Review Your Options Before Rolling Over IRA

retirementAs many people are aware, if a distribution is made from an IRA prior to the time the individual has attained age 59 1/2, the distribution is classified as a premature withdrawal and an additional 10% penalty tax is levied on the amount of the withdrawn funds. There are, however, some exceptions to this rule. One of the most common exceptions is if a person takes a series of substantially equal periodic payments over a period of time.

The Internal Revenue Code contains a provision which provides that upon the death of an IRA owner, if the beneficiary inherits the IRA and takes his or her share as a beneficiary rather than rolling it into his or her own IRA, the beneficiary may make a premature withdrawal from the inherited IRA without a penalty.

Most people are familiar with the rule that upon the death of an IRA owner where the spouse is the primary beneficiary he or she may make a direct rollover into his or her own IRA without incurring any income tax liability. In a recent case, Charlotte Campbell, the surviving spouse, elected to rollover her deceased husband’s IRA into her own previously established IRA. After four years had passed, Mrs. Campbell decided to withdraw a significant portion of her IRA. At the time of Mr. Campbell’s death, he was 73. At the time that Mrs. Campbell rolled Mr. Campbell’s IRA into her own IRA, she was 51 and she was 55 years old at the time that she made her withdrawal.

Mrs. Campbell did not pay the IRS the 10% penalty on the premature withdrawal however, she did claim the distribution as income.

The IRS levied the 10% penalty on the premature distribution since Mrs. Campbell was 55 years old at the time that she made the withdrawal.

Mrs. Campbell argued that her husband’s funds did not lose their character after she had rolled them into her own IRA. Mrs. Campbell also argued that she did not have to pay a 10% penalty because she had inherited the IRA from her deceased husband.

The Tax Court held that when Mrs. Campbell received the IRA from her deceased husband, she made a direct rollover into her own IRA. Since she rolled over her deceased husband’s IRA, at the time she made her withdrawal, the proceeds did not come from an Inherited IRA, but rather from Mrs. Campbell’s own IRA. The Tax Court stated in its decision, “We further find that the source of the amount received, whether originating from her deceased husband’s IRA, or petitioner’s own contributions, is irrelevant. We recognize that petitioner may not have technically redesignated the IRA as her own. She did not need to ‘redesignate’ the IRA. The IRA was her previously existing account. We therefore find no merit to petitioner’s argument that the rolled over funds retain their character because she did not redesignate her IRA”. (Gee v. Commissioner, 127 T.C. 1 (2006)).

The Tax Court also stated that, “Petitioner cannot have it both ways. She cannot choose to roll the funds over into her own IRA and then later withdraw funds from her IRA without additional tax liability because the funds were originally from her deceased husband’s IRA. Accordingly, once petitioner chose to roll the funds into her IRA, she lost the ability to qualify for the exception from the 10-percent additional tax on early distributions. The funds became Petitioner’s own and were no longer from her deceased husband’s IRA once petitioner rolled them into her own IRA. The funds therefore no longer qualify for the exception.” (See id.) Unfortunately for Mrs. Campbell if she had not rolled over her deceased husband’s IRA into her own IRA, the distribution would have been exempt from the 10% additional tax penalty.

Litigation with the IRS is time consuming and expensive. Before rolling an IRA into your own separate IRA, you should obtain advice to determine what the various options are as they relate to your specific fact situation. This small step can save you time and money in the long run.

Our estate planning attorneys offer a FREE Consultation to learn about your specific circumstances, answer your questions and provide you with a recommended action plan for your specific needs.  There is no obligation and no cost.

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