How many of you have had an IRA or 401K indirect or even a direct retirement rollover that triggered a tax and penalty from the IRS? Have any of you borrowed from retirement to pay it back within 60 days only to get a bill from the IRS?–even if you have complied fully with the IRS Code Section 408(d)(3)(A)(i)? Did your broker ever send you an incorrect form 1099R? When you call your tax attorney for help she tells you to wait for IRS form 5498 being sent by your broker. But unfortunately the IRS does not usually wait. And get this: even though the 1099R and 5498 are so related to each other that the Government combines 1099 and 5498 instructions into one document they are mailed to you months apart. The result? You receive an IRS notice, bill and penalty. What can you do? If you are planning to either rollover a direct or indirect IRA or similar tax deferred retirement account or perhaps are thinking of borrowing against your retirement account in 2014 as a year-end tax strategy please stay with us on TaxView with Chris Moss CPA to learn how to avoid the latest Loan Rollover Tax Traps (LRTT) that the IRS has set up to trip you up into paying more taxes and penalty.
Most of us know the rollover or “roll” drill. It’s always better to do a direct rollover also referred to as a trustee to trustee transfer. But if you go the indirect rollover route the IRS gives you only one roll per year. Why would you ever do an indirect roll? Some of you roll to change brokerage firms and others indirect roll to borrow the money. This leads many of you including Alvan Bobrow to LRTT#1. Alvan Bobrow v IRS US Tax Court (2014). Alvan Bobrow is a tax attorney who maintained various IRA accounts at Fidelity as did his wife Elisa. Bobrow received various indirect distributions in 2008 and rolled them 61 days later. The IRS audited for 2008 and sprung LRTT trap #1. Bobrow’s tax return fell right in this first LRTT on the tax course claiming that it was Fidelity’s fault that Bobrow was one day late. The Court did not find Bobrow’s testimony credible.
Judge Nega citing Wood v IRS US Tax Court (1989) distinguishes Bobrow because Wood physically hand delivered stock certificates to Merrill Lynch within 60 days and Merrill Lynch had assured Wood that the roll of the stock into the IRA would be consummated as instructed. Unfortunately Merrill Lynch failed to record the transfer due to a bookkeeping error. The stock certificates were in fact were actually transferred four months later. The IRS audited and disallowed the entire transaction. Woods appealed to US Tax Court in Wood v IRS US Tax Court (1989). Judge Ruwe says it is well settled that where book entries are at variance with the facts, the decision must rest on the facts. Wood’s testimony was credible and Merrill declined to testify. On the other hand in Bobrow v IRS US Tax Court (2014) Bobrow never asked Fidelity to testify and Bobrow’s testimony did not provide the facts necessary to prove his case. Unfortunately Bobrow fell to LRTT #1: You cannot blame your brokerage firm unless you have absolute proof of why your roll failed to roll. IRS Wins, Bobrow Loses.
What about rolls from an estate? Jankelovits tripped that LRTT #2 in Jankelovits v IRS US Tax Court (2008). Jankelovits transferred funds from her deceased aunt’s IRA as beneficiary of her estate. Unfortunately LRTT #2 says you can’t do indirect rolls from an estate, but only trustee to trustee transfers citing IRS Code Section 408(d)(3)(C) and IRS Pub 590. While Jankelovits testified that he asked the bank for a “nontaxable” roll, Judge Gale points out that unlike in Wood v IRS US Tax Court (1989) Childs v IRS US Tax Court (1996) or Thompson v IRS US Tax Court (1996), none of the bank employees involved with Jankelovits either testified or admitted any wrong doing. With no witness testimony to support Jankelovits, this taxpayer tripped into LRTT#2: You must roll an estate for a nonspouse with a direct “trustee to trustee” roll or you get no roll at all. IRS wins, Jankelovits loses.
Our next to last roll of the day will drop us into LRTT#3: rolls must be from a pretax contribution and clearly noted as such to the destination broker. Bohner v IRS US Tax Court (2014). Bohner was a retired social security administration government worker. Bohner was given a chance in 2010 to catch up his retirement account for any period which he made no contributions while he was on salary. His maximum catch up was $17,832 to be paid to the Government plan called CSRS. Bohner borrowed from a friend and send the $17,842 on to CSRS with no explanation to CSRS as to the origin of these funds. Bohner then paid back the friend from a Fidelity IRA later that year with what I can only portray as a backward reverse indirect roll. Bohner did not report the roll as taxable in 2010 and did not explain his backward reverse indirect roll to the IRS on his tax return, even though he was issued by Fidelity a 1099R saying that the withdrawal of these funds was indeed taxable. The IRS audited and disallowed the roll.
Judge Kerrigan concludes that if Bohner had made a direct trustee to trustee pretax roll from Fidelity to CSRS perhaps the roll would have been legally completed tax free. But the Court notes that the funds that rolled originated from post-tax borrowed money. LRTT#3 requires the roll to be from pretax funds citing Montgomery v. United States, 18 F.3d 500 (7th Cir. 1994). IRS Wins Bohner loses.
Our last roll will be to explore LRTT#4, namely that the entire amount of the roll received from the old IRA must be the same amount paid into the new IRA, or in other words, the funds you roll out must be the same funds you roll in as evidenced in Lemishow v IRS US Tax Court (1998). The facts are simple. Lemishow rolled his Keogh and IRA funds to purchase stock. Lemishow then rolled the stock into a new Smith Barney IRA account. Lemishow filed his 1993 tax return and did not report the roll as taxable. The IRS audited and disallowed the roll claiming all distributions from the Keogh and IRA were taxable. Lemishow appealed to US Tax Court in Lemishow v IRS US Tax Court (1998). Judge Tannewald points us to legislative history showing that rollovers facilitate portability of pensions and therefore must be the “same money or property” that came from the originating IRA to the destination IRA citing Employee Retirement Income Security Act of 1974. To have avoided LRTT#4 Lemishow should have rolled cash into Smith Barney then purchased stock from within the newly created IRA. IRS wins Lemishow loses.
How can all this help you save taxes, and more important avoid the LRTTs out there to trip your roll “over” the IRS tax cliff? First and foremost never use an indirect roll. Use trustee to trustee direct rolls. Second, if you absolutely have no other choice but to use an indirect roll have your tax attorney coordinate with your originating broker and your destination broker to make the 60 day window bullet proof. Third, make sure your 1099R is correct. If not, send it back to the broker and demand that it be amended even if it means you file an extension. While you’re on extension, wait for your 5498 and make sure that the form 5498 is correct as well. Finally, don’t file your tax return claiming tax free treatment of the roll until your tax attorney includes in your tax return his written transaction history documenting names and phone numbers of the broker witnesses on both sides of the roll. When you get audited by the IRS disallowing your roll you will have a bullet proof tax return ready to spring from the LRTTs that the Government has sprung and roll that distribution right back to the IRA tax free where it belongs. Thanks for joining Chris Moss CPA on TaxView.
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Chris Moss CPA