MAJOR CHANGE in interpretation of 60 day rollover rule

UPDATE

 

The Tax Court ruled in the case of Bobrow v. Commissioner, T.C. Memo 2014-21, that the one-time per 12 calendar month 60-day rollover rule applies to ALL of the taxpayer’s IRAs, and not to each IRA separately.  This is in direct conflict with information contained in IRS Publication 590 and in Proposed Regulation 1.408-4(b)(4)(ii).

UPDATE:  In IRS Announcement 2014-15, the IRS has indicated that it will withdraw Proposed Regulation 1.408-4(b)(4)(ii) and will interpret the 60-day rollover rule in accordance with Bobrow.  However, in order to give IRA custodians and trustees time to update their administrative procedures and their IRA disclosure documents, the IRS has announced that it will delay the application of the Bobrow interpretation of the 60-day rollover rule until January 1, 2015.

A summary of the ruling is below:

Bobrow, TC Memo 2014-21

The Tax Court has ruled that Code Sec. 408(d)(3)(B)’s one-rollover-per-year rule applies to all of a taxpayer’s IRAs, not to each of his IRAs separately.

Facts. Alvan and Elisa Bobrow, husband and wife, were a married couple who filed a joint federal income tax return. On Apr. 14, 2008, he requested and received two distributions from his traditional IRA in the combined amount of $65,064. On June 6, 2008, he requested and received a $65,064 distribution from his rollover IRA. On June 10, 2008, Alvan transferred $65,064 from his individual account to his traditional IRA. On July 31, 2008, Elisa requested and received a $65,064 distribution from her traditional IRA. On Aug. 4, 2008, they transferred $65,064 from their joint account to Alvan’s rollover IRA. On Sept. 30, 2008, Elisa transferred $40,000 from Taxpayers’ joint account to her traditional IRA.

The taxpayers did not report any of the distributions as income. They claimed that they implemented tax-free rollovers of all of the distributions. IRS asserted that the June 6 distribution to Alvan and the July 31 distribution to Elisa were taxable.

Background. Generally, Code Sec. 408(d)(1) provides that any amount distributed from an IRA is includible in gross income by the distributee. However, Code Sec. 408(d)(3)(A) allows a payee or distributee of an IRA distribution to exclude from gross income any amount paid or distributed from an IRA if the entire amount is subsequently paid (i.e., rolled over) into a qualifying IRA, individual retirement annuity, or retirement plan not later than the 60th day after the day on which the payee or distributee receives the distribution.

Code Sec. 408(d)(3)(B) limits a taxpayer from performing more than one nontaxable rollover in a one-year period with regard to IRAs and individual retirement annuities. Specifically, Code Sec. 408(d)(3)(B) provides: “This paragraph [regarding tax-free rollovers] does not apply to any amount described in subparagraph (A)(i) received by an individual from an individual retirement account or individual retirement annuity if at any time during the 1-year period ending on the day of such receipt such individual received any other amount described in that subparagraph from an individual retirement account or an individual retirement annuity which was not includible in his gross income because of the application of this paragraph.”

The reference to “any amount described in subparagraph (A)(i)” refers to any amount characterized as a nontaxable rollover contribution by virtue of that amount’s being repaid into a qualified plan within 60 days of distribution from an IRA. The one-year limitation period begins on the date on which a taxpayer withdraws funds from an IRA. (Code Sec. 408(d)(3)(B))

June 6 distribution to husband failed the one-rollover-per-year rule. The Tax Court ruled in favor of IRS, that the June 6 distribution was taxable because Alvan failed the one-rollover-per-year rule.

The Bobrows asserted that the Code Sec. 408(d)(3)(B) limitation is specific to each IRA maintained by a taxpayer and does not apply across all of a taxpayer’s IRAs. Therefore, they argued, Code Sec. 408(d)(3)(B) did not bar nontaxable treatment of the distributions made from Alvan’s traditional IRA and his rollover IRA. The taxpayers did not cite any supporting case law or statutes that would support their position.

The Court said that the plain language of Code Sec. 408(d)(3)(B) limits the frequency with which a taxpayer may elect to make a nontaxable rollover contribution. By its terms, the one-year limitation laid out in Code Sec. 408(d)(3)(B) is not specific to any single IRA maintained by an individual but instead applies to all IRAs maintained by a taxpayer. In support of this theory, the Court emphasized the word “an” in each place that it appears in Code Sec. 408(d)(3)(B).

The Court then explained its rationale for concluding that the June 6 distribution, rather than the Apr. 14 distribution, was taxable. When Alvan withdrew funds from his rollover IRA on June 6, the taxable treatment of his April 14 withdrawal from his traditional IRA was still unresolved since he had not yet repaid those funds. However, by recontributing funds on June 10 to his traditional IRA, he satisfied the requirements of Code Sec. 408(d)(3)(A) for a nontaxable rollover contribution, and the April 14 distribution was therefore not includible in the taxpayers’ gross income. Thus, Alvan had already received a nontaxable distribution from his traditional IRA on April 14 when he received a subsequent distribution from his rollover IRA on June 6.

Finally, the Court took note that Alvan received two distributions on April 14. It said that it would be inappropriate to read the Code Sec. 408(d)(3)(B) limitation on multiple distributions so narrowly as to disqualify one of the April 14 distributions as nontaxable under Code Sec. 408(d)(3)(A). So, it treated the amounts distributed on April 14 as one distribution for purposes of Code Sec. 408(d)(3)(A).

The July 31 distribution to wife was repaid too late. IRS put forth two arguments as to why the July 31, 2008, distribution was ineligible for nontaxable rollover treatment: (1) the funds were not returned to a retirement account maintained for Elisa’s benefit, and (2) repayment of funds was not made within 60 days.

As to argument (1), IRS asserted that because she distributed the funds first to the taxpayers’ joint account and the taxpayers thereafter transferred $65,064 from their joint account to husband’s rollover IRA, the July 31 distribution was paid into an IRA set up for Alvan’s benefit and not into an IRA set up for Elisa’s benefit. The Court disagreed with that argument: it said that money is fungible, and the use of funds distributed from an IRA during the 60-day period is irrelevant to the determination of whether the distribution was a nontaxable rollover contribution.

The Court did agree with IRS’s second argument. Partial repayment was not made until Sept. 30. Sixty days after July 31 was Sept. 29

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