Content Contributed by Ascensus.
By Jonathan Yahn, JD, CPC
Years ago, IRA owners could take multiple distributions and roll them over in the same year—as long as they rolled over only one distribution per IRA. Some individuals took this opportunity to an extreme by opening multiple IRAs in order to take advantage of this rule. For example, a business owner with a cash flow problem might use multiple IRA distributions to meet payroll. By maintaining 12 separate IRAs, the owner could take a distribution to meet expenses and roll over that distribution within 60 days—assuming of course that the owner had the assets to complete the rollover. But if not, another distribution from a different IRA could be used to replace the funds taken from the first IRA. This “robbing Peter to pay Paul” potentially could go on all year.
But this scheme came to a screeching halt in 2014. A U.S. Tax Court decision (Bobrow v. Commissioner) radically revised the one-per-12-month rollover rule, restricting rollovers to individuals rather than to IRAs. The IRS provided further guidance in Announcement 2014-32, clarifying that, irrespective of the number of IRAs that individuals have, they can roll over only one distribution per 12-month period. This restriction includes Traditional, Roth, SEP, and SIMPLE IRAs.
Case Study: What If Someone Violates the One-Per-12-Month Rollover Rule?
Consider a scenario that we recently encountered on our consulting lines. (Some details have been changed.) A financial adviser’s client wanted to move various IRAs to the adviser’s firm. Rather than simply transfer the assets, the client had taken two distributions from two separate IRAs: one for about $40,000 and another for about $90,000. The client had already rolled over the smaller distribution and was about to roll over the larger one when the adviser discovered the potential problem. Both distributions had been taken within the same week, and both were still within the 60-day rollover window.
Relief is available only for violations of the 60-day rollover rule.
The financial adviser thought that there might be some way that the IRS would allow multiple rollovers within 12 months if there were a good reason. Unfortunately, the provision that he was thinking of limits relief to those who have failed to roll over a distribution within 60 days of the distribution; it does not apply to the one-per-12-month requirement.
Internal Revenue Code Section 402(c)(3)(B) allows the IRS to waive the 60-day requirement in certain cases. The IRS may waive the 60-day requirement “where the failure to waive such requirement would be against equity or good conscience . . . .” IRS Revenue Procedure (Rev. Proc.) 2016-47 provides guidance about obtaining such a waiver. This Rev. Proc. includes details on how individuals may “self-certify” that they are eligible for a waiver, including a model letter that they can fill out. Valid reasons for a 60-day rule waiver include financial organization errors, the death (or serious illness) of a family member, or depositing a distribution into an account mistakenly believing that it was an IRA.
Congress has not extended IRS relief to violations of the one-per-12-month rule. And while it may seem that an overly strict enforcement policy might violate “equity or good conscience,” so far, the IRS simply has had no statutory authority to waive the one-per-12-month requirement.
Options are limited for violations of the one-per-12-month rule.
Even in situations when an individual is not at fault, good options are scarce. For example, if a financial organization employee provides inaccurate information about the rule, the individual may still have limited recourse. Here are some approaches to consider.
- If multiple distributions occur within the 60-day window, the individual may try to limit the tax liability by rolling over the largest one. In our case study, the client could have rolled over a total of $90,000. At least this would have made the problem—not being able to roll over the additional $40,000—a bit less severe.
- If the distributing financial organization is at fault (e.g., giving bad advice, not following instructions), the individual may succeed at having the organization agree to void the transaction and redo it as (for example) a transfer. As with any situation like this, the financial organization may have to make a business decision based on possible risks—and may ask for specific written instructions from the client. Some might also insist on some kind of hold harmless agreement.
- If the financial organization is at fault to any extent, it may decide to offer the client a way to avoid some of the consequences of a failed rollover. Assume that in our case study both distributions had been rolled over: the $90,000 one first and the $40,000 second. Here, the second rollover would be disallowed, and the IRA owner would have to treat $40,000 as a regular contribution. If the IRA owner was ineligible to make a regular contribution for the year, then he would have to remove the entire $40,000 (plus the net income attributable) as an excess contribution. Further, because this contribution could not be treated as a rollover, it would be taxable to the client in the year it was distributed. Let’s assume that the client would have to pay around 25% in federal and state taxes on $40,000, or $10,000. (If the client were under age 59½, an additional 10% tax would also likely apply.) The financial organization probably would not offer to pay the amount of additional tax, as this would seem to create a bit of a windfall for the client. But it might help start a discussion about how the financial organization could somehow put the client in an acceptable tax position.
Important Takeaways
Why even discuss a rollover scenario for which there are such limited and unsatisfactory responses? At least three reasons come to mind.
1) Know the rules. This may seem obvious. But from our experience, there are many workers that struggle with the complex rules that govern our retirement plan industry. The rules aren’t necessarily intuitive. In fact, sometimes they seem—as in this case—to defy common sense. If you don’t know the rules that a client wonders about, don’t fake it. Admit that you would “like to look into that” for your client, and then follow up with the correct information. Most clients will respect an authentic “may I get back to you on that” along with a prompt and accurate response.
2) Don’t give “advice.” There may be a fine line at times between reciting the rules and giving advice. And you may find yourself reciting this phrase repeatedly to your clients over the years: “I can’t give tax, legal, or accounting advice, but here’s the rule as I understand it.” You may also want to verify with your compliance or legal area exactly what they would prefer you to say. So while you certainly want to help your clients, knowing the limits of your understanding—and your proper role with your clients—will help keep you and your financial organization from the predicament in our case study.
3) Learn how to protect your organization while helping your clients. You may make mistakes. And you may have to deal with clients that have a valid complaint based on some interaction with you or a colleague. So it makes sense to have a response plan in place before you actually need it. For example, conferring with your legal/compliance team about when and how to refer problems to them may facilitate a broader discussion about various roles in your organization. You may, for example, come up with tools, such as checklists and decision trees, that will help front-line workers refer challenging situations to the right colleagues.
The real-life case study above may sound familiar to you. The rollover rules changed without any prior warning, catching some financial organizations off guard. But even for those who consistently stay abreast of new developments, it’s easy to miss something. So whether it’s the one-per-12-month rollover rule—or some other provision—you or someone you serve will likely get tripped up at some point. Knowing how to respond may lessen the impact and may even help you keep a client.