Tax Court Says One Tax-Free Rollover Per Year Means Just That

 

There is a lot of confusion regarding this subject, and since this is tax season, I thought it'd be appropriate to address it.

The Internal Revenue Code says that if you receive a distribution from an IRA, you can't make a tax-free (60-day) rollover into another IRA if you've already completed a tax-free rollover within the previous 12 months.

The long-standing position of the IRS, reflected in Publication 590 and proposed regulations, is that this rule applies separately to each IRA you own. Publication 590 provides the following 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."

Very clear. Clear, that is, until earlier this year, when the Tax Court considered the one-rollover-per-year-rule in the case of Bobrow v. Commissioner.

Bobrow v. Commissioner

In this case, Mr. Bobrow (anecdotally, a tax lawyer) did the following:

On April 14, 2008, he withdrew $65,064 from IRA #1. On June 10, 2008, he repaid the full amount into IRA #1.

On June 6, 2008, he withdrew $65,064 from IRA #2. On August 4, 2008, he repaid the full amount into IRA #2.

Mr. Bobrow completed each rollover within 60 days. He made only one rollover from each IRA. So, according to Publication 590 and the proposed regulations, this should have been perfectly fine. However, the IRS served Mr. Bobrow with a tax deficiency notice, and the case went to the Tax Court. The IRS argued to the Court that Mr. Bobrow violated the one-rollover-per-year rule.

The Tax Court agreed with the IRS, relying on its previous rulings, the language of the statute, and the legislative history. The Court held that regardless of how many IRAs he or she maintains, a taxpayer may make only one nontaxable rollover within each 12-month period.

Strangely, neither the IRS nor Mr. Bobrow appear to have cited the Service's long-standing contrary position in Publication 590 and the proposed regulations. 

So what's the rule now?

It's not clear. Taxpayers who rely on the proposed regulations or the IRS's official Publication 590 to make multiple tax-free rollovers within a 12-month period do so at their own risk. It's hoped that the IRS will clarify its position in the near future. Honestly, it is extremely sad and ironic that a taxpayer who followed IRS guidelines, ends up paying additional taxes and penalties.

Separately, don't forget--you can make unlimited direct transfers (as opposed to 60-day rollovers) between IRAs. Direct transfers between IRA trustees and custodians aren't subject to the one-rollover-per-year rule.

*The one-rollover-per-year rule also applies--separately--to your Roth IRAs. Roth conversions don't count as a rollover for this purpose.

Not eligible for a Roth IRA... think again if a Backdoor Roth IRA may be an option for you (a great tax planning strategy).

I am a huge fan of this strategy and have advocated for high income earners who have no regular IRAs outside of their 401(k) or work retirement plans to implement this option. As a result, I am including a link to a Wall Street Journal video on this subject and further explanation below.

http://live.wsj.com/video/psstthe-backdoor-route-to-a-roth-ira/09198754-C88E-4767-84F5-1FAD8547EBE9.html?KEYWORDS=Psstthe+Backdoor+Route+to+a+Roth+IRA+video#!09198754-C88E-4767-84F5-1FAD8547EBE9

Going through the back door can pay off for high-income retirement savers.

Roth IRAs, which offer tax-free income, are not an option for many investors. Married couples earning $191,000 or more and singles earning $129,000 or more in 2014 are barred from contributing directly to Roth IRAs.

There is a simple detour that works for many of them. They can put money into a traditional (non-deductible) IRA and then roll that into a Roth IRA, getting all the benefits.

 Roth

With a Roth IRA, contributions are made with after-tax dollars, but earnings compound without tax and can be withdrawn tax-free in retirement. With a traditional IRA, in contrast, qualifying savers get an upfront tax deduction but owe tax when money is withdrawn.

Most high earners who can't contribute directly to a Roth also can't make a deductible IRA contribution. For instance, you cannot make a tax-deductible (traditional) IRA contribution if you are covered by a retirement plan at work and have 2014 income of at least $116,000 on a joint return or $70,000 as a single filer.

High earners are still allowed to contribute to a traditional IRA, but just not receive a tax deduction and that's the first step in the indirect route to a Roth IRA. The next step, which might occur as soon as a few days later: Convert that traditional IRA to a Roth, which is a move available to all.

There's one big caveat: This strategy works best for people who don't already have money in traditional IRAs. That's because in conversions, earnings and previously untaxed contributions in traditional IRAs are taxed—and that tax is figured based on all your traditional IRAs, even ones you aren't converting.

For an investor who doesn't already hold traditional IRAs, creating one and then quickly converting it into a Roth IRA will cost little or nothing in tax, because after a short holding period there's likely to be little or no appreciation in the account.

However, if you already have money in traditional IRAs, particularly ones for which you took a deduction, you could face a far higher tax bill on the conversion. You want to be careful that you don't get caught in this tax trap.

One possible workaround, is to roll older traditional IRAs into your 401(k) plan, if the plan allows. Then converting a new IRA into a Roth will cost you taxes on only the earnings, if any, of the new account. Most 401(k)s do not allow for IRA rollovers, and this option is much more common among small employer plans.

For further questions on this issue, please contact me directly.

Please welcome our new Director of Operations!

JillWe are pleased to announce that Jill Green has joined the firm as our Director of Operations.

Jill Green's background spans more than 15 years in business management and coaching.  As Director of Operations, Jill will manage daily operational activities, maximizing the efficient use of resources while focusing on the firm's strategic vision in order to enhance and improve the client's experience.

Prior to joining Integrity Advisory, Jill  worked as a Business Coach with the Urban Entrepreneur Partnership (UEP), a Program of The Kauffman Foundation.  At the UEP, Jill worked one-on-one with entrepreneurs to educate and coach them to start, manage, and grow a profitable, sustainable business.  Jill has worked with businesses in all stages of development assisting them with feasibility studies, marketing strategies & planning, operations management, and strategic planning.

Jill was also co-owner of two national franchise restaurants where she directed marketing campaigns, led operations for special events and prepared and analyzed monthly income statements with annual revenues of approximately $4 million.

Jill earned her bachelor's degree in Business Administration from Rockhurst University in Kansas City, MO, graduating cum laude.  Jill serves in a volunteer capacity with the Rockhurst University Leadership Studies Advisory Board.

Quotes

"Shun idleness. It is a rust that attaches itself to the most brilliant metals."

                             Voltaire

 "Good planning helps make elusive dreams come true."

                             Lester R. Bittel

 "Tough times don't last. Tough people do."

                             Author Unknown

 

Tony Moeller, CPA

 

The information listed in this commentary is a compilation of various publicly available sources and is for informational purposes only. It is not a recommendation or solicitation of any particular investment or strategy. A risk of loss is involved with investments in the stock and bond markets.

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