IRA Rollover Limit May Lead to Tax Penalties for Clients
Practitioners need to be aware of the tax-free IRA rollover rules that took effect on Jan. 1, 2015 to protect their clients from major tax problems and penalties.
For many years the IRS indicated in Publication 590 that if you have multiple IRAs, it was permissible to do multiple IRA rollovers.
The old rules, as described in Publication 590, stated, Generally, if you make a tax-free rollover of any part of a distribution from a traditional IRA, you cannot, within a 1-year period, make a tax-free rollover of any later distribution from that same IRA. You also cannot make a tax-free rollover of any amount distributed, within the same 1-year period, from the IRA into which you made the tax-free rollover. The 1-year period begins on the date you receive the IRA distribution, not on the date you roll it over into an IRA.
The IRS gave an 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 one 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.
Based on IRS Publication 590, taxpayers could have multiple IRA rollovers during a one-year period since the one-year limitation rule was applied on an IRA by IRA basis. In essence, each IRA maintained by an IRA owner would have a separate one-year period.
The old rules were widely known by practitioners, financial institutions and consumers. They could be used as an income tax-planning technique to provide a tax-free, penalty-free loan to a taxpayer if the taxpayer had a number of separate IRAs.
Those old rules were used by many until the Tax Court spoke in Bobrow v. Commissioner in 2014. In the Bobrow case, the Tax Court held that the one-year limitation rule under Internal Revenue Code Section 408(d)(3)(B) applied on an aggregate basis and not on an IRA-by-IRA basis.
THE NEW RULES
The IRS explained in Publication 590-A how the IRA rollover rules will now work, starting this year. Beginning in 2015, you can make only one rollover from an IRA to another (or the same) IRA in any 1-year period regardless of the number of IRAs you own. The limit will apply by aggregating all of an individuals IRAs, including SEP and SIMPLE IRAs as well as traditional and Roth IRAs, effectively treating them as one IRA for purposes of the limit. However, trustee-trustee transfers between IRAs are not limited and rollovers from traditional IRAs to Roth IRAs (conversions) are not limited.
In the new publication, the IRS provided a fresh example, with a taxpayer named John, who has three traditional IRAs; IRA-1, IRA-2, and IRA-3. On January 1, 2015, John took a distribution from IRA-1 and rolled it over into IRA-2 on the same day. For 2015, John cannot roll over any other 2015 IRA distribution, including a rollover distribution involving IRA-3. This would not apply to a conversion.
The IRS decided that it was best to have the new rules for administrative purposes become effective as of Jan. 1, 2015 and not applied on a retroactive basis.
IRS Announcement 2014-32 was fairly comprehensive and made the following points:
1. Amounts received from an IRA will not be included in the gross income of a distributee to the extent that the amount is paid into an IRA for the benefit of the distributee under the 60-day rollover rule.
(Note that Publication 590-B indicates that certain distributions are not eligible for rollover. For example, amounts that must be distributed (required minimum distributions) during a particular year are not eligible for rollover treatment.)
2. The Internal Revenue Code at Section 408(d)(3)(B) is the key section involved under the one-rollover-per-year limit on IRA rollovers.
3. The IRS announcement stated that an individual receiving an IRA distribution on or after Jan. 1, 2015 cannot roll over any portion of the distribution into an IRA if the individual has received a distribution from any IRA in the preceding one-year period that was rolled over into an IRA, but subject to transitional rules for certain prior transactions.
4. The IRS, in Publication 590 and its proposed regulations, had previously provided that the IRA rollover rules were based on an IRA-by-IRA basis. However, in Bobrow v. Commissioner, the Tax Court held that the one-rollover-per-year limit applied on an aggregate basis and not on an IRA by IRA basis.
5. The IRS will apply the Bobrow interpretation of the law under Section 408(d)(3)(B) for distributions occurring on or after Jan. 1, 2015.
6. A rollover from a traditional IRA to a Roth IRA (a conversion) is exempt from the one-rollover-per-year rule. It is not considered in applying the one-rollover-per-year rule to other rollovers.
7. A rollover from a Roth IRA to any Roth IRA (including the same Roth IRA) would preclude any other Roth IRA rollovers to any Roth IRA under the one-year rule. It would also preclude any rollovers from one traditional IRA to a traditional IRA (including the same traditional IRA) under the one-year rule.
8. A rollover from a traditional IRA to any traditional IRA (including the same traditional IRA) would preclude any other traditional IRA rollovers under the one-year rule. It would also preclude any rollover from any Roth IRA to a Roth IRA (including the same Roth IRA) under the one-year rule.
9. According to the IRS, for purposes of Announcement 2014-32 the term traditional IRA includes a simplified employee pension under IRC Section 408(k) and a Simple IRA under IRC Section 408(p).
10. The IRS indicated that the one-rollover-per-year limitation does not apply to a rollover to an IRA from a qualified plan. In addition, the IRS also indicated that the one-rollover-per-year limitation does not apply to rollover to a qualified plan from an IRA.
