Tax Planning for Retirees

MOST RECENT DEVELOPMENTS

Self-Certification of Permissible Reasons for Violating the 60-Day Rollover Requirement. – A retiree may be able to give a written certification to an IRA trustee that the he or she has permissible reasons for failing to satisfy the 60-day rollover requirement. The IRA trustee may then accept the rollover contribution despite violation of the 60-day requirement (unless the IRA trustee or plan administrator otherwise knows the rollover is not valid). For this purpose, the IRS has provided a list of permissible reasons for excusing a violation. (Rev. Proc. 2016-47, 2016-37 I.R.B. ___.) See Chapter 5 and Chapter 2 of the treatise.

Lump Sum Election by Members of the U.S. Military Under the Blended Retirement System (BRS). – U.S. military retirees may take part of their monthly retired pay as a taxable lump sum at retirement if they first joined a military branch after December 31, 2017, or if they otherwise opted into the retirement system as it was revised effective January 1, 2018 (the “BRS” system). The retiree may elect (more than 90 days before retirement) to take either a 25 percent or a 50 percent lump sum. The lump sum is calculated as 25 percent or 50 percent of the discounted retired pay otherwise due a member from the date of retirement until age 67. Monthly payments before age 67 are accordingly reduced by 25 percent or 50 percent, but revert to 100 percent at age 67. The lump sum payment is immediately taxable if it is not rolled over to another plan or IRA. (10 USC § 1415; 38 USC § 5304(d).). See Chapter 14 of the treatise for an explanation of the taxation of military retired pay.

Judicial Review of IRS Denials of Waivers of the 60-Day Rollover Rule. The Tax Court has held that IRS denials of waivers of the 60-day rollover requirement are subject to judicial review. The court concluded it may reverse an IRS denial of a waiver if it finds the IRS abused its discretion, i.e., acted “arbitrarily, capriciously, or without sound basis in law or fact.” However, the taxpayer must have actually requested the waiver (i.e., by ruling request, self-certification, or during an examination). A court generally will not find the IRS abused its discretion if it did not have an opportunity to exercise its discretion. (Trimmer v. Commissioner, 148 T.C. No. 14 (2017).) See Chapter 5 and Chapter 2 of the treatise.

Filing Election to Report Income on Receipt of Unvested Property. If a retiree has an interest in restricted property that has not yet vested, the retiree may have previously elected to report as ordinary compensation income the excess of the fair market value of the interest on the date of receipt over the amount paid for the interest (the bargain element). A retiree would normally have made this election if he or she wished to avoid reporting as ordinary compensation income any later pre-vesting increase in value of the property interest.

In the past, the retiree had to file an election statement with the IRS within 30 days after receiving the unvested interest and had to attach a copy of the statement to his or her tax return. However, for property transferred on or after January 1, 2015, a retiree need not attach the statement to his or her tax return. (Reg. Sec. 1.83-2(c), (f).) See Chapters 10 and 11 of the treatise.

Purchase of Employer Stock from Employee at Less than Fair Market Value. Shares of employer stock or stock rights received by an employee are not deferred compensation under Section 409A merely because a restriction may require the employee to sell the stock at less than fair market value upon the employee’s involuntary separation from service, or if the sale is contingent on a condition within the employee’s control. (Prop. Reg. § 1.409A-1(b)(5)(iii)(A).) See Chapter 9 of the treatise.

Beneficiary Elections for Time of Payment of Deferred Compensation. An unfunded nonqualified plan may allow a beneficiary of a deceased participant to elect to change the time and form of payment of deferred compensation. Thus, the plan may allow a beneficiary to elect to defer payments to any of the types of permissible dates or events that were available to the participant. Furthermore, the accelerated payment rules will now not prohibit a beneficiary’s election to receive payments (1) on or relative to the death or disability of the beneficiary or (2) upon the beneficiary’s unforeseeable emergency. (Prop. Reg. § 1.409A-3(j)(1), (2) (on which a taxpayer may rely until the regulations become final).) See Chapter 9 of the treatise.

Time Allowed for Payment of Deferred Compensation after Death of Participant or Beneficiary. Compensation payable by reason of the death of a retiree or beneficiary may now be paid any time during the period beginning on the date of death and ending on the last day of the first full calendar year following death. Regardless of the terms of the plan, any payment made within such period is not subject to the restrictive rules applicable to subsequent deferral elections and is not an impermissible accelerated payment. Furthermore, so long as the payment is made within that period, the payment recipient is free to choose the taxable year of payment. (Prop. Reg. § 1.409A-3(b), (d)(2) (on which a taxpayer may rely until the regulations become final).) See Chapter 9 of the treatise.

