Formation, operational and administrative aspects of an Individual Retirement Account (IRA)

The formation, operational and administrative aspects of an Individual Retirement Account (“IRA”) published in Section 408 of the Internal Revenue Code of 1986. Under the general rule, any distribution from an IRA to the IRA owner will be subject to income tax in the year received.

However, Section 408(d)(3)(A)(i) generally provides that any amount distributed from an IRA will not include the gross income of the IRA owner. To the extent, the amount received by the IRA owner is subsequently paid into an IRA for the benefit of that IRA owner no later than 60 days after the IRA owner received the distribution. This series of transactions involving first the distribution of cash, for example, from an IRA to the owner of that IRA with that IRA owner then contributing that cash into another one of such owner’s IRAs within the 60 day period is often referred to as a “rollover” or “rollover contribution.”

These rollovers often occur when the IRA owner wants to establish an IRA with a different custodian. Section 408(d)(3)(B) provides that an individual is permitted to make only one rollover described in the preceding sentence in any 1-year period. Before the Tax Court case discussed below, it appeared from some IRS guidance that this “1-year” rule applied to each separate IRA of someone who owned two or more IRAs but not on an “aggregate” basis.

For example, current Proposed Regulations under Section 408[1] and IRS Publication 590, Individual Retirement Arrangements (IRAs), provide that this limitation is applied on an IRA-by-IRA basis. Publication 590 provides the following example:

You have two traditional IRAs, IRA-1 and IRA-2. You make a tax-free rollover of the distribution from IRA-1 into a new traditional IRA (IRA-3). You cannot, within one 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.

Thus, under the above scenario (and supposedly IRS guidance), a rollover from one IRA to another would not affect a rollover involving other IRAs of the same individual.

However, a recent Tax Court opinion, Bobrow v. Comm’r, T.C. Memo. 2014-21 held that the limitation applies on an aggregate basis. This means that an individual cannot make an IRA-to-IRA rollover if he or she had made such a rollover involving any of the individual’s IRAs in the preceding 1-year period.

This Tax Court decision results in the following:

• The IRA owner must include in gross income any previously untaxed amounts distributed from an IRA if that IRA owner had made an IRA-to-IRA rollover in the preceding 12 months; and
• The IRA owner may be subject to the 10% early withdrawal tax on the amount included in gross income.
• Additionally, if the IRA owner pays these amounts withdrawn from one IRA into another (or even the same) IRA, they may be:
• Excess contributions, and
• Taxed at 6% per year as long as they remain in the IRA.

Part II of this article will describe the response and new guidance from the IRS regarding rollovers and the “1-year” rule.

[1] Prop. Reg. Sec. 1.408-4(b)(4)(ii)