New Once-Per-Year IRA Rollover Rule Emerges from Bobrow v Commissioner Tax Court Case

Posted by Michael Kitces on Wednesday, March 26th, 7:01 am, 2014 in Taxes

The Internal Revenue Code allows individuals who receive a distribution from an IRA to avoid tax consequences by rolling the funds over to an IRA within 60 days. However, to avoid abuse of the rule, the tax code prescribes that taxpayers can only complete an IRA rollover once in a 12-month period, which the IRS in the past has interpreted to apply to IRAs on an account-by-account basis. In turn, the "separate accounts" treatment of the IRA rollover rule potentially allows taxpayers to chain together multiple IRA rollovers, in an attempt circumvent the 1-year rule and gain "temporary" use of IRA funds for an extended period of time.

However, a recent Tax Court case, Bobrow v Commissioner, has shut down the separate IRAs rollover strategy altogether. In a case that started out as a taxpayer who botched a version of the sequential separate accounts rollover strategy, and drew the IRS' ire in the process, ended out with a finding of guilt for not only of botching the rollovers but having the Tax Court (re-)interpret IRC Section 408(d)(3)(B) as well. In the decision, the Tax Court applied the 1-year IRA rollover rule to apply in the aggregate across all IRAs, invalidating the separate IRA rollover treatment not only for Bobrow but all taxpayers as well!

In the aftermath of the Bobrow case, the IRS has now issued IRS Announcement 2014-15, stating that it will acquiesce to the Tax Court decision, update its Proposed Regulations and Publication 590, and issue new Proposed Regulations soon that will definitively apply the 1-year IRA rollover rule on an IRA-aggregated basis going forward. However, to allow time for transition - including taxpayers in the midst of rollovers left in the lurch, and IRA custodians who must update their own processes and procedures - the IRS has declared that the "existing" rules will be allowed through the end of the year. However, the new rules allowing only one IRA rollover in a 1-year period will be effective starting January 1, 2015 (potentially dating back to IRA rollovers that occur in 2014), so advisors and their clients should plan accordingly!

Understanding the IRA Rollover Rule

Withdrawals from IRAs are normally taxable, but the standard "rollover rule" of IRC Section 408(d)(3)(A) stipulates that as long as the funds are rolled over within 60 days, the distribution will not be taxable. However, to prevent abuse, IRC Section 408(d)(3)(B) applies a limitation, that the 60-day rollover rule cannot be applied more than once in a 1-year period (measured as 365 days from the date that the first distribution occurred).

Historically, though, this rollover rule has typically been applied on an account-by-account basis. For instance, if an individual has two retirement accounts - IRA #1 and IRA #2 - and takes a distribution from IRA #1 that is rolled over into a new account (IRA #3), then no further rollovers can occur from IRA #1 or IRA #3 in the next year (as both accounts "participated" in one rollovers in a 1-year period already), but the taxpayer could theoretically still engage in a standalone rollover from IRA #2 and still be eligible for the 60-day rule. (Notably, in the case trustee-to-trustee transfers of IRAs, the funds are never received, and consequently do not count towards the 1-year period under Revenue Ruling 78-406; the 60-day rollover requirement and the 1-year rule only apply to rollovers where the individual actually receives the money.)

Why would someone wish to do this? It becomes a means of using the funds in an IRA as a form of temporary loan - one that potentially be chained together with a sequence of IRA rollovers. For instance, continuing the prior example, let's say that the individual needed to free up $100,000 of funds to cover the downpayment on a new house, while waiting for an existing home to sell. The individual might draw a $100,000 distribution from IRA #1, and use it to cover the downpayment on the house. Then shortly before the end of the 60-day window, the individual could take a distribution from IRA #2, and use the proceeds to complete the rollover under IRA #1 within the 60-day time window. Then just short of another 60-day period (now almost 120 days from the original distribution), if the existing home is finally sold, the taxpayer can use the proceeds to replace the $100,000 from IRA #2. The end result: notwithstanding the 60-day rollover rule, the taxpayer effectively used  $100,000 of IRA funds for almost 120 days by chaining together 60-day rollovers from multiple IRAs. And if there were enough IRAs with dollars available, the loan could theoretically have been stretched even further!

While this latter version of chaining together multiple rollovers is arguably a bit murky - since IRA #2 does end out being involved in two separate rollovers, one as the distributor and the other as the recipient - the former example with three IRAs has been blessed by the IRS. In fact, an example to this effect is specifically included as a part of IRS Publication 590, which itself is drawn from an example in Proposed Regulation 1.408-4(b)(4)(ii). Nonetheless, a recent court case where a taxpayer botched a version of the multiple rollover rule resulted in a surprise, not only for the taxpayer, but the IRS as well.

Bobrow v. Commissioner

The recent case of Bobrow v. Commissioner (TC Memo 2014-21) involved a scenario that was remarkably close to the chain-IRA-rollover-loan strategy noted above. In this instance, Bobrow started out by taking a distribution of $65,064 from his IRA on April 14th, 2008. On June 6th of that year, he took out a distribution of $65,064 from a second IRA, and four days later (on June 10th, still within the 60-day rollover period) used the funds to repay the first IRA. Then on July 31st of that year, he took out a third distribution of $65,064 from his wife's IRA, and four days later (on August 4th, again just barely within the 60-day rollover period) repaid his second IRA. Finally, on September 30th, he made a final deposit to repay the wife's IRA.

