Marks Paneth Tax Alert: Rules Surrounding IRA Rollovers Become Less Friendly to Taxpayers

By Robert J. Hughes  |  July 9, 2014  |  Download PDF

Earlier this year, the US Tax Court made a controversial ruling regarding IRA (Individual Retirement Account) rollovers that contradicted an IRS publication designed to explain the law to taxpayers. Soon after, the IRS announced that it would adopt the court’s less taxpayer-friendly interpretation of the rollover rules. Taxpayers with multiple IRAs will have to be much more careful when making rollovers to ensure they don’t violate the aggregate rules and generate unnecessary tax liability — and possibly interest and penalties. This alert provides a brief overview of the Tax Court case, the IRS response and some other rules surrounding IRA rollovers that taxpayers should be aware of.

Introduction

Earlier this year, the US Tax Court made a controversial ruling regarding IRA (Individual Retirement Account) rollovers that contradicted an IRS publication designed to explain the law to taxpayers. In Bobrow v. Commissioner, the court ruled that the one-rollover-per-year rule applies to all of a taxpayer’s IRAs in aggregate, rather than on an account-by-account basis.

Soon after, the IRS issued Announcement 2014-15, which adopted the court’s less taxpayer-friendly interpretation of the rollover rules. The IRS also plans to revise Publication 590, Individual Retirement Arrangements, which included the IRA-by-IRA rollover guidance.

Taxpayers with multiple IRAs will have to be much more careful when making rollovers to ensure they don’t violate the aggregate rules and generate unnecessary tax liability — and possibly interest and penalties.

SNAPSHOT OF BOBROW

In the case, married taxpayers received a series of IRA distributions in 2008 involving several IRA accounts. They didn’t report any of the distributions as income, claiming that all the distributions had been rolled over tax-free.

The Tax Court ruled that the husband had used up his one-rollover-per-year privilege on his first distribution and, therefore, subsequent distributions were taxable. The court looked to the original law, finding that the plain language indicated the aggregate rule applies. The court felt that, if Congress had intended for the rollover rule to apply on an IRA-by-IRA basis, it would have worded the statute differently.

The wife’s IRA distribution was also taxable, but under a different rule: Her rollover didn’t occur within the requisite 60-day period (though it was only one day late).

In addition to more than $51,000 of unpaid federal taxes related to the botched rollovers, the Tax Court upheld a 20% accuracy-related penalty on the unpaid balance.

The Tax Court refused the taxpayers’ motion to reconsider its decision on the basis that it conflicted with IRS Publication 590. The court noted that neither the taxpayers nor the IRS mentioned Publication 590 at trial. Even if the parties had posed this argument, the court determined that the publication wouldn’t have provided substantial authority for the taxpayers’ position.

Another reason the court denied the taxpayers’ motion was that the IRS and taxpayers had reached the basis for a proposed settlement together. So, as far as the Tax Court is concerned, the issue is closed.

If the taxpayers try to appeal Bobrow, they’re unlikely to win, given the recent IRS announcement that it will adopt the aggregate rollover interpretation. It’s possible that Congress could revise the rollover rule, which was originally enacted in 1974 when IRAs were less popular. But no legislation has been proposed to date.

IRS ADOPTS AGGREGATE INTERPRETATION

Regardless of the ultimate resolution of Bobrow, the IRS expects to propose regulations providing that the IRA rollover limitation applies on an aggregate basis. The regulation wouldn’t be effective in 2014, however.

The IRS has received comments about the administrative challenges presented by Bobrow and understands it will require IRA trustees to make changes in how they process IRA rollovers and draft IRA disclosure documents. Accordingly, the IRS announced that it won’t apply the new interpretation to any rollover that involves an IRA distribution occurring before Jan. 1, 2015.

SOME EXCEPTIONS REMAIN

There are still some important exceptions to the one-rollover-per-year limitation. Neither of the following transactions counts as a rollover for purposes of this limitation:

1. A direct trustee-to-trustee transfer made from one IRA to another without passing through the taxpayer’s hands.
2. A distribution from a qualified retirement plan that is rolled over into an IRA.

Also be aware that, in the case of married individuals, the one-rollover-per-year rule is applied separately to IRAs owned by the individual and to IRAs owned by the individual’s spouse. So what your spouse does with his or her IRAs has no effect on what you can do with your IRAs.

POINTS TO REMEMBER

The general statutory rule is that an amount distributed from an IRA (except to the extent the distribution consists of nondeductible contributions) must be included in the recipient’s gross income for federal income tax purposes. If the taxpayer is under age 59½, a 10% early withdrawal penalty generally also will apply.

An exception to the income inclusion and early withdrawal penalty may apply, however, when the distributed amount is rolled over into an IRA, individual retirement annuity or qualified retirement plan, such as a 401(k), by no later than the 60th day after the day on which the taxpayer received the distribution.

The following statutory fine print related to IRA rollovers may trip up taxpayers:

• The 60-day period begins the day after you receive the distribution.
• The funds are due back in an IRA on the 60th day. You don’t get a break if the 60th day falls on a holiday or weekend.
• If you make the contribution after the 60-day deadline, you could be subject to a 6% excess contribution penalty.
• The same property must be rolled over. For example, if you withdraw 100 shares of ABC Company from IRA-1, those shares must be rolled over to IRA-2.
• You can’t roll over a required minimum distribution.

Of course, the one-rollover-per-year limitation also must be met. The one-year waiting period between rollovers begins the day you receive the distribution.

WHERE DO WE GO FROM HERE?

As the complexity of IRA plans has blossomed over the last 40 years, Publication 590 has likewise grown to 114 pages (including tables and indices). The publication contains enough fine print to confuse even sophisticated taxpayers. Now the one-rollover-per-year limitation further complicates matters. If you’re considering an IRA rollover, contact us to make sure it will meet the applicable rules to avoid unnecessary taxes and survive IRS scrutiny.

TAX PLANNING GUIDE

To facilitate ongoing access to the latest tax rules and regulations, Marks Paneth offers an online tax guide that is updated on an ongoing basis.

FOR MORE INFORMATION

If you have questions about anything you read in this alert or in our tax guide, please contact a Marks Paneth tax advisor or Robert J. Hughes, Tax Principal, by phone at 212.503.8942 or by email at  rhughes@markspaneth.com.

IRS CIRCULAR 230 DISCLOSURE 

Treasury Regulations require us to inform you that any Federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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