Jan 8, 2015

New Year, New Rule

A new, taxpayer-unfriendly rule regarding IRA rollovers took effect as the calendar rolled over to a new year. Starting on Jan. 1, 2015, if an IRA rollover occurs from one IRA, the IRA owner can’t do another rollover from any IRA for a 12-month period. To give you some perspective, let’s look at what’s changed and what it means for IRA owners.

‘Chained’ rollovers

While IRA withdrawals are typically taxable, IRC Section 408(d)(3)(A) — also known as the “rollover rule” — states that the distribution is not taxable if the funds are rolled over within 60 days. However, there’s a restriction: IRC Section 408(d)(3)(B) permits use of the 60-day rollover rule only once in a 12-month period, defined as 365 days from the distribution date, not as a calendar year.

The rollover rule has generally been applied on an account-by-account basis in the past. What has that meant for investors? Here’s an example from a previous version of IRS Publication 590:

Someone who owns two traditional IRA accounts — IRA #1 and IRA #2 — rolls over a distribution from IRA #1 into a new account, IRA #3, after 60 days.

No further rollovers can occur from IRA #1 or IRA #3 in the next year because of the one-year rule.

But the IRA owner could still roll over a distribution from IRA #2, which would be eligible for the 60-day rule.

By stringing together this sequence of “chained” rollovers, the owner of these accounts could access IRA funds as short-term loans while circumventing the 60-day rule temporarily.

Aggregate rollovers

But in IRS Announcement 2014-2015 last March, the agency announced plans to revise IRS Publication 590 to reflect the US Tax Court’s 2014 ruling in Bobrow v. Commissioner — a case involving a series of IRA rollovers in 2008, a disputed 60-day window of tax-free opportunity and a partial taxable distribution. The court’s opinion, which contradicted IRS Publication 590, has halted the separate IRA rollover strategy by mandating that the one-year rollover rule applies across all IRAs owned by an investor.

Although IRS Announcement 2014–15 stated that the one-year IRA rollover rule would apply to a taxpayer’s aggregated IRA accounts going forward, the new rule actually took effect on Jan. 1 to allow IRA custodians transition time for revising procedures for handling and reporting on IRA rollovers to ensure compliance with the updated rule. Announcement 2014-32 issued last November further clarified that the IRS will not apply the new interpretation to any rollover that involves an IRA distribution occurring before Jan. 1, 2015. This, in effect, offered a reprieve for account owners in the middle of a chain of IRA rollovers by giving them time to wind them down.

But there are exceptions to the aggregate IRA ruling, including:

Direct IRA transfers made from trustee to trustee without the taxpayer receiving IRA funds.

Distributions from a qualified retirement plan that are rolled over to an IRA.

Roth IRA conversions.

It’s also worth noting that the aggregate IRA rule is applied separately to IRAs owned by spouses.

Because a direct transfer from one custodian/trustee to another avoids any issues with the one rollover per year rule, a taxpayer may want to consider whether a direct transfer can be done instead of an actual rollover transaction. A 60-day rollover seems appropriate only in limited situations where the taxpayer needs the funds for a short period and intends to repay the funds within 60 days.

In with the new … but be cautious

A new year and new tax rules — it’s become a tradition, especially as IRA rollover rules continue to become more complex. Taxpayers with multiple IRAs would do well to talk with their financial advisors about rollovers in 2015 to avoid violating the new rule. After all, who wants to start the new year with unnecessary liability for taxes, penalties and interest?

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