 |
| |
 |
| |
 |
| |
 |
| |
 |
| |
 |
| |
 |
| |
 |
Key Tax Developments Affecting Retirees
IRA Tax Developments
Distributions Taxed to Former Spouse Regardless of Community Property Laws. – A
distribution from a qualified retirement plan to a retiree's former spouse under a court’s “qualified
domestic relations order” (a QDRO) is generally taxable to the spouse. The Tax Court has
determined that community property laws of a state do not change this result – i.e., do not make
the distribution taxable to the retiree. Seidel v. Commissioner, T.C. Memo 2005-67 (2005). See
Chapter 2 of the treatise for a discussion of QDROs under qualified retirement plans.
Protection from Bankruptcy for Funds in IRAs and Retirement Plans. – Funds in IRAs and
qualified retirement plans are generally exempt from forfeiture in bankruptcy proceedings.
However, in the case of IRAs and Roth IRAs, an individual’s bankruptcy exemption is generally
limited to the sum of (a) $1,000,000, (b) the amount of funds rolled over from qualified plans (and
earnings thereon), and (c) funds in SEPS and Simple IRAs. This bankruptcy exemption should
also protect inherited IRAs. (Bankruptcy Abuse Prevention and Consumer Protection Act of 2005,
Pub. L. No. 109-8, § 224; In re Nessa, 426 B.R. 312 (B.A.P. 8th Cir. 2010); In re Tabor, 2010-1 U.S.
T.C. 50,479 (Bankr. M.D. Pa.) (inherited IRAs). To the contrary, in a poorly reasoned opinion, see
In re Chilton, 2010-1 U.S.T.C. 50,275 (Bankr. E.D. Tex.).) See Chapter 5 of the treatise, generally,
for a discussion of the taxation of funds in IRAs.
IRS Allows Correction of Overpayment of Required Minimum IRA Distributions. – An IRA must
start making minimum distributions by April 1 of the year after the owner reaches age 70 ½.
Recipients generally rely on their IRA administrators to compute and distribute the correct
amount. Where an administrator erroneously distributed an amount in excess of the required
minimum, the IRS ruled that the taxpayer could roll the excess back into his IRA – even though the
normal 60-day rollover period had expired. (Ltr. Rul. 200443034 and 200438046.)
For descriptions of other situations where the IRS has waived the 60-day rollover requirement,
click here. Also, see Chapter 8 of the treatise for a discussion of minimum distribution
requirements; see Chapter 5 of the treatise for a discussion of the requirements for a rollover
from an IRA.
Division of an Inherited IRA Held by a Trust. – If a trust is the named beneficiary of an inherited
IRA, the beneficiaries of the trust may arrange transfers to new and separate inherited IRAs for
each trust beneficiary, provided the trust is a “see through” trust. A see-through trust is a trust with
identifiable individual beneficiaries that is irrevocable or that will automatically become
irrevocable upon the retiree’s death, and that satisfies certain procedural requirements.
However, the beneficiary of such a newly separated IRA who bases his required minimum
distributions on life expectancy must use the life expectancy of the oldest trust beneficiary –
unless the use of multiple trusts effectively allows each beneficiary to use his or her own life
expectancy. (Reg. § 1.401(a)(9)-4, Q&A 5; Ltr. Rul. 200809042; Ltr. Rul. 200537044.) See
Chapters 5 and 8 of the treatise for discussions of divisions of IRAs and trusts and the effect of
the divisions on minimum distribution requirements.
Use of Multiple Trusts to Maximize IRA Tax Deferral. – Generally, dividing an inherited IRA (not
held in trust) into separate accounts or separate inherited IRAs for each beneficiary will allow the
younger beneficiaries to maximize tax deferral on their interests in the IRA by taking distributions
over their longer lifetimes. Unfortunately, though, for this purpose, beneficiaries may not treat as
separate accounts or separate IRAs those interests of the beneficiaries originally held indirectly
through a trust. Nevertheless, a retiree may be able to solve this problem neatly by providing for
multiple trusts or sub-trusts, one for each beneficiary – if certain other requirements are satisfied.
(Ltr. Rul. 200537044.) See Chapter 8 of the treatise for a discussion of the use of trusts in
maximizing tax deferral.
Transfer of Funds from an IRA to a Health Savings Account. – If a retiree does not yet qualify for
Medicare, the retiree may be eligible to make tax-deductible contributions to a health savings
account (HSA). An HSA is an account that pays medical expenses not otherwise covered by a
high deductible health plan.
After 2006, a taxpayer may make a nontaxable trustee-to-trustee transfer of funds to an HSA from
an IRA (but not from a "simple retirement account" or a "simplified employee pension"). The
transfer is not deductible, and the taxpayer may generally make only one such transfer during his
or her lifetime. In addition, the total contributions to HSAs and Archer MSAs for the year (including
the IRA transfer) may not exceed the usual annual limitation on such contributions. (Tax Relief
and Health Care Act of 2006, Pub. L. No. 109-432, § 307; I.R.C. §§ 223, 408(d)(9)) See Chapter 5
of the treatise for a discussion of the taxation of IRAs.
Division of IRA in Divorce with Consequent Reduction of Distributions. – The transfer of one-
half of the funds in an IRA to the taxpayer’s divorcing spouse is not taxable to the taxpayer.
Furthermore, if the taxpayer were receiving substantially equal periodic payments to avoid the 10
percent penalty tax on early distributions, a proper reduction in the amount of those payments to
account for the division of funds will not trigger the 10 percent penalty tax. (Ltr. Rul. 200717026.)
See Chapter 5 of the treatise for a discussion of the 10 percent penalty tax on early distributions.
