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Proceed With Caution - New Rule on IRA Rollovers Tax

Due to a recent Tax Court case, Bobrow v. Commissioner, the IRS recently issued a notice stating that beginning January 1, 2015 each taxpayer will be limited to one 60-day IRA rollover per year on an aggregate basis.

The new rule will apply across all of a taxpayer’s Individual Retirement Accounts and Individual Retirement Annuities (IRAs) in aggregate while the old rule applied on an IRA by IRA basis. For example, using the old rules, a taxpayer could withdraw funds from IRA #1 and redeposit the funds into a qualifying IRA or retirement plan (IRA #2) within 60-days of the date of withdrawal without the money being taxed as income or incurring the 10% early withdrawal penalty.  The taxpayer could not do another rollover transaction using IRA #1 or IRA #2 during the 1-year period, defined as 365-days, starting on the date of the withdrawal. 

Under the old rules, the taxpayer could also rollover IRA #3 to IRA #4 within the 60-day limit which would start a new one-year period for those two IRAs. Taking the example further, the taxpayer could rollover IRA #5 to IRA #6 starting another one-year period for those IRAs. This series of transactions allowed taxpayers, including Mr. Bobrow, to use this taxpayer-friendly rule to gain access to the funds for longer than the 60-day period, in essence, using it as a short-term loan. This will no longer be allowed beginning January 1, 2015.

The IRS has since stated it will follow the Bobrow decision and issue new Proposed Regulations to apply the “one-year wait” period to all of a taxpayer’s IRAs in aggregate.  The new rule becomes effective on January 1, 2015 and only one rollover will be allowed per taxpayer in a one-year period beginning on the date of withdrawal from the IRA.  The IRS has also stated in the announcement that it will not apply the Bobrow interpretation to any rollover that involves IRA distribution occurring before 1/1/2015.

It is important to distinguish a rollover from a trustee to trustee transfer. A rollover involves taking the funds out of one IRA with the taxpayer taking possession of those funds then re-depositing the funds into another IRA.  The taxpayer must deposit the withdrawn funds in another IRA no later than the 60th day after the day on which the taxpayer receives the distribution.

In contrast, a trustee to trustee transfer is when the taxpayer instructs their IRA custodian, such as Fidelity Investments, to transfer their IRA to a different custodian, such as Charles Schwab. The taxpayer never has possession of the funds. The trustee to trustee transfer is not a taxable transaction and the one-year wait rule does not apply.

IRA transactions can be complicated and specific rules must be followed in order to avoid premature taxation and/or penalties. In some cases the penalties can be severe. Please contact us if before you initiate an IRA transaction.

About the author:  Joan Bucher Ellison is a staff accountant at Young, Craig & Co. and a Certified Financial Planner ™ professional  with a Master of Science in Taxation.

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