Distributions From Forfeited IRA are Not Taxable – Houston Tax Attorneys

You commit a crime, you are convicted, and you do your time. Then the IRS steps in to collect taxes. The IRS takes your assets to pay the tax that arose from your criminal activity.

As part of this, the IRS seizes your IRA funds. Are you responsible for paying income taxes on the IRA distribution–even through you never received the money and you did not have control over the IRA at the time the funds are withdrawn?

The recent Sixth Circuit decision in Hubbard v. Commissioner, No. 24-1450 (6th Cir. Mar. 19, 2025), considers whether a taxpayer must pay income tax on IRA funds that were forfeited to the government following a criminal conviction.

Facts & Procedural History

The taxpayer in this case was a pharmacist who owned and operated a pharmacy in eastern Kentucky. His business generated substantial income, allowing him to acquire multiple homes, luxury vehicles, a boat, jet skis, and establish an IRA. By 2017, his IRA had nearly $500,000 in untaxed money.

The source of the taxpayer’s wealth, however, was illegal. He operated what courts described as a “pill mill,” selling large quantities of oxycodone to those addicted to the drug and supplying pseudoephedrine to methamphetamine manufacturers. Following criminal proceedings, a jury convicted the taxpayer of drug and money-laundering offenses. This resulted in a 30-year prison sentence. Importantly, there were no tax fraud charges.

As part of the criminal case, prosecutors invoked criminal forfeiture laws to seize the taxpayer’s assets acquired with proceeds from his illegal activities. The district court ordered the forfeiture of specific property—his homes, vehicles, watercraft, and financial accounts, including his IRA—to the IRS.

In 2017, the IRS seized the nearly $500,000 from the taxpayer’s IRA. The IRS treated this seizure as a taxable distribution to the taxpayer. While the taxpayer was in prison, the IRS sent him a notice of deficiency claiming he owed nearly $300,000 in combined in income taxes, early withdrawal penalty, and interest and penalties for failing to file a tax return.

The taxpayer challenged this notice in tax court. He argued that the tax liability “should be paid by [the] feds” since his account “was forfeited to” them. Although the IRS conceded that the taxpayer shouldn’t have to pay the early withdrawal penalty, it maintained that he still owed income taxes. The tax court sided with the IRS, finding that the taxpayer owed taxes and penalties. This appeal followed, which reversed the tax court.

Understanding Criminal Forfeiture

Criminal forfeiture laws allow the government to seize property connected to illegal activity to “ensure that crime does not pay.” While English common law permitted authorities to confiscate all of a convicted defendant’s property, American forfeiture laws typically target only “specific assets” with a connection to the crime.

The Sixth Circuit explained that there are two general types of forfeitures in our legal system, i.e., a specific property forfeiture and a personal money judgment forfeiture. The tax implications are not the same for each type.

What is a Specific Property Forfeiture?

The first type of forfeiture identifies “specific property” that the defendant must relinquish. The government becomes the owner of this property upon conviction.

Some forfeiture laws incorporate a “relation back” doctrine that treats the government as having ownership rights in the property dating back to when the crime was committed.

This type of forfeiture resembles an “in rem” judgment because it permits the government to seize only the identified “tainted property” rather than the defendant’s other assets.

What is a Personal Money Judgment Forfeiture?

The second type of forfeiture is a personal money judgment. This type of forfeiture allows courts to impose a “personal money judgment” identifying a sum that the defendant must pay.

With this type of forfeiture, the court calculates this amount based on the value of the forfeitable property involved in the crimes.

This type of forfeiture resembles an “in personam” judgment because the government may collect the debt from any of the defendant’s current or future assets.

Which Type Applied In Hubbard’s Case?

This case involved a specific property forfeiture. The district court identified specific property subject to forfeiture—including his IRA—and ordered the IRS to seize only these assets. The court did not enter a personal money judgment against the taxpayer.

The order stated that the forfeited assets “shall be forfeited to the United States and no right, title, or interest in the property shall exist in any other party.” This meant that the government became the IRA’s owner at the time of the order.

Distributions from Forfeited IRAs, Generally

Questions about gross income start with Section 61(a) of the tax code. Section 61(a) says that “gross income means all income from whatever source derived.” This broad language is intentional. It reflects Congress’s intent to exercise its full constitutional taxing power under the Sixteenth Amendment. The Supreme Court has consistently interpreted this provision broadly, holding that it covers “all economic gains” not specifically exempted by statute. The breadth of Section 61(a) extends beyond direct cash receipts to include just about all forms of economic benefit.

Beyond this general definition, Section 408(d)(1) specifically addresses IRA distributions, stating that “any amount paid or distributed out of an individual retirement plan shall be included in gross income by the payee or distributee, as the case may be.” This language is key here because it identifies who bears the tax burden—the “payee or distributee” of the funds.

These provisions would clearly apply if the taxpayer owned the IRA at the time of the distribution. But the taxpayer did not own the IRA at the time of the distribution. The government owned the IRA.

