Earlier this year, the United States Tax Court issued a decision which will create significant new potential traps for individuals who take a distribution from an IRA with the intention of escaping tax by rolling it over to another IRA within 60 days.
Code Section 408(d)(3)(A)(i) indicates that, in general, an IRA distributee can avoid tax on the distribution if it is paid back into an IRA within 60 days. However, Code Section 408(d)(3)(B) states that the above exclusion does not apply to a second IRA distribution if, at any time during the 1-year period ending on the date of the second distribution, the individual received a previous IRA distribution and rolled it over into an IRA.
For many years, the IRA industry believed that the “once a year” limitation applied on an IRA-by-IRA basis, and not globally to all IRAs owned by a single individual. This belief was based on a cornucopia of authorities, including private letter rulings, proposed regulations, and even IRS Publication 590, the 2013 version of which includes the following example:
- Example. 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 any other traditional IRA. 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.
The Tax Court case, Bobrow v. Commissioner, overturned all of these authorities and held that the plain language of the statute requires that the limitation apply on an aggregate basis. Thus, the IRA owner in that case, who made a rollover involving one of his IRAs, was precluded for a year from making a second tax-free rollover involving any of his IRAs.
Subsequently, the IRS indicated in Announcement 2014-15 that it will follow the Bobrow decision and apply the limitation on an aggregate basis. However, and helpfully, the announcement also stated that it will not apply the aggregate limitation to distributions occurring before January 1, 2015.
An interesting bit of aftermath to the Bobrow decision is the Court’s response to the taxpayers’ Motion for Reconsideration of the decision. The Motion argued that the Court’s interpretation was inconsistent with Publication 590, and therefore (1) the decision should be overturned and (2) the taxpayers’ penalties should be abated for reasonable cause. After the motion was filed, the IRS and the taxpayer reached a settlement, so the Court’s order on the motion denied it as moot. However, the order also indicated that Publication 590 was not “substantial authority” and stated that “taxpayers rely on IRS guidance at their own peril.”
So, in light of this development, what should taxpayers do? The easiest way to avoid running afoul of it is to structure all IRA transfers as direct transfers from one IRA to another. The rollover limitation only applies when a taxpayer takes a distribution from an IRA and, within 60 days, contributes it back into an IRA. It does not apply to trustee-to-trustee transfers, in which IRA funds are transferred directly from one IRA custodian to another. If taxpayers structure all of their transfers between IRAs as direct transfers between IRA trustees, they will not need to worry about the once-a-year limitation.