A U.S. Tax Court judge, at the urging of the government, has penalized an IRA rollover move—by a prominent tax lawyer, no less--that the Internal Revenue Service has allowed for decades and describes in its official Publication 590, Individual Retirement Arrangements (IRAs).
The decision, involving Alvan L. Bobrow, a leader of Mayer Brown’s tax practice and former General Tax Counsel for
Even if the judge does reconsider, however, ordinary taxpayers can learn some valuable lessons from this out-of-the-ordinary case. (More on those later.)
At issue is a provision of the tax code---408(d)(3)-- that allows IRA owners to withdraw funds from an IRA without having the money taxed or subjected to the 10% early withdrawal penalty so long as they redeposit the cash, or roll it over to a different IRA, within 60 days after the date of withdrawal. When it was first adopted in 1974, taxpayers had to wait three years after pulling off this maneuver to do it again. In 1978, Congress shortened that waiting period to one year.
In proposed (but never finalized) regulations issued in 1981 and in editions of Publication 590 since 1984, the IRS has instructed taxpayers that the one year restriction applies separately to each IRA, the friend of the court brief from the tax lawyer's group says. (According to the IRS pub, if you take money from IRA-1, and move it into a new IRA-3, the one year wait applies from the date of withdrawal to both IRA-1 and IRA-3. But it won’t apply to IRA-2, which wasn’t involved in that first rollover.)
On April 14, 2008, Bobrow took $65,064 out of one of his IRAs at
In a decision handed down in January, Tax Court Judge Joseph W. Nega ruled that Alva Bobrow’s June 6th withdrawal from his second IRA could not qualify for rollover treatment because the “plain language” of the law makes it clear that the once a-year rollover restriction applies to all of a taxpayer’s IRAs combined. (The American College of Tax Counsel brief says the law is “at least ambiguous” as to whether the one per year rule applies on a per taxpayer, or per IRA basis.)
The IRS doesn’t dispute that both Publication 590 and the 1981 proposed regulations apply the one year wait rule separately on an IRA by IRA basis and that this has been the common understanding of IRA custodians. In fact, last week, it acknowledged as much---it issued a notice stating that it intends to adopt the Bobrow decision and limit 60-day rollovers to one per taxpayer a year, but only beginning on January 1, 2015, to give IRA custodians time to change their materials. (Presumably, the IRS will also use that time to rewrite Pub. 590.)
Oddly, in disallowing one of Bobrow's rollovers, the government originally matched his second June 6 withdrawal with his first June 10 repayment, and concluded that the second, but not the first withdrawal qualified for rollover treatment. Later, however, in a reply brief in the Tax Court case, the government's lawyers came up with two earlier Tax Court decisions from 1992 and 1993 that they said stood for the proposition that rollovers are limited to one per taxpayer a year and argued that Alvan Bobrow's second rollover, but not his first, should be disallowed.
Bobrow didn’t return calls and an email asking for comment. But it apparently didn’t help Nega’s opinion of his case that on his self-prepared tax returns he treated the July 31 $65,064 withdrawal from Elisa’s IRA as a rollover too. It appears that only $40,000 was redeposited into her IRA and not until September 30, 2008, which was the 61st day after the day of withdrawal, a one day miss. (Lesson #1: August has 31 days; consult your calendar when doing a rollover.)
The Bobrows argued they had told Fidelity to move the full amount from their checking account into Elisa’s IRA before September 30. But in his opinion, Nega wrote that the couple hadn’t “provided any supporting documentation to evidence that the delay in repayment was due to Fidelity’s error.” The judge held that the entire $65,064 taken from Elisa’s account was a taxable distribution and subject to a 10% early distribution penalty, since she wasn’t yet 59 ½ when the money was withdrawn.
Moreover, Nega sustained a 20% substantial underpayment penalty against the couple on the extra $51,298 that they owed as a result of the two disallowed rollovers, finding that the Bobrows hadn’t met either of the two reasons a taxpayer can escape such a penalty: that they had “substantial authority” for treating the rollovers the way they did or that they disclosed the relevant facts on their return and had a “reasonable basis” for treating the item the way they did. Bobrow apparently didn’t cite either the IRS Publication 590 or the proposed regulations in arguing his case, although IRA expert Bruce D. Steiner, a partner at Kleinberg, Kaplan, Wolff & Cohen in New York,says that might not have made a difference since both the IRS manual for auditors and a U.S. Tax Court decision hold that taxpayers can’t rely on those sources to sustain their positions. (Lesson #2: Incredibly, an ordinary taxpayer can’t use the IRS’ own publication to win a fight with an IRS auditor according to the manual used to train those auditors. )
Bobrow also appears to have teed off the judge, Steiner observes, by arguing that he had reasonable cause for treating the rollovers as tax exempt because he was a tax lawyer who 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.” Wrote Nega: “It appears that petitioners would have us conclude that petitioner husband’s career as a tax attorney is proof that they acted with reasonable cause and in good faith.” (Lesson #3: A Tax Court judge will, if anything, hold you to a higher standard if you are a CPA, tax lawyer, or otherwise should be familiar with the tax code.)
Significantly, according to Nega’s opinion, the Bobrows “did not disclose in their return relevant facts concerning the distributions” and so couldn’t escape penalties with merely a “reasonable” basis for their position, anyway. All of which suggests some additional lessons.
#4: Whenever possible, move IRA money only in a trustee to trustee transfer—say, having
#5: Don't do more than one 60-day rollover a year after January 1, 2015, even if the transactions involve different IRAs. Right or wrong, the IRS has now staked out a new one-taxpayer-per-year position.
#6: If you receive a distribution from an IRA or 401(k)—even one that qualifies for a rollover and isn’t taxable---be sure to fill out lines 15A and 15B on your 1040 reporting the distribution and the taxable part, since these distributions are reported by the custodian to the IRS on a 1099R and will be computer matched by the IRS.
#7: If you take a distribution before age 59 ½, even one you believe meets one of the exceptions to the 10% penalty for early withdrawals, attach Form 5329 Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. You plug in a code on that form to explain why it wasn’t subject to the 10% penalty—say, 08, for IRA distributions made for higher education expenses. The form is required and full disclosure helps protect you against penalties.
#8: If you're using a rollover to borrow from your IRA, don't expect the IRS to like it. As tax lawyer Ed Morrow observed in a Wealth Strategies Journal analysis of the case here: "Some of the harsh treatment of the Bobrows undoubtedly occurred due to the abusive tint of the transactions - these were not rollovers to facilitate transition to another IRA provider or a different plan after retirement - they appear to be back door attempts at getting short-term, interest-free loans."
#9: Whenever you do a 60 day rollover, track it diligently and keep copies of any instructions to your IRA trustee, in case something goes wrong, advises Morrow.
#10: If you miss the 60 day deadline and enough money is at stake, consult a tax lawyer or CPA who is knowledgeable about IRAs; it might make sense to apply for a private letter ruling from the IRS allowing you a dispensation from the 60 day rule, says Steiner. Sure a tax pro is expensive. But the potential tax and penalty on a botched rollover can add up to way more.
