Final Regulations Change Allocation Rules for Roth IRA Rollovers

The IRS finalized a taxpayer-friendly rule eliminating the requirement that each disbursement from a designated Roth account that is directly rolled over to an eligible retirement plan be treated as a separate distribution from any amount paid directly to the employee (T.D. 9769). The former rule meant that these amounts were separately subject to Sec. 72(e)(2), which allocates pretax and after-tax amounts for each distribution.

As a result, if disbursements are made from a taxpayer’s designated Roth account to both the taxpayer and the taxpayer’s Roth IRA or designated Roth account in a direct rollover, then pretax amounts are now allocated first to the direct rollover, rather than being allocated pro rata to each destination. Also, a taxpayer can direct the allocation of pretax and after-tax amounts that are included in disbursements from a designated Roth account that are directly rolled over to multiple destinations, applying the same allocation rules that apply to distributions from other types of accounts.

Prior Regs. Sec. 1.40A-1, Q&A-5(a), provided that “any amount paid in a direct rollover is treated as a separate distribution from any amount paid directly to the employee.” Under the new regulation, the separate distribution requirement would not apply to distributions made on or after Jan. 1, 2016 (a one-year delay from the proposed rule, REG-105739-11), or, if the taxpayer chooses, on or after Sept. 18, 2014. The new rules refer taxpayers to Notice 2014-54, which was issued at the same time as the proposed regulations, for the detailed rules on allocating pretax and after-tax amounts for distributions to multiple destinations.

Under the new rules, all disbursements of benefits from the plan to the recipient that are scheduled to be made at the same time are treated as a single distribution regardless of whether the recipient has directed them to be made to a single destination or multiple destinations. If the pretax amount of the aggregated disbursements that are treated as a single distribution is less than the amount of the distribution that is directly rolled over to one or more eligible retirement plans, the entire pretax amount is assigned to the amount of the distribution that is directly rolled over.

A transition rule to the effective date permits taxpayers choosing not to apply the separate distribution rule during the transition period (on or after Sept 18, 2014, and before Jan. 1, 2016) to reasonably interpret the last sentence in Sec. 402(c)(2) (generally requiring that pretax amounts be treated as rolled over first) to allocate pretax and after-tax amounts among disbursements made to multiple destinations. A reasonable interpretation includes the rules described in Notice 2014-54.

—Sally P. Schreiber (sschreiber@aicpa.org) is a Tax Adviser senior editor.