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Tax Court changes rules for IRA rollovers

By From page B8 | April 13, 2014

It seems that the tax law concerning IRAs just changed, not by an act of Congress but by an unexpected Tax Court ruling. The decision states that a taxpayer can perform only one tax-free “rollover” of an individual retirement account each year, regardless of how many IRAs they may have.

In an IRA rollover, the investor gets a check for their funds paid directly to them. They then have 60 days to deposit that money into a new IRA account to avoid any penalties. Any cash not rolled over in time, however, is marked as taxable income by the IRS and can be subject to an additional 10 percent tax if you’re younger than 59½.

The best example is when someone takes an IRA from a bank CD as a check and walks it across the street to deposit at another bank because the interest rate is higher. People who have CDs at banks tend to buy a lot of CDs and could have multiple bank IRAs.

By contrast, a direct transfer of IRA funds from one provider to another doesn’t allow you to touch a penny of the funds. It is done between the IRA trustees/custodians, and can be done as frequently as you want without penalty.

The Tax Court decision essentially says that you have only one IRA in the aggregate even though you may have many accounts or specific investments. The consequence is that you may only do one rollover per 12 months from any IRA account. This won’t preclude seeking higher interest rates, but the administrative part will be more rigid.

Some commentators believe that the Tax Court ruling was not so much about IRA transfers but the practice of tapping into IRA money under the guise of a rollover and then having 60 days to play with it tax-free. Apparently the IRS was displeased that some people were withdrawing money from IRAs under the guise of a rollover and then having a “tax-free loan” for 60 days.

The central point is that you never have been allowed to borrow from an IRA. That is not what they are for. The sole intent is to put money away until you’re more than 59½ years old.

A related issue is that for estate planning, multiple IRA accounts have value as separate accounts if you want to designate different beneficiaries or if you make a mistake, it taints only one account and not the rest. Splitting up the money can make sense in these cases. It’s like a crab that loses its leg but doesn’t lose the whole body.

Up to now, taxpayers have relied on the plain-language publication from the IRS that says each IRA account can do a rollover once a year. The court decision is contrary to existing IRS guidelines, demonstrating that the legal basis is fundamental. IRS guidelines and private letter rulings are not binding on everyone. The statutes and case law are the controlling law and should be followed.

The problem is that no normal people want to read the law; they want to rely on the plain-language version from the IRS. Unfortunately, relying on common-language publications from the IRS to guide your tax strategies will not be a defense in court because ignorance of the law is not a defense.

So the taxpayer on the wrong end of this decision claimed they followed the rules as set forth in the IRS publication. The IRS position, supported by the court, states they owe taxes, early withdrawal penalties, late penalties and interest for incorrect filing. This is a whopping large amount.

The unsettling part of this whole story is that apparently we cannot even rely on government publications for direction. Should this taxpayer suffer when the IRS reverses its position or has misleading publications?

Mark Sievers, president of Epsilon Financial Group, is a certified financial planner with a master’s in business administration from the University of California, Berkeley. Contact him at [email protected]

Mark Sievers


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