60-day rollover workaround?

Submitted by Tom Brattain on Thu, 2010-09-16 21:45

A client needs about $85K, fairly quickly, but likely only for about 4 months. He is applying for an adequate line of credit, but, in today’s environment, it is not easy to get an unsecured loan of that size.

He has several IRA accounts. Some have more than the $85K.

My understanding is that he can only do a distribution-and-return “rollover” once in a 365-day period, BUT that this is once per IRA account.

With this, it appears that he can take $85K from IRA #1, use it for close to 60 days, then take $85K from IRA #2. He uses the $85K from IRA #2 to complete the rollover back into IRA #1 (or into a new IRA #3) within the 60 days, which gives him 60 NEW days to “roll” the distribution from IRA #2, either back to IRA #2 or into another new IRA #4.

If he had several, adequately large IRAs, he could effectively defer the taxes until he wins the lottery. (For the record, he is not buying $85K worth of lottery tickets. I am being fecetious.)

He needs cash to close on his NEW residence, pending the receipt of funds from the pending sale of his residence. In reality, he will not roll all of the distribution back in. Naturally, any amount that is not rolled over would be taxable as of the date of the distribution.

His wife also has IRAs, so I expect that we could do the same thing by using his, then paying it off with a distribution from hers, then taking from his #2 to pay off her #1, etc.

If nothing else, it would at least allow him to defer the tax into next year, by having the “non-rolled” IRA distribution occur after 1/1/2011, which would be better for him.

This seems “too good to be true”, but Publication 590, under “Rolling From One IRA to Another” spells out this situation, except that it does not specifically permit or deny using the distribution from #2 to “cover” the distribution from #1.

Is there something I am missing? Please advise!



Submitted by Alan Spross on Fri, 2010-09-17 03:10

408(d)(3) was interpreted to mean what Pub 590 indicates it means. But I know of no more detailed explanation of the rollover limitation than what appears in Pub 590, p 24. Further, these rollover limitations are from a practical standpoint enforced at the IRA custodian level because the IRS is not provided with the dates of any of these rollover distributions, just the year. In addition, the 1099R and 5498 forms for each specific account look exactly the same whether funds are rolled back to the same IRA or the funds are provided by a different IRA in a step transaction like the scenario you describe.

But it does appear that the scenario would not work if the IRS audited the client because any of his IRA accounts in the chain will both receive a rollover contribution and distribute a rollover contribution within a 12 month period and generate those 1099R and 5498 forms that could trigger a question, particularly if the IRS receives them from a bunch of different accounts.



Submitted by Anonymous (not verified) on Sat, 2010-09-18 01:29

alan, I wanted to ask a follow-up question on this topic and also a new one. I am a bit confused:

If someone had 3 separate IRAs and did 3 rolllovers (distributions and rollover contributions) on each, every 60 days to stretch out the availabitly of the funds is that not OK? – I will assume that the funds are there for each IRA, as not to imply the “same” money is moved around. Did I understand your response correctly that you say NO?
(Example: each of the IRAs has 100K to start with let’s say)

Secondly, do you think the IRS will look at the following transactions as suspicious, even though they are perfectly legal:
1. 5/01 60-day Rollover of 10K from Roth back.
2. 08/01 Distribution of 15K from same Roth that will not be rolled over (penalty applies).
3. 09/01 Distribution of 5K from same Roth (penalty and taxes will apply due to amount in question being converted in 2010.

Thanks,

pko



Submitted by mk foss on Sat, 2010-09-18 01:46

Let me tackle your first question. Let’s assume the taxpayer takes a distribution of $99k from IRA one on January 15. On March 10 he realizes he doesn’t have enough money to pay it all back – so he takes a distribution from IRA two of $90K and $9K that he scrounged from some where to put the $99k back before 60 days have elapsed. On May 1 he realizes that he doesn’t have 90K to roll back into IRA 2 so he takes a distribution from IRA 3 of 90K to roll into IRA 2. All of that is legal and there is no tax assuming that IRA 3 funds are restored within 60 days. But you can only do this once per year per IRA so if there are only 3 IRAs the story ends for that year. I have a client with 10 IRAs and he has played this game more than once. The IRS has never questioned the process – knock on wood (there’s always a first time).

