I am not a
fan of the 60-day IRA rollover.
I admit that
my response is colored by being the tax guy cleaning-up when something goes awry.
Unless the administrator just refuses a trustee-to-trustee rollover, I am hard
pressed to come up with a persuasive reason why someone should receive a check during
a rollover.
Let’s go
over a case. I want you to guess whether the rollover did or did not work.
Taxpayer’s
mom died in 2008.
Mom had two
IRAs. She left them to her daughter, who received two checks: one for $2,828 and
a second for $35,358.
The daughter
rolled over $35,358 and kept the smaller check.
On her tax
return, she reported gross IRA distributions of $38,194 (there is a small difference;
I do not know why) and taxable distributions of $2,828.
She did not
have an early distribution penalty, as that penalty does not apply to inherited
accounts.
The IRS
flagged her, saying that the full $38,194 was taxable.
What do you
think?
Let’s go
over it.
There is no question
she was well within the 60-day period.
The money
went into an IRA account. This is not a case where monies erroneously went into
something other than an IRA.
This was the
daughter’s only rollover, so we are not triggering the rule where one can only
roll IRA monies in this manner once every twelve months.
The Court
decided that the daughter was taxable on the full amount.
Why?
She ran
face-first into a sub-rule: one cannot rollover an inherited account, with the
exception of a surviving spouse.
The daughter
argued that she intended to roll and also substantially complied with the rollover
rules.
Here is the Tax
Court:
The Code’s lines are arbitrary. Congress has concluded that some lines of this kind are appropriate. The judiciary is not authorized to redraw the boundaries.”
This is a polite
way of saying that tax rules sometimes make no sense. They just are. The Tax
Court, not being a court of equity, cannot decide a case just because a result might
be viewed as unfair.
The Court
did not address the point, but there is one more issue at play here.
There are
penalties for overfunding an IRA.
Say that you
can put away $6,500. You instead put away $10,000. You have overfunded by
$3,500.
So what?
You have to
get the excess money out of there, that’s what.
Normally I recommend
that the $3,500 be moved as a contribution to the following year, nixing the
penalty issue.
Let’s say that
you do not do that. In fact, you do not even know to do that.
For whatever
reason, the IRS examines your return five years later. Say they catch the issue.
You now owe a 6% penalty on the overfunding.
That’s not
bad, you think. You will pay $210 and move on.
Nope.
It is 6% a
year.
And you
still have to get the $3,500 out.
Except it is
now not $3,500. It is $3,500 plus any earnings thereon for five years.
Say that amount
is $5,500, including earnings.
You take out
$5,500.
You have
five years of 6% penalties. You also have tax on $2,000 (that is, $5,500 minus
$3,500).
If you are
under 59 ½ you probably have an early-distribution penalty on the $2,000.
Plus
penalties and interest on top of that.
I like to
think that the Tax Court cut the taxpayer a break by not spotlighting the
overfunding penalty issue.
Our case
this time was Beech v Commissioner.
