Mistakes Proved Fatal To An IRA Owner’s Attempted Rollover

An IRA owners attempt to roll over a distribution from an investment in a certificate of deposit to an annuity was a failure, due to two critical mistakes, according to a recent Tax Court memorandum opinion.

The court explained away two other similar rulings in which taxpayers had been permitted to correct rollover mistakes and thus continue the tax deferral in their IRAs.

Richard Crow had an IRA at a local bank from 1976 to 1998. In August 1998, he met with a bank representative to discuss his future plans for the account. Subsequently he withdrew $39,295 from the account and closed it out, transferring the funds, along with some additional money, to a nonqualified annuity. In 1999, the bank sent Crow a Form 1099-R documenting the distribution as a taxable IRA withdrawal.

The receipt of a Form 1099 should have been an alert to Crow, as it suggests that a taxable transaction has taken place. The taxpayer (or the person who prepares his tax return) must follow up with the appropriate documentation to show why the distribution is not taxable. This should have led to the determination that the funds had been transferred in error to a taxable account, making it possible to correct the mistake.

Instead, Crow ignored the Form 1099 and did not claim the distribution as income on his 1998 return. Predictably, the IRS came knocking at his door about a year later, wanting to know why he had not included the distribution in his 1998 income. At that point, Crow contacted the bank.

In a curious sequence of events, the bank prepared a corrected Form 1099, listing the distribution as a rollover, and notified the IRS that the account “had been erroneously closed out as reg CD [sic] and should have been done as a trustee transfer.”

The bank even prepared a “Retirement Account Correction Worksheet” detailing what it called a recharacterization, and changed the distribution code on the Form 1099 to “Trustee Transfer.” However, the courts opinion indicates that the IRS had no record of receiving the updated form.

The general rule for IRA distributions is that while any nondeductible contributions (or other investment in the contract) may be excludable from income on a pro rata basis, all remaining amounts are included in gross income.

However, distributions that are rolled over to an eligible retirement account under the rollover rules set forth in the Code are not includable as income until they are later distributed from the receiving account. Even if the distribution is made directly to the taxpayer, he has 60 days, under the rollover provisions, to get the funds into the eligible retirement account.

(The definition of “eligible retirement account” has since been expanded by 2001 legislation, but the amendments would not have affected the outcome of this case.)

As of the date of disposition of this case, neither Crow, his attorneys nor the bank appeared to recognize that what was fatal to this case was the fact that the rollover was not made to an individual retirement annuity. Arguments were made and cases were cited in support of the proposition that a taxpayer who has done everything he could “reasonably be expected to do in order to roll over” the distribution should not be penalized by a bookkeeping error.

But the court held that the fact that the funds were still in a nonqualified annuity was fatal to Mr. Crows case.

Crow did get points for good behavior, so to speak. Since the court felt that he “had good cause and acted in good faith in not reporting the distribution on his 1998 return,” the court at least refrained from imposing the accuracy-related penalty on him for the 1998 error.

(The citation for this case is Crow v. Comm., TC Memo 2002-178.)

April K. Caudill, J.D., CLU, ChFC, is managing editor of Tax Facts & ASRS, publications of The National Underwriter Company.


Reproduced from National Underwriter Life & Health/Financial Services Edition, October 14, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.