You commit a crime, you are convicted, and you do your time. Then the IRS steps in to collect taxes<\/a><\/strong>. The IRS takes your assets to pay the tax that arose from your criminal activity. <\/p>\n As part of this, the IRS seizes your IRA funds. Are you responsible for paying income taxes on the IRA distribution\u2013even through you never received the money and you did not have control over the IRA at the time the funds are withdrawn? <\/p>\n The recent Sixth Circuit decision in Hubbard v. Commissioner<\/em>, 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.<\/p>\n 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.<\/p>\n The source of the taxpayer\u2019s wealth, however, was illegal. He operated what courts described as a \u201cpill mill,\u201d 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<\/a><\/strong>. <\/p>\n As part of the criminal case, prosecutors invoked criminal forfeiture laws to seize the taxpayer\u2019s assets acquired with proceeds from his illegal activities. The district court ordered the forfeiture of specific property\u2014his homes, vehicles, watercraft, and financial accounts, including his IRA\u2014to the IRS.<\/p>\n In 2017, the IRS seized the nearly $500,000 from the taxpayer\u2019s 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<\/a><\/strong>.<\/p>\n The taxpayer challenged this notice in tax court<\/a><\/strong>. He argued that the tax liability \u201cshould be paid by [the] feds\u201d since his account \u201cwas forfeited to\u201d them. Although the IRS conceded that the taxpayer shouldn\u2019t 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.<\/p>\n Criminal forfeiture laws allow the government to seize property connected to illegal activity to \u201censure that crime does not pay.\u201d While English common law permitted authorities to confiscate all of a convicted defendant\u2019s property, American forfeiture laws typically target only \u201cspecific assets\u201d with a connection to the crime.<\/p>\n 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.<\/p>\n The first type of forfeiture identifies \u201cspecific property\u201d that the defendant must relinquish. The government becomes the owner of this property upon conviction. <\/p>\n Some forfeiture laws incorporate a \u201crelation back\u201d doctrine that treats the government as having ownership rights in the property dating back to when the crime was committed.<\/p>\n This type of forfeiture resembles an \u201cin rem\u201d judgment because it permits the government to seize only the identified \u201ctainted property\u201d rather than the defendant\u2019s other assets.<\/p>\n The second type of forfeiture is a personal money judgment. This type of forfeiture allows courts to impose a \u201cpersonal money judgment\u201d identifying a sum that the defendant must pay. <\/p>\n With this type of forfeiture, the court calculates this amount based on the value of the forfeitable property involved in the crimes. <\/p>\n This type of forfeiture resembles an \u201cin personam\u201d judgment because the government may collect the debt from any of the defendant\u2019s current or future assets.<\/p>\n This case involved a specific property forfeiture. The district court identified specific property subject to forfeiture\u2014including his IRA\u2014and ordered the IRS to seize only these assets. The court did not enter a personal money judgment against the taxpayer.<\/p>\n The order stated that the forfeited assets \u201cshall be forfeited to the United States and no right, title, or interest in the property shall exist in any other party.\u201d This meant that the government became the IRA\u2019s owner at the time of the order.<\/p>\n Questions about gross income start with Section 61(a) of the tax code. Section 61(a) says that \u201cgross income means all income from whatever source derived.\u201d This broad language is intentional. It reflects Congress\u2019s 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 \u201call economic gains\u201d 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. <\/p>\n Beyond this general definition, Section 408(d)(1) specifically addresses IRA distributions, stating that \u201cany 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.\u201d This language is key here because it identifies who bears the tax burden\u2014the \u201cpayee or distributee\u201d of the funds.<\/p>\n 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.<\/p>\n This ownership question was central to the court\u2019s analysis. The Sixth Circuit had to determine whether the taxpayer remained the \u201cpayee or distributee\u201d for tax purposes despite no longer owning or controlling the IRA when the funds were withdrawn. <\/p>\n The court concluded that once the IRS became the owner of the IRA through the forfeiture order, the agency\u2014not the taxpayer\u2014became the \u201c[o]ne to whom money [was] paid or payable\u201d and the \u201cbeneficiary entitled to payment\u201d under ordinary definitions of these terms.<\/p>\n 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. <\/p>\n 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. <\/p>\n This subsection specifically identifies \u201cincome from discharge of indebtedness\u201d as a form of gross income. This principle, sometimes called \u201ccancellation of debt\u201d income<\/a><\/strong>, recognizes that when a taxpayer\u2019s 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.<\/p>\nFacts & Procedural History<\/span><\/h2>\n
Understanding Criminal Forfeiture<\/span><\/h2>\n
What is a Specific Property Forfeiture?<\/span><\/h4>\n
What is a Personal Money Judgment Forfeiture?<\/span><\/h4>\n
Which Type Applied In Hubbard\u2019s Case?<\/span><\/h4>\n
Distributions from Forfeited IRAs, Generally<\/span><\/h2>\n
Distribution from Forfeited IRA as Discharge of Debt Income<\/span><\/h2>\n
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