A Major Change in the Rules of IRA Rollovers

With a recent ruling by the United States Tax Court (the Court), there is now a big change in the rules of nontaxable IRA rollovers. In the case of Bobrow v. Commissioner of Internal Revenue, the Court ruled that the one nontaxable rollover per-year (365-day period) does not apply to each IRA separately, but that it applies to all of a taxpayer’s IRAs.

In the world of IRAs, this is a game changer that nobody saw coming. Advisors have always used IRS Publication 590 to guide them on how to handle IRAs, and the ruling made by the Court conflicts with that publication. Historically, the rule has been on a per-IRA basis, meaning that if a taxpayer had more than one IRA, they could do a nontaxable rollover for each IRA for the year. The IRS even gives the following example in Publication 590.

“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 last year, rolled over, tax free, any distribution from IRA-2 or made a tax-free rollover into IRA-2.”

However, this no longer applies. In its ruling the Court stated, “Regardless of how many IRAs he or she maintains, a taxpayer may make only one nontaxable rollover contribution within each one-year period.” The Court refers to Internal Revenue Code 408(d)(3)(B) which takes precedence over the IRS Publication 590. The ruling states, “The plain language of section 408(d)(3)(B) limits the frequency with which a taxpayer may elect to make a nontaxable rollover contribution. By its terms, the one-year limitation laid out in 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.”

So what now? The IRS has acknowledged that it will take time to implement this change and does not plan to apply the decision made in Bobrow v. Commissioner of Internal Revenue to any IRA rollover prior to January 1, 2015. While taxpayers have a bit of time until the IRS applies these changes, it is a good idea to start planning now. Instead of rollovers, taxpayers may want to consider moving money by way of direct transfers, which avoid the one rollover per-year rule.

If you have any questions about how the Court’s ruling will change your current rollover plans or would like to work on developing a new strategy for handling your IRAs, feel free to contact me at (805) 963-7811 or rmaloy@bpw.com.