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Don't Panic Over This IRA Rollover Case

The first thing many new law students learn is that bad facts make bad law. For those wanting to use an IRA rollover, the U.S. Tax Court took what could be the worst possible facts to make a ruling that stunned countless financial advisors. But that doesn't mean you have to stop using the IRA rollover strategy entirely -- and most importantly, there's a better alternative that you should generally use to avoid having to do an IRA rollover at all.


U.S. Tax Court building, Washington, D.C. Photo credit: Wikimedia Commons.

Understanding the IRA rollover case
For years, financial experts have thought that you could do more than one tax-free IRA rollover in a given year. The key was that those rollovers had to come from different accounts in order to qualify as tax-free.

Yet one tax lawyer decided to push the envelope with his personal finances. According to the Tax Court's explanation of the facts, tax attorney Alvan Bobrow took $65,000 out of his traditional IRA account, intending to replace that money within 60 days, as the tax law states, in order to have the transaction treated as an IRA rollover rather than a taxable distribution. If Bobrow had simply done that without any further money movements, IRA rollover rules would have applied, and there would have been no dispute.

The problem, though, is that right before Bobrow repaid the $65,000 to his traditional IRA account, he took $65,000 out of a different IRA account. Then, just before the 60-day period for that withdrawal expired, Bobrow's wife took $65,000 out of her traditional IRA, with a $65,000 repayment to Bobrow's second IRA account taking place just days later. Eventually, the Bobrows repaid the wife's IRA withdrawal and took the position that all of the transactions were tax-free IRA rollovers. The IRS disagreed, arguing in part that the nested withdrawals and repayments didn't line up the way the Bobrows contended.

Being a tax attorney, Bobrow chose to represent himself in the Tax Court after the IRS imposed taxes on him and his wife, and he earned a smackdown from the Tax Court that sent ripples throughout the retirement planning community. Rather than simply saying that Bobrow's serial withdrawals weren't eligible for tax-free IRA rollover status because they came in quick succession and were nested within each other, the Tax Court suggested that in all instances taxpayers are limited to one tax-free IRA rollover per 12-month period. That broader finding conflicted with the IRS' own guidance in its publication on IRAs, which contemplates situations in which completely unrelated transactions using multiple IRAs could all qualify for tax-free IRA rollover treatment.

Massive overreaction
In response, many experts are saying that people have to completely change their planning, with IRA trustees amending client agreements. But for most people, the decision is almost completely irrelevant, because there are better ways to move money than using IRA rollovers.

Specifically, there's a difference between an IRA rollover and what's known as a direct transfer. With an IRA rollover, you actually take control of the money you withdraw from your IRA for a period of time, only later redirecting it either back to the original IRA or into another IRA. By contrast, a direct transfer allows you to move IRA assets between financial institutions without ever taking direct control of your money. The tax law distinguishes between an IRA rollover and a direct transfer on exactly those grounds, allowing unlimited direct transfers but only the single IRA rollover per 12-month period.

The unfortunate thing here for some taxpayers is that there are legitimate reasons for wanting to take more than one IRA rollover in a given year. The Bobrow case will take reduce the flexibility to perform transactions that are much less questionable than those the Tax Court ruled against.

But for your own IRA planning, don't let the Bobrow case scare you. Simply by using direct transfers, you can avoid the IRA rollover trap and keep the IRS happy.

Take advantage of this little-known tax "loophole"
Recent tax increases have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "The IRS Is Daring You to Make This Investment Now!," you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Tune in to Fool.com for Dan's regular columns on retirement, investing, and personal finance.


Read/Post Comments (4) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 06, 2014, at 9:05 AM, Mathman6577 wrote:

    Looks like a lawyer got caught trying to game the system. Poor baby.

  • Report this Comment On April 06, 2014, at 12:36 PM, BillS wrote:

    Actually, said lawyer ruined it for everyone, gaming the system or using it legitimately.

    And Dan, just a comment on direct transfers - some institutions won't do that. I'll let others speculate on whether it's intentional or not, but every time I've tried to transfer 401K funds or IRA out of Fidelity (or even roll from one 401K to another), Fidelity insists on doing it as a transfer - liquidating the entire account and sending me a check. After sending me to their "saves" department for a lecture on how I'd be so much better off leaving funds with them.

  • Report this Comment On April 07, 2014, at 10:37 AM, Mathman6577 wrote:

    A few bad apples always ruins it for everyone.

    I rolled over a 401k to a Fidelity IRA recently. That and the fact that I am a libertarian will probably attract the attention of the IRS. Right Lois? :)

  • Report this Comment On April 07, 2014, at 11:11 AM, SCStockPicks wrote:

    I think Bill S has the real question, will this ruling be applied beyond IRAs to include all qualified plans (401K, 457, etc)?

    If that's the case, a lot of people will find themselves unable to consolidate assets following the loss or change of a job. Many, if not most, 401k providers will not do a direct transfer.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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