The US income tax system relies on voluntary reporting by individuals, with just enough cross-checking (through W-2s, 1099s and other third-party documentation), and the possibility of individual audits to encourage compliance. But what happens when the crosschecking shows too many taxpayers are in need of individual attention? In an interesting bureaucratic twist, the Internal Revenue Service has opted for more voluntary reporting – while making individual attention very expensive for the taxpayer. Here’s the rest of the story:
The Problem of Too Many Rollovers
As the Baby Boomers reach age 70, there has been a surge in required minimum distributions from qualified retirement plans. To meet these requirements, many retirees are reconfiguring their holdings, often by transferring and/or consolidating funds via rollovers.
IRA rollover provisions give account holders a 60-day window in which to take a tax-free distribution from an existing IRA and deposit it into a new one. As long as the distribution is re-deposited to a new IRA within 60 days, there are no income taxes or early-withdrawal penalties which might be associated with a normal distribution. (Note: A rollover should not be confused with an IRA transfer, which is a transaction in which IRA funds are moved between financial institutions without a distribution to the account holder.)
The Boomer-fueled increase in rollovers has resulted in a corresponding rise in transactions that haven’t been completed on time. Each failed rollover requires reporting to the IRS, either to assess taxes and penalties, or to determine if the failure is the result of a correctable error or circumstance.
In the past, taxpayers looking for tax and penalty relief from failed rollovers had to petition the Internal Revenue Service for a review in the form of a Private Letter Ruling (PLR) to determine if their case qualified for an extension or exemption. But with so many taxpayers asking for individual waivers, the IRS just can’t keep up. Instead, they are attempting to resolve the majority of failed rollovers without PLRs.
If the taxpayer can attribute the rollover failure to one of 11 IRS-approved conditions, the taxpayer can “self-certify” that their situation deserves an exemption. Here are reasons the IRS lists as acceptable conditions for an exemption from the 60-day rollover deadline:
- An error was committed by the financial institution receiving the rollover contribution or making the distribution to which the rollover relates;
- The distribution, having been made in the form of a check, was misplaced and never cashed;
- The distribution was deposited into and remained in an account that the taxpayer mistakenly thought was an eligible retirement plan;
- The taxpayer’s principal residence was severely damaged;
- A member of the taxpayer’s family died;
- The taxpayer or a member of the taxpayer’s family was seriously ill;
- The taxpayer was incarcerated;
- Restrictions were imposed by a foreign country;
- A postal error occurred;
- The distribution was made as a levy to collect prior taxes owed, but the proceeds of the levy have been returned to the taxpayer; or
- The party making the distribution to which the rollover relates delayed providing information that the receiving plan or IRA required to complete the rollover despite the taxpayer’s reasonable efforts to obtain the information.
To assist with this self-reporting, the IRS even provides a model letter (found in the Appendix to IRS Revenue Procedure 2016-47) that taxpayers can print, write in the amount, and check off the appropriate reason for missing the deadline. This letter is not sent to the IRS, but submitted to the institution serving as custodian for the new IRA (which then reports it to the IRS).
If the taxpayer cannot attribute their rollover problem to one of the 11 pre-approved conditions, they may still request a PLR, but at a much higher cost. Previously, the IRS assessed “user fees” for PLRs based on the amount involved.
Prior to the new guidelines, a rollover of less than $50,000 incurred a PLR fee of $500. From $50,000 to $100,000, it rose to $1,500. For any amount over $100,000, the cost was $3,000. Now, the PLR fee for a rollover waiver is $10,000 – no matter how large or small the amount in question.
How This Impacts You
It is important to note that not all reasons for missing a rollover deadline are valid. Some taxpayers see the 60-day rollover window as a short-term loan opportunity, in which the funds can be used tax-free for 60 days before being redeposited to a new IRA. The increased cost of a PLR is a way to discourage abuse.
For example, if $30,000 of rollover funds are used as a down payment on a new house, but the old house doesn’t sell in time to replace the down payment, the account holder faces a two part dilemma: wondering whether the IRS would grant an exemption, and whether it’s worth paying $10,000 to find out.
Additionally, IRS rules prohibit sequential IRA rollovers (where a distribution from one IRA is used as the deposit for a previous rollover now due), and taxpayers are allowed just one IRA rollover in a 12-month period. Because direct transfers are the prevailing method for repositioning qualified retirement account assets today, the time limitation on rollovers is usually not an impediment to reconfiguring IRA assets. But since there are still circumstances where a rollover may be either required or preferred, individuals should be careful; taking a rollover today means not being able to take another one for 12 months.
As an example, suppose a soon-to-be retiree wants to consolidate three IRAs in one annuity contract to provide regular distributions to meet RMD requirements. Only one of the accounts could be a rollover; the other two would have to use direct transfers to reposition the funds.