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January 2022

Much Additional Work for Everyone if a Rollover or a Transfer is Handled Incorrectly

Although many individuals don’t know the difference between a rollover or a transfer the following email response illustrates why it so important for bankers to know the difference.

When there is a transfer there is no taxable event which needs to be reported to the IRS. The IRS custodian/trustee remitting the IRA funds to the successor IRA custodian/trustee is not required to prepare a Form 1099-R to report the distribution being made to the successor custodian/trustee because no distribution was “received” by the individual.

There must always be IRS reporting if a person has received an IRA withdrawal. A form 1099-R must be prepared even if the person subsequently makes a rollover contribution. The IRS believes a person needs to pay tax on the distribution unless the person makes a qualifying rollover and completes their tax return to reflect the rollover and claim the distribution is not required to be included in their income.

The situation. FF (brokerage) had issued a check to Jane Doe for $42,000 in June of 2019. Jane Doe had brought the check to ABC bank within 15 days. The $42,000 was contributed to her traditional IRA. ABC Bank processed the transaction as a transfer. FF issued Jane Doe a 2019 Form 1099-R showing she had received a distribution of $42,000. The 2019 Form 5498 prepared by ABC Bank did not show a rollover contribution in box 2. Jane prepared her tax return and she excluded the $42,000 from her taxable income.

Because there was no Form 5498 prepared showing that she had made a rollover contribution the IRS sent her in 2021 a tax bill for $8,400 including penalties and interest. She (or H&R Block on her behalf had written the IRS) and explained she had made a rollover. ABC Bank had written a letter indicating it should have processed the $42,000 contribution as a rollover.

The IRS in January of 2022 has informed Jane Doe that her explanation was not being accepted. Why? Although ABC Bank wrote a letter explaining that it should have reported her $42,000 contribution as a rollover, it did not prepare a corrected 2019 Form 5498 showing the rollover. The IRS apparently will not remove a tax assessment unless an IRA custodian prepares a corrected Form 5498.

It appears the IRS has the policy - we are not going to treat the transaction as a rollover and non-taxable unless the financial institution serving as the IRA custodian prepares a corrected Form 5498 showing there was a rollover.

Now that Jane Doe has furnished the IRS with the corrected 2019 Form 5498 we expect the IRS will remove its claim for $8,400. The IRS may not be in a good mood, however, because they have spent a lot of time on this situation.

It is possible the IRS will assess ABC Bank a $100 fine for preparing her 2019 Form 5498 incorrectly and then not correcting it once the bank learned of the error. Making corrections is always time consuming for everyone involved - Jane Doe, ABC Bank and the IRS.