No Relief on This IRA Rollover Mistake

IRS DENIES Once-per-Year Rollover Relief
PLRs 200749016 and 200749018
Issued December 7, 2007

In these two IRS Private Letter Rulings (PLRs) the taxpayer, an IRA owner who we’ll call “Betty”, requested that the 60-day rollover rule be waived due to a company error. When funds are withdrawn from an IRA where the intention is to transfer those funds to another IRA, that transfer (the rollover) must be completed within 60 days from the day the funds were received by the IRA owner. IRS has the authority to waive the 60 days when it can be shown that there was a true intent to do a rollover but the rollover was not completed for a reason beyond the IRA owner’s control, such as an advisor or financial institution mistake, or a medical condition, or some other similar situation. IRS has granted relief to taxpayers in hundreds of PLRs.

Betty had an IRA invested in an annuity with a long surrender charge period. She and her current advisor had been discussing what Betty should do with this IRA annuity for several years. They were waiting for the surrender period to end before moving the funds.

In December Betty was able to take a portion of the annuity with no charge which she did with the help of a client service person in her advisor’s office. She requested and received a check that was payable to her. She then wrote her own check to her advisor’s company with the intention that these funds be transferred to an IRA. The client service person had no instructions to put the funds into an IRA. The advisor had an existing non-IRA account for Betty which is where Betty’s IRA funds were deposited.

This scenario was repeated four months later, in April, when the balance of the IRA annuity could be distributed with no surrender charge. Betty received a check and sent the advisor her check which was also added to her non-IRA account. The problem was not discovered until Betty received a friendly reminder from IRS about her non-payment of taxes on the first distribution.

At this point, Betty was long past the 60-day rollover period. She only had two choices. She could either pay all the taxes due on the total distribution of her IRA which would leave her with no IRA or she could go to IRS, pay the IRS fee and a preparer’s fee, and request a 60-day rollover PLR. Betty opted to go for the PLR for both of her rollovers.

No Relief on Additional Rollover

IRS granted a waiver for the first distribution, but rejected the request for the waiver on the second distribution. Why? Because you can only do one rollover per year (365 days), per IRA. Betty could rollover the December distribution, but having done that she was not eligible to do any further rollovers from that account until a year had passed from the date she received the December distribution. This made the April distribution ineligible for a rollover, even if it went to an IRA. While IRS has the authority to waive the 60-day rollover rule, they do not have the authority to waive the “once-per-year” rollover rule. When that rule is violated, there is no relief and the entire extra rollover amount is taxable and subject to the 10% early withdrawal penalty for those IRA owners under age 59½.

60-Day Rollover vs. Trustee-to-Trustee (Direct) Transfer

To avoid these types of problems, advisors should encourage clients not to do rollovers. Funds should be transferred by doing trustee-to-trustee transfers (also called “direct rollovers” or “direct transfers”) without anyone touching the money in between. (A check made payable to the new custodian but received by the client is a direct transfer, not a
rollover.) The funds go directly from one IRA custodian to another. If a transfer is made from one IRA to another via a trustee-to-trustee transfer, and the IRA owner is subject to required distributions, the required distribution does not have to be withdrawn from the amount transferred. This is yet another reason to use the trustee-to-trustee transfer as opposed to a rollover where you receive a check and redeposit those funds into an IRA within 60 days.

Once funds are made payable to an IRA owner or plan participant, then that is considered a rollover (a 60-day rollover as opposed to a direct rollover) since the person can cash that check and use the funds.

If the transfer is done as a direct rollover, then there can never be a 60-day problem since the funds are transferred directly. Direct rollovers also avoid the 20% mandatory tax withholding on eligible rollover distributions from company plans and the once-per year (once every 12 months per IRA account) limit on IRA rollovers. You can do as many direct rollovers as you wish. In addition, advisors must always keep track of money that is moving to avoid problems.

Once-per-Year IRA Rollover Rules
If Betty had moved these funds in a trustee-to-trustee transfer, she would not have had a problem. But Betty did a 60-day rollover. In fact, she did two 60-day rollovers. She received two checks that were payable to her from the same IRA.

IRA to IRA or Roth to Roth rollovers are subject to the once-per-year rule. The account owner can only rollover IRA funds once every 12 months. Naturally, that is not as simple as it sounds. The 12 month period is a full 12 months. Betty received her distribution in December. She was not eligible to do another rollover from that IRA until the following December. The 12 months begin with the date the funds are received by the account owner.

The once-per-year rule also applies to each IRA separately. An IRA owner with five IRAs can do five rollovers in one year as long as each rollover comes out of a different IRA. The funds rolled over can go back to the IRA they came from or they can go to a different IRA. A receiving IRA can take in rollover funds from multiple IRAs but once it has received rollover funds, any funds distributed out of that IRA are not eligible for rollover until 12 months have passed.

Example:
Carl has two IRAs, IRA 1 and IRA 2 that have never had funds rolled into or out of them. Carl takes a distribution from IRA 1 on May 1st and does a rollover to a new IRA, IRA 3. Carl cannot rollover any other funds from either IRA 1 or IRA 3 until May 2nd next year.

Carl also takes a distribution from IRA 2 on July 5th. Carl can roll over this distribution to IRA 3, back to IRA 2, or to another new IRA since no previous rollovers have been done from IRA 2 even though Carl has already done a rollover this year from IRA 1. Carl cannot do another rollover from IRA 2 until July 6th next year.

