Be Careful About Moving Your IRA Money

The Tax Court has recently highlighted another IRA rollover tax trap. There are two basic ways to move money from one IRA to another—a direct rollover and a trustee-to-trustee transfer. Although a direct rollover may be more convenient, the trustee-to-trustee transfer is safer.

If money or property is transferred from one IRA or Keogh account to a new IRA through a trustee, the transfer is tax-free. As an alternative, the taxpayer may withdraw property or money from the IRA or Keogh and then, without incurring taxes, may deposit the money or property into another IRA or Keogh within sixty days. In this direct rollover, the initial withdrawal is subject to a 20% withholding but the transfer is otherwise tax-free.

In a case recently before the Tax Court, a taxpayer withdrew money from his IRA and Keogh accounts and used most of it to purchase stock. Then, within the sixty-day period, he deposited the stock and the leftover cash into another IRA. That’s where he went wrong. The Tax Court read the Internal Revenue Code closely to mean that the contribution to the new IRA had to be in exactly the same form as had been withdrawn from the old IRA or Keogh, i.e. the same amount of money and the same property. Violating this rule proved costly for the taxpayer, who became responsible for taxes and a significant negligence penalty.

This highlights one of the disadvantages of making a direct rollover rather than doing a trustee-to-trustee transfer. Here, had the taxpayer transferred the money first and then directed his new IRA to purchase the stock, he would have avoided the taxes and penalty.

There are a number of other complications involved in the making of direct rollovers from one IRA or Keogh to a different IRA. If you are considering taking money or property out of one account and transferring it to another IRA within sixty days, you first should seek counsel to avoid the trap described in this article and a number of other such traps for the unwary.