In Bobrow, et ux v. Comm'r., T.C. Memo. 2014-21 (Jan. 28, 2014), the Tax Court held that individual retirement account rollover year rules preclude a rollover from a two separate IRAs within the 12-month period beginning with the first of two IRA distributions.[1] That holding is contrary to Publication 590’s clear statement to the contrary on which many taxpayers have no doubt relied. Thus, numerous taxpayers now face tax peril that can undermine retirement security. A fix is badly needed.
Tax Court Opinion
Alvan Bobrow maintained a contributory IRA and a rollover IRA.[2] Elisa Bobrow, Alvan’s wife, maintained a contributory IRA. The couple had a joint non-IRA account, and each had a separate non-IRA account.
Alvan and Elisa executed the following transactions involving those IRAs:
- On April 14, 2008, Alvan withdrew two distributions totaling $65,064 from his contributory IRA.
- On June 6, 2008, Alvan withdrew $65,064 from his rollover IRA.
- On June 10, 2008, Alvan transferred $65,064 from his non-IRA account to his contributory IRA.
- On July 31, 2008, Elisa withdrew $65,064 from her contributory IRA.
- On Aug. 4, 2008, $65,064 was transferred from the couple’s joint (non-IRA) account to Alvan’s rollover IRA.
- Finally, on Sept. 30, 2008, $40,000 was transferred from the couple’s joint (non-IRA) account to Elisa’s contributory IRA.
It wasn’t noted in the opinion that if both of Alvan’s rollovers were permissible, the effect would have been that Alvan had the use of $65,064 of IRA funds continuously from April 14 through Aug. 4, a total period of 172 days.
The Internal Revenue Service argued that the June 6 distribution from Alvan’s rollover IRA couldn’t be rolled over on Aug. 4 because only one rollover is allowable in any 12-month period. In this case, that period began on June 6, 2008 because the June 6 distribution was rendered nontaxable by reason of the June 10 rollover.
The court analyzed Internal Revenue Code Section 408(d)(3)(A), limiting rollovers to one per year and held that “[t]he plain language of section 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 section 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.”[3]
Thus, the court went on to hold that Alvan couldn’t make two rollovers within the same 12-month period, even though Alvan withdrew and re-contributed funds from and to two separate IRAs.
The IRS argued that Elisa’s Sep. 30 rollover attempt was invalid because the distribution she sought to roll over to her own IRA was deposited in Alvan’s rollover IRA and therefore wasn't available to roll over to her own IRA. The taxpayers argued that didn’t matter because money is fungible, and the court agreed, saying, “the use of funds distributed from an IRA during the 60-day period is irrelevant to the determination of whether the distribution is a nontaxable rollover contribution.” Alternatively, the IRS argued that the Sept. 30 rollover was invalid because it occurred more than 60 days after the distribution.
Elisa’s $40,000 rollover attempt occurred 61 days after her distribution, one day late. The court explored possible relief, but found none. Because there was no evidence of reliance on the IRA custodian resulting in the failure to meet the 60-day rollover deadline, an extension of that deadline was precluded.[4] One wonders if the taxpayers misread 60 days to mean two months.
Because each spouse withdrew $65,064 that couldn’t be rolled over, the total amount taxable to the couple on their joint return was $130,128.
The court sustained imposition of IRC Section 72(t)’s 10 percent excise tax on Elisa’s withdrawal before attaining age 59 ½ in the amount of $6,506.40.
The IRS also sought and was awarded the accuracy-related penalty. The court said that no exception to the penalty applied. The taxpayers cited no authority other than Alvan’s professional background as a tax attorney, which the court seized on to further justify the penalty. Nor was it shown that the adequate disclosure exception to the penalty applied.
The penalty might have been avoided. It appears the court didn’t consider the definition of “substantial authority” found in Treasury Regulations Section 1.6662-4(d)(3), including subparagraph iii’s list of authorities that may constitute substantial authority in. These include, inter alia:
… private letter rulings and technical advice memoranda issued after October 31, 1976; actions on decisions and general counsel memoranda issued after March 12, 1981 (as well as general counsel memoranda published in pre-1955 volumes of the Cumulative Bulletin); Internal Revenue Service information or press releases; and notices, announcements and other administrative pronouncements published by the Service in the Internal Revenue Bulletin.
IRS Publication 590 says that the 12-month period runs with respect to each IRA of a taxpayer. Nowhere in the opinion is there any mention of IRS Publication 590. Publication for preparing both 2007 and 2008 income tax returns states:
Waiting period between rollovers. 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.
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.
The above language has appeared at least since 1994 and still appears in Publication 590 to this day. It’s shocking, then, that the IRS would litigate this point now.
In the wake of the court’s holding, the IRS will no doubt claim an excess contribution has been made to Alvan’s rollover IRA, subject to the 6 percent excise tax imposed annually until the excess contribution is withdrawn from the account, together with related net income. The IRS did likewise in Martin v. Commissioner.[5]
A Better Alternative
There’s a better alternative to moving funds from one IRA to another: Trustee to trustee transfers, or direct transfers.[6] However, the IRA owner has no ability to use the funds because no funds pass through the IRA owner’s hands. The court pointed out that direct transfers aren’t rollovers and, thus, aren’t subject to the one-rollover-per-year rule.
Fallout
The Tax Court’s decision in Bobrow, doesn’t just affect the taxpayer; it also threatens to impair the retirement security of many IRA owners who relied on Publication 590. It’s anyone’s guess how many IRAs have violated the court’s interpretations and have excess contributions as a result, compounding an annual 6 percent tax, penalties and interest.
This tax disaster of the IRS’ own making must be fixed. If it isn’t fixed, or if it’s only fixed for past years, guidance that taxpayers may rely on is needed regarding how the 12-month rule applies when different types of IRAs are simultaneously present, including:
- IRAs
- Individual retirement annuities
- Accounts established by employers and certain associations of employees as part of a trust
- Simplified employee pension (SEP) IRA accounts
- SEP IRA annuities
- Deemed IRA accounts
- Deemed IRA annuities
- Roth IRAs
Endnotes
[1] Alvan L. Bobrow, et ux v. Comm'r., No. 7022-11, T.C. Memo. 2014-21 (Jan. 28, 2014).
[2] The court referred to contributory individual retirement accounts as “traditional.” Many commentators have used “traditional IRA” to distinguish Internal Revenue Code Section 408 IRAs from IRC Section 408A Roth IRAs. A contributory IRA, on the other hand, distinguishes an IRA funded through taxpayer contributions from an IRA funded by a rollover, including a rollover from an employer-sponsored qualified (non-IRA) plan.
[3] IRC Section 408(d)(3)(B) provides: This paragraph [relating to IRA rollovers] does not apply to any amount described in subparagraph (A)(i) [relating to IRA rollovers to another IRA] 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.
[4] IRC Section 408(d)(3)(I) and Revenue Procedure 2003-16, 2003-4 I.R.B. 359.
[5] Martin v. Commissioner, No. 7762-92, T.C. Memo. 1993-399 (Aug. 30, 1993), aff’d CA-5 (March 30, 1994). See also T.C. Memo. 1994-213 (May 12, 1994), holding facts of case couldn’t be re-litigated because of the doctrine of collateral estoppel.
[6] See Revenue Ruling 78-406, 1978-2 C.B. 157.