Two recent letter rulings show that 'distribution' is a flexible term.
Many tax effects hinge on receiving a "distribution" from a retirement plan. Two recent letter rulings show that "distribution" is a flexible term, that money can be "undistributed," and that even I can be wrong sometimes.
Question: Can a distribution be "undistributed"?
Sean inherited a 401(k) plan from his mother. Sean sent the plan administrator properly filled out forms instructing the administrator to transfer the inherited 401(k) account to an "inherited IRA" (Account #123) that Sean had previously opened at XYZ Bank to receive these funds. The 401(k) account was properly titled "Sean, as beneficiary of Mother." The IRA Account #123 was also properly titled "Sean, as beneficiary of Mother." Sean also has a taxable checking account at XYZ Bank (Account #456). XYZ Bank, due to a clerical error, deposited the funds into Sean's taxable checking Account #456 instead of into the inherited IRA Account #123.
Can this mistake be fixed, or is Sean stuck with a 100% distribution of this inherited retirement plan?
Once upon a time I would have said Sean has no remedy other than a possible claim against XYZ Bank for its negligence. I thought that once funds have been distributed out of a retirement plan to a nonspouse beneficiary, there is no way to get the funds into another plan or even back into the same plan. You see, I believed that once money was "out" of a retirement plan, it could not get back "in" to a retirement plan unless it was an eligible rollover distribution, and distributions to nonspouse beneficiaries are never eligible rollover distributions. Nonspouse beneficiaries can have a direct trustee-to-trustee transfer from an inherited plan to an inherited IRA but cannot use the "60-day rollover" method.
How wrong I was. Apparently there is another pathway used by savvy practitioners, plan administrators, and IRA providers--a path I call undistributing the distribution!
My change of viewpoint started when the IRS issued Private Letter Ruling 2011-39011, in which a father had died leaving his qualified retirement plan benefits to his minor child. The child's mother was appointed as guardian of the child. The retirement plan benefit was eligible for a "nonspouse beneficiary rollover" (i.e., a direct trustee-to-trustee transfer into an inherited IRA). Instead of arranging such a transfer, however, the mother-guardian requested a lump sum distribution on the child's behalf. The distribution was reported on the child's 2008 income tax return, and income tax was paid on it.
Apparently, the mother misused some or all of the child's funds. A new conservator was appointed, who obtained a court order compelling the mother to pay back the misappropriated funds. Because "But for the decision by [the mother/guardian] to receive a lump sum distribution...and her subsequent misuse of the funds" a tax-free transfer "could have been made to an inherited IRA," the IRS ruled that the funds could now be transferred into an inherited IRA, the child's income tax return for 2008 could be amended to erase the reported lump sum distribution, and the child could get a refund of the income taxes paid!
In effect, the IRS permitted a "late rollover" of the distribution. The IRS doesn't mention the 60-day deadline hardship waiver procedure for good reason--the distribution wasn't eligible for a 60-day rollover, so there is no "deadline" to be waived!
But subsequently I learned that such "impossible" transfers are not unheard of. Apparently if you can convince an IRA provider or plan administrator that it has made a mistake in sending money out of a retirement plan, you may be able to effect an "undistribution" of the funds. Some financial institutions have procedures for reversing a transaction, revising the paper trail, and even filing corrected "1099-R" forms with the IRS. I was told that the IRS itself even suggested this solution to one practitioner! I am indebted to Denise Appleby (see "Resources" below) and other "IRA gurus" who told me of their successes in helping participants and beneficiaries deal with these sticky problems.
So Sean should approach XYZ bank about revising its paper trail to show the correct account (the inherited IRA) as the recipient of this distribution. If he wants professional assistance with that process, I would suggest he call Denise Appleby or someone else experienced with this type of problem--not me!
Question: Can two distributions be considered one distribution?
Beatrice has been dissatisfied with the services of her IRA provider, ABC Company, and decided to move the account to a different provider, DEF Company. She was told that a direct IRA-to-IRA transfer would take weeks to complete, so to speed things up, she requested a distribution to herself of the entire IRA balance of $250,000. ABC Company sent her a check (payable to her) for the cash in the account ($160,000) on Date 1. She deposited that check in the new rollover IRA at DEF Company on Date 2. ABC Company took a little longer to liquidate some of the other investments in her IRA, but about 10 days after Date 1, on Date 3, they gave her a second check (also payable to her) for the remaining $90,000 of the account. She now wants to deposit this second check in her new rollover IRA at DEF Company, but isn't there a rule that a person cannot roll over, to an IRA, two distributions from the same IRA received within 12 months of each other? Is she stuck with a taxable distribution regarding that second check?
Answer: Again, maybe yes!
As of a while ago, I would have said Beatrice has a big problem. There is a hard-and-fast rule that a person cannot roll over (to an IRA) two distributions received within 12 months of each other from a single IRA. The IRS cannot waive this rule.
But then along came Private Letter Ruling 2011-05047, in which "Taxpayer A" received "distributions" (plural) from an IRA that he sought to roll over. The ruling recites that "On Date 1, Taxpayer A requested a total distribution of Amount D from IRA X. On the following day, Taxpayer A received most of the balance of IRA X and, on Date 2, Taxpayer A received a check for the remainder of the balance of IRA X." Taxpayer A intended to roll over "Amount D" to another IRA he had already established, but due to a series of family emergencies and a serious medical condition he missed the 60-day rollover deadline.
The IRS allowed a late rollover (i.e., waived the 60-day rollover deadline) for both of the "distributions...totaling Amount D." Although the one-rollover-per-12-months rule is recited in the ruling, the IRS does not seem to view it as applying to Taxpayer A's "distributions." Is that because Taxpayer A had requested a total distribution? Is this ruling telling us that if you request a total distribution and the IRA provider pays it out to you piecemeal it is still considered one single distribution for purposes of the one-rollover-per-12-months rule? Or is there some other unspecified rationale as to why these two distributions were really just one distribution? Or was this just a mistake by the writer of this letter ruling?
Although you cannot rely on someone else's private letter ruling as precedent, this ruling shows there may be more flexibility regarding the one-rollover-per-12-months rule than previously thought.
Resources: For Denise Appleby consulting, visit http://applebyconsultinginc.com. I highly recommend Denise's charts and quick reference guides for retirement and investment professionals.
For the "one rollover per year rule," see § 408(d)(3)(B) of the Internal Revenue Code, and explanation at ¶ 2.6.05 (pages 188–190) of my book Life and Death Planning for Retirement Benefits (7th ed. 2011; http://www.ataxplan.com).
Natalie Choate will be speaking at a location near you if you live in Boston (Nov. 19, 2012) or Cambridge (April 19, 2013), Mass.; South Bend (Oct. 17, 2013), Evansville (Nov. 16, 2012), or Indianapolis (June 21, 2013), Ind.; Atlanta (Nov. 1, 2013); San Diego (Feb. 15, 2013), or San Francisco (April 23-24, 2013); St. Charles, Ill. (Nov. 29, 2012); Venice/Sarasota (Jan. 8, 2013), Orlando (Jan. 17–18, 2013), or Palm Beach Gardens (Feb. 20, 2013), Fla.; Manchester, N.H. (March 7, 2013); Overland Park, Kan. (April 26, 2013); Asheville, N.C. (May 1, 2013); Columbus, Ohio (May 17, 2013); or Denver (Aug. 9, 2013). See all of Natalie's upcoming speaking events at http://www.ataxplan.com/seminars/schedule.cfm.