Advisers who are salivating over big IRA rollovers from new clients: Watch out. The IRS has a bull's-eye on those dollars.
Starting Jan. 1, the Internal Revenue Service will begin enforcing a rule permitting only one 60-day IRA-to-IRA rollover every 365 days, regardless of how many IRAs a taxpayer owns. The finding runs contrary to the IRS' own interpretations of the tax code, as the agency has indicated that taxpayers can do one rollover annually for each account, according to a legal blog posted on tax guru Ed Slott's website.
“You can only do one rollover a year, and that's very concerning to us,” said Robert S. Keebler, partner with Keebler & Associates. “Financial advisers need to be on their toes.”
The change follows a U.S. Tax Court decision filed Jan. 28 involving a married couple in Short Hills, N.J. Per the decision, the husband received a pair of distributions from his traditional IRA in the combined amount of $65,064 on April 14, 2008. He received a distribution of $65,064 from his rollover IRA on June 6, 2008. The husband made a third transaction on June 10, 2008, moving $65,064 from his individual account to his traditional IRA.
Meanwhile, the wife took a $65,064 distribution from her traditional IRA on July 31, 2008. The couple then moved $65,064 from their joint account to the husband's rollover IRA on Aug. 4, 2008. Finally, the wife moved $40,000 from their joint account to her traditional IRA on Sept. 30, 2008.
The IRS and the couple locked horns over the characterization of the transactions. According to the decision, the couple described the April 14, June 6 and July 31 transactions as distributions. The couple also said the June 10, Aug. 4 and pre-Sept. 30 transactions were qualified repayments for those distributions.
The IRS said that of the three “repayments,” only the June 10 transaction was a qualified repayment.
The court found that in the one-year-period starting on April 14, 2008, the husband could have completed only one distribution and repayment as a nontaxable rollover contribution under the tax code. The other transactions are subject to the one-IRA-to-IRA-rollover-per-year rule and are includible in the couple's gross income. The couple was saddled with a hefty tax bill, including additional penalties.
Mr. Slott noted that the couple's many transactions went against the spirit of IRS Publication 590, wherein the agency indicated that one rollover per year for each account was allowed. “This is supposed to let you move money from one adviser to another or from one bank to another, and not to have the use of the money in between,” Mr. Slott said. “[The husband in the case] did so many rollovers, he had use of the money for six months. So he pushed the case a little too far.”
There's a lesson for advisers who are looking for new clients with large sums in their IRAs: Ask the client about where the money came from. “They have to ask the new prospect whether there was any IRA money rolled over in the last 12 months,” Mr. Slott said. “If it has been, you can't take it as a rollover, but you can take it as a direct trustee-to-trustee transfer.”
In fact, it might make more sense for advisers to insist on a direct transfer of the assets because clients can forget that they've done an IRA rollover within the last year. A second rollover will leave them owing taxes. “If the client tells you they haven't done a rollover, but they forgot, then your new relationship is already on a sour note,” Mr. Slott said. He noted that it's a value-add for the adviser, who can facilitate a direct transfer by coordinating with the custodians to move the money.
Indeed, some institutions will refuse to do direct transfers and offer only a check to the client. If that's the case, have the client request that the check be made to the receiving IRA so that it will still count as a direct transfer. Don't have the check made out to the accountholder.
For existing clients: Stop making those IRA-to-IRA rollovers. “The IRS won't enforce it until Jan. 1, 2015,” said Mr. Slott. “Clean up all of your old rollovers, stop them as a practice and educate everyone.”
“Every adviser loves big rollovers because they're big money, but if you blow this rule, you'll end up with an even bigger problem,” he added.