As we all know, tax law is often convoluted. To illustrate the complexity, the U.S. Tax Court recently ruled against what is clearly stated in an IRS publication designed to explain the law to citizens. In the new case, the Court stated that the one-rollover-a-year rule applies to all of an individual's IRAs rather than on an account-by-account basis. Here is an explanation of the controversial decision and the rules involved in transferring money from one IRA to another.
Our nation's tax laws are complex and may not always make sense to taxpayers. Even tax professionals have difficulty at times. In one new case, the U.S. Tax Court issued a ruling that contradicts what is clearly stated in an IRS document published to help explain the law and citizens' responsibilities.
In the recent decision, the Tax Court ruled that the one-IRA-rollover-per-year limitation applies to all of an individual's IRAs rather than on an account-by-account basis. The decision contradicts longstanding guidance in IRS Publication 590, Individual Retirement Arrangements, which says the one-rollover-per-year limitation applies to each IRA separately. That is a more taxpayer-friendly interpretation than what the Tax Court has now ruled. The one-rollover-per-year limitation can be an important issue for folks who have several IRAs.
Here is what you need to know, starting with some necessary background information.
Some Transfers Don't Count Against You
Helpfully enough, a direct trustee-to-trustee transfer made from one IRA to another without passing through the taxpayer's hands doesn't count as a rollover for purposes of the one-IRA-rollover-per-year limitation.
Also, a distribution from a qualified retirement plan that is rolled over into an IRA doesn't count as a rollover for purposes of the one-IRA-rollover-per-year limitation.
Bottom Line: You can make as many of these transactions as desired within a one-year period without running afoul of the one-IRA-rollover-a-year rule.
IRA Rollover Basics
The general statutory rule is that an amount distributed from an IRA must be included in the recipient's gross income for federal income tax purposes (except to the extent the distribution consists of non-deductible contributions).
A favorable exception applies when the distributed amount is rolled over into a IRA, individual retirement annuity, or qualified retirement plan by no later than the 60th day after the day on which the taxpayer received the distribution.
In that case, the rolled over amount is tax-free. To be perfectly clear, the 60-day period starts on the day after you receive an IRA distribution. In other words, start counting on that day and don't go more than 60 days out. You don't get any extra slack if the end of the 60-day period falls on a weekend or holiday.
By law, the tax-free rollover privilege is limited to one rollover within any one-year (12-month) period. The one-year period starts on the date the amount that is rolled over is received.
The IRS has historically taken the position, in Publication 590, Individual Retirement Arrangements, that when an individual has several IRAs, the one-rollover-per-year limitation applies separately to each IRA. Therefore, you could not conduct more than one tax-free rollover during any 12-month period with any particular IRA, but if you had two or more IRAs, you could potentially make two or more tax-free rollovers during a 12-month period (one for each account).
Now the Tax Court has ruled that this taxpayer-friendly interpretation of the one-rollover-per-year limitation is wrong.
Note: In the case of a married individual, 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.
Facts of the Case
Alvan and Elisa Bobrow were a married couple filing a joint tax return. In 2008, the following IRA transactions took place:
Husband's IRA Transactions
|On April 14, 2008, Alvan received two distributions totaling $65,064 from his traditional IRA (IRA-1).|
|On June 6, 2008, Alvan received a $65,064 distribution from his rollover IRA (IRA-2).|
|On June 10, 2008, Alvan transferred $65,064 from his individual account (apparently a checking account) to his traditional IRA (IRA-1). This was apparently intended to accomplish a tax-free rollover of the amount distributed from IRA-1 on April 14, 2008. The transfer occurred within the permitted 60-day window for rolling over the April 14, 2008 distribution.|
|On August 4, 2008, $65,064 was transferred from Alvan and Elisa's joint account (apparently a checking account) to Alvan's rollover IRA (IRA-2). This was apparently intended to accomplish a tax-free rollover of the amount distributed from IRA-2 on June 6, 2008. The transfer occurred within the permitted 60-day window for rolling over the June 6, 2008 distribution.|
Wife's IRA Transactions
|On July 31, 2008, Elisa received a $65,064 distribution from her traditional IRA (IRA-1).|
|On September 30, 2008, Elisa transferred $40,000 from the couple's joint account to her traditional IRA-1. This was apparently intended to accomplish a tax-free rollover of $40,000 of the amount distributed from her IRA-1 on July 31, 2008. Unfortunately, however, the transfer occurred outside the permitted 60-day window for rolling over any part of the July 31, 2008 distribution.|
What the Taxpayers Reported and the IRS Response
The taxpayers did not report any of the 2008 IRA distributions as income on their Form 1040 for the year. For various reasons, they claimed all the distributions had been rolled over tax-free.
