Wednesday, April 9, 2014

IRA Rollover Decision Stuns Advisors



There was a recent Court decision that stunned and upset a number of tax and financial advisors. It has to do with IRA rollovers.

We need to be clear, though, on the type of rollover that we are talking about. There are two ways to rollover an IRA:

(1)  You have the trustee presently handling your IRA transfer the funds to another trustee. This is done trustee-to-trustee, and you never see the money. Let’s call this “Type 1.”
(2)  You have the trustee presently handling your money send you a check. You then have 60 days to transfer it to another trustee. If you go past the 60 days – say 61 – you have income, and possibly penalties. Let’s call this “Type 2.”

We are talking today about Type 2.


The IRS Publication on this matter is Publication 590, and here is its explanation on rollovers from one IRA to another. For those playing the home game, the following is from page 21:

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.

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."

So the IRS is saying that the one-year rollover limitation applies on an IRA-per-IRA basis.

How did tax pros work with this? Let’s say that someone has $1.05 million in an IRA. You have him/her split this (likely trustee-to-trustee) into seven IRAs, each with $150,000. You then have him/her roll $150,000 from IRA-1. Sixty days later, he/she draws $150,000 from IRA-2 to repay IRA-1, thereby resetting the 60-day clock. When that expires, he/she borrows from IRA-3 to repay IRA-2. And so on.

I have seen this done. I have never liked it. However Publication 590 said you could, so it was considered tax legitimate.

Now we look at Bobrow v Commissioner.

Here is the setup:

·       Bobrow received a $65,064 distribution from an IRA on April 14, 2008
·       Bobrow received a $65,054 distribution from an IRA on June 10, 2008
·       Bobrow’s wife received a $65,054 distribution from her IRA on July 31, 2008

Once you know the technique, it is easy to see it in practice.

The IRS said that the Bobrows had income for 2008, and it wanted taxes of $51,298, as well as penalties of $10,260.

The IRS laid-in with Section 408(d)(3)(B)(the bolding is mine):
408(d)(3)(B) LIMITATION.— This paragraph does not apply to any amount described in subparagraph (A)(i) 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.

Did you notice the “an?” The Code does not refer to IRA-1 or IRA-2. Granted, the last sentence goes on to say “an” IRA not includible in gross income because of the application of this paragraph. I can see an interpretation limiting the rule to the IRA involved in the roll and not other IRAs the taxpayer may have. Apparently that was also the IRS’ reading in Publication 590.

The Tax Court said no. Its reading was one roll per year – that’s it, period. It does not matter how many IRAs the taxpayer has. The limit applies on a per-taxpayer and not a per-IRA basis. The Court held for the IRS, even for the penalties.

Now think about this for a second.

The Code outranks any IRS Publication in the hierarchy of tax authority. It has to, obviously. If an IRS publication misinterprets the Code, it is the Publication that has to step aside. It is unfortunate for those who relied on the Publication, but I understand the tax side of this.

But I do not understand the penalties. The IRS could have granted reasonable cause to the Bobrows and abated the penalties. Bobrow would present a good reason for his tax position in order to obtain abatement. Here is a good reason: relying on IRS Publication 590. The IRS nonetheless assessed penalties, and the Tax Court sustained the IRS.

And that to me is abusive tax practice. Good grief, this is like a game of three-card monte.


The decision surprised many advisors. It has certainly done away with serial Type-2 IRA rollovers. The IRS and the Tax Court have ended the technique of using multiple IRAs as bridge loan money. 

My advice? Make your rollovers trustee-to-trustee and this issue will not affect you.

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