The IRS recently released clarifying guidance on the one-per-year limit on tax-free rollovers between IRAs.
Several months ago, the Tax Court stunned practitioners and taxpayers alike by holding in the Bobrow case that an individual could not make more than one nontaxable 60-day rollover within each one-year period, even if the rollovers involved different IRAs. Publication 590, Individual Retirement Accounts (IRAs), provided that the one-rollover-per year was applied on an IRA by IRA basis, not on an aggregate IRA basis. This contradiction left many in limbo for a short period of time. Somewhat surprisingly, the IRS quickly indicated that it would ignore the longstanding instructions in Publication 590 and follow the interpretation of the Court.
The new announcement is designed to bridge the gap between the old rules and the new rules for 2014/2015. The aggregate rule will apply to distributions from different IRAs after 2014. For 2015, a 2014 distribution that was rolled over is disregarded for purposes of determining whether a 2015
Distribution can be rolled over, provided that the 2015 distribution is from a different IRA that neither made nor received the 2014 distribution.
As the IRS has indicated repeatedly, these new rules do not impact trustee-to-trustee transfers, rollovers between qualified plans and IRAs, and Roth conversions.
‘Tis the season many start thinking about converting regular IRA accounts into a Roth IRA. After all, unlike the taxable withdrawals out of a regular IRA account, funds coming out of a Roth are completely tax-free after age 59½.
Many individuals have made non-deductible contributions into their regular IRA accounts, thereby resulting in the IRA having a basis. A surprising number of these individuals believe that one can pull the basis out of the IRA and deposit that into a Roth IRA, for a tax-free conversion. Therein lies the trap.
One cannot pick and choose what part of the IRA is being converted. The conversion is deemed to come from all dollars in all IRAs equally. Note that a SEP and SIMPLE are also IRAs and count in this computation. A 401(k) is not an IRA.
Example: A self-employed individual has an IRA account worth $100,000 and has previously made $30,000 of nondeductible contributions (basis). He also has a SEP worth $200,000, and a 401(k) worth $700,000 from a previous employer. The individual wants to convert $40,000 to a Roth.
Is this tax free? No! In fact, only 10% of the conversion will be nontaxable. This percentage is determined by dividing the basis ($30,000) by the value of all IRA accounts ($300,000).
Note that if the individual would have rolled his 401(k) into an IRA, the nontaxable percentage of the conversion would drop to a paltry 3%, leaving 97% of the conversion to be taxed. Thus, careful consideration should also be given to rolling over 401(k) balances into an IRA.
For assistance with this issue or any other tax matters, please contact your Aronson tax advisor at 301.231.6200.