The advisor was shaken. She had just learned that earlier this year the U.S. Tax Court slapped taxes and penalties on a couple who attempted multiple 60-day rollovers in a matter of months, each involving a different individual retirement account at Fidelity (see chart). A client of the advisor had likewise executed some of these rollovers in a short time frame—on the advisor’s recommendation—in order to consolidate retirement assets. Had the planner unwittingly walked the client into an immediate seven-figure tax bill?
When it is done correctly, there is no current-year tax consequence to moving money from one IRA to another via a 60-day rollover. A chief requirement is that within 60 days of an individual receiving a distribution from an IRA, he must redeposit the full amount, including any withheld income tax, into the same or another retirement account. Any amount not rolled over in that span gets taxed as ordinary income.
In January, U.S. Tax Court Judge Joseph Nega ruled in the case of Bobrow v. Commissioner that taxpayers are allowed a single 60-day IRA-to-IRA rollover every 12 months no matter how many accounts they own.
That’s what sent the advisor into shock, and she wasn’t the only one. Both long-standing proposed Treasury regulation 1.408-4(b)(4)(ii) and IRS Publication 590 indicate taxpayers get one of these rollovers per year for each IRA they have.
Yet “IRS publications don’t have any legal significance. The court isn’t bound in any way by those pronouncements of the IRS,” says Chicago attorney Bobbi Bierhals, a partner in the Private Client Practice Group at McDermott Will & Emery. “And the words of the Internal Revenue Code trump proposed regulations.”
Indeed, the judge in the Bobrow case looked to the exact wording of Code Section 408(d)(3)(B), observes Bierhals. “His ruling emphasized the fact that the code says receiving a non-taxable rollover from an IRA precludes receiving another one from an IRA for one year. It doesn’t say from such IRA, which would indicate a per-account basis,” says Bierhals.
The petitioners in the Bobrow case were a couple, Alvan and Elisa Bobrow. Alvan took a distribution on April 14, 2008. This distribution was successfully rolled over within 60 days (and thus non-taxable), so the court disallowed non-taxable rollover treatment for his June 6, 2008, distribution.
The couple’s woe grew when the court refused to accept their explanation for why the repayment of Elisa Bobrow’s IRA was a day late and 25 grand short.
Ultimately their taxes and penalties were reduced in a settlement with the IRS.
Relief
For everyone else, relief came March 20 in the form of IRS Announcement 2014-15. It said the agency would not apply the U.S. Tax Court’s ruling “to any rollover that involves an IRA distribution occurring before January 1, 2015.”
Yes, the advisor we met at the beginning has calmed down dramatically. But it was a heart-stopping reminder that the Internal Revenue Code really is the ultimate tax authority.
“If it’s not in the tax code, then you go to regulations, then proposed regulations, and only if there is no other official guidance do you look at IRS publications—and cross your fingers,” says Denise Appleby, CEO of Appleby Retirement Consulting Inc., a Grayson, Ga., provider of IRA technical support to financial, tax and legal professionals.
Clients also need to know about the ruling in the event they might get cute and move IRA money without telling you.
Start their education by harping on the ugly fallout of a second (or third, etc.) 60-day rollover within 12 months. The amount taken from the IRA is considered a taxable distribution, assuming the money was not previously taxed. In addition, the 10% early distribution penalty applies if the client is under age 59 and a half. Pile on state income tax, too.
Fine Points And Open Items
But that’s not all. When the money is later put back into IRA-land to complete the second rollover, “it could create an excess contribution that’s subject to a 6% excise tax for every year it remains in the account, if it is not properly corrected by the IRA owner’s tax-filing due date plus extensions,” Appleby says.
It is an excess contribution if the amount put back, plus any other IRA contributions the client has made for the year, tops the annual IRA contribution limit. Currently that limit is $5,500, or $6,500 for clients at least age 50 by the end of the year.
It could also be considered an excess contribution if the client is not eligible to contribute to an IRA in the first place, Appleby says. Thus, if the client is over age 70 and a half and rolls the money into a t
raditional IRA, or if funds are rolled to a Roth IRA and the client’s income exceeds the amount permitted for making Roth contributions, the entire amount is an excess contribution, she explains.
Next, tell the client he gets one 60-day rollover per 365-day period. “It’s not per calendar year,” says Harry Rubins, an independent financial consultant with Foothill Securities in Santa Rosa, Calif. The 365-day period begins with the day the client receives the first distribution that is rolled over.
Be sure to inform clients about the types of transfers not affected by the Bobrow case, Rubins says. They may make unlimited rollovers from employer plans to IRAs and vice versa as well as unlimited direct trustee-to-trustee transfers, which many advisors greatly prefer over 60-day rollovers.
“I always tell clients there are a lot of potential problems with a 60-day rollover that can be avoided with a trustee-to-trustee transfer,” says Rubins. The Bobrow case proves his point, especially when you consider that Alvan Bobrow is a tax attorney!
There is also no limit on the number of Roth conversions and recharacterizations clients can make, Appleby adds.
In the absence of IRS guidance at the time of this writing, experts were debating whether clients get one 60-day rollover per 365-day period for their traditional IRAs and another one for their Roth IRAs. Or is it one for both?
Here’s another issue: Suppose a client has 10 IRAs with $10,000 each. Will he only be able to access $10,000 once per year with a 60-day rollover, rather than being able to access all the money if he had $100,000 in a single account?
“It’s an important question for individuals with multiple IRAs. Taxpayers sometimes need money on a short-term basis and may have no other place to get it,” says Appleby, adding, “These are the only clients who should be doing 60-day rollovers” instead of direct trustee-to-trustee transfers.
Impact On Planning
An obvious implication of the case is that 60-day rollovers must be used sparingly going forward. “That could be an issue if you have a client with multiple IRAs at multiple places that you’re trying to consolidate,” says Wichita planner Richard Stumpf, principal of Financial Benefits Inc., a comprehensive planning firm.
What about all the customer-service reps out there who don’t understand their own organization’s paperwork for a trustee-to-trustee transfer? Getting huffy and demanding a check immediately is a luxury that can no longer be afforded on impulse. Get a supervisor involved if that’s what it takes to move the money smartly, recommends Rubins, the Santa Rosa advisor.
The Bobrow case quashes an aggressive strategy that some have used to circumvent the prohibition on borrowing from an IRA. Following the Bobrows’ pattern of transactions, you can see that taking two distributions before repaying the first one, and thereafter alternating distributions and repayments, leaves IRA assets in the hands of the account owner until the last account is replenished. That gambit is fini.
Many advisors eschew 60-day rollovers and rightfully so. For such a planner, the Bobrow case’s greatest significance may be the opportunity to present oneself as an expert in the ever-changing, confusing world of retirement accounts.