This ownership question was central to the court’s analysis. The Sixth Circuit had to determine whether the taxpayer remained the “payee or distributee” for tax purposes despite no longer owning or controlling the IRA when the funds were withdrawn.

The court concluded that once the IRS became the owner of the IRA through the forfeiture order, the agency—not the taxpayer—became the “[o]ne to whom money [was] paid or payable” and the “beneficiary entitled to payment” under ordinary definitions of these terms.

Thus, the Sixth Circuit Court held that the broad language of Section 61(a) did not cause the distribution to be taxable income to the taxpayer.

Distribution from Forfeited IRA as Discharge of Debt Income

Since Section 61(a) did not work, the IRS had to find some other rationale for including this in income. The IRS argued that Subsection 61(a)(12) made the distribution income for income tax purposes.

This subsection specifically identifies “income from discharge of indebtedness” as a form of gross income. This principle, sometimes called “cancellation of debt” income, recognizes that when a taxpayer’s financial obligation is satisfied by a third party or otherwise canceled, the taxpayer has realized an economic benefit equivalent to receiving cash and using it to pay the debt.

The seminal case interpreting discharge of indebtedness as income is Old Colony Trust Co. v. Commissioner. In that case, the Supreme Court held that when an employer paid an employee’s tax obligations directly to the government, this payment constituted additional taxable income to the employee. The Court reasoned that the “discharge” of an “obligation” was economically equivalent to a “receipt” of the same sum of money.

Courts have since applied this principle to numerous situations, including involuntary distributions from retirement accounts. For example, the tax court has held that when IRA funds are garnished to pay child support (Vorwald v. Commissioner), to satisfy tax debts (Schroeder v. Commissioner), or to pay restitution (Rodrigues v. Commissioner), the IRA owner must still pay taxes on the distributions despite never receiving the funds directly. This is even true if the debt that is cancelled is exceedingly old.

The question in this case was whether the criminal forfeiture of the taxpayer’s IRA created a “debt” that was discharged when the IRS seized the funds. The Sixth Circuit answered this question by examining the specific type of forfeiture involved.

The court reasoned that had the district court entered a “personal money judgment” against the taxpayer, that judgment might have created a debt. In that case, the withdrawal of IRA funds might have created a tax obligation by reducing a debt the taxpayer owed.

However, since the district court instead granted the IRS ownership of the “specific property” (the IRA), the IRS did not withdraw the funds to “discharge” an “obligation” that the taxpayer owed. Rather, the IRS withdrew the funds because it owned them. As the court noted, “if the forfeiture order created a debt merely by transferring ownership of the IRA from Hubbard to the IRS, why wouldn’t the order have created a debt in Hubbard’s homes and cars too?” The court concluded that Section 61(a)(12)’s discharge of indebtedness provision did not apply because no debt was being discharged—ownership of the asset itself had changed hands through the specific property forfeiture.

As such, the Sixth Circuit Court concluded that there was no debt and the distribution from the IRA did not create cancellation of debt income.

The Takeaway

This decision highlights the distinction between different types of forfeitures and their tax consequences. When the government obtains ownership of specific property through forfeiture (rather than imposing a money judgment), the former owner may not be liable for taxes on subsequent transactions involving that property. For IRA accounts specifically, this means that when the government becomes the owner through forfeiture, it—not the former account holder—becomes the “payee or distributee” responsible for any tax consequences from withdrawals.

The IRS may not be able to distinguish between the types of forfeited IRAs, as the custodians will likely just issue Forms 1099R and that will start the IRS assessment process. Those who have been assessed tax on forfeited IRAs in the past and those that will likely continue in the future should consider their options based on this case, which may include filing refund claims, or challenging the IRS on this issue as the taxpayer did in this case.

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Stephan Dorsey

Stephan is the sports journalist for the Maple Grove Report.

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Claiming a Casualty Loss for Property You Don’t Own – Houston Tax Attorneys

Natural disasters can be expensive. This is particularly true for those who own or have an interest in real estate.

Our tax laws provide some relief through casualty loss deductions and theft loss deductions. But what happens when someone pays to repair property they don’t legally own? This question is particularly relevant when parents continue to financially support their adult children by paying for property repairs after a disaster. Can they claim the casualty loss deduction on their own tax returns?

The recent case of Taylor v. Commissioner, T.C. Summary Opinion 2025-10 (March 3, 2025), addresses this situation and provides an opportunity to consider the ownership requirement for casualty loss deductions.

Facts & Procedural History

The taxpayer and his then-spouse acquired real estate in Texas in 1992. Following their divorce in 2000, the taxpayer-husband transferred his interest to his wife via a special warranty deed.

The taxpayer-wife died in 2007 and her minor daughters inherited the property. The taxpayer-husband was appointed guardian of the estate for his then-minor daughters.

The daughters reached adulthood by 2012, so the taxpayer-husband transferred the property to the children via a deed. When Hurricane Harvey struck in 2017, the property was owned by the taxpayer-husband’s now adult daughters. The taxpayer-husband did not live in the property in 2017.

The taxpayer-husband paid expenses to repair the damage to the property and he paid the insurance on the property. He claimed a $49,500 casualty loss deduction on his 2017 tax return for the damage.

