IRS Issues Guidance on Allocation of After-Tax Amounts to Rollovers.
(Parker Tax Publishing October 13, 2014)

This IRS has issued rules for allocating pre-tax and after-tax amounts among disbursements that are made to multiple destinations from a Code Sec. 401(a) qualified plan, a 403(b) plan, or a governmental 457(b) plan. Notice 2014-54 (9/18/14); REG-105739-11 (9/19/14).

Subject to certain exceptions, if any portion of an eligible rollover distribution paid to an employee from a qualified plan trust is transferred to an eligible retirement plan (including an IRA), the transferred portion is not taxable in the year paid. Generally, the maximum amount that may be rolled over is the portion of the distribution that would otherwise be includible in gross income.

However, a participant can roll over even the nontaxable portion if the rollover is made:

(1) through a direct trustee-to-trustee transfer to a qualified plan trust or to a 403(b) annuity contract and the trust or contract provides for separate accounting for the amounts transferred (and earnings), including separately accounting for the portion of the distribution that is includible in gross income and the portion that is not includible, or

(2) to an IRA. In either of these cases, the amount transferred is treated as consisting first of the portion of the distribution that would otherwise be includible in gross income.

Under Code Sec. 402A, an applicable retirement plan i.e., a qualified plan, a 403(b) plan, or a governmental 457(b) plan, may include a designated Roth account. A qualified distribution from a designated Roth account is not includible in gross income. Reg. Sec. 1.402A-1, Q&A-5(a) provides rules for a distribution from a designated Roth account that is rolled over. These rules provide in part that any amount paid in a direct rollover is treated as a separate distribution from any amount paid directly to the employee.

Notice 2014-54 provides rules for allocating pre-tax and after-tax amounts among disbursements that are made to multiple destinations. These allocation rules generally apply to distributions made on or after January 1, 2015. Under Notice 2014-54, in determining the portion of a disbursement of benefits from a plan that is not includible in gross income under the rules of Code Sec. 72, all disbursements of benefits from the plan to the recipient that are scheduled to be made at the same time (disregarding differences due to reasonable delays to facilitate plan administration) are treated as a single distribution regardless of whether the recipient has directed that the disbursements be made to a single destination or multiple destinations.

Practice Tip: If the pre-tax amount in 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 pre-tax amount is assigned to the amount of the distribution that is directly rolled over. In such a case, if the direct rollover is to two or more plans, then the recipient can select how the pre-tax amount is allocated among these plans by informing the plan administrator of the allocation before making the direct rollovers.

If the pre-tax amount in aggregated disbursements in a distribution equals or exceeds the amount of the distribution that is directly rolled over to one or more eligible retirement plans, the pre-tax amount is assigned to the portion of the distribution that is directly rolled over, up to the amount of the direct rollover (so that each direct rollover consists entirely of pre-tax amounts). Any remaining pre-tax amount is next assigned to any 60-day rollovers (i.e., rollovers that are not direct rollovers) up to the amount of the 60-day rollovers. If the remaining pretax amount is less than the amount rolled over in 60-day rollovers, the recipient can select how the pre-tax amount is allocated among the plans that receive 60-day rollovers. If, after assigning the pre-tax amount to direct rollovers and 60-day rollovers, there is a remaining pre-tax amount, that amount is includible in the distributee's gross income. If the amount rolled over to an eligible retirement plan exceeds the portion of the pre-tax amount assigned or allocated to the plan, the excess is an after-tax amount.

Along with Notice 2014-54, the IRS issued proposed regulations under Code Sec. 402A. Under the proposed regulations, the requirement in Reg. Sec. 1.402A-1, Q&A-5(a) (relating to distributions from designated Roth accounts) that "any amount paid in a direct rollover is treated as a separate distribution from any amount paid directly to the employee" would not apply to distributions made on or after the applicability date of final regulations, which is proposed to be January 1, 2015. However, taxpayers may apply the proposed regulations to distributions made before that date, so long as the distributions are made on or after September 18, 2014. For distributions from designated Roth accounts, the allocation rules of Notice 2014-54 will apply to distributions made on or after the applicability date.

For distributions made on or after September 18, 2014, but before the allocation rules of Notice 2014-54 apply, taxpayers may apply a reasonable interpretation of the last sentence of Code Sec. 402(c)(2) to allocate after-tax and pre-tax amounts among disbursements made to multiple destinations. The IRS also intends to update its safe harbor in Code Sec. 402(f) explanations to reflect this revised method for applying the last sentence of Code Sec. 402(c)(2).

For a discussion of rollovers of distributions from qualified plans, see Parker Tax ¶131,550. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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