For approximately 20 years prior to 2015, an individual could roll over a distribution from an IRA free of tax as long as that IRA wasn’t involved with a tax-free rollover distribution within the preceding one-year period. For example, suppose an individual with three IRAs took a distribution from IRA-1 and rolled it over tax-free by timely (within 60 days) contributing it to IRA-3. Within one year of the distribution, the individual could then have taken a distribution from IRA-2, but not from either IRA-1 or IRA-3, and rolled it over tax-free.
Beginning in 2015, taxpayers cannot accomplish more than one tax-free rollover in any one-year period, regardless of how many IRAs they may have. In the example above, the distribution from IRA-2, within one year of the distribution from IRA-1, can no longer be rolled over tax-free.
Did the law change? It didn’t, only the IRS’s enforcement policy following the United States Tax Court’s 2014 opinion in Bobrow v. Commissioner, wherein the court determined that the relevant statute permits only one tax-free rollover during any one-year period.
Proposed regulations issued in 1981 applied the statutory rule on an IRA-by-IRA basis, meaning that a taxpayer’s rollover from IRA-1 to IRA-3 wouldn’t preclude a tax-free rollover from IRA-2 to another IRA within one year of the distribution from IRA-1. In 1992, the Tax Court issued an opinion involving an individual who withdrew funds from an IRA, rolled them over tax-free into a second IRA, and then, within one year of the withdrawal, took additional withdrawals from the second IRA. The proposed regulations didn’t explicitly cover this situation, but the Tax Court determined that the withdrawals from the second IRA couldn’t be rolled over tax-free because of the statutory limitation providing for one rollover in any one-year period.
Thereafter, around 1994, the IRS expanded on the proposed regulations, stating in Publication 590 that subsequent withdrawals from either the distributing IRA or the IRA to which a rollover contribution was made, and made within one year of the withdrawal from the distributing IRA, couldn’t be rolled over tax-free. Withdrawals from an IRA not involved with the tax-free rollover, however, remained eligible for tax-free rollover treatment, even if the later withdrawal was within one year of the earlier one.
During the next 20 years or so, individuals with multiple IRAs were thus generally thought to be able to string together IRA rollovers tax-free and, effectively, achieve short-term, interest-free loans. For example, suppose an individual needed to borrow $25,000 for 120 days. The individual could have taken a $25,000 distribution from IRA-1 and deposited those funds to a personal account. Within 60 days after the distribution, the individual could then have taken a $25,000 distribution from IRA-2 and, following a deposit of those funds to the personal account, could have withdrawn $25,000 from that account and contributed it to IRA-3, effectively completing a tax-free rollover of the distribution from IRA-1. Then, within 60 days of the distribution from IRA-2, when the individual obtained the funds to repay the borrowing, the individual could then have contributed them to IRA-4, effectively completing a tax-free rollover of the distribution from IRA-2. Eventually, however, one variation of this practice ran afoul of what the Government believed was proper, leading to the 2014 Tax Court opinion in Bobrow.
Bobrow v. Commissioner
Tax attorney Alvin Bobrow had two IRAs. He took distributions from IRA-1 and IRA-2 on Days 1 and 54, respectively, and made contributions to IRA-1 and IRA-2 on Days 58 and 113, respectively. Each transaction was in the same amount, approximately $65,000. Effectively, Bobrow was able to borrow $65,000 from his IRAs for 113 days, interest-free. But was it tax-free?
Bobrow thought so, arguing that his distribution from IRA-1 was timely rolled over into IRA-1, and that his distribution from IRA-2 was timely rolled over into IRA-2. Neither the proposed regulations nor Publication 590 explicitly prohibited this, but they didn’t explicitly approve of it either. Either way, the Government evidently believed Bobrow’s tax-free treatment was abusive, and argued that the court’s 1992 case precluded Bobrow from achieving more than one tax-free rollover within a one-year period.
The Tax Court agreed, observing as well that “Congress added the . . . limitation as a way to ensure that taxpayers didn’t take advantage of [the rollover rule] to repeatedly shift nontaxable income in and out of retirement accounts.” The court then determined that the distribution from IRA-1, followed by the contribution 57 days later to IRA-1, qualified as a tax-free rollover, but that the distribution from IRA-2 couldn’t be rolled over tax-free because it was within one-year of the nontaxable distribution from IRA-1.
Trustee-to-trustee transfers aren’t subject to the one-rollover-per-year limitation. These can be accomplished by having an IRA trustee transfer amounts directly to another IRA trustee or by providing the IRA owner with a check made payable to the receiving IRA trustee. Likewise, the limitation doesn’t apply to a rollover to or from a qualified plan, such as a 401(k), or from a traditional IRA to a Roth IRA. If you're unsure about your specific situation, please check with your trusted Friedman LLP advisor.