Liberalization of the Test for Favorable Treatment of Recurring Part-Year Compensation under Section 409A and Section 457(f). Recurring part-year compensations generally loses its exclusion from Section 409A if a taxpayer defers more than a specified amount from one calendar year to the next (more than $18,000 for 2016). However, proposed regulations (on which taxpayers may now rely) provide that this limitation is satisfied for purposes of Section 409A if the employee’s total compensation for the year is less than a specified limit ($265,000 for 2016). This alternative is also effective now for purposes of Section 457(f) (where it entirely supplants the year-to-year deferral limit). The alternative will also entirely replace the deferral limit for purposes of Section 409A when the proposed regulations become final. (Prop. Reg. Sec. 1.409A-1(b)(13).) See Chapter 9 of the treatise.

Substantial Risk of Forfeiture Relating to the Purpose of Compensation under a Section 457(f) Plan. Compensation is deferred under unfunded nonqualified plans (Section 457(f) plans) of States and tax-exempt organizations as long as the compensation is subject to a substantial risk of forfeiture. For this purpose, the most common type of substantial risk of forfeiture relates to the required performance of substantial future services. However, proposed regulations (on which taxpayers may now rely) also make it clear that a substantial risk of forfeiture includes a condition related to a purpose of the compensation (e.g., related to the employer’s governmental or tax-exempt activities or organizational goals). (Prop. Reg. Sec. 1.457-12(e)(1)(i), (iii).) See Chapter 9 of the treatise.

Substantial Risk of Forfeiture Relating to Involuntary Severance of Employment under a Section 457(f) Plan. Proposed regulations (on which taxpayers may now rely) provide that taxpayers may condition payment of deferred compensation under Section 457(f) on involuntary severance from employment without cause. For this purpose, involuntary severance without cause includes a severance for “good reason,” (e.g., a severance due to unfavorable changes in an employee’s pay, authority, duties, or working conditions). (Prop. Reg. Secs. 1.457-12(e)(1), 1.457-11(d)(2)(ii).) See Chapter 9 of the treatise.

Substantial Risk of Forfeiture Relating to a Covenant Not to Compete under a Section 457(f) Plan. A covenant not to compete may now constitute a substantial risk of forfeiture under a 457(f) plan. However, to qualify, several conditions must be satisfied to guarantee that the covenant is bona fide. Caution: a covenant not to compete cannot constitute a substantial risk of forfeiture under Section 409A. (Prop. Reg. Sec. 1.457-12(e)(1)(iv).) See Chapter 9 of the treatise.

Extension of a Substantial Risk of Forfeiture under a Section 457(f) Plan. A taxpayer may now extend an existing substantial risk of forfeiture for two years or more under a Section 457(f) plan. However, the extension must occur at least 90 days before the lapse of the existing substantial risk of forfeiture and the extension must provide a materially greater benefit. Somewhat similar rules apply to initial deferrals of regular current compensation. Caution: retirees must still take care not to violate restrictions on the timing of elections and payments under Section 409A. (Prop. Reg. Sec. 1.457-12(e)(2)).) See Chapter 9 of the treatise.

Short-Term Deferrals Are Not Deferred Compensation under Either Section 457(f) or Section 409A. The proposed regulations governing Section 457(f) plans (on which taxpayers may rely) make it clear that short-term deferrals are not deferred compensation subject to Section 457(f). A deferral is generally short-term if an employer must make payment within the first 2½ months of the taxable year following the first year the compensation is not subject to a substantial risk of forfeiture. Although the definition of short-term deferral under Section 457(f) is substantially the same as under Section 409A, there are some differences in the definition of substantial risk of forfeiture. (Prop. Reg. Sec. 1.457-12(d)(2).) See Chapter 9 of the treatise.

Treatment of a Spouse’s Community Property Interest in an IRA Distribution to a Nonspousal Beneficiary. – The IRS has ruled that an IRA distribution to a nonspousal beneficiary may be taxable to the beneficiary even though the surviving spouse has enforceable property rights in the distributed funds under state community property laws. Proper planning for this anomaly might involve either (1) a lifetime conversion of the spouse’s community property rights into the separate property of the retiree or (2) designation of the surviving spouse as an IRA beneficiary to the extent of his or her community property rights. Or after decedent’s death, the nonspousal beneficiary might make a timely disclaimer of the IRA to the extent of the spouse’s community property interest. (Priv. Ltr. Rul. 201623001.) See Chapter 5 of the treatise for a discussion of community property interests in IRAs.