IRS Finalizes Rules for Allocating Roth Distributions

The Internal Revenue Service (IRS) has issued final regulations eliminating the requirement that each disbursement from a designated Roth retirement plan 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 and therefore separately subject to the rule in section 72(e)(2) of the Internal Revenue Code (the Code) allocating pre-tax and after-tax amounts to each distribution.

The IRS says no comments were received regarding the proposed regulations, so these regulations finalize the proposed regulations, with a one-year delay of the applicability date from January 1, 2015, to January 1, 2016. They are substantively the same as the proposed regulations, but express the rule differently to better reflect the ongoing rule and the transition rule.

Under the final rules, if disbursements are made from a taxpayer’s designated Roth account to the taxpayer and also to the taxpayer’s Roth IRA or designated retirement plan Roth account in a direct rollover, then pre-tax amounts will be allocated first to the direct rollover, rather than being allocated pro rata to each destination.

Also, a taxpayer will be able to direct the allocation of pre-tax 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 to distributions from designated Roth accounts that apply to distributions from other types of accounts. 

The final regulations apply to distributions from designated Roth accounts made on or after January 1, 2016, and for such distributions taxpayers are required to follow the allocation rules described in Notice 2014-54. 

The regulations also preserve the separate distribution rule for distributions made prior to the January 1, 2016, applicability date, except that a taxpayer is permitted to choose not to apply the separate distribution rule to distributions that are made on or after September 18, 2014, and before January 1, 2016.