Typically a taxpayer does not have to include in gross income an amount distributed from an IRA if the funds are placed into another IRA within 60 days. This is often called a rollover. To avoid abuse of the exclusion, it only applies to one IRA rollover in a 12 month period. Historically the IRS interpreted that to apply on a per IRA basis, and had a proposed regulation and IRS publication stating the same rule. A February Tax Court decision interpreted that rule differently, and as a result, the IRS released Announcement 2014-15 stating that as early as January 1, 2015, the one per 12 month rule applies in the aggregate, to all IRAs of a taxpayer.
In Bobrow (full decision available here), Mr. and Mrs. Bobrow attempted a series of IRA distributions and re-investments that essentially transferred money between multiple IRAs. For example, a distribution from a second IRA was used to reinvest in the first IRA so the first distribution would not be taxed. The two mistakes that likely triggered the IRS review of the whole transaction was the final repayment was completed on the 61st day, and was not the full amount of the original distribution. The issue for the court to decide was whether the IRA distributions by the Bobrows were to be included in income, or whether the distributions fit the one-per-year rollover exclusion.
The court turned to the applicable Internal Revenue Code sections, and stated the general rule that any amount distributed from an individual retirement plan is included in gross income and taxable. However, the distribution is not included in gross income if the entire amount is subsequently paid into a qualified IRA within 60 days from when receipt of the distribution. This exclusion is limited to one rollover in a 12 month period.
The court ultimately held, contrary to the IRS position of one rollover per year per IRA, that the one rollover per year rule applied in the aggregate, to all IRAs of the taxpayer. The court reasoned that Congress originally allowed the tax-free rollover because the American workforce had become more mobile and Congress wanted to allow rollovers of retirement contributions when switching employers. However, Congress implemented the one-per-year limitation to ensure taxpayers did not use a series of rollovers as a means to shift nontaxable income in and out of retirement accounts. Guided by this reasoning, the court held that the one-per-year rule applied in the aggregate, such that a taxpayer may only exclude one rollover per year from gross income, regardless of the number of IRAs. Thus, only one of Mr. Bobrow’s distributions and subsequent repayment would be excluded from income. All other distributions were included in the Bobrows’ gross income and taxable.
The IRS acknowledges this is likely a major change for plan administrators and taxpayers, since previously this was interpreted to allow one rollover per year per IRA. The IRS plans to release a proposed regulation on the issue, but has stated the regulation would not be effective until January 1, 2015, at the earliest.