Rollovers to Roth IRAs are Complicated by Substance-Over-Form Doctrines

Abstract

Judicially created “substance-over-form” doctrines can undermine some rollovers to Roth IRAs. Among the most vulnerable are successive rollovers that seek to minimize the tax on “taxable qualified rollover contributions” (TQR contributions). A taxpayer may make a TQR contribution to a Roth IRA from a traditional IRA or from a qualified retirement plan, tax-deferred annuity or eligible state/local government plan.

Also subject to attack under substance-over-form doctrines are TQR contributions made in conjunction with the purchase of qualifying longevity annuity contracts (QLACs). Perhaps most vulnerable of all are TQR contributions to a Roth IRA of a taxpayer’s previous contributions to a traditional IRA, if made to avoid limitations on a taxpayer’s direct contributions to a Roth IRA (so-called “back door” Roth contributions).

Application to these transactions of substance-over-form doctrines (including particularly the step transaction doctrine) yields mixed results. On the one hand, the IRS is not likely to succeed in applying the doctrines to multiple rollovers from a qualified plan to a Roth IRA, even if the taxpayer used a traditional IRA as a mere conduit for some of the rolled-over amount. It is also highly likely that the purchase of a QLAC with some of the funds in a traditional IRA, followed by a TQR contribution of the remaining IRA balance, would survive an attempt to apply the doctrines.

Furthermore, it is unlikely the IRS would succeed in nullifying a rollover to a qualified plan of the earnings portion of an IRA distribution, followed by a TQR contribution to a Roth IRA of the investment portion. On the other hand, the step transaction doctrine would almost certainly apply if the qualified plan then immediately distributed the amount of the rollover received from the IRA.

It is also highly likely that the step transaction doctrine would apply to a nondeductible contribution to a traditional IRA that is immediately rolled over in a TQR contribution to a Roth IRA (a “back-door Roth contribution”).