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Letter Ruling Provides Guidance on Inherited IRAs

KYEstates brings you PLR 200945011 (Nov. 6, 2009), a Letter Ruling that KYEstates can’t quite bring itself to really love, even though Natalie Choate surely does.  The Letter Ruling has both good news and bad news for taxpayers.  First, the good news: under the facts of the Letter Ruling, lump-sum, immediate income in respect of a decedent (IRD) is avoided.  Next, the bad news: the inherited IRA can’t be “stretched” over the life expectancy of the account owner’s children, and is instead subject to the “five year rule”.The facts of the Letter Ruling were as follows: A owned an IRA.  A died at age 72, having begun to take required minimum distributions.  A had named as the sole beneficiary of his IRA his spouse, B.  A did not name any contingent beneficiaries for the IRA.  B, therefore, was the sole “designated beneficiary” of the IRA under section 401(a)(9).  B survived A by only seven days.  B was 70 years and 11 months old at B’s date of death.  During her life, B did not disclaim the IRA, did not take any distributions from the IRA, and did not elect to treat the IRA as her own.  B did not name any beneficiaries of her interest in the IRA. (KYEstate$ editor’s note: Good Grief!  B’s spouse had just died and the survivorship period was only seven days – what does the IRS expect?)  As a result, the right to receive the IRA passed by B’s will to the two children of A and B (conveniently named by the IRS), C and D.

A’s personal representative proposed to divide the IRA into two inherited sub-IRAs by means of trustee-to-trustee transfers.  No distributions would be made from the IRA and no rollovers would be made into the two created sub-IRAs

The taxpayer requested the following rulings:
1) The division of the IRA and establishment of the two sub-IRAs would not be a transfer triggering recognition of IRD under section 691(a)(2), a distribution of taxable income to the recipient under section 408(d)(1), or rollovers under section 408(d)(3).
2) That after the division of the IRA and establishment of the two sub-IRAs, the Estate should not take into its gross income any amounts distributed from the sub-IRAs to C and D.
3) That the sub-IRAs will constitute separate accounts within the meaning of Treas. Reg. Sec. 1.401(a)(9)-8, Q&A-2.

The Service undertook a detailed analysis of the applicable statutes and regulations and determined as follows:

1) The division of the IRA and establishment of the two sub-IRAs will not be a transfer within section 691(a)92), will not constitute a distribution of taxable income under section 408(d)(1) to B’s estate, or a rollover under section 408(d)(3).
2) C and D will each include in their gross income the amounts of IRD from their respective sub-IRA when the distribution(s) from the sub-IRA are received by them, respectively.
3) After the division and establishment of the two sub-IRAs, C and D will be the payees of amounts distributed from the IRA pursuant to section 408(d)91).  Therefore, neither A’s estate nor B’s estate will include in its taxable income any amounts distributed from the IRAs.
4) Separate IRAs may be created for C and D for individual investment purposes, but not for purposes of establishing distribution periods based on the individual, separate life expectancies of C and D.  (In other words, “stretch” distribution tailored to C and D’s life expectancies is not available.)  Each sub-IRA comes within the 5-year rule (see section 401(a)(9)(B)(ii), because B, the surviving spouse IRA holder, died before her required beginning date).

It’s useful that the IRS blessed the transfer to C and D.  Because the division and establishment of the sub-IRAs will not create negative income tax consequences for the estate, the estate does not need not retain the IRA and remain open over the IRA’s entire distribution period.

Barry Picker has commented to Steve Leimberg’s newsletter that the IRS was wrong in the ruling when it required application of the 5-year rule.  Picker’s argument can be summarized as follows:

B was A’s designated beneficiary.  Although B died shortly after A, B made no disclaimer, so B would still be regarded as the designated beneficiary as of the following September 30, the beneficiary designation date.  Therefore, the payout period should be measured against the spouse’s life expectancy, based on what B’s age would have been in year following B’s death.  Because B was dead, the life expectancy would have been reduced by one in each year of distributions, until the account was fully paid out.

In this instance, B’s failure to designate beneficiaries for the IRA (or, alternatively, A’s failure to designate C and D as contingent beneficiaries) prevented using the individual life expectancies of children C and D as the basis for “stretch” distributions. The Letter Ruling is yet another demonstration of the intricacy of the income tax regulations relating to IRAs.  The T&E community is fortunate that in most instances, Natalie Choate figures these situations out for us.  Barry Picker also did a great job analyzing this Letter Ruling – he observed that upon inheriting an IRA, a spouse should either roll it over into the spouse’s own name, or if the spouse is going to remain a beneficiary, should name the spouse’s own beneficiaries on the account.  Picker commented to Leimberg: “Sounds weird.  It is.  Blame Congress.”

When it comes to the near-insane complexity of the IRA regulations, KYEstates won’t argue about blaming Congress….

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