Rollover contribution to second IRA disallowed

The Tax Court held that a taxpayer who received distributions from two individual retirement accounts (IRAs) and later transferred the amounts back into his IRAs had taxable income equal to the amount of the second transfer. According to the court, the plain language of Sec. 408(d)(3)(B) allows a taxpayer to make only one tax-free rollover contribution during a one-year period. The IRS subsequently announced that it will not apply this interpretation to distributions occurring before Jan. 1, 2015.

Generally, individuals must include the amount of distributions received from an IRA in their gross income. Taxpayers are not taxed to the extent those distributions are paid (often referred to as rollover contributions) into a qualifying IRA, retirement annuity, or retirement plan no later than the 60th day after the day on which the distribution is received. Sec. 408(d)(3)(B) states that the tax-free treatment does not apply to any distribution received by a taxpayer and subsequently rolled over 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 … which was not includible in his gross income because of the application of this paragraph.”

Alvan Bobrow, a tax attorney, maintained a traditional IRA and a rollover IRA. He received distributions totaling $65,064 on April 14, 2008, from his traditional IRA and another distribution of $65,064 on June 6, 2008, from his rollover IRA. On June 10, 2008, he transferred $65,064 back into his traditional IRA, and he transferred another $65,064 back into his rollover IRA on Aug. 4, 2008. On July 31, 2008, his wife, Elisa, withdrew $65,064 from her traditional IRA, and on Sept. 30, 2008, she transferred $40,000 into the IRA. She claimed that she instructed Fidelity Investments, the account custodian of her IRA, to transfer $65,064 from the couple’s joint checking account into her IRA at some time before Sept. 30, 2008. On their 2008 federal income tax return, the taxpayers treated all three sets of transactions as tax-free rollover contributions, but the IRS disagreed. The taxpayers petitioned the Tax Court for relief.

The taxpayers argued that the limitation of Sec. 408(d)(3)(B) applies to each IRA owned by a taxpayer and, although it prevents multiple tax-free rollover contributions from the same IRA during a one-year period, it does allow a tax-free rollover contribution from each IRA during a one-year period. The court disagreed, stating that the plain language of Sec. 408(d)(3)(B) states that once the taxpayer has received a tax-free rollover from “an” IRA, another distribution from “an” IRA cannot be rolled over tax-free during the one-year period. Thus, the court held, the $65,064 distribution received by the husband on June 6, 2008, was fully taxable since he had already received a distribution from another IRA on April 14, 2008, that was not taxable.

The taxpayers also argued that, due to the wife’s instructions to Fidelity, the entire $65,064 distribution received from her IRA should be a tax-free rollover contribution, despite the fact that they made only a partial repayment on the 61st day following the distribution. The court found no evidence to support that she had given such instructions and held that the 60-day period could not be waived under Rev. Proc. 2003-16 because she had not satisfied its requirements; thus, her entire distribution of $65,064 was taxable.

The court also upheld the IRS’s assessment of a 20% accuracy-related penalty under Sec. 6662(a). The taxpayers stated the tax-attorney husband had “analyzed the transactions at issue in the light of the provisions of section 408(d)(3), and concluded that the three transactions should all be treated as nontaxable”; however, the court held that, if he had done so, he must have read the statute’s plain language and should have realized that multiple rollovers were not permitted in a one-year period.

Two months later, in late March, the IRS announced it would follow the court’s holding (Announcement 2014-15). The IRS noted that a proposed regulation issued in 1981, Prop. Regs. Sec. 1.408-4(b)(4)(ii), and Publication 590, Individual Retirement Arrangements (IRAs), provide that the rollover limitation is applied on an IRA-to- IRA basis. Neither the proposed regulation nor the publication was mentioned in the Tax Court’s opinion. The IRS said it would withdraw the proposed regulation, revise the publication, and issue new proposed regulations consistent with the Tax Court’s holding. However, to allow IRA trustees time to change procedures and disclosure documents, the new regulations will not be effective before the beginning of 2015.

  Bobrow, T.C. Memo. 2014-21

By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota–Duluth.