Tax Court Limits IRA Rollovers, IRS Grants Transition Relief

The IRS recently issued an announcement that will impact taxpayers’ use of IRA rollovers.  An IRA rollover is technically a receipt of funds from one IRA followed by a contribution to another IRA within the 60-day period beginning the day after the date of receipt.  If the rollover is accomplished within the 60-day period, the receipt of the IRA funds is not taxable.  If the contribution to the second IRA occurs after 60 days, the receipt of the IRA funds is considered a taxable distribution (with a 10% early withdrawal penalty if the owner is younger than 59 ½) and the contribution to the second IRA will generally not be permitted and will be counted as an excess contribution subject to penalties.  A similar result occurs if more than one rollover is made within 12 months.  The 12-month period is measured beginning on the date of receipt. 

The 12 month provision discussed in IRC §408(d)(3) has been interpreted by IRS Publication 590 and Prop. Reg. 1.408-4(b)(4)(ii), which state that the once-every-12 months IRA rollover provision be applied on an IRA-by-IRA basis.  On January 28, 2014, the Tax Court ruled in Bobrow v. Commissioner, T.C. Memo. 2014-21, that the once-every-12 months IRA rollover provision applies at the taxpayer level and not at the IRA level.  This decision greatly disrupts the commonly accepted interpretation of the tax law.  On March 20, 2014, the IRS issued Announcement 2014-15 stating that it will follow the Tax Court’s decision and revise Publication 590 and the regulation.  The announcement grants transition relief applying the former interpretation to IRA rollovers made through December 31, 2014, to give IRA owners and custodians time to change to the new procedure.

A direct transfer by one IRA custodian to another IRA custodian is termed a direct “trustee to trustee” transfer and is not considered a rollover for this purpose.  Therefore, the practical implication of this new ruling is that taxpayers should move IRA funds by arranging for the direct transfer from one institution to another institution, rather than receiving the funds and then depositing the funds within the 60-day period.

New Obama Budget Proposal Includes Old Tax Increases and Some Surprises

Pres. Obama released his fiscal year 2015 budget proposal on March 4, 2014.  Most commentators view the proposal as a political document designed for the elections this fall.  Nevertheless, some tax proposals have a way of finding themselves law in the future and so it is important to be aware of the proposals.

The following tax increases are proposed:

·       Increase IRS funding by 6.3% to increase the number of tax audits.

·       Reduce the tax rate benefit of itemized deductions to 28% (which impacts taxpayers paying tax at the higher 33%, 35%, and 39.6% rates).

·       Implement the so-called “Buffett Rule” to require millionaires to pay no less than a flat 30% tax on income after the deduction of charitable contributions.

·       Prevent individuals from saving additional money in tax-preferred retirement accounts once their accumulated balances exceed roughly $3.2 million per person.

·       Require non-spouse beneficiaries of IRAs and qualified plans and annuities to fully distribute the inherited account by the end of the fifth year.
·       Require Roth IRAs to make lifetime minimum required distributions when the account owner turns age 70 1/2 (currently only Roth 401(k) accounts are required to make lifetime MRDs).

·       Increase the estate, gift, and generation skipping tax (GST) rate from 40% to 45%.

·       Lower the estate tax and GST exemptions from $5.34 million to $3.5 million.

·       Lower the gift tax exemption from $5.34 million to $1.0 million.

·       Require grantor-retained annuity trusts (GRATs) to have a minimum 10-year term and to have a remainder value greater than zero.

·       Eliminate the benefits of sales to “defective” grantor trusts by coordinating the income tax rules with the transfer tax rules.

·       Limit the duration of the exemption from GST tax to 90 years for “dynasty” trusts created after the date of enactment.

·       Eliminate the unlimited number of permitted annual gift tax exclusions for gifts of present interests of $14,000 in favor of a flat $50,000 per donor for all gifts.

·       Require professional service business profits to be subject to Social Security and Medicare taxes regardless of whether the business is conducted through an S corporation, an LLC, or a limited partnership.

·       Repeal the last-in, first-out (LIFO) method of inventory tax accounting.

·       Limit the amount of real estate like-kind exchange gain that can be deferred to $1 million per taxpayer per year after 2014.

·       Tax “carried interests” (partnership or LLC profits interests) as ordinary income instead of long-term capital gain.

·       Eliminate the specific identification method and require the average cost method for identifying the cost basis of stocks purchased after 2014.

Several new tax-cut proposals are proposed:

·       Permanently increase the Section 179 equipment expensing limit from $25,000 to $500,000.

·       Permanently extend the research and experimentation tax credit (expired after 2013).

·       Permanently increase the exclusion for qualified small business stock to 100%, and extend the time for tax free reinvestment from 60 days to 6 months for stock held for more than 3 years.

·       Make the expanded American Opportunity Tax Credit for college costs permanent.  It is currently scheduled to revert to the lower credit amount after 2017.

·       Allow non-spouse beneficiaries of IRAs and qualified plans to rollover the inherited balances within 60 days (presently only spouse beneficiaries can do so).

·       Eliminate required minimum distributions for those who attain age 70 ½ if the IRA balance is $100,000 or less.

·       Establish the MyRA savings bond announced in the state of the union address.