IRA Rollover Pitfalls to Avoid

IRA Rollover Pitfalls

For individuals with multiple IRAs, the Tax Court ruling in Bobrow v. Comm’r, T.C. Memo. 2014-21, should give pause, as it completely turns on its head the conventional wisdom under which financial advisors have been operating for years.  The tax court ruled that IRA rollovers are limited to one per taxpayer, not one per IRA, for each 12-month period.

Rollovers can generally occur between traditional IRAs, Roth IRAs, SIMPLE IRAs, SEP IRAs, 403(b) plans, and others.  As summarized by the court in Bobrow, “IRC Section 408(d)(3)(A) allows a payee or distributee of an IRA distribution to exclude from gross income any amount paid or distributed from an IRA if the entire amount is subsequently paid into a qualifying IRA, individual retirement annuity, or retirement plan not later than the 60th day after the day on which the payee or distributee receives the distribution.”  In other words, the owner of an IRA can receive distribution from the IRA, but within 60 days thereof, contribute it to another qualifying IRA, without income tax consequence, as a rollover.  This ability, however, is not without restrictions.

IRS Publication 590 tells us that “if you make a tax-free rollover of any part of a distribution from a traditional IRA, you cannot, within a 1-year period, make a tax-free rollover of any later distribution from that same IRA.” (emphasis added).  The same IRS Publication 590 provides in an example that two rollovers within 12 months are permissible as long as they were not involving the same IRAs.

However, unfortunately for the taxpayers in Bobrow v. Comm’r, T.C. Memo. 2014-21, though IRS Publication 590 stated that more than one nontaxable rollover within 12 months could be permissible, Internal Revenue Code Section 408(d)(3)(B) provides that a taxpayer may make only one nontaxable rollover contribution within each one-year period, not per IRA, but per taxpayer.  The IRS’s own Publication 590 explaining this rule is wrong and should not be relied upon.

Unfortunately for the Bobrows, this was a misunderstanding that cost them more than $60,000 in tax and penalties.

Why is a Living Trust Important?

A revocable living trust is a document a person (Trustor) creates to manage assets during that person’s lifetime, and to administer the disposition of those assets after the Trustor’s death.

Living Trusts are so named as they take effect during the Trustor’s lifetime, rather than a document, such as a will, which is only effective upon a person’s death. This results in one of the first advantages of a living trust over a will. During the Trustor’s lifetime, and while the Trustor has mental capacity, the Trustor can serve as the person responsible for managing the Trust assets. This person is called the Trustee. However, unlike a will, should the Trustor become incapacitated and unable to manage his/her own affairs, the Successor Trustee (the individual named to serve as an alternate to the original Trustor) can step in and manage the Trust Estate for the Trustor.

Without a Living Trust, an individual might not have anyone in place to manage his/her affairs for him/her upon incapacity. This could result in the family’s having to petition the court for conservatorship, which could be a lengthy and expensive proposition.

A second major advantage of a Living Trust is the ability to administer an estate in a timely and generally cost-efficient manner after the death of a Trustor. Unlike a will, there is often no need to petition the court after the death of a Trustor. Instead, the Trustee can gather the estate assets and ensure that the Trustor’s wishes are accommodated typically without need for court intervention. The administration of a Will, on the other hand, will generally require an Executor (the person named in the Will to administer the estate) to petition the court, and proceed through the probate process whereby the court oversees the administration of the estate. The probate process is often lengthy and can be quite expensive.

A third advantage of a Living Trust is privacy. As the administration of a Living Trust can avoid the probate process, the nature of the decedent’s property and the identity of the decedent’s beneficiaries can remain private. This is in contrast to the probate of a will, a court process which becomes a public record, and enables others to learn of the details of the decedent’s property as well as the identities of those will inherit that property.

While a Living Trust may not be for everybody, it is also not solely the domain of the wealthy. In fact, in California, estates valued above $150,000 will be subject the probate process unless a Living Trust is properly utilized.

Dianne Harmata is an attorney with Harmata & Associates, a law firm which practices estate and business planning. Dianne Harmata can be reached at 619-233-4711 or via email at Dianne@Harmata.com