trial.  And nearly every day, the Tax Court reminds  a couple CPAs or EAs  who sign petitions that they shouldn't be doing that -- but it doesn't throw out the case. 

And IRS can't levy without offering a Collection Due Process hearing.  An unfavorable decision there can be appealed to Tax Court, also.  Cost?  $60. 

Asking the local Taxpayer Advocate for help in these cases is like asking the Democratic National Committee for help when you don't like something Joe Biden said.  They're all playing for the same team.  That was the last place to go for help in this situation.  Going to a Member of Congress?  They just send it over to the National Taxpayer Advocate, who might at that point pay more attention to it.  

[scheunemanncpa · Accepted solution]

This is usually a self directed IRA which needs a custodian who charges fees to hold the asset(s).  When it goes belly up, the owner quits paying the custodian fees and they issue the 1099 for the original value.  It is difficult at best to get the IRS to change their thinking that a 1099 is always right.  My client that had this issue freaked out and wanted to pay the tax so he wouldn't go to jail.  I know that is wrong, but a lot of taxpayers think that can happen no matter what you tell them.  I took the original cost as a capital loss, since technically he had basis by paying tax on the 1099R amount.  We got the tax back in a way by doing this, but he had to take $3,000 per year since he had no capital gains.

[BobKamman]

Sometimes the path of least resistance yields the greatest tax savings, even when wrong.  Report as income a mythical distribution, then report a loss for the same amount, spread over several years so the taxpayer doesn't dip into a lower bracket?  What can go wrong? With any luck, it might keep their AGI at a point where EIC is maximized, or Medicare premiums are not increased.  

I had a case where I argued a $45,000 loss as co-signer on a job-connected loan was ordinary rather than capital. It would have saved my clients $5,000 in one year.  I lost, and instead $3,000 a year saved them $1,000, fifteen times.  Better than an annuity.  

In this case, though, we're back to playing "trick the IRS computer."  One way to freeze the CP2000 process is with an amended return before the document matching starts.  Leave the $7,000 off the original return, then amend it with reference to the incorrect 1099-R but adding, say, $200 for potential recovery.  (What kind of bankruptcy was it?  Chapter 11, with company surviving reorganization?  Is there litigation by other shareholders that might reach a settlement with directors, officers and promoters?)

Of course the risk then is that IRS thinks it can bypass deficiency procedures when processing a balance-due amended return.  For me, there's less risk to sending a client down the street, than to signing a return under penalty of perjury that I know is wrong.