The IRS conducted a tax audit and issued a Notice of Deficiency in 2021, determining a deficiency of $17,537 in federal income tax and an accuracy-related penalty under Section 6662(a). The IRS did not challenge the substantiation for the casualty loss deduction, as it normally does. Rather, it challenged the deduction on the basis of the taxpayer’s ownership of the property.

The taxpayer petitioned the U.S. Tax Court, challenging the IRS’s determination. The question for the court was whether the taxpayer-husband is entitled to a tax loss for the property that he used to own given that he paid for the repairs to the property.

About Casualty Loss Deductions

Section 165(a) of the tax code provides for a tax loss deduction for “any loss sustained during the taxable year and not compensated for by insurance or otherwise.” This is a very broad provision. This broad provision is then narrowed by specific limitations that are set out in the tax code.

Specifically, for individual taxpayers, Section 165(c) restricts deductible losses to three categories:

Losses incurred in a trade or business
Losses incurred in transactions entered into for profit, though not connected with a trade or business
Personal losses arising from “fire, storm, shipwreck, or other casualty, or from theft”

The third category—personal casualty losses—enables taxpayers to deduct losses from sudden, unexpected events like hurricanes, floods, and fires. These deductions provide important tax relief for taxpayers facing significant financial setbacks due to disasters and other unexpected events.

The Ownership Requirement for Casualty Losses

While Section 165 itself doesn’t explicitly say that there is an ownership requirement, the courts have consistently held that only the owner of property at the time of a casualty can claim the resulting loss deduction. This judicial interpretation reflects the fundamental purpose of the casualty loss provision: to provide tax relief to those who have suffered an economic loss from damage to their property.

The leading case establishing this principle is Draper v. Commissioner, 15 T.C. 135 (1950), where the Tax Court denied a casualty loss deduction to a taxpayer who replaced his adult daughter’s property destroyed in a fire. The court held that since the taxpayer didn’t own the property, he couldn’t claim the deduction, regardless of his financial contribution to replacing the items.

This ownership requirement continues to be enforced in more recent cases. In Rogers v. Commissioner, T.C. Memo. 2019-90, the Tax Court reaffirmed that “a casualty loss deduction is authorized only when the claimant is the owner of the property with respect to which the loss is claimed.”

Paying for Someone Else’s Property Repairs

Many taxpayers voluntarily pay expenses for property they don’t own–particularly when helping family members. That is the situation in the Taylor case.

These payments might include:

Parents paying repair costs for properties owned by their adult children
Individuals paying expenses for properties owned by elderly parents
Taxpayers contributing to repairs for damaged properties in their communities

When these payments are made out of generosity or family support, they generally do not create a deductible interest in the property for tax purposes. The IRS and courts consistently maintain that paying expenses for someone else’s property–regardless of the amount or reason–does not transfer the casualty loss deduction to the payer.

From a tax perspective, voluntary payments for property expenses are more akin to gifts than investments creating deductible interests. This principle applies even in cases where the taxpayer previously owned the property or has an emotional attachment to it.

The court in Taylor acknowledged that the taxpayer may have paid for the repairs to the damaged property. However, it found that these voluntary payments did not establish a deductible interest in the property under Section 165. The court noted that a tax deduction for a casualty loss for property is allocated to the person who owned the property and incurred the economic loss, not to those who voluntarily pay to repair it. Citing Draper v. Commissioner, the court reaffirmed that a taxpayer cannot claim casualty loss deductions for property owned by adult children, even if the taxpayer pays for expenses related to that property.

Exceptions to the Ownership Rule

While the general rule requires legal ownership for casualty loss deductions, tax law recognizes certain limited exceptions where non-title holders might claim such deductions. These exceptions generally involve taxpayers who have economic interests in the property despite not holding legal title:

Equitable ownership – where a taxpayer is making payments under a contract to purchase property but hasn’t yet received formal title
Leasehold interests – where a tenant has made substantial improvements to leased property
Life estates and remainder interests – where the taxpayer holds a legally recognized partial interest
Properties held in certain trust arrangements where the taxpayer maintains beneficial ownership

Taxpayers who wish to maintain tax benefits while supporting family members might consider alternative approaches based on these interests. With a little tax planning, such as converting a house to a rental property (rental property losses would fall under the business/profit-seeking categories of Section 165(c) rather than personal casualty losses), maximizing partial asset dispositions, etc., the taxpayer very well may be able to claim the casualty loss for property that they do not own. Suffice it to say that these approaches should be implemented with proper documentation and genuine economic substance to withstand IRS scrutiny.

The Takeaway

This case reiterates that a casualty loss deduction goes to the owner. The taxpayer has to own the property that suffered the damage. Simply paying for repairs or maintenance does not transfer the deduction to the payer, regardless of family relationships or previous ownership history. When supporting family members with property expenses, taxpayers should understand that these payments generally don’t create tax benefits. If tax considerations are important, alternative arrangements that maintain legitimate ownership interests should be established before a casualty occurs.