There have been several twists and turns this year relating to the "once-a-year rule" for IRA rollovers. In the latest move, the IRS has provided additional guidance in the wake of a controversial U.S. Tax Court decision applying the rule to all IRAs owned by an individual. Significantly, the IRS is providing taxpayers with greater flexibility in their year-end tax planning decisions.
Three Exceptions to the Once-a-Year-Rule
The IRS states in Publication 590 that that the once-a-year rule doesn't apply to the following distributions:
1. If made from a failed financial institution by the Federal Deposit Insurance Corporation (FDIC) as receiver for the institution.
2. If not initiated by either the custodial institution or the depositor.
3. If made because the custodial institution is insolvent and the receiver is unable to find a buyer for the institution.
No Tax Fuss on Trustee-to-Trustee Transfers
When you roll over funds from one IRA to another, 20 percent of the distribution is generally withheld in taxes. If you meet the 60-day rollover requirement, you can recoup the withholding amount when you file your tax return for the year of the distribution.
But a trustee-to-trustee transfer in which the funds go directly from one IRA custodian to another isn't subject to withholding. Technically, this isn't a rollover because your hands never touch the money. Thus, the IRS says such transfers aren't subject to the once-a-year rule.
Assuming you don't need the interest-free use of IRA funds for 60 days, this is the recommended approach for most taxpayers. Consult with your tax adviser if you have questions about how to execute a tax-free IRA rollover.
Normally, you must pay tax on distributions received from an IRA at ordinary income rates reaching as high as 39.6 percent. However, if you roll over the funds to another IRA (or other qualified retirement plan), the distribution isn't taxable if it is completed within 60 days. It doesn't matter what you do with the money in the interim as long as you meet the 60-day deadline. In effect, it's like getting an interest-free loan from Uncle Sam for up to two months.
But the rollover tax break is filled with numerous pitfalls for the unwary. For example, the following rules might trip you up if you're not careful:
The 60-day period begins the day after you receive the distribution. It ends on the 60th day. There's no extension if the 60th day falls on a holiday or weekend.
If you make the contribution after the 60-day deadline you could be assessed a 6 percent excess contribution penalty.
If you're under age 59 1/2, you could be hit with a 10 percent penalty tax, on top of the regular income you owe, if you don't meet the 60-day requirement (unless a special tax law exception applies).
Waivers may be available for certain situations, such as an error by the financial institution, death, disability or hospitalization. However, the IRS does not routinely allow waivers.
When you roll over assets, you must redeposit the same assets within 60 days. For example, if you withdraw 100 shares of XYZ Corp. from IRA-1, the same XYZ shares must be rolled over into IRA-2.
You can't roll over a required minimum distribution (RMD). These distributions from IRAs are mandatory after reaching age 70 1/2.
The Once-a-Year-RuleAnother important tax law provision restricts IRA rollovers involving the same IRA within the same year. Generally, if you roll over funds tax-free from an IRA, you're prohibited from making another tax-free rollover of a distribution from that IRA during the same year, unless an exception applies (see right-hand box). Furthermore, you can't make a tax-free rollover of any amount distributed, within the same one-year period, from the IRA into which you made the tax-free rollover.
Previously, most tax professionals treated this rule as applying separately to each IRA a taxpayer owns. The IRS itself appeared to concur on page 25 of its Publication 590, Individual Retirement Accounts. But IRS publications for taxpayers are not a legally binding authority. And in a case decided earlier this year, the Tax Court determined that the once-a-year rule applies to all IRAs owned by a taxpayer.
Facts of the Court Case
A married couple, Alvan and Elisa Bobrow, received a series of IRA distributions in 2008, involving several IRAs. They didn't report any of the distributions as income, claiming that all the distributions were rolled over tax-free.
The Tax Court ruled that Alvan 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 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.
Elisa's IRA distribution was also taxable, because her rollover did not occur within the requisite 60-day period -- even though she was only one day late.
In addition to more than $51,000 of unpaid federal taxes related to the botched rollovers, the Tax Court also upheld a 20 percent accuracy-related penalty (under Internal Revenue Code Section 6662) on the unpaid balance. (Bobrow, TC Memo 2014-21, 1/28/14)
IRS Issues New Guidance
In the aftermath of the Bobrow Tax Court decision, the IRS stated in Announcement 2014-15 that it would follow the new interpretation of the once-a-year rule. However, to allow taxpayers more time to accommodate their plans, it postponed enforcement of the change until January 1, 2015. Now, in IRS Announcement 2014-32, the IRS is giving some taxpayers even more time to pull off the multiple IRA maneuver.
Saving grace: A transitional rule allows you to avoid the restriction imposed in the Bobrow case for a distribution received in 2014 as long as the 60-day requirement is met. In other words, a second rollover won't violate the once-a-year rule for 2014 payouts even if the rollover is completed in 2015. This gives taxpayers one last chance at maximizing the rollover rules by taking a distribution by December 31, 2014 and then completing the rollover within 60 days.
The new ruling also clarified several other issues. For instance:
A conversion from a traditional IRA to a Roth IRA isn't subject to the once-a-year-rule (but the rule does apply to rollovers from one Roth IRA to another Roth IRA).
The rule doesn't apply to a rollover to or from a qualified retirement plan such as a 401(k).
The rule doesn't apply to a trustee-to-trustee transfer from one IRA to another (see right-hand box).
Finally, in case you're wondering, the IRS had previously promised to update the section of its Publication
590 concerning the once-a-year-rule. At last check, it has yet to do so. Presumably, the changes will be made in time for the 2015 tax-filing season for 2014 returns.