November 2014

Additional IRS Guidance on the Once Per year Rollover Rule and the IRS Can't Be Serious About IRA Transfers

The author of this article is an old tennis nut. John McEnroe’s 1981 tennis exclamation of the 1980’s that “you can not be serious” fits many situations.

The IRS has recently issued additional tax guidance on the once per year rollover rule which goes into effect on January 1, 2015. IRS NewsWire 2014-107 and Announcement 2014-32. This is the third or fourth time the IRS has issued guidance since the tax court’s decision (Bobrow) in January of 2014. The court ruled that a person is allowed to make only one distribution/rollover in a one-year period regardless of how many different IRA plan agreements a person has.

The initial IRS guidance maybe was not as comprehensive or clear as it should have been. One would hope the IRS wants to provide comprehensive guidance on tax subjects so that everyone involved can perform their tax duties.

The most recent guidance makes clear that a person who rolls funds from one Roth IRA to another Roth IRA is ineligible to rollover funds from his or her traditional IRA to another traditional IRA during the one-year period commencing on the withdrawal of the Roth IRA funds. And that any subsequent distributions by this person within the one-year time period from any or his or her IRAs will be ineligible to be rolled over tax free.

The IRS has still not yet commented (furnished guidance) whether an IRA trustee must or should inform existing IRA owners of this change in the once per year rollover year. An existing IRA regulation does require an amended disclosure statement be furnished, but the IRS has not explained why this regulation does not apply if they believe that such an amendment is not required.

The IRS portrays itself as being taxpayer friendly. If the IRS was so friendly, the IRS did not need to agree so quickly to follow the tax court decision. One tax court decision need not be the final decision. The IRS could have appealed the tax court’s decision or asked Congress to change the law to expressly authorize the continuance of the old rule allowing rollovers on a per plan agreement basis. One would think this would be a bipartisan topic.

The IRS is in the business of maximizing the tax revenues of the federal government. Limiting the number of rollovers a person is eligible to make will in some cases lead to more individuals having to pay incomes taxes they otherwise would not have had to pay or at least not as soon. Unlike with pension plans, the law and the IRS has not adopted any procedures allowing IRA mistakes to be corrected. The IRS likes IRA mistakes in the sense that additional taxes in many cases will be owed and paid. However, this conflicts with the fact that the more a person pays in taxes on account of his or her IRA mistakes means less funds for retirement. In some cases, the IRS doesn't’t care and the IRS wants to maximize its collection of tax dollars.

The IRS states in its guidance that it encourages IRA trustees to offer to its IRA owners a transfer distribution of funds rather than a distribution followed by a rollover contribution. A transfer is not subject to the once per year rule as there is no actual taxable distribution. Allowing transfers will lessen the impact of the new once per year rollover rule. The IRS understands that IRA trustees are not required by the tax laws to participate in a transfer. The two involved IRA plan agreements must authorize the transfer.

The IRS states, “IRA trustees can accomplish a trustee to trustee transfer by transferring amounts directly from one IRA to another or by providing the IRA owner with a check made payable to the receiving IRA trustee.”

The IRS does not give a comprehensive discussion (or any examples) on what it means by making “the check payable to the receiving IRA trustee.” Admittedly, the IRS is trying to give a keep it as simple as possible explanation. But sometimes an approach can be too simple and tax problems are sure to arise.

With the many law changes impacting transfers, some transfers are reportable and some are not. Reportable means one of the IRA trustees must report the transfer distribution on a Form 1099-R and the one of the trustees must report the contribution on the Form 5498 either as rollover, conversion, recharacterization or a qualified HSA funding distribution. In this rollover guidance the IRS offers no guidance as to how reportable transfers are to be handled by the two IRA trustees or by the IRA trustee and the HSA trustee.

Furnishing an IRA trustee or an HSA trustee with only a check will not assure the proper tax administration. In order to assure the correct administration of the transferred IRA funds, the receiving IRA trustee will in some cases need to be furnished certain historical information from the transmitting institution. The IRS does not discuss this topic in any detail. It appears the IRS may be allowing the individual to furnish this information and not require that the remitting institution furnish it. This is shortsighted and it is why this situation is a “you can’t be serious” situation. The IRS should furnish additional guidance.

