When is a rollover not a rollover?
The tax court had a moment of dissent this week over the question in 143 T.C. No. 11 (Bohner).
The taxpayer, a retired federal government employee, wanted to increase his retirement pension. To do so under the Civil Service Retirement System (CSRS), he could elect to remit a make-up contribution of $17,832. That amount would make up for a period during which no retirement contributions had been withheld from his salary and take the place of after-tax contributions he did not make originally. To make the election, he had to send the money by April 28, 2010.
During April 2010, the taxpayer borrowed money from a friend, made a $5,000 withdrawal from his traditional IRA, and used funds from his own bank account to come up with the $17,832. He mailed a check to the CSRS on April 27, 2010.
In May 2010, he requested another distribution from his traditional IRA in the amount of $12,832. He used those funds to reimburse his friend and to replenish his own bank account.
At year end, the trustee of the traditional IRA sent the taxpayer Form 1099 showing the total distributions of $17,832 and indicating the distributions were fully taxable.
There’s no dispute CSRS is considered a qualified retirement plan and that the taxpayer could deposit the funds. The question is whether one or both of the withdrawals from his traditional IRA were rollover contributions to CSRS.
The taxpayer says they both are. He reported the withdrawals on his tax return but marked them both as nontaxable.
The IRS says the deposit to CSRS did not constitute a rollover contribution because CSRS does not, and is not required to, accept rollovers.
The IRS also argues the deposit to CSRS was not a rollover because the funds paid to CSRS were not a distribution from an IRA (because the actual money for the check to CSRS came from the taxpayer’s bank account and his friend).
The court dismissed the second argument, saying tax law does not require a taxpayer to roll over the exact same money received in a distribution from an IRA.
But the first argument—that the deposit was not a rollover because CSRS does not accept rollovers—led to dissent.
Which of these three opinions do you think was the final decision?
The IRS is correct because CSRS has the discretion to choose to not accept rollover contributions. No statute or regulation restricts the discretion to do so.
CSRS chose not to accept rollovers. Since CSRS did not accept the taxpayer’s remittance as a rollover, he must include both withdrawals in his taxable income for 2010.
The law is fairly straightforward. The requirements for a distribution to be treated as a rollover are found in section 408(d)(3)(A)(ii). That section says a distribution from an IRA will not be included in gross income if the entire amount received from the IRA is paid into an eligible retirement plan no later than 60 days after the date the payment is received.
In this case, the taxpayer received the first distribution on April 15, 2010. Twelve days later, he wrote a check exceeding the amount of the distribution for payment into CSRS.
Accordingly, he fulfilled all of the requirements for a rollover contribution under section 408(d)(3)(A)(ii), and the first distribution should not be included in his gross income.
The second distribution may fail to qualify as a rollover for other reasons.
The first distribution should not be included in gross income because the taxpayer fulfilled the requirements for a rollover contribution.
The second distribution fails under the statutory definition of a rollover. The taxpayer made his payment into CSRS on April 27, 2010, before he received the second distribution on May 3, 2010.
Section 408(d)(3)(A) requires the amount received as a distribution be paid into the eligible retirement plan no later than 60 days after distribution. A distribution cannot be rolled over before it is received.
THE COURT’S DECISIONFor a full explanation, hover your mouse over the link
Even if CSRS accepted rollovers, section 408(d)(3)(A)(ii) would permit it to accept as a rollover only the portion of the IRA distribution includible in gross income.
The taxpayer attempted to effect a rollover in order to make the payment to CSRS with pretax dollars. He did not distinguish for CSRS the extent to which the payment was made with pre- or post-tax dollars. His deposit was to make up for wage contributions which were not withheld in prior years; those contributions would have been taxable.
CSRS does not provide for the acceptance of rollovers. Because the payment was not accepted as a pretax contribution, it is taxable.
Therefore, section 408(d)(3) does not apply and the $17,832 withdrawn from the traditional IRA must be included in gross income under section 408(d)(1).