Generally, any amount distributed from a traditional IRA is includable in the account owner’s gross income. Section 408(d)(3)(A) of the Internal Revenue Code (“IRC”) allows the account owner to exclude from gross income any amount distributed from the IRA if the entire amount is repaid into another qualifying IRA, retirement plan, or retirement annuity not later than 60 days after the account owner received the distribution. This type of tax-free transfer is commonly known as a rollover.
IRC section 408(d)(3)(B) permits an account owner to make one rollover per year from one traditional IRA account to another. Beginning in 2015, the way this rule is applied was changed. For 2014 and earlier, a rollover from an account owner’s first traditional IRA account to a second traditional IRA account did not prevent additional tax-free rollovers during the one year period as long as different IRA accounts were involved. In essence, the IRS applied the rule on an account-by-account basis.
However, in January of 2014, the US Tax Court in Bobrow v Commissioner interpreted § 408(d)(3)(B) to mean that the one per year limitation rule applied to all traditional IRAs owned by a particular taxpayer. In other words, additional rollovers are not allowed even if different accounts are involved both in the distribution and in the receipt of the IRA proceeds. In the Bobrow case, because the taxpayer broke this rule, the IRA distribution was included in the taxpayer’s gross income. In addition, some hefty penalties applied due to the taxpayer’s failure to report the income on his tax return.
In response to the Bobrow decision, the IRS announced that it will apply the Tax Court’s interpretation only to rollovers made on or after January 1, 2015. Only one 60 day rollover per year will be allowed within the one year period beginning on the date the taxpayer receives the IRA distribution.
Taxpayers can avoid the one per year rule by having the IRA proceeds transferred directly from one IRA trustee to another IRA trustee. In a “trustee-to-trustee transfer,” the distribution from the transferring IRA is deposited directly into the recipient IRA and does not pass through the hands or taxable accounts of the taxpayer. Such a transfer will not be included in the taxpayer’s gross income and more than one trustee-to-trustee transfer can be made from a taxpayer’s IRA account (or accounts) in any given year.
Sixty day rollovers can go wrong for many reasons other than the one per year rule. The 60 day deadline for depositing the IRA proceeds into the recipient IRA might be missed. The wrong asset might be rolled over. Generally, the same property that was distributed must be rolled over to the recipient account. If the account owner received cash then cash must be rolled over; if the account owner received property then the same property must be rolled over. The rollover may wind up in the wrong account – either through the mistake of the account owner or through the mistake of the IRA trustee. Unless corrective action is available and is timely taken, these errors will result in an unintended distribution, which will require reporting the distribution as gross income on the account owner’s income tax return.
In such cases, whether corrective action is possible depends on the circumstances and on whether the error is addressed in time. Although the IRS is authorized to grant waivers and relief under certain circumstances, there is often little consistency in its use of that authority. The sooner the taxpayer seeks competent professional advice, the better the chance that a “fix” will be possible.