Failed 60-Day Rollovers: When an IRA Transfer Becomes a Tax Bill

Retirees move money between accounts more than anyone. Consolidating old 401(k)s, chasing a better CD rate, changing advisors. Most of those moves are fine. The ones that go through your hands as a check are where things break.

The 60-day rule

IRC 408(d)(3)(A) lets you take a distribution from an IRA and avoid tax on it if you deposit the amount into an eligible retirement plan or IRA within 60 days after you receive it. Employer plan distributions have a parallel rule in IRC 402(c). Miss the 60 days and the amount is a distribution: taxable under 408(d)(1), and subject to the 10 percent additional tax under 72(t) if you are under 59 and a half and no exception applies.

The once-a-year rule

IRC 408(d)(3)(B) adds a second limit. You can do only one IRA-to-IRA rollover in any 12-month period. Since 2015, the IRS applies that limit across all of your IRAs combined, not account by account. The rule does not apply to:

• Trustee-to-trustee transfers, where the money moves directly between custodians and you never receive it.
• Rollovers from an employer plan to an IRA, or from an IRA to an employer plan.
• Roth conversions from a traditional IRA.

The lesson is simple. Ask for a direct trustee-to-trustee transfer whenever possible. It avoids the 60-day clock, the once-a-year rule, and withholding.

The 20 percent problem with employer plans

When an employer plan pays an eligible rollover distribution to you instead of directly to an IRA, IRC 3405(c) requires 20 percent federal withholding. To roll over the full amount within 60 days, you must replace that 20 percent from other money. If you deposit only the 80 percent you received, the withheld 20 percent is treated as a distribution: taxable, and possibly subject to the 10 percent tax. You get credit for the withholding on your return, but the tax on the unrolled portion is real.

Required minimum distributions cannot be rolled over

If you are past your required beginning date, the RMD for the year cannot be rolled over. IRC 408(d)(3)(E) says so. Retirees sometimes take a lump distribution in the first months of the year intending to roll it to a new IRA, without realizing that the first dollars out are treated as the year's RMD. Rolling that portion over creates an excess contribution. See RMD ages and the required beginning date.

The excess contribution trap

A failed rollover can hurt twice. First, the amount is a taxable distribution. Second, if you deposited it into an IRA anyway after the deadline, or in violation of the once-a-year rule, that deposit is not a valid rollover. It is a regular contribution, and almost always far larger than the annual limit. The excess is subject to a 6 percent excise tax under IRC 4973 for each year it stays in the account. People discover this years later, after several years of the 6 percent have stacked up. If you find an invalid rollover, remove the excess and its earnings promptly.

Check the 12-month window before you move anything

Before any indirect IRA rollover, look back 12 months across every IRA you own, including Roth, SEP, and SIMPLE IRAs, because the IRS treats all of them as one IRA for this rule. If you did an indirect rollover in that window, use a trustee-to-trustee transfer instead. Custodians do not track your rollovers at other institutions, so this check is yours to make.

Rescue option one: self-certification

Revenue Procedure 2020-46 lets you self-certify that you qualify for a waiver of the 60-day deadline. You give the receiving custodian a written certification, using the model letter in the revenue procedure, stating that you missed the deadline because of one or more listed reasons, such as:

• An error by the financial institution making or receiving the distribution.
• The distribution check was misplaced and never cashed.
• The money was deposited into an account you mistakenly thought was an eligible retirement plan.
• Your principal residence was severely damaged.
• A member of your family died.
• You or a family member was seriously ill.
• You were incarcerated.
• Postal error.
• The distribution was made on account of an IRS levy and the levied proceeds were returned to you.

You must complete the rollover as soon as practicable after the reason no longer prevents it, which the procedure treats as satisfied within 30 days. The custodian can accept the certification and report the deposit as a rollover. Self-certification is not a waiver granted by the IRS. If the IRS later examines the return, it can decide the requirements were not met. Be truthful and keep documentation of the reason.

Self-certification addresses the 60-day deadline. It does not fix a violation of the once-a-year rule.

Rescue option two: a private letter ruling

If no self-certification reason fits, you can ask the IRS for a waiver through a private letter ruling under section 408(d)(3)(I), which allows the IRS to waive the 60-day requirement when failing to do so would be against equity or good conscience. Rulings carry a user fee and take time. They make sense for large amounts.

There is also an automatic waiver in narrow cases where a financial institution received the funds in time and its error alone caused the failure.

Indirect rollovers in retirement

Retirees most often fall into the 60-day trap in three situations: moving a CD at maturity from one bank's IRA to another's, consolidating several small IRAs at once, and taking money out temporarily to cover a short-term need with the plan of putting it back. The third is the riskiest. Using an IRA as a 60-day loan is legal once in 12 months, but if the replacement money does not arrive in time, the withdrawal becomes taxable and you cannot fix it with a second rollover. If you need short-term cash, almost any other source is safer.

Fixing an invalid deposit before the 6 percent starts

If a late or second rollover landed in an IRA, you can usually stop the excise tax before it begins. Under IRC 408(d)(4), a contribution withdrawn along with its net income by the due date of your return, including extensions, for the year it was made is treated as if it had never been contributed, so the 6 percent tax under section 4973 does not apply for that year. The earnings withdrawn are taxable. Ask the custodian for a "removal of excess contribution," not an ordinary distribution, so the 1099-R is coded correctly. If the excess stayed in past that deadline, Form 5329 is where the 6 percent is reported for each year it remained.

How the IRS finds out

The distributing custodian files Form 1099-R. The receiving custodian files Form 5498, which reports rollover contributions. If the 1099-R shows a distribution and no matching rollover appears, or the rollover appears too late, the IRS's matching system can propose tax on the full amount. If you rolled over correctly, report the gross distribution on your return with the taxable amount as zero and write "rollover" next to the line, per the Form 1040 instructions. Leaving that off is a common source of notices. See Form 1099-R distribution codes that trigger IRS notices.

If the rollover truly failed

Then it is a taxable distribution and you report it that way. If you are under 59 and a half, check the exceptions in the 10% early withdrawal penalty exceptions. If the resulting tax bill is more than you can pay, file on time and set up a payment arrangement.

Next step

When moving retirement money, ask for a direct transfer. If a rollover already went wrong, act quickly: check whether self-certification applies, and remove any invalid deposit before the 6 percent excise tax keeps compounding. Call (813) 229-7100 if the IRS has already sent a notice. The firm's page on penalty abatement covers relief for related penalties.