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Divided Tax Court Holds That CSRS Did Not Accept Contribution as a Rollover.
(Parker Tax Publishing October 16, 2014)

A taxpayer who used an IRA withdrawal to fund an increased annuity under the Civil Service Retirement System (CSRS) was subject to tax on the withdrawal because CSRS did not accept the taxpayer's contribution as a rollover. Bohner v. Comm'r, 143 T.C. No. 11 (9/23/14).

Dennis Bohner was a federal employee and participated in the Civil Service Retirement System (CSRS) during his years of government service. After he retired, the Office of Personnel Management (OPM) mailed him a letter dated April 13, 2010, explaining that he could increase his CSRS retirement annuity by sending $17,832 with respect to creditable government service for a period during which no retirement contributions had been withheld from his salary. The letter required that he deposit the funds within 15 days of the date of the letter. The letter was silent on whether the deposit could be made through a tax-free rollover contribution. Dennis elected to deposit the $17,832. Because he did not have enough funds to make the entire payment directly from his bank account, he borrowed a portion of the $17,832 from a friend. On April 27, 2010, Dennis mailed a check to OPM for $17,832.

During 2010, Dennis maintained a traditional IRA. He made two separate requests to withdraw funds from his IRA during 2010; a request for a $5,000 distribution, of which $4,500 was sent to him on April 15, 2010, and $500 was withheld to satisfy federal income tax liability in connection with the distribution; and a request for a $12,832 distribution, which was sent to him in full (with no withholding) on May 3, 2010. Dennis used the funds he received from his IRA to reimburse his friend and to replenish his bank account. The IRA custodian issued Dennis a Form 1099-R in which it reported $17,832 of distributions and listed the entire $17,832 as taxable income. On his 2010 Form 1040A, Dennis reported receiving the $17,832 of distributions from his IRA, but did not report any of the $17,832 as taxable income. The IRS issued Dennis a deficiency notice treating the $17,832 withdrawal from the IRA as taxable income.

CSRS is a retirement plan designed to provide retirement annuities to federal civil service employees. An eligible employee contributes portions of his or her salary to CSRS, and the employing agency withholds the contributions from the employee's salary. Matching contributions are made from funds appropriated for the employing agency. To make up for years for which no retirement contributions were withheld from a civil service employee's pay, CSRS includes a provision that allows the employee to elect to make a deposit for creditable government service and thus increase his or her CSRS retirement annuity.

In general, any amount paid or distributed out of an IRA is included in the taxpayer's gross income as provided in Code Sec. 72. However, this general rule does not apply to a rollover contribution. A rollover contribution is any amount paid or distributed out of an IRA to the individual for whose benefit the account or annuity is maintained if the entire amount received is paid into an eligible retirement plan no later than 60 days after receipt. An eligible retirement plan includes a qualified trust, which is defined as a tax-exempt employees' trust described in Code Sec. 401(a).

In the past, the IRS has taken the position that CSRS is a qualified trust, and the IRS did not dispute that CSRS is a qualified trust in this case. The IRS contended, however, that Dennis's deposit to CSRS did not constitute a rollover contribution under Code Sec. 408(d)(3) because CSRS does not, and is not required to, accept rollovers.

The Tax Court, in a divided decision, held that CSRS did not accept Dennis's deposit as a rollover and therefore, Dennis had to include his IRA withdrawals in income for 2010. The court noted that the letter OPM sent to Dennis after he retired, which explained how he could make a deposit to make up for years for which no retirement contributions were withheld from his pay, was silent on whether the deposit may be made as a rollover. The court also noted that the statutory rules governing CSRS do not specifically permit civil service employees to remit the deposit by means of a tax-free rollover contribution from an IRA or another eligible retirement plan. The related regulations likewise do not require CSRS to accept tax-free rollovers as a form of deposit. Further, deposited amounts take the place of after-tax contributions that were not originally made.

The court pointed out that this case involved an indirect transfer rather than a direct transfer from the IRA to CSRS. As such, CSRS was likely not aware that Dennis was attempting to make a tax-free rollover contribution, and there was nothing in the record to suggest that Dennis informed CSRS of his attempt to make a rollover. Unless it explicitly accepted rollovers, a qualified plan such as CSRS would not be aware of the proper tax treatment of the payment upon distribution. Thus, the majority of the court concluded that CSRS did not accept Dennis's deposit as a rollover.

OBSERVATION: Six judges dissented, taking the position that at least the first distribution should have qualified for rollover treatment.

For a discussion of rollovers of distributions from traditional IRAs, see Parker Tax ¶134,540. (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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