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IRA rollover ruling stuns advisers and savers

Retirement experts call it a game changer for the 50 million or so households in the US that own an individual retirement account.

By Money Staff Apr 4, 2014 12:28PM

This post comes from Robert Powell at partner site MarketWatch.


MarketWatch on MSN Money

This column has been updated to clarify that the one-year period during which two or more IRA-to-IRA rollovers should be avoided starts when the IRA owner receives the distribution.


Uncle Sam's Tax Court just ruled that the one-rollover-per-year rule applies to all of a taxpayer's IRAs rather than to each IRA separately. And that ruling, experts say, is in direct conflict with IRS Publication 590, the bible for IRAs.


"Industry leaders, financial advisers, and everyone else who handles IRAs are stunned," said Denise Appleby, the editor and publisher of The IRA Authority.


Close-up of a Banking Services Pamphlet © Keith Brofsky, Photodisc, Getty ImagesAccording to Appleby, there are two ways to move money between IRAs:

  1. Transfers, which are not reported to the IRS and not reported on a tax return. The IRA owner never touches the money. You can do this as often as you like, whenever you like, Appleby said.
  2. And rollovers. With this method, the IRA owner takes the money as a distribution and they have 60-days to rollover (put back) the amount in an IRA. And this, you can do only once per 12-month period, said Appleby.

According to Appleby, the IRS, through their publications and regulations, has said for at least 20 years that the rollover method applies on a "per-IRA" basis. In other words, if you have 10 IRAs, you can do 10 rollovers for the year (12-month period), as long as an IRA does it only once (or the year). 


Here's the guidance found in Publication 590, which everyone viewed as gospel:

Generally, if you make a tax-free rollover of any part of a distribution from a traditional IRA, you cannot, within a one-year period, make a tax-free rollover of any later distribution from that same IRA. You also cannot make a tax-free rollover of any amount distributed, within the same one-year period, from the IRA into which you made the tax-free rollover.  The one-year period begins on the date you receive the IRA distribution, not on the date you roll it over into an IRA.

The IRS gives this example: You have two traditional IRAs, IRA-1 and IRA-2. You make a tax-free rollover of a distribution from IRA-1 into a new traditional IRA (IRA-3). You cannot, within 1 year of the distribution from IRA-1, make a tax-free rollover of any distribution from either IRA-1 or IRA-3 into another traditional IRA.


However, the rollover from IRA-1 into IRA-3 does not prevent you from making a tax-free rollover from IRA-2 into any other traditional IRA. This is because you have not, within the past year, rolled over, tax free, any distribution from IRA-2 or made a tax-free rollover into IRA-2.


Enter Alvan and Elisa Bobrow, who had a few IRAs.


In 2008, Alvan rolled over two distributions from his IRAs and took the position that the rollovers were valid because they were done in a timely manner, and involved different IRAs, Appleby wrote in her analysis of the court case. His position was that he had not broken any rules, as explained by the IRS in their publication for the past 20 years.


The IRS disagreed and determined that only one of the two rollovers was valid. So, Uncle Sam and the Bobrows went off to court. And the Tax Court — much to the surprise of all IRA experts — agreed with the IRS.


The mistake cost the Bobrows an additional $51,298 in income tax and a penalty of $10,260. Maybe they should be thankful; it could have cost them $31,000 more, according to Appleby. You can read the gory details in Bobrow v. Comm’r, T.C. Memo. 2014-21.


So what was the bottom line? In essence, only one of the Bobrow's distributions was eligible for rollover during the 12-month period. In fact, that Tax Court concluded that the Internal Revenue Code Section 408(d)(3)(B) limitation — the relevant section of the federal tax code — applies to all of a taxpayer's retirement accounts and that regardless of how many IRAs he or she maintains, a taxpayer may make only one nontaxable rollover contribution within each one-year period.


In other words, we've all been operating under the impression that what was written in Publication 590 — you know, the IRS’ very own publication — was correct. But it's not.


In fact, the Bobrow case highlights, according to Appleby, an important rule that we sometimes overlook: "If conflicting information is provided in multiple sources, one must consider the hierarchy and reliability of such sources. In this case, Publication 590 is not authoritative and is not considered official guidance. The Tax Code is the more authoritative, and supersedes any other guidance in the event of conflict."


So what now?

Well, according to Appleby, the IRS will be changing its publications, changing what they have been saying for 20-plus years. The IRS will implement this change for everyone -- everyone except the Bobrows who have to pay those penalties, starting Jan. 1, 2015.


You should plan ahead so that — starting in 2015 — you avoid making two or more IRA-to-IRA rollovers during a 12-month period. This 12-month (one-year) period is not determined on a calendar-year basis. Instead, it starts when the IRA owner receives the distribution, Appleby said.