11. The one-rollover-per-year limitation rule does not apply to trustee-to-trustee transfers.
IRA ROLLOVER HEADACHES
A violation of the one-rollover-per-year-limit on IRA rollover will lead to headaches. Not only may the violation of the rollover limitation rule trigger taxable events (income taxes and possible accuracy penalties and early distribution penalties), but it may in many instances be treated as an excess contribution that was made to the receiving IRA as well. An excess contribution to an IRA is subject to a 6% penalty tax that is ongoing on the excess amount that it remains in the IRA at the end of each year. A special correction rule, however, applies to the first year that an excess contribution is made.
The IRS issued information release IR-2014-107 on Nov. 10, 2014. The release states in part the following:
Although an eligible IRA distribution received on or after January 1, 2015 and properly rolled over to another IRA will still get tax-free treatment, subsequent distributions from any of the individuals IRAs (including traditional and Roth IRAs) received within one year after that distribution will not get tax-free rollover treatment.
According to IRC Section 408(d)(3)(B) the tax-free rollover rules do not apply to any amount 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 . . . from an individual retirement account or an individual retirement annuity which was not includible in gross income.
SPOUSAL IRA ROLLOVERS
Based on the above legal analysis, spousal IRA rollovers would fall with the one-per-year limit on IRA rollovers. The Tax Court opinion and the law clearly indicates that any amount received by an individual from an individual retirement account or individual retirement annuity (regarding tax-free rollovers) is subject to the one-per-year limit on IRA rollovers.
Obviously, the law does not distinguish between a spousal rollover from a decedents IRA and a rollover from the spouses own IRA. The law is inclusive and covers any IRA distribution received by an individual under the one-per-year limit on IRA rollovers.
One cannot argue that a spouse is not an individual with respect to a spousal IRA rollover. Further, it cannot be successfully argued that upon the death of an IRA owner survived by a spouse beneficiary that the spouse is not the legal owner of the decedents IRA as a matter of law.
Of course, the spouse beneficiary of the decedents IRA is the legal owner of the decedents IRA as of the date of death of deceased IRA owner. The surviving spouse is the beneficiary of a non-probate asset and as such owns the deceased IRA owners account.
This legal position is consistent with Revenue Procedure 89-52, in which the IRS clearly indicates, in the context of an inherited IRA that is payable to nonspouse beneficiaries, that each beneficiary will own a 50% share of the IRA.
Once an IRA owner dies survived by a spouse beneficiary, then the deceased IRA owners account is maintained for the benefit of the surviving spouse within the purview of Section 408(d)(3) of the Internal Revenue Code. If this were not the case, the spousal rollover of IRA would not be valid under the Internal Revenue Code. As previously discussed, on the death of IRA owner survived by a surviving spouse, the owner of the deceased IRA owners account is then the surviving spouse. At that time, the deceased IRA owners account is then maintained for the surviving spouse and should be subject to the one-per-year limit on IRA rollovers.
Based on the above analysis, the following are examples of issues that a surviving spouse should be aware of:
A COMPREHENSIVE EXAMPLE
John is an IRA owner who dies at age 68 on May 1, 2015 survived by his spouse Mary. His spouse Mary is age 65 in 2015 and has her own IRA. She is also the beneficiary of Johns IRA.
Assume that Mary receives an IRA distribution of $100,000 from her own IRA on Feb. 1, 2015 and rolls it over to another IRA in her name on March 1, 2015.
In addition, on June 15, 2015 she receives a distribution from Johns deceased IRA of $200,000 and rolls it over to her own IRA on July 1, 2015.
Question 1: Has Mary violated the one-per-year limit on IRA rollovers?
Answer: Yes. Since Mary received a distribution of $200,000 from Johns deceased IRA account on June 15, 2015, she is in violation of the one-per-year limit on IRA rollovers.
The reason is that under the one-per-year limit in IRA rollovers, Mary could not rollover tax-free any IRA distribution she receives during the one-year measuring period rule under the Internal Revenue Code.
Since Mary received IRA distribution from her own IRA on Feb. 1, 2015, then under the aggregation rule, she would have to wait until at least Feb. 1, 2016 in order to take another IRA distribution that would be eligible for tax-free rollover treatment.
Question 2: Assume the facts in Question 1. What are the tax consequences that are triggered as a result of the $200,000 rollover by Mary on July 1, 2015?
Answer: According to the IRS and the law, Mary would have to report the $200,000 amount in income for calendar year 2015. In addition, she would be subject to an excess contribution tax penalty of 6% unless corrected in the manner required by the IRS.
Question 3: How can the taxable event described in the answer to question 2 be avoided?
Answer: Mary should arrange for Johns deceased IRA to be directly transferred from Johns deceased IRA account to Marys IRA.
Although the Bobrow case covers traditional IRAs, the language in Bobrow and in the Internal Revenue Code is broad enough to include all IRAs, including a decedents IRA that is payable to a surviving spouse.
Seymour Goldberg, CPA, MBA, JD, is a senior partner in the law firm of Goldberg & Goldberg, P.C., in Long Island, N.Y., and professor emeritus of law and taxation at Long Island University.