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New Once-Per-Year IRA Rollover Rule

In the aftermath of the recent tax court case, Bobrow v. Commissioner, the IRS announced it will adopt the taxcourt’s ruling and issue new Proposed Regulations that will definitively apply the 1-year IRA rollover rule on an IRA-aggregated basis going forward.

ira_rollover_05Under current ruling the Internal Revenue Code (IRC) permits an individual one rollover distribution from one IRA to another IRA within a one year period. Additionally, as provided in Proposed Treasury Regulation Section 1.408-4(b)(4)(ii), the IRS interpreted this statutory limitation as applying separately to each IRA. In other words, the IRS has taken the position over many years that an individual with multiple IRA accounts can apply the rollover rule to each IRA account without having to include the amount distributed to them within their gross income. For example, if you have four (4) IRAs, you can do four (4) rollovers for the year (1-year IRA rollover rule).

However, the U.S. Tax Court held otherwise and the IRS now intends to follow the Tax Court’s interpretation. As a result:

• Beginning January 1, 2015, you will have to include in gross income any amounts distributed from an IRA to be rolled over to another IRA, if you made an IRA-to-IRA rollover in the preceding 12 months, and

• Depending on your age and circumstances, you also may be subject to the 10% early withdrawal tax on the amount you have to include in gross income.

Please note that the above mentioned rules do not apply to transfers such as trustee to trustee transfers or “direct rollovers” wherein an IRA custodian sends the money directly to another IRA without the taxpayer taking possession. Caution is only necessary for those taxpayers considering taking a distribution then rolling those funds over to the same or another IRA within 60 days.

By: Katie Mokry, Accountant

IRA Rollover Rules

After retiring or leaving a job, one big question might be: What should you do with the money in qualified retirement plan accounts with your former employer? These accounts include 401(k)s, profit-sharing plans and stock bonus plans. The standard advice is to roll everything over into an IRA. That advice generally makes sense, because you can take over management of the funds while continuing to defer taxes on income generated. However, as the court case described in this article illustrates, the standard advice isn’t best in all situations.

Arrange for a “Direct” Rollover: If you decide to go this route, arrange for a “direct” or “trustee-to-trustee” rollover from the qualified retirement plan into your IRA. In other words, the check from the company plan should be made out to the trustee or custodian of your rollover IRA. You may be able to arrange for a wire transfer directly into the rollover IRA.

Key Point: While the IRA must be set up in advance to receive the upcoming rollover contribution, the account can be empty prior to the transaction.

Why is a direct rollover important? If you receive a retirement plan distribution check payable to you personally, 20 percent of the taxable amount of the distribution must be withheld for federal income taxes. You are left with a check for only 80 percent to deposit into the account, although you are responsible for depositing 100 percent.

You have 60 days to come up with the other 20 percent and deposit it into the IRA. Otherwise, you will owe income tax on that 20 percent, plus a 10 percent early withdrawal penalty tax generally applies if you are under age 55 when leaving your job.

Of course, if you fail to deposit the 20 percent, you will still be entitled to a federal income tax refund, because the withholding will exceed the actual tax (and 10 percent penalty if applicable) that you owe. However, you won’t get that refund until after filing a tax return for the year the withholding occurs. That could be many months later. Even worse, your rollover IRA balance will be 20 percent smaller, which means lost tax deferral benefits.

Note: The mandatory 20 percent federal income tax withholding rule doesn’t apply if you are rolling money from one IRA to another. It only applies to distributions from a qualified retirement plan, such as a 401(k) plan. However, you must always meet the 60-day rule, even for an IRA-to-IRA rollover.

Obey the 60-Day Rule: Another pitfall is failing to meet the 60-day rule. Specifically, you must deposit the retirement account distribution into an IRA within 60 days to achieve a tax-free rollover. The 60-day period starts on the day after the funds are received from the retirement plan and ends on the day you deposit them into an IRA.

Note: Unlike many IRS deadlines, you don’t get extra time if the end of the 60-day period occurs on a weekend or holiday.

In fact, the only instance when failing to meet the 60-day rule isn’t disastrous to your tax planning objectives is if the failure is due to “circumstances beyond your control.” Even in these cases, you have to prove to the IRS that you are blameless.