It is tax time, so I wanted to write about an interesting tax court case that was recently decided.  After reading this article, you be the judge.  Does the IRS have integrity?  To me, a big part of integrity is sticking by your word.

A recent decision of the federal tax court could have broad implications for taxpayers.  The court decision involves rollovers from individual retirement accounts or IRAs.

There are two methods for moving money between IRAs.  The taxpayer can transfer money from one IRA directly to another IRA.  A direct IRA-to-IRA transfer is a non-taxable event.

The second method involves an IRA rollover.  Through this method, the taxpayer removes money from his IRA and has up to sixty days to re-deposit his money into another IRA.  If the taxpayer re-deposits the money into a new IRA, then the distribution is not taxable.

Many taxpayers have multiple IRAs.  For instance, a taxpayer might have an IRA worth $10,000, an IRA worth $70,000, and an IRA worth $35,000.

For the past twenty years, the IRS has had a rule that a taxpayer can make an IRA-to-IRA rollover once every twelve months and that the twelve-month rule applies separately to each IRA that the taxpayer owns.

In other words, in my example above, the taxpayer could rollover the $10,000 IRA in January, the $70,000 IRA in June, and the $35,000 IRA in September, and as long as the taxpayer waited twelve months from the date of each rollover to rollover that same IRA again, then each of the rollovers would not be treated as a taxable event.  The twelve-month rule applied per IRA; it did not apply to the IRAs in the aggregate.

The IRS even stated this position in a publication, publication 590.  An IRS publication is a document that explains how a certain tax rule works.  Since the IRS stated this rule in a publication, many taxpayers took this position to be the law and made multiple IRA rollovers in the same year, but never involving the same IRA in any twelve-month period of time.

In the recent court case, however, the IRS sought to tax an individual who made multiple IRA rollovers in the same year, even though no one of the taxpayer’s IRAs was rolled-over more than once in a given twelve-month period of time.  Stated otherwise, the IRS was seeking to tax the individual in contravention of the rules and examples provided in its own publication.

In this case, the IRS contended that the rollover rule only permits a taxpayer to make one IRA rollover per twelve-month period of time, no matter how many IRAs a taxpayer owns.  So, for instance, if the taxpayer owns three IRAs and rolls over one of those IRAs, then the taxpayer cannot rollover any other IRA for twelve months without the distribution from the subsequent IRAs being treated as a taxable distribution.

Stunningly, the tax court agreed with the IRS.  So, the taxpayer in this case, who took his actions based upon a longstanding interpretation of the law, an interpretation that the IRS published to taxpayers, was taxed on the subsequent distributions he took in the given tax year.

Personally, I have no problem with the IRS limiting rollovers to once every twelve months.  What I think is unconscionable and wrong is the IRS publishing a document that tells taxpayers doing “this” is all right, then litigating against a taxpayer who relies on the IRS’s publication, claiming the taxpayer did something wrong.