And, check with your IRA custodian. According to Appleby, they need to change their IRA agreements, because those agreements say what the IRS has been saying for years — which means they are wrong.


And finally, Appleby said individuals should start moving money via transfers and not rollovers. "There are too many pitfalls with rollovers and none with transfers," she said.


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282Comments
Apr 4, 2014 1:36PM
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So I have another comment.  Let me understand this right.  The Government published and document that said it was legal and now admits they made a mistake.  Now they go after the people who followed their mistakes guidelines and they think that is OK.  Talk about not being accountable for your own actions.  WOW.
Apr 4, 2014 12:55PM
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Just one more sign of how desperate the Federal Government (via the IRS) is becoming to rake in new sources of revenue.  The Tax Court is no friend to the taxpayer 99% of the time.
Apr 4, 2014 1:33PM
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Just one more way for the government to steal your money.


Apr 4, 2014 2:19PM
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So, the tax codes are so convoluted and complicated that the IRS cannot even get it right, isn't it time to gat rid of the IRS and the current tax code for a Fair Tax


Apr 4, 2014 1:39PM
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If the IRS were a corporation it would be held responsible for its own published instructions--these would be considered part of an implied contract. But apparently the IRS thinks it is above contract obligations. It would be great if someone helped these people take this to the Supreme Court, because I doubt they would see it that way--the IRS way I mean. As it is now, the IRS can hit anyone even if they follow the IRS publications to the letter.
Apr 4, 2014 2:06PM
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Those of you who believe the gov doesn't have the power to confiscate your 401k or IRA, or the will to exercise that power, are naive....
Apr 4, 2014 1:44PM
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Those thiefs are at it again, it is time for us to fire every judge, congressman, senator, and abolish the thiefs at the irs,

we need to remove the communist that is occuping our whitehouse and begin with we the people enforcing our constitution, and ridding america of those that want to be greedy and not listen to their bosses which is us. the citizens.

Apr 4, 2014 1:46PM
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Just another way the government keeps you form moving your money to a more desirable place. I hope they appeal.
Apr 4, 2014 1:53PM
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Lets see and you were expecting something else like not getting screwed again by government?
Apr 4, 2014 1:13PM
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You can't trust the government, and the best thing we could do to the IRS is have Russia nuke them.
Apr 4, 2014 2:19PM
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GET RID OF THE IRS NOW. TEA PARTY. TAXED ENOUGH ALREADY!
Apr 4, 2014 2:08PM
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They have been doing this with student loans for years.  Only one consolidation allowed.  They are scum.
Apr 4, 2014 2:22PM
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I know it'd take a Constitutional Amendment, but the best thing would be to deport the entire IRS to Russia. No hardship for them--their prior job experience and attitudes would be highly desirable to the KGB.
Apr 4, 2014 12:59PM
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More Obama manipulation of capitalism to make it fall more in line with his socialist utopia.

 

He does not want you to have a diverse portfolio, so step one is to make you have only one IRA, instead of diversifying across several IRA's, because more than one is impossible to manage.  THis gets you used to having a single source of retirement. Eventually, he will become that single source of retirement.

Apr 4, 2014 1:28PM
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We are pretty much helpless now, these scumbags own it all on and off the floor.....Now forget about news, events, numbers, this is all market manipulation once again....Of course that good guys are not going to give up but, things looking bleak with a bit less than 3 hours to go....Crooks are destroying the Nasdaq why? Because they can...As simple as that....Like we warned earlier, tighten up those seat belts, will be a bumpy afternoon. Do not let small rallies fool you, they are selling on all rallies attempted we are falling triple digits today unless a miracle happens late afternoon.
Apr 4, 2014 2:08PM
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Obama befriended Mohamed Morsi and the Muslim Brotherhood. Now Obama has been caught sleeping with Al Qaeda. Scary times being a American with a total nut case for a president. As long as Obama and his administration are in power it is only going to get worse. Things are already bad in America and, to think it's going to get worse is very sad.
Apr 4, 2014 1:50PM
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At my place of employment I had our 401K provider add the option of a Roth 401K to our 401K program which completely avoids this problem.  If you don't have a Roth 401K then please ask your employer to add it as this should be quite easy.
Apr 4, 2014 1:11PM
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I personally keep my IRA separate from each job as they offer different investment options that allow me to have more options and a more diverse portfolio. Some Employer IRA's only offer only vanilla options while other give you many choices. This ruling should have little effect on most people as the majority of Americans dont change their jobs every year.
Apr 4, 2014 5:04PM
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. "A government big enough to give you everything you want, is a government big enough to take away everything that you have."   Thomas Jefferson.
Apr 4, 2014 2:48PM
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Do you really think something set up by the govt. is going to disagree with a govt. agency? Tax Court has always been rigged to favor the IRS.
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