The IRS seems to authorize the check may be made payable to “ABC Bank” and does not require additional information such as “ABC Bank as Roth IRA trustee fbo Jane Doe” or “ABC Bank as the inherited traditional IRA trustee fbo John Smith abo Mary Smith’s IRA” or “ABC Bank as the HSA trustee fbo of Maria Bell.”

Current IRS procedures provide that an IRA trustee is not to report a “non reportable” transfer on either the Form 1099-R or the Form 5498. CWF has received quite a few consulting calls indicating that some brokerage firms (some large ones) prepare the Form 1099-R for all transfers. This makes their life easier, but complicates the life of every departing IRA owner since he/she must explain on his/her tax return why the amount on the Form 1099-R is not taxable. The IRS apparently does not fine an IRA trustee which prepares a Form 1099-R not required to be prepared. The IRS needs to start imposing fines on such IRA trustees.

As a reminder there are certain distributions which are ignored for purposes of applying the once per year rule. Making a Roth IRA conversion contribution is not counted as a distribution/rollover. Making an HSA Funding distribution is not counted as a distribution/rollover. However, moving funds from an IRA to a 401(k) does count as a distribution/rollover.

Set forth are various examples illustrating why furnishing just a check will not allow for the proper tax administration. Hopefully, the IRS will again furnish additional guidance.

1. Jane Doe instructs First Bank that she wishes to transfer $30,000 of her traditional IRA funds to Second Bank. She does not make clear into what type of account the $30,000 is to be reinvested. The check is made payable to Second Bank. No additional information is provided. Jane could instruct Second Bank that she wants the funds to go into a Roth IRA. She should include the $30,000 in her income. However, if both banks treat this transaction as a non-reportable transfer, the IRS will have no way short of a full audit to determine if Jane reports the transaction properly on her federal income tax return. She might escape including the $30,000 in her income. Presumably, the two IRA trustees could be fined for not preparing the Form 1099-R and the Form 5498 as is required when there is a Roth IRA conversion. Funds moving from a traditional IRA to a Roth IRA via transfer or rollover is a reportable transaction.
2. John Hall instructs First Bank that he wishes to transfer $7,550 of his traditional IRA funds to Second Bank. He does not make clear into what type of account the $7,550 is to be reinvested. The check is made payable to Second Bank. No additional information is provided. John could instruct Second Bank that he wants the funds to go into his HSA. He would exclude the $7,550 from his income. However, if both banks treat this transaction as a non-reportable transfer, there will be noncompliance with the IRS reporting rules applying to an HSA Funding Distribution/Contribution
3. Mary Long instructs First Bank that she wishes to transfer $45,000 of her inherited traditional IRA funds to Second Bank. Her mom had designated Mary as the beneficiary of her IRA. Mary does not make clear into what type of account the $45,000 is to be reinvested. The check is made payable to Second Bank. No additional information is provided. Mary could instruct Second Bank that she wants the funds to go into her own personal traditional IRA. The mistake could be intentional or unintentional. This means she no longer would have to comply with the required distributions rules. She would not be required to take an RMD until she would attain age 70½. If both banks treat this transaction as a non-reportable transfer, the IRS will have no way short of a full audit to determine that Jane made a non qualifying transfer.
4. One last example. Jane withdrew $30,000 from IRA#1 on June 10, 2014 and she rolled it into IRA #4. She will be eligible to take a distribution from IRA #4 and roll it over only if she does so on or after June 10, 2015,and she has taken no other distribution from any of her other IRAs on or after January 1, 2015 which she rolled over. In conclusion, although the IRS states in recent guidance that all that is needed to transfer IRA funds is to issue a check to the other IRA trustee, CWF suggests that IRA transfer forms, IRA conversion forms and the form for an individual to certify the making a qualified HSA funding distribution still be used. The goal is to limit the mistakes made by individuals and IRA trustees.