Exceptions to the Once-per-Year Rule

While the once-per-year rule applies to most IRA to IRA or Roth to Roth rollovers, there are some exceptions. The three types of rollovers listed below are not subject to the once- per-year rule. They can be done an unlimited amount of times within a year:

  • Roth conversions
  • Rollovers from employer plans to IRAs
  • Rollovers from IRAs to employer plans

Possible Fixes

The three exceptions listed above open up the door to potential ways to correct the situation when more than one rollover in a 12 month period is done by a client, but ONLY if the problem is discovered within the 60 days. This is why it is so important for advisors to keep track of the 60 days for their clients.

Roth IRA Conversion
If Betty, or her advisor, became aware of the fact that she could not rollover her second distribution, Betty could have converted those funds to a Roth IRA. Betty could then recharacterize the Roth conversion and move the funds in a trustee-to-trustee transfer back to a traditional IRA. Huh? Why would she do this? Here’s why.

The conversion to a Roth is not subject to the once-per-year rule so Betty can take a second distribution (within a year) from her IRA and do a Roth conversion. Since that is a second rollover from the same IRA within a year, it cannot be rolled over to another IRA. But it can be converted to a Roth IRA. Then, if Betty does not want to keep the Roth IRA, she can simply recharacterize it back to a traditional IRA. The result is that the funds end up as a second IRA rollover within a 12 month period, but it is ok since the second distribution was done as a Roth IRA conversion which is exempt from the once- per-year year rollover rule.

The recharacterization rules say that once Betty recharacterizes from the Roth IRA to a traditional IRA by moving the funds in a trustee-to-trustee transfer, the funds are treated as though they had always been in the IRA account they end up in. So, ultimately Betty’s funds end up back in an IRA without a once-per-year rollover rule violation.

Rollover to an Employer Plan
If Betty had an employer plan, such as a 401(k), that allowed her to transfer in IRA funds, then she could also put her IRA distribution that is ineligible for an IRA rollover into her employer plan. Only pre-tax amounts can be rolled to the employer plan and the plan must have a provision allowing it to accept a rollover of IRA funds. The rollover would have to be done within the 60-day window.

Other Rollover Rules

What would happen if Betty took two distributions from the same IRA during the 60-day period? She can choose one of those distributions to rollover and she will have to pay income tax on the other one. Betty cannot add the two distributions together and put them back into an IRA on the same day and count them as one rollover. Once she has rolled a distribution back to an IRA she cannot change her mind. If her second distribution is larger than the first one, but the first one has already been rolled over, Betty will end up owing tax on the second distribution.

If the rollover amount becomes a frozen deposit during the rollover period, the time the deposit is frozen will not count toward the 60 days. A frozen deposit is one that cannot be withdrawn because the financial institution is insolvent or bankrupt or because withdrawals have been restricted by the state due to the insolvency or bankruptcy of other institutions in the state. The IRA owner will have at least 10 days after the deposit is no longer frozen to complete the rollover.

For IRA to IRA or Roth to Roth rollovers, the same property received is the property that must be rolled over. For example, Carl, in our previous example could not receive a distribution of cash and then rollover shares of stock that he purchases with the cash or that he currently owns. Carl cannot receive a distribution of stock in XYZ Company and rollover an equivalent value in shares of ABC Company stock. There is an exception to this rule for rollovers of property distributed from a company plan. That property can be sold and the cash received (but not any other type of replacement property) can be rolled over to an IRA.

When ineligible funds are rolled over, they become an excess contribution in the IRA account. They are subject to the 6% per year excess accumulation tax if they are not timely removed from the account.

A non-spouse beneficiary can NEVER do a 60-day rollover; they can only do a trustee-to-trustee transfer. Any check made payable to a non-spouse beneficiary will be a taxable distribution. There is no relief available if this mistake is made.

Roth Conversions
The 60-day rule also applies to Roth conversions. For example, if you withdraw from your traditional IRA, you have 60 days to convert to your Roth IRA. The better method is with a direct trustee-to-trustee transfer, so there is no risk of exceeding the 60-day limit. However, the once-every-12-months rule does not apply to rollovers from traditional
IRAs into Roth IRAs.

60-Day IRA Loans
Be careful when using the 60-day loan route. The rules are rigid, with virtually no exceptions other than if IRA funds become frozen due to insolvency problems of your bank or financial institution. Other than the “frozen deposit” exception, there are no other allowable excuses if you don’t return the IRA funds within 60 days. Even the 60-day PLRs won’t help you here.

Advisor Action Plan

  • Transfer IRA money in a trustee-to-trustee transfer, whenever possible. This avoids the 60-day and once-per-year rollover rule problems.
  • Check and double check on all retirement plan money that is moving. Make sure it gets into the right account whether it is a rollover or a direct transfer. Check that intended transfers to other IRAs end up in IRAs and not in non-IRA accounts. Errors need to be corrected quickly.
  • Ask clients if they have done another IRA rollover in the past 12 months before accepting or processing any rollovers.
  • Explain to clients that once they do an IRA to IRA rollover, they cannot do another rollover for the next 12 months.
  • Ask all new clients if the funds you are taking in come from a retirement account. Unbelievable as it may sound; sometimes clients forget to tell you this.