Considering a Tax-Free Rollover? Take Note of the Tax Court’s Additional Requirement…

September 24th, 2014 by Lapekas Law Staff

Yesterday the U.S. Tax Court added an additional requirement for a distribution from an individual retirement plan (and subsequent contribution to an eligible retirement plan) to qualify as a tax-free rollover. In  Bohner v. Commissioner, 143 T.C. 11 (Sept. 23, 2014) the Tax Court essentially held that an “eligible retirement plan” may determine whether an individual’s IRA rollover is tax-free by simply refusing to “accept” tax-free rollovers—regardless of whether the form of the transaction otherwise qualifies as a tax-free rollover. If you read no farther, take note: before you attempt to conduct a tax-free rollover from one retirement account to another, not only must you be sure it qualifies under IRC § 408(d)(3)(A), but you must also be certain the retirement account to which you are transferring the funds accepts rollovers. “Accepts” means that, not only must the IRA accept the deposit, but it must also accept the tax treatment of a subsequent distribution of that deposit.

Mr. Bohner was en employee of the Social Security Administration and participated in the CSRS (the Civil Service Retirement System) during his employment. When he retired in 2010, he was notified that he could increase his CSRS retirement annuity if he remitted $17,832 (this amount accounted for the period of his employment during which he did not make any contributions to his CSRS account).

Mr. Bohner did not have enough money in his checking account to fund the entire amount, so he borrowed a portion of the $17,832 from a friend. He withdrew money from his traditional IRA at Fidelity Investments to reimburse himself and to repay his friend. When he filed his 2010 tax return, Mr. Bohner did not include any amount withdrawn from his Fidelity IRA in his taxable income. He considered the IRA withdrawal and payment to the CSRS as a tax-free rollover. The IRS, however, did not, and treated the withdrawal as includable in his taxable income.

Generally, any previously un-taxed amount paid out of an individual retirement plan is includable in gross income of the payee. IRC § 408(d)(1). However, if the distribution qualifies as a “rollover contribution” under section 408(d)(3), the entire amount is not taxable. With some exceptions not applicable here, section 408(d)(3) provides generally that an amount paid out of an individual retirement plan is a rollover contribution if

(i) The entire amount received is paid into an individual retirement account or individual retirement annuity for the benefit of such individual not later then the 60th day after the day he received the payment; or

(ii) The entire amount received is paid into an eligible retirement plan for the benefit of such individual not later than the 60th day after the date on which the payment or distribution is received, except that the maximum amount which may be paid into such plan may not exceed the portion of the amount received which is includible in gross income.
The CSRS is an “eligible retirement plan.”

Interestingly, though the Tax Court perhaps could have reached the same result on other grounds (the statutes governing CSRS do not allow for pretax contributions, or the timing of the Fidelity distribution and CSRS contribution precluded rollover treatment), its primary reason for reaching its holding was that the “CSRS did not accept [Bohner’s] remittance as a rollover.”

Judge Buch’s dissenting opinion addresses issues of statutory interpretation and is an interesting read in and of itself for this reason. Judge Buch points out that the Court “candidly states that ‘there is no provision in the Internal Revenue Code concerning whether a qualified trust [the CSRS] must accept a rollover that is an indirect transfer from an IRA in order to constitute an eligible retirement plan for purposes of section 408(d)(3)’. Then they go on to create such a rule.”

He further notes that the “The strongest statutory authority the opinion of the Court can muster is the statement ‘The statutory provisions governing CSRS do not include a provision allowing pretax employee contributions.’ But the statutory framework of CSRS also does not include a provision prohibiting pretax employee contributions. A review of that statutory framework reveals that it is silent on the subject of its Federal income tax treatment.”

The Bohner decision is ripe fodder for academic discussion, but practically speaking, unless the 11th Circuit holds otherwise, we must consider that section 408(d)(3)’s definition of a “rollover contribution” has just been expanded.