After an audit, the IRS claimed that the June 6, 2008 distribution of $65,064 to Alvan from his IRA-2 was taxable because he had already used up his one-rollover-per-year privilege by rolling over the April 14, 2008 distribution from his IRA-1.
The IRS said the July 31, 2008 distribution of $65,064 to Elisa from her IRA-1 was also taxable because none of that amount was rolled over within the requisite 60-day period.
The Tax Court's Decision
The taxpayers took their case to the Tax Court where they met with a generally unsatisfactory fate. Here are the main elements of the decision:
The Tax Court concluded that Alvan successfully rolled over the April 14, 2008 distribution of $65,064 from his IRA-1 when he re-deposited $65,064 into IRA-1 on June 10, 2008. So far so good.
Unfortunately, the Tax Court then agreed with the IRS that the June 6, 2008 distribution of $65,064 from Alvan's IRA-2 was taxable because of the one-rollover-per-year rule. According to the Tax Court, Alvan used up his one-rollover-per-year privilege when he successfully rolled over the April 14, 2008 distribution. Specifically, the Tax Court opined that the plain statutory language of the one-rollover-per-year limitation found in Internal Revenue Code Section 408(d)(3)(B) is not specific to any particular IRA owned by an individual. Instead, the limitation applies to all IRAs maintained by an individual.
The Tax Court also agreed with the IRS that the July 31, 2008 distribution of $65,064 from Elisha's IRA-1 was taxable because none of that amount was rolled over within the requisite 60-day period. The $40,000 deposit into her IRA on September 30, 2008 was one day too late, because the 60-day period expired on September 29, 2008.
To add insult to injury, the Tax Court agreed that the IRS had properly assessed the 20% accuracy-related penalty (under Internal Revenue Code Section 6662) on the entire unpaid federal income tax bill that resulted from the failed rollover attempts. Ouch! In coming to this conclusion, the Tax Court blissfully ignored the IRS's own longstanding guidance, in Publication 590, which would have allowed tax-free rollover treatment for the distributions received from both of Alvan's IRAs. (Alvan Bobrow, TC Memo 2014-21)
Established IRS Guidance Conflicts with Court's Opinion
As we stated earlier, the IRS position in Bobrow and the Tax Court's decision directly conflicts with longstanding IRS guidance found in Publication 590. Specifically, the publication states:
"Generally, if you make a tax-free rollover of any part of a distribution from a traditional IRA, you cannot, within a 1-year period, make a tax-free rollover of any later distribution from that same IRA. You also cannot make a tax-free rollover of any amount distributed, within the same 1-year period, from the IRA into which you made the tax-free rollover."
Example 1 below explains how to apply the one-rollover-per-year rule to multiple IRAs and is taken almost verbatim from the current version of Publication 590 (for use in preparing 2013 returns).
Example 1: You have two traditional IRAs: IRA-1 and IRA-2. You make a tax-free rollover of a distribution from IRA-1 into a new traditional IRA (IRA-3). You cannot, within 1 year of the distribution from IRA-1, make a tax-free rollover of any distribution from either IRA-1 or IRA-3 into another traditional IRA. However, the rollover from IRA-1 into IRA-3 does not prevent you from making a tax-free rollover from IRA-2 into another IRA (other than IRA-1 or IRA-3). This is because you have not, within the last year, rolled over tax-free any distribution from IRA-2 or made a tax-free rollover into IRA-2.
Example 2: You could also roll over an amount distributed from IRA-1 back into IRA-1 and an amount distributed from IRA-2 back into IRA-2 without violating the one-rollover-per-year rule, according to the guidance in Publication 590.
Despite what Publication 590 states, the Tax Court's Bobrow decision ruled that you can only make one tax-free IRA rollover transaction within any one-year period.
The End Result
The Bobrow decision is bad news for folks with multiple IRAs. These individuals must now be extremely careful when attempting to make tax-free rollovers of amounts distributed from their IRAs. Because the Bobrow decision conflicts with longstanding IRS guidance, the taxpayers in that case may decide to appeal, and we hope they do. Meanwhile, be careful and consult with an EHTC adviser before making any significant IRA transactions that you intend to be tax-free rollovers.