In a game-changing decision that has wide-ranging ramifications for financial advisers and tax professionals alike, the Tax Court ruled that the once-a-year IRA rollover rule applies to all of one's individual retirement accounts, not to each separately (Alvan L. Bobrow, et ux., v. Commissioner, TC Memo 2014-21, Docket No. 7022-11, Jan. 28).
The court's ruling directly conflicts with a long-standing Internal Revenue Service position in IRS Publication 590 and in private-letter rulings that says that the rule applies separately to each IRA.
Under Internal Revenue Code Section 408(d)(3)(B), an IRA owner can roll over only one distribution within a one-year period. This period is 365 days, not a calendar year, and starts on the day that the IRA owner receives the distribution.
Until now, it was clear that this rule applied separately to each IRA, allowing multiple rollovers during the 365-day period if taken from separate accounts. The Bobrow decision changes that.
Alvan and Elisa Bobrow are married and held multiple accounts with Fidelity Investments. He had two IRAs and she had one.
On April 14, 2008, Mr. Bobrow withdrew $65,064 from one of his IRAs. On June 6, 2008, he withdrew $65,064 from his other IRA.
On June 10, 2008, Mr. Bobrow used that money in an attempt to complete a rollover of his first IRA distribution.
On July 31, 2008, Ms. Bobrow withdrew $65,064 from her IRA. The money was used in an attempt to complete a rollover of Mr. Bobrow's second IRA distribution.
Finally, on Sept. 30, 2008, $40,000 was moved from a non-IRA account to Ms. Bobrow's IRA.
ALL OR ONE
The Bobrows claimed that all their IRA distributions were successfully rolled over in their entirety. The IRS claimed that only one of the Bobrows' rollovers was successfully rolled over.
The court agreed with the IRS that only one of the Bobrows' rollovers was successfully completed, but arrived at the decision using different logic than the IRS.
The court ruled that the once-a-year IRA rollover rule applies to all of a client's IRAs, not each account individually. The court also ruled that Ms. Bobrow's rollover was late.
The court decided that the IRS had assessed the Bobrows' tax liability correctly but, in somewhat of a curveball, using different reasoning than the IRS had used. Instead of taking the view that Mr. Bobrow's first rollover was taxable because it was ineligible for rollover, the Tax Court ruled that he violated the once-a-year rule when he “rolled over” his second IRA distribution, taken in June 2008, despite the fact that the distribution came from a different account than his first distribution.
Despite all the guidance to the contrary, as well as arguments from Mr. Bobrow, the Tax Court decided that the once-a-year rollover rule applies to all a taxpayer's IRAs together, not individually. Its rationale was that the language of the tax code limits the taxpayer to one rollover per year, with no qualifiers.
NO GAMING THE SYSTEM
The court further said that Congress put limits on IRA rollovers as a way to ensure that taxpayers don't take advantage of the 60-day rollover rule by repeatedly moving IRA funds in and out of their accounts on a tax-free basis. In other words, the court thought that Congress wanted to avoid having taxpayers game the system — like the Bobrows tried to do — artificially creating a longer-than-60-day rollover period.
This court decision is a warning to advisers.
Although possibly representing a significant departure from previous advice, in light of the court's decision in Bobrow, it would be prudent to instruct clients to avoid making any more than one 60-day IRA-to-IRA rollover per year.
If clients want to move money more frequently, they can still use trustee-to-trustee transfers, which can be made at any time, without regard to the once-per-year rollover rule. Direct transfers (trustee-to-trustee transfers) are still the preferred method to steer clear of this kind of tax trouble.
If nothing else, this shows that once again, when it comes to a client's retirement savings, which represent a lifetime of work, it pays to play it safe.
Violating the once-a-year rule can make distributions taxable and, if moved into another retirement account, subject to the 6% penalty for excess contributions.
Ed Slott (firstname.lastname@example.org), a certified public accountant, provides daily retirement-planning information at theslottreport.com and created Ed Slott's Elite IRA Advisor Group.