By Peter Barton, JD, CPA, professor of accounting, and Roy Weatherwax, PhD, CPA, Arthur Andersen Professor of Accounting, University of Wisconsin-Whitewater

he Tax Court, in Lemishow v. Commissioner, a case of first impression, ruled that certain otherwise excludable rollovers from Keogh and individual retirement accounts (IRAs) were taxable due to a change in the character of the property deposited into a new IRA. This case is especially important because the rising stock market and the new Roth IRAs have encouraged rollovers. Generally, distributions from IRAs and from qualified retirement plans, including Keogh (self-employed) plans, are taxable under IRC section 72. However, rollovers into other qualified plans or into IRAs are excludable if they satisfy IRC section 408(d)(3)(A) for IRA distributions or section 402(c)(1) for qualified plan distributions. IRC section 408(d)(3)(A)(i) requires that "the entire amount received (including money and any other property)" be paid into an IRA within 60 days of the distribution. Partial rollovers are allowed under section 408(d)(3)(D). Regulations section 1.408-4(b) states that "the same amount of money and any other property" must be paid into another IRA. Section 402(c)(1) more explicitly distinguishes between money (cash) and other property. It requires the distributee to transfer, within 60 days, "any portion of the property received" into a qualified retirement plan or IRA, and, if the property is "other than money," the amount transferred must be the "property distributed." Section 402(c)(6) allows an exception for qualified retirement plan distributions if the property is sold and the cash proceeds are transferred to a qualified retirement plan or IRA within 60 days. This exception does not apply to IRA distributions.

Lemishow withdrew $480,414 from his Keogh and IRA accounts and purchased $377,895 of GP Financial stock by subscription from GP Financial. Within 60 days, he opened a new IRA and deposited the stock into it. Lemishow did not report the distributions on his return, and the IRS added the $480,414 to his income. The Tax Court ruled that the rollover requirements were not satisfied and the entire $480,414 was taxable. The court cited the language used in the regulations and the legislative history to support its ruling. If Lemishow had deposited the cash into the new IRA, the distributions would have been excludable.

New section 408A covers Roth IRAs. Rollovers to Roth IRAs from other IRAs are allowed for taxpayers with adjusted gross income of $100,000 or less. Although these rollovers are taxable transactions under section 408(A)(d)(3)(3), later distributions from Roth IRAs are excludable if the rules of Sec. 408A(d) are satisfied. Also, sections 408A(c)(6)(A) and 408A(e) require that rollovers to Roth IRAs satisfy Sec. 408(d)(3), which is controlled by Lemishow. A rollover to a Roth not satisfying Lemishow would presumably result in taxable distributions from the Roth for amounts in excess of basis.

Lemishow requires that property eligible for tax-free rollover treatment be of the same type as the property distributed. (There is a limited exception for property distributed and sold, as noted above.) Thus, cash distributions must be rolled over as cash, and other property distributions must be rolled over as is. This rule applies to all IRA and qualified retirement plan rollovers, including rollovers into Roth IRAs. If a rollover does not satisfy Lemishow, it cannot be corrected once the 60-day period has expired. Therefore, it is important for CPAs to educate clients before rollovers occur. *