I’m not sure I understand your second question, so I’ll leave that to Alan’s capable brain.



Submitted by Anonymous (not verified) on Sat, 2010-09-18 02:19

Thanks for the response.

My second question is just saying there are multiple transactions within the Roth and I was more curious how inquisitive the IRS gets with that type of activity, although within the rules. So, I am just wondering if there is a greater chance that the client will be audited. That’s all.

pko



Submitted by Alan Spross on Sat, 2010-09-18 03:05

I was having trouble following that question also.

So will try to dissect it somewhat.
1) This is just a distribution that was rolled back to the same Roth IRA within 60 days.
2) This is an early distribution, but the only reason for any penalty (without ordinary tax) would be if a conversion was distributed within 5 years.
3) This is the most confusing transaction – do you mean that there was a 2010 conversion to this Roth not mentioned before, and now that 2010 conversion is being withdrawn? If so, that will create an accelerated tax from what would have been deferred to 2012, and the penalty because the conversion was not held 5 years?

Here is where this gets complicated if the above is correct. The IRS released a draft copy of the 2010 8606 form that was then quickly rescinded, probably because it did not address all the variables. But upon review it appeared to me that the IRS intended to consider Roth distributions after a 2010 conversion as coming from the conversion funds. This is very confusing because the ordering rules for non qualified Roth distributions assigns all distributions first from regular contributions, and then from conversions starting with the oldest. Perhaps all these mismatches is the reason the draft was pulled. The IRS needs to decide where distributions are coming from if taken after a 2010 conversion with income deferred.

This is a real mess. Suppose you have a fully qualified Roth prior to 2010 and then do a conversion. Normally you are entitled to withdraw the entire balance that was in the Roth tax free, so why would a distribution have to be assigned to the new conversion funds before allowing distributions from the qualified balance that was there before.

And the above may have nothing to do with your question at all?



Submitted by Alan Spross on Sun, 2010-09-19 04:49

More musings on the IRA rollover question.

This is from Pub 590, the IRS’ effort to explain Sec 408(d)3:

“You also cannot make a tax free rollover of any amount distributed within the same 1 year period, from the IRA into which you made the tax free rollover”.

It is not clear whether this limitation applies equally to situations where the rollover is deposited first and then the distribution is taken OR the distribution is taken first from an IRA and then that same account receives the rollover contribution. The example in Pub 590 refers to circumstances where a given IRA first receives the rollover and then a rollover distribution from that same IRA is disallowed in the 12 month window. The 12 months looks both back and forward.

In the example Mary Kay cited from a client, each IRA account issued a rollover distribution PRIOR to receiving the rollover contribution from a different IRA. This essentially accomplishes the same result as the example in Pub 590 of a disallowed rollover, ie the same dollars are moving multiple times between IRAs, just in a different order. But when the distribution is taken first, it opens up the potential for an amount to stay outside any IRA indefinitely, similar to check kiting. That appears to be a more material infraction than simply doing a second 60 day rollover from the same account. In that case the same money is limited to 120 days of personal use, rather than unlimited use until the funds are finally replaced. This is why I think the intent of the rollover limit has been violated in both scenarios. Obviously, the risk of detection lies mostly with the IRA Custodians, and their observation of a pattern is likely to be linked to their own expenses in handling all these rollovers.

The IRS rarely gets involved in either of these situations because short of an audit, they do not have the data to determine whether 12 months have passed since 1099R and 5498 forms do not include dates, just years. And each of the above two situations are such that the 1099R and 5498 forms will look exactly the same, ie each given IRA account will have a 1099R and a 5498 unless the 60 day period spans the end of a calendar year. So whether the client takes the distribution or deposits the rollover first, it will not be evident from the 1099R and 5498 forms.



