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Changes to IRA Rollover Rules, Less Taxpayer-Friendly

A controversial ruling regarding IRA rollovers that contradicted an IRS publication designed to explain the law to taxpayers was made by the U.S. Tax Court, earlier this year. In Bobrow v. Commissioner, the court ruled that the onerollover-per-year rule applies to all of a taxpayer’s IRAs in aggregate, rather than on an account-by-account basis.

 

Shortly thereafter, 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.

A Brief Review of Bobrow v. Commissioner

In the case of Bobrow v. Commissioner, 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. 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 It’s possible that Congress could revise the rollover rule, which was originally enacted in 1974 when IRAs were less popular.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 January 1, 2015.

Some Remaining Exceptions

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.

It’s also important to note 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 yours. 

Some Important Points to Keep in Mind

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 will also generally 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 or before 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.

If you’re considering an IRA rollover, contact your Untracht Early advisor to make sure it will meet the applicable rules to avoid unnecessary taxes and avoid potential IRS scrutiny.

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