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Friday, March 28, 2014

You are entitled to make one tax-free rollover from one individual retirement account or individual retirement annuity (“IRA”) into another IRA in any 1-year period, not one rollover into each separate IRA you own.  This is a new interpretation by the Tax Court and IRS.

Section 408(d)(3)(B) of the Internal Revenue Code limits rollovers from one IRA into another IRA to one in any 1-year period.  As provided in Proposed Treasury Regulation Section 1.408-4(b)(4)(ii), the IRS interprets this statutory limitation as applying separately to each IRA.  In the current version of IRS Publication 590, the IRS provides 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.

However, in Bobrow v. Commissioner, T.C. Memo. 2014-21, the Tax Court recently held that the limitation applies on an aggregate basis, so that only one IRA-to-IRA rollover may be made in any 1-year period with respect to all IRAs you own.  In the above example, the Tax Court’s ruling means that, after the tax-free rollover from IRA-1 to IRA-3, no tax free rollover from either IRA-1, IRA-2, IRA-3 or any newly established IRA into any other IRA would be permitted within the 1-year period beginning on the date of the rollover from IRA-1 to IRA-3.

In an advance copy of Announcement 2014-15, the IRS indicates that it intends to follow the Bobrow decision and withdraw the proposed regulation, but will not apply the aggregate one IRA-to-IRA rollover rule to rollovers which occur prior to January 1, 2015.  As the IRS points out in the Announcement, a direct trustee to trustee transfer is not a rollover, so this new interpretation does not prohibit IRA consolidation that does not involve a rollover.

There may be some interesting lessons to learn from this about-face.  First of all, appreciate that the same Treasury Department that proposed the regulation described above and developed the example described above from Publication 590 (its own publication provided to assist taxpayers with compliance)  is the one that challenged the position taken by Mr. Bobrow in reliance on these items before the Tax Court.  So much for reliance on a position of Treasury and/or the IRS as articulated in one of its own compliance publications.

Second, the change in position is likely to catch some people by surprise, especially seniors trying to do proper planning and who do not read all of the Tax Court cases and IRS Announcements.  These are not the folks who are “gaming the system” by taking out distributions as short-term loans and paying them back within the 60-day rollover period.  Instead, these taxpayers innocently take distributions and roll them over within the 60-day period usually because the financial institution holding the IRA assets makes a direct transfer difficult (if not impossible).  And, of course, many of them don’t even appreciate the difference between a rollover and a direct transfer.  They are simply trying to consolidate their accounts.

If you intend to do any tax planning or financial organization that involves IRA rollovers, now’s the time.

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