New IRA Rollover Interpretation Has Implications For Banks

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In a new interpretation with implications for banks, the Internal Revenue Service (IRS) announced its intent to change course and limit rollovers from an Individual Retirement Account (IRA) to one rollover per year per person, as an aggregate limit.

Section 408(d) of the Internal Revenue Code requires that most distributions from individual retirement accounts be subject to taxation in the year of the distribution. Section 408(d)(3) creates an exception for rollovers made within 60 days after the distribution. But Section 408(d)(3)(B) provides that the rollover exception “. . . does not apply to any amount described in subparagraph (A)(i) received by an individual from an individual retirement account or individual retirement annuity if at any time during the 1-year period ending on the day of such receipt such individual received any other amount described in that subparagraph from an individual retirement account or an individual retirement annuity which was not includible in his gross income because of the application of this paragraph.” In other words, if the individual has rolled over another IRA distribution within the preceding year, then he or she cannot use the rollover exception and will therefore be taxed on the distribution.

Previously the relevant Treasury Regulation had taken the view that the statutory language would be applied on an IRA-by-IRA basis. This permitted multiple rollovers in a specific 12-month period as long as only one rollover was made from any particular IRA. An individual with, say, four IRAs was permitted to roll each into a new IRA over the course of the year, for example.

But in January the U.S. Tax Court took a stricter view of the statute in the case of A.L. Bobrow v. Commissioner, T.C. Memo. 2014-21, limiting the individual in that case to a single rollover per year. The Bobrow case involved a man who made multiple IRA-to-IRA rollovers in a single year. Although he argued his actions were permissible, the Tax Court disagreed.

“The plain language of Section 408(d)(3)(B) is not specific to any single IRA maintained by an individual but instead applies to all IRAs maintained by a taxpayer,” the Court said, and the statute speaks in general terms about “an” IRA. “Had Congress intended to allow individuals to take nontaxable distributions from multiple IRAs per year, we believe Section 408(d)(3)(B) would have been worded differently.”

Now the IRS has informed taxpayers in Announcement 2014-15 that it intends to follow the Tax Court’s interpretation.

“The IRS anticipates that it will follow the interpretation of Section 408(d)(3)(B) in Bobrow,” the agency said. A proposed regulation adopting the IRA-by-IRA position will be withdrawn, and the portion of Publication 590 that explains this subject will be rewritten, the IRS said, to reflect the aggregate application of the rule.

Recognizing the administrative challenges facing IRA trustees to accommodate the changes (like updating disclosure documents and rollover processing requirements), the IRS said it will not apply the Bobrow interpretation to distributions that occur before January 1, 2015.

To read the IRS announcement, click here.

To read the U.S. Tax Court decision in A.L. Bobrow v. Commissioner, click here.

Why it matters: For banks, the new interpretation of Section 408(d)(3)(B) places an additional administrative burden to confirm with customers that no other rollovers occurred during the preceding 12-month period in order to report correctly the taxability of funds. Updates to the relevant forms and training for bank employees interfacing with customers are also necessary to be in compliance with the January 1, 2015, effective date. It is important, as well, to distinguish between rollovers and direct transfers of IRA funds between the trustees and custodians. It remains the case that trustee-to-trustee transfers can be made without any limit and avoid taxation every time. Only a true rollover – where the individual receives the distribution and deposits it to the new IRA within 60 days – is subject to the one-per-year limit.

Banks should not adopt a wait-and-see approach pending a possible reversal of Bobrow on appeal, as the IRS stated in its announcement that “[r]egardless of the ultimate resolution of the Bobrow case, the Treasury Department and the IRS expect to issue a proposed regulation under Section 408 that would provide that the IRA rollover limitation applies on an aggregate basis.”

 

Topics:  Aggregation Rules, Banks, Income Taxes, IRA, IRA Rollovers, IRS

Published In: Finance & Banking Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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