IRA Custodian Not Telling IRA Owner About The 60-Day Rollover Rule Is Not A Valid Excuse For Missing The Deadline
Frustrated IRA owner, realizing that he owes taxes on a distribution that he planned to
Taxpayers often “borrow” funds from their retirement accounts to fill short-term financial needs, and roll over the amounts within 60 days of receipt. But, as a taxpayer found out in PLR 202033008, IRAs are not designed for loans, and taking one can result in unintended distributions that cannot be repaid to the IRA.
Taking a distribution from an IRA with the intent of returning (rolling over) the amount so that it is non-taxable is a risky business. Risky because missing the 60-day rollover deadline could result in the amount being included in income, which is the contrary effect of a rollover. The IRS will waive the 60-day deadline under certain qualifying circumstances, such as if the deadline is missed because of an error made by a financial institution. But, as one taxpayer found out in Private Letter Ruling (PLR) 202033008- the IRA custodian not informing him about the 60-day deadline is not a qualifying circumstance.
Amounts held in IRAs and other retirement accounts grow on a tax-deferred basis. This tax-deferred benefit is lost for amounts that are distributed (withdrawn), and such amounts are instead included in the account owner’s income for the year in which the distribution is made. But an exception applies to distribution amounts that are properly rolled over (recontributed to an eligible retirement account). One of the requirements that must be met for an amount to be ‘properly rolled over’, is that the rollover must be completed within 60 days of the account owner receiving the distribution.
The IRS May Waive The 60-Day Deadline
As provided under I.R.C. § 408(d)(3)(I ), the IRS has the authority to waive the 60-day deadline, where “…failure to waive such requirement would be against equity or good conscience, including casualty, disaster, or other events beyond the reasonable control of the individual subject to such requirement”. When determining whether to grant a waiver of the 60-day deadline, the IRS will consider factors such as whether the deadline was missed due to errors committed by a financial institution and the use of the amount distributed. For example, in the case of payment by check, whether the check was cashed and the funds were in use at the time the rollover was required to be completed.
Requirement For Written Explanation To Recipients Of Distributions Eligible For Rollover Treatment: Notice Of Rollover Rules (IRC § 402(f) Notice)
If a plan administrator receives a request for a distribution from an employer-sponsored retirement plan and the amount is eligible to be rolled over, the plan administrator must provide the distributee with a written explanation of the rollover rights and the tax and other potential consequences of the distribution or rollover. This includes an explanation that the distribution will not be subject to income tax, if the amount is rolled over to an eligible retirement plan within 60 days after the date on which the distributee receives the distribution.
This requirement applies to employer-sponsored retirement plans, which are defined benefit plans, defined contribution plans, 403(b) plans and eligible deferred compensation 457(b) plans.
It does not apply to any IRAs. Instead, the IRA owner is provided with an IRA Disclosure Statement that includes an explanation of the availability of income-tax free rollovers, when the IRA is established.
THE FACTS OF THE PLR
The following are the highlights of the PLR.
IRA Owner Took IRA Advice From Real Estate Agent
According to PLR 22033008, the IRA owner (let’s call him Sorano for the purpose of this article) and his spouse wanted to sell their existing home and purchase a new home. The couple worked with a real estate agent, who advised Sorano to take the money that was needed to purchase the new house from his IRA. The real estate agent assured Sorano that he could “repay the amount back into his IRA at a later time, after the sale of his current residence”, but made no mention of the 60-day rollover deadline.
Sorano had no other funds available to make the cash purchase, and followed the advice of his real estate agent, to take a distribution of the amount from his IRA.
While the distribution request form included language explaining that the amount may be taxable, it did not make any reference to whether the amount could be rolled over within 60 days. However, it included language to the effect that the IRA owner agreed to obtain legal and tax advice to make the determination of whether the amount would be taxable.
First Home Sold Too Late
When the first home was eventually sold, the 60-day deadline had already passed. And, for that reason, the IRA custodian refused to accept the amount for rollover.
Stated Reason for Waiver Request
Based on these facts and circumstances, Sorano asked the IRS to waive the 60-day deadline, asserting that his failure to meet the deadline was caused by the failure of the real estate agent and IRA custodian to inform him of the 60-day rollover period.
IRS’s Reason For Denying The Request
As mentioned earlier, the IRS will generally waive the 60-day deadline for reasons that include the deadline being missed due to errors committed by a financial institution. However, the IRS determined that this was not a case of ‘financial institution error’, and denied the waiver request. In their response, the IRS explained that:
- Unlike a plan qualified plan which is subject to the IRC § 402(f) notice requirement (see above), the Tax Code does not impose such requirements on IRA custodians; and the failure of the realtor and the financial institution to provide this information does not rise to the level of financial institution error.
- The information and documentation submitted to the IRS showed the amount was withdrawn for use as a short-term interest-free loan to purchase a new home, and the check was in fact cashed and used for that purpose. And,
- When Congress enacted the rollover provisions, the intent was to facilitate movement of assets between retirement accounts. Using a distribution as a short-term loan to cover personal expenses is not consistent with such intent.
IRA LESSONS FROM PLR 202033008
PLR 202033008 provides valuable lessons and insight into the operational and compliance requirements of IRAs, which include the following:
- When it comes to IRAs, much of the responsibility for compliance with rollover rules rests with the IRA owner.
- The IRS is strict about applying the rollover rules; and waivers are granted under narrowly defined exceptions. It is not always easy to meet these exceptions.
- IRA owners should seek IRA advice from trained IRA professionals. This includes advice on how to manage their IRA distributions and rollovers, to avoid unintended and adverse tax consequences. The 60-day deadline is only one of the many rules that apply. Another is the one-per-12-month IRA-to-IRA rollover rule. Under this rule, this rollover would not have been permitted if the IRA owner had already performed an IRA-to-IRA rollover during the preceding 12 months, even if it was being done within the 60-day period.
Another important point of consideration not mentioned in the PLR, is that the IRS charges a fee of $10,000 for a PLR request. This means that in addition to the unfavourable ruling which requires the amount to be included in income, the IRA owner is out of pocket for $10,000 plus any fees paid to the professional whose service was engaged to assist with requesting the PLR. Further, income tax would be owed on any pre-tax amount, plus a 10% early distribution penalty if the IRA owner was under age 59 ½ at the time the distribution was made from the IRA and does not qualify for an exception.
While PLRs are not authoritative, they give a good idea of how the IRS might respond to a case with similar facts and circumstances. And, PLR 202033008 presents an opportunity for others to learn from the mistakes that were made. For advisors, it creates an opportunity to educate clients about the rules that govern their IRAs.
IRA Custodians Can Help
Finally, the PLR demonstrates that there is room for improvement for IRA custodians who do not include more information about the tax consequences of distributions on their distribution request forms. While it is true that they have met their disclosure requirements by providing IRA owners with IRA disclosure statements, we all know that almost no one reads the fine print of these contracts, and even for those that do, it is not realistic to expect someone to check their IRA Disclosure Statement every time they want to engage in an IRA transaction. Adding an extra line or two, in a strategic–cannot be missed–place on an IRA distribution form, can help to avoid the negative consequences of an IRA owner being unaware of the tax implications of an IRA distribution.