Submitted by Anonymous (not verified) on Mon, 2010-09-20 01:04

Thanks alan for spending so much time on this question.

In summary, my issue is the following:

ONLY Roth IRA at 12/31/2009 contains 15K + minor earnings. The 15K are from a 2009 conversion – taxes paid and client is under 59 1/2.

Transactions in 2010 occur in this order:
1. 10K is distributed and rolled over within 60 days,
2. 5K is converted into the Roth
3. 15K is distributed
4. 5K is distributed

So my point was really if this will be easily understood by the IRS when reported.
I realize the 15K will have a 1.5K penalty and the 5K will be taxed and penalized (.5K) all this in 2010.

Do you agree?

Thanks,

pko



Submitted by Alan Spross on Mon, 2010-09-20 03:44

I can’t say if the IRS will have a problem understanding the 8606 and 1040, but this is how the 2010 sequence should be reported on the pending final draft of the 2010 8606:

1) Custodian will issue a 5k 1099R on the TIRA for the conversion. This should be reported on Part II of Form 8606 and the box checked to report the 5k conversion fully in 2010.
2) Custodian will issue 30k of Roth distributions on a 1099R for the Roth IRA. The distribution section of the new 8606 will be Part IV. Ignore the rollover when completing Part IV. 20 k is reported as a NQ distribution, all of which comes from conversions, but no ordinary income tax is generated since the taxes were paid pursuant to the conversion reporting sections. However, the early withdrawal penalty should be 2k since 20k of conversions are coming out prior to the 5 year holding period. This is reported on Part I of Form 5329.

The taxable amount of 5k for the conversion feeds over to line 15a of Form 1040 and the 10,000 rollover is also reported there. 15a will therefore be 15k, and 15b will be the taxable 5k with “rollover” entered next to 15b so that no tax in due on the 10k rollover.

Net result is that tax on 15k was paid for 09, and 5 k for 2010. That 20k comes out in 2010 tax free but subject to 10% penalty.

Whether the IRS would understand this in a normal year is iffy, but with a new 8606 for 2010 and all the added complexities on 2010 conversions, the IRS may be more likely to inquire about some element of this. Right now, I think they are having trouble with the new 8606, specifically on the acceleration of income provisions if someone converts, defers the income, and also takes distributions. In your example, it will be important to opt out of the deferral.

The small amount of earnings will of course be subject to both tax and penalty, but left it out of the above since you said it was very small.
Hopefully, that TIRA had no basis in it…………..



Submitted by Bill Simonette on Mon, 2014-08-11 14:34

If a client has multiple IRA’s, (17), can she  take each one out every 365 days? Or are the rules changing, as it relates to this?



Submitted by Alan - IRA critic on Mon, 2014-08-11 16:28

They are changing effective 1/1/2015 to a one rollover limit within a 12 month period for ALL of a taxpayer’s IRAs. Until then the limit is still one per IRA account. With 17 different accounts, client needs to change over to using direct transfers instead of 60 day rollovers otherwise starting next year the extra rollovers will be disallowed resulting in taxable distributions, possibly subject to penalty as well. Here is the IRS Announcement:  http://www.irs.gov/pub/irs-drop/a-14-15.pdf



Submitted by Bruce Steiner on Mon, 2022-08-08 22:06

  • Alan:  that was always the law (at least since Congress changed it from 3 years to one year).  There were a couple of Tax Court cases to that effect:  Marshall H. Martin in 1992, and Bidyat K. Bhottadayya in 2007.
  • The proposed regulation and the Publication were incorrect.  However, taxpayers may not rely on a proposed regulation or an IRS Publication.  
  • Interestingly, Mr. Bobrow, the taxpayer in the case cited in the IRS Announcement that you provided, is a tax lawyer.  I once heard him speak at a continuing legal education program.


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