However, in the Bobrow scenario, there was a problem. September 30th was actually the 61st day after the distribution from his wife's IRA, such that the rollover was not actually completed in a timely manner. In addition, the deposit that occurred on September 30th was actually for only $40,000, not $65,064; as a result, the rollover for her IRA was also incomplete from a financial perspective. As a result of the 61-day time window (not to mention the incomplete dollar amount), the last IRA rollover was apparently reported as a taxable distribution, though Bobrow claimed that the final rollover had been requested in a timely manner (prior to September 30th) and for the correct dollar amount (though he could not produce any documentation to substantiate this). Along the way, this dispute drew the attention of the IRS, which both claimed that the wife's distribution should be/remain taxable (as it was not completed within 60 days), and further that Bobrow's multiple IRA rollovers should be collapsed into one transaction that began with the first April 12th distribution and ended with the "final" August 4th rollover (since Bobrow's second IRA was essentially involve in two rollovers, one to repay the first IRA, and the second to be repaid for its own, the IRS argued that it shouldn't even be treated as a second/separate IRA for the purposes of the existing rules). Notably, if the IRS prevailed on the second point, Bobrow's IRA rollover also would not have been completed in a timely 60-day manner (from April 12th to August 4th), and would become taxable just as his wife's (which was also not completed in its own 60-day rollover window). (It's not clear what the consequences would have been for attempting rollovers chained together between a husband and wife; since Bobrow's wife's IRA rollover was deemed invalid due to the 60-day rule itself, this issue was never directly considered by the Tax Court.)

Ultimately, though, the Tax Court surprised both Bobrow and the IRS. It not only ruled that the taxable distribution of the wife's IRA would stand (as the rollover was not done within 60 days, and Bobrow could not produce any documentation to substantiate that he had tried to complete the rollover in a timely manner), but it also interpreted IRC Section 408(d)(3)(B) to apply to all of an individual's IRAs at once. In other words, the Tax Court not only invalidated Bobrow's second IRA rollover because a rollover had already occurred with the first account; it even invalidated the IRS' own Publication 590 examples where multiple IRA rollovers occur using entirely separate accounts! In essence, just as IRC Section 408(d)(2) requires that all IRAs are aggregated together as one account for determining the tax consequences of an IRA distribution (e.g., in the case of a withdrawal or rollover where there are multiple accounts that have different levels of after-tax contributions), so too must all IRAs be aggregated for purposes of the once-per-year rollover rule!

IRA Rollover 1-Year Rule Going Forward

The net results of the Bobrow case is that any distribution from any IRA invalidates subsequent IRA rollovers within a 1-year period beginning on the date that the first distribution occurs from the first IRA! (Though, again, trustee-to-trustee transfers do not count for/against this rule, as the amounts are not actually received by the taxpayer and thus aren't treated as "distributions" in the first place.) Going forward, not even the multiple-IRAs-handled-separately approach are a valid way to chain together multiple IRA rollovers, despite the fact that they were described as a valid example in Publication 590! If an IRA rollover occurs from one IRA, the taxpayer cannot do another rollover from that IRA or a different one either! 

In fact, the IRS recently issued IRS Announcement 2014-15, which announced that the IRS will be acquiescing to the Bobrow decision, and will be withdrawing its Proposed Regulation 1.408-4(b)(4)(ii) example and updating Publication 590 accordingly. The IRS also declared that it plans to issue proposed Regulations to further permanently codify that in the future, the IRA rollover rule will be applied on an aggregate basis across all IRAs. However, the IRS acknowledged that because this has been a significant departure from the standard view on the IRC Section 408(d)(3)(B) rollover limitation - including the IRS' own position - that no new Regulations will take effect before January 1st of 2015, and in fact the IRS declared that it will not pursue the Bobrow interpretation for any rollover that involves an IRA distribution occurring before January 1st 2015. So for those who were in the midst of such "chain IRA rollovers" already, or planned to implement them later this year, the coast is clear for the rest of 2014 at least. (This time window also gives IRA custodians a chance to update their processes and procedures for handling and reporting on IRA rollovers to ensure compliance with the updated rule as well.)

The bottom line, though, is that advisors and their clients should be aware that, at least beginning next year, the IRA rollover rule - like so many other rules pertaining to IRAs - will now apply aggregated across all IRAs, which essentially means the 1-year rollover limitation is not just a per-IRA limitation but a per-taxpayer limitation (i.e., a taxpayer can only do one rollover across any/all of his/her IRAs in a year). Bear in mind, though, that for the IRA rollover rule, the 1-year window begins on the date that the distribution occurs, not merely on a calendar year basis. Thus, even IRA rollovers that occur this year - outside the Bobrow rule - may still impact subsequent IRA rollovers that occur in 2015 if they are within the 365-day window! Beware and plan accordingly!

2 Pingbacks/Trackbacks

Blog Updates by Email

Nerd’s Eye View Praise

@MichaelKitces Twitter

Out and About

Monday, December 8th, 2014

TBD @ Private Event

Tuesday, December 9th, 2014

Cutting Edge Tax Planning Developments & Opportunities Setting a Proper Asset Allocation Glidepath in Retirement Future of Financial Planning in the Digital Age @ FPA Central Pennsylvania

Thursday, December 11th, 2014

TBD @ NAPFA DC Study Group