From: Ed Slott © 2004

Author of “The Retirement Savings Time Bomb and How To Defuse It”

Publisher of Ed Slott’s IRA Advisor

www.irahelp.com

April 27, 2004

Rockville Centre, NY

For the First Time …

IRS Denies Ruling Request to Extend the 60-day Rollover Rule

Private Letter Ruling (PLR) 200417033

Dated: January 30, 2004

Released by IRS on April 23, 2004

Denied!

On April 23, 2004 IRS issued the first Private Letter Ruling where they ruled against a taxpayer asking to have the 60-day rollover requirement waived on a 2002 IRA distribution. IRS ruled unfavorably once before but that was because the request involved a 2001 IRA distribution and IRS did not have authority to waive the 60-day rollover requirement until 2002. Of the more than 30 favorable rulings issued so far on this point for qualifying taxpayers, this is the first time IRS denied the request for more time to complete the rollover.

Background:

These rulings relate to the fact that a cash distribution from an IRA (or other tax-deferred retirement account) must be re-contributed in cash within 60 days to an IRA (or other retirement account) in order to maintain the tax deferral.

Until the 2001 tax law, the 60-day limit was absolute. That tax law contained a provision, effective in 2002, that allows the IRS the discretion to grant waivers to the 60-day rule. The committee report indicated that this might be permitted in the case of a taxpayer's death, for example.

This allowed IRS to grant a time extension to return the funds to an IRA or other retirement account and maintain the tax deferral. In January 2003, IRS issued Rev. Proc. 2003-16, which included guidance on applying for a 60-day rule waiver.

In many of the previous rulings where IRS ruled favorably, IRS granted a waiver of the 60-day rollover requirement and gave each taxpayer 60 days from the ruling date to complete the rollover by contributing the funds back to an IRA.

In each of the rulings, IRS noted that “Section 408(d)(3)(I) of the Code provides that the Secretary may waive the 60-day requirement under sections 408(d)(3)(A) and 408(d)(3)(D) of the Code where the 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. Only distributions that occurred after December 31, 2001, are eligible for the waiver under section 408(d)(3)(I) of the Code.”

In addition, IRS referred to Rev. Proc. 2003-16, 2003-4 I.R.B. 359, which “provides that in determining whether to grant a waiver of the 60-day rollover requirement pursuant to section 408(d)(3)(I), the Service will consider all relevant facts and circumstances, including:

 (1) errors committed by a financial institution;

(2) inability to complete a rollover due to death, disability, hospitalization, incarceration, restrictions imposed by a foreign country or postal error;

(3) the use of the amount distributed (for example, in the case of payment by check, whether the check was cashed); and

(4) the time elapsed since the distribution occurred.”

The First Denial From IRS

IRS had been extremely liberal in allowing an extension of the 60 days for all kinds of reasons, but not this time. In all the other rulings the taxpayers wanted to complete a valid rollover and the IRS bent over backwards to help them do that, even if they missed the 60-day limit. The point of Congress granting authority to IRS allowing the relief was to promote portability of funds between IRAs and other retirement plans. In this ruling, the taxpayer went far beyond what Congress and the IRS had in mind.

Facts of this Ruling:

Here, the taxpayer withdrew funds from his IRA in May and August 2002 because he was out of work, his unemployment benefits ran out, and he needed the money to live on and pay bills. In late 2002 (after the 60 days expired) he obtained permanent employment and wanted to redeposit the funds in his IRA so that the previous distributions would not be taxable. IRS denied this request because they said he really had no intention of doing a rollover but instead was in effect using the IRA distributions as a “short term interest free loan” and IRS ruled against him. He was not permitted to redeposit the funds into an IRA and the 2002 IRA distributions will remain taxable.

In the ruling, IRS stated the following, explaining why it denied the ruling request:

“It appears from the information you submitted that you used the funds from your IRA distribution to pay living expenses and educational tuition. In effect, you have engaged in a transaction that amounts to a short term interest free loan. The Committee Report describing legislative intent indicate that the Congress enacted the rollover provisions to allow portability between eligible plans including IRAs. Using a distribution as a short term loan to cover personal expenses is not consistent with the intent of Congress to allow portability between eligible plans. The information presented does not demonstrate circumstances that would justify a waiver of the 60-day rollover period pursuant to section 408(d)(3)(I) of the Code. Under these circumstances, the failure to waive the 60-day requirement would not be against equity or good conscience.

Therefore, the Service hereby denies the request to waive the 60-day rollover requirement with respect to the distribution of Amount B.”

Lessons Learned:

There are actually two lessons learned here.

The first is to use direct transfers (trustee-to-trustee transfers) when moving retirement funds from one plan or IRA to another. If you truly intend to transfer the funds to another retirement account (unlike the case here), you should have the funds transferred directly and not do a rollover.

Rollover vs. Direct Transfer (trustee-to-trustee transfer)

A rollover is where you withdraw funds from your IRA and redeposit them to another IRA or plan. With a direct transfer, the IRA funds are never withdrawn and redeposited. They go directly from one financial institution to another.

Although all the taxpayers who qualified received favorable rulings, they still had to go through the time and expense of requesting a PLR from IRS. At least some of the problems in these rulings could have been avoided if the funds were transferred directly from one IRA institution to another via a trustee-to-trustee transfer (a direct transfer). With a trustee-to-trustee transfer there is no 60-day rule since the funds are transferred directly and immediately.

You can only use the 60-day rule once per 12 months. The IRS could not, by law, rule favorably if you had already used the 60-day rollover for the same funds within the past 12 months, even if you had a legitimate reason. A trustee-to-trustee transfer avoids the 60-day rule and the one rollover per year rule. You can do an unlimited amount of trustee-to-trustee transfers within a year. A trustee-to-trustee transfer also avoids the 20% mandatory withholding when you withdraw from a company plan. If you make a direct transfer from the 401(k) to your IRA, there is no 20% withholding requirement.

The second lesson is that IRA owners should not try to use the 60-day rule to borrow from their IRA. You see this kind of advice all the time and now it is clear that if you borrow from your IRA and cannot return the funds to an IRA or plan within the 60 days (which is often the case), IRS will not bail you out. You will owe income tax on the full distribution, plus a 10% early withdrawal penalty if you were under age 59 ˝ when you withdrew from your IRA (and no exceptions to the 10% penalty applied). Do not use IRA funds for short-term loans.

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By Ed Slott © 2004

Reprinted from Ed Slott’s IRA Advisor  (June 2004 issue)

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