IRA roll over; client cashed the checks

[Ross]

Taxpayer wanted to roll $115k over into another IRA. The companies issued them checks. Instead of voiding the checks, the taxpayer deposited them into their bank account and wrote the new IRA company checks for the same amount as the distribution checks within a week. This happened in August and October. I remember hearing something like "whatever you do, do not cash the checks" if this happens. There was state withholding, but now the taxpayer owes $18k on their Federal return and they do not have the funds. Is there any way to un-due this? TIA.

[Koss]

Rollover

If they performed a rollover within 60 days, then the distribution is not taxable. I don't understand what the issue is.

You said there was state withholding. Was there federal withholding?

If the taxpayer wrote checks that were equal to the amount of the checks they received, then they did not roll over the entire amount, because of the withholding. So they may have a small taxable distribution. The taxable amount of the distribution should be equal to the amount of the withholding. The amount they actually rolled over is not taxable.

Did the new financial institution properly identify the contribution as a rollover contribution? If they did not, that should be easy to fix.

A "hands-free" rollover, or trustee-to-trustee transfer, should not have any withholding. The check should be made out from one bank to the other bank. That's why they say the taxpayer should not cash the checks. But even if the distribution is made directly to the taxpayer, they can still roll it over within 60 days. If tax was withheld, then they would have to come up with that money out of their pocket in order to successfully roll over the entire amount. But even if they don't do that, they can still do a partial rollover of whatever amount they choose.

BMK

[Burke]

First, a taxpayer is allowed only one rollover per year. It appears from your post there were two? If he observed the 60-day rule, and transferred the gross amt of the funds including the withholding at either time, he more than likely would qualify for the tax-free rollover on one of them. Normally, a pension plan would withhold taxes (fed and state) if checks were made payable to the TP. And he would have to come up with the withheld funds to meet the rollover provisions when he moved the money to the new custodian-IRA. Did he do this? On either occasion?

[Ross]

There were two different IRAs, one in the amount of $68k and one in the amount of $47k. One was cashed in August, the other October. A few days after receiving the net checks, the taxpayer put them into a new IRA. The $68k one had Federal and State withholding, the $47k only had state withholding. So it appears that they should only pay tax on the amount of the withholding. I assume they should check w/ the new IRA company to confirm the amounts were classified as a rollover?!? Thanks.

[Roland Slugg]

You are correct. As long as the two distributions came from different IRAs, presumably with two different trustees, then the one-year limitation doesn't apply. The taxpayer needs to be careful, though, not to attempt a rollover distribution from the IRA with the new trustee within one year, unless it is a direct, trustee-to-trustee transfer.

There was state withholding on one of the distributions but no federal withholding? I didn't think that was possible. I always thought it had to be both or neither.

If the taxpayer was under 59½ when he received the distributions, he will owe the 10% penalty on the taxable amount. Several mistakes were made in the handling of these distributions, and it would have been so easy to do it right.

[Burke]

There were two different IRAs, one in the amount of $68k and one in the amount of $47k. One was cashed in August, the other October. A few days after receiving the net checks, the taxpayer put them into a new IRA. The $68k one had Federal and State withholding, the $47k only had state withholding. So it appears that they should only pay tax on the amount of the withholding. I assume they should check w/ the new IRA company to confirm the amounts were classified as a rollover?!? Thanks.

I see. I was assuming they were both from the same company pension plan. If these were IRA's, then the TP probably had the option to check whether or not taxes would be withheld. He must have checked only the state box on the second. Be that as it may, yes -- he definitely needs to make sure he completed the proper paperwork with the NEW institution to indicate these were rollovers. If he did not, he needs to see if they will correct this. They will show this information on the 5498 they send him. And yes, the amount withheld -- IF not included in the new IRA at the time -- will be taxable, reportable on Line 15b. Plus the 10% penalty if he was under 59 1/2. Your software should take care of this when you complete the inputs properly. Then he may receive rather large refunds due to the withholding.