New IRS Policies Regarding IRA Distributions May Affect Brokers and Investors

By David Tanner

For over thirty years, the Internal Revenue Service (“IRS”) has taken the position that an individual with two IRAs, IRA1 and IRA2, could take a distribution from IRA1 and IRA2 within one year of each other without taxes or penalties. This is contingent upon the fact that the funds from the distributions be placed in an IRA within sixty days of the distribution. However, that has changed because of the tax court’s decision in Bobrow v. Commissioner, T.C.Memo 2004-21. In Bobrow, the taxpayer, took a distribution from one IRA and placed the funds into a joint checking account he had with his wife. Just before the sixty-day time period elapsed, he took a distribution from another IRA, IRA2, and placed those funds into IRA1. Then, his wife took a distribution from her IRA and placed the funds in the joint checking account she had with her husband in order to place the funds into IRA2 to avoid paying taxes on the distribution.

The taxpayer believed that his actions were consistent with IRS Publication 590 and treasury regulation 1-408-4(b)(4)(ii) because they stand for the proposition that individuals were limited to one tax free rollover per account, not one tax free rollover in total. The IRS cited tax court cases to argue, contrary to its stated position, that individuals were limited to one tax-free rollover per year. While it may seem surprising that the IRS may take a position in litigation that was counter to its stated position, it was free to do so. IRS Publications are not binding on the IRS because they are not authoritative. Also, proposed regulations, as opposed to final regulations, are not binding on the IRS and cannot be cited as authoritative for taking a certain tax position. The tax court stated that the plain meaning of the statute indicated that it meant to apply the one year limitation to the individual, not the account. In addition, the tax court cited legislative history showing that Congress was concerned about taxpayers shifting investments between IRAs.

As a result of Bobrow, the IRS has withdrawn the proposed regulation and is working to rewrite Publication 590 to reflect their new position. It is important that brokers and investors are aware of this because it is a dramatic change from a longstanding policy. Failure to comply with the new rule will result in the taxpayer’s additional IRA rollovers being taxable. Furthermore, the taxpayer may be subject to a twenty-percent substantial underpayment penalty because there is not “substantial authority” or a “reasonable basis” for believing that taxpayers can make more than one tax-free IRA rollover in one year.