The IRS Allowed an IRA Loan to a Church Secured by Life Insurance. – The IRS allowed a
taxpayer’s IRA to loan money to a church, with the loan secured by an insurance policy on the
taxpayer’s life. The taxpayer was not a board member or employee of the church and did not own,
control, or have a financial interest in the church. In addition, the church was the sole owner of the
life insurance policy and enjoyed all the rights under the policy, subject to restrictions imposed by
the security agreement. (Ltr. Rul. 200741016.) See Chapter 5 of the treatise for a discussion of
prohibited IRA investments and transactions.
Personal Sale of Stock at a Loss and Repurchase by an IRA. – The tax law generally does not
allow a taxpayer to deduct a loss on the sale of stock or securities if the taxpayer purchases
substantially identical stock or securities within 30 days after the sale (a so-called "wash sale").
The IRS has now held that the loss remains nondeductible even if the taxpayer's IRA
repurchases the substantially identical stock. Furthermore, in such a case, the taxpayer may not
increase his or her cost basis in the IRA to account for the excess of the IRA's repurchase price
over the taxpayer’s sales price. (Rev. Rul. 2008-5, 2008-3 I.R.B. ___.) See Chapter 5 of the
treatise for a discussion of the taxation of IRAs.
IRA Distributions Paid Directly to Charities. – During the years 2006 through 2009, a retiree age
70 ½ or older may exclude from taxable income certain distributions paid by his or her IRA directly
to a qualified charity. The amount of excludable charitable distributions for a given year is limited
to the lesser of (1) $100,000, (2) the amount of the payments to the charity, or (3) the portion of
IRA funds otherwise deemed potentially taxable. (I.R.C. § 408(d)(8); Notice 2007-7, 2007-5 I.R.B.
395.) See Chapter 5 of the treatise for a discussion of the taxation of IRAs.
Withdrawal of After-Tax Excess Contributions – A taxpayer may avoid penalties on an excess
contribution by withdrawing it before his or her return is due for the year of the contribution.
However, if the taxpayer does not make a timely withdrawal, a subsequent withdrawal is taxable
as an ordinary distribution. (Ltr. Rul. 200904029; I.R.C. § 408(d)(4).) See Chapters 2, 4, 5, and 6
of the treatise for an explanation of the taxation of distributions from tax-favored plans and
arrangements.
IRS Lien Not Extinguished by Rollover to Another Plan or IRA. – If the IRS files a tax lien that
attaches to IRA funds, an owner cannot extinguish the lien merely by rolling over the funds from
the IRA to a qualified plan. (Miles v. Commissioner, T.C. Memo 2007-208, aff'd by unpublished
opinion, 2010-2 U.S.T.C. 50,661 (9th Cir. 2010)). See Chapter 5 of the treatise.
IRA Provisions Placing Restrictions on Distributions. – A retiree may incorporate into an IRA
specific distribution restrictions not otherwise required by the tax law, provided the restrictions do
not interfere with required minimum distributions. For example, the IRS ruled that a taxpayer
suffering from bipolar disorder could incorporate restrictions into her IRA that delayed her
requested distributions long enough to allow her attorney to counsel her. (Ltr. Rul. 201150037.)
See Chapter 5 of the treatise.
Married Individuals and Registered Domestic Partners in Community Property States. – The
taxation of distributions from IRAs (and deductions for contributions to IRAs) are determined
without regard to community property laws. Nevertheless, the IRS and several state courts have
held that community property laws continue to apply to IRAs for testamentary and divorce
purposes. These rulings and cases may also have some applicability to IRAs held by same-sex
spouses and registered domestic partners in states that apply community property laws to such
taxpayers. (I.R.C. §§ 219(f)(2), 408(g); In re Mundell, 124 Idaho 152, 857 P.2d 631, 633 (Idaho
1993); McVay v. McVay, 476 So. 2d 1070, 1073-1074 (La. Ct. App. 1985); Ltr. Rul. 201021048;
CCA 201021050; Ltr. Rul. 8040101; FSA 199935055.) See Chapter 5 of the treatise.
To next page
To previous page
To home page
Distributions Taxed to Former Spouse Regardless of Community Property Laws. – A
distribution from a qualified retirement plan to a retiree's former spouse under a court’s “qualified
domestic relations order” (a QDRO) is generally taxable to the spouse. The Tax Court has
determined that community property laws of a state do not change this result – i.e., do not make
the distribution taxable to the retiree. Seidel v. Commissioner, T.C. Memo 2005-67 (2005). See
Chapter 2 of the treatise for a discussion of QDROs under qualified retirement plans.
Protection from Bankruptcy for Funds in IRAs and Retirement Plans. – Funds in IRAs and
qualified retirement plans are generally exempt from forfeiture in bankruptcy proceedings.
However, in the case of IRAs and Roth IRAs, an individual’s bankruptcy exemption is generally
limited to the sum of (a) $1,000,000, (b) the amount of funds rolled over from qualified plans (and
earnings thereon), and (c) funds in SEPS and Simple IRAs. This bankruptcy exemption should
also protect inherited IRAs. (Bankruptcy Abuse Prevention and Consumer Protection Act of 2005,
Pub. L. No. 109-8, § 224; In re Nessa, 426 B.R. 312 (B.A.P. 8th Cir. 2010); In re Tabor, 2010-1 U.S.
T.C. 50,479 (Bankr. M.D. Pa.) (inherited IRAs). To the contrary, in a poorly reasoned opinion, see
In re Chilton, 2010-1 U.S.T.C. 50,275 (Bankr. E.D. Tex.).) See Chapter 5 of the treatise, generally,
for a discussion of the taxation of funds in IRAs.
IRS Allows Correction of Overpayment of Required Minimum IRA Distributions. – An IRA must
start making minimum distributions by April 1 of the year after the owner reaches age 70 ½.
Recipients generally rely on their IRA administrators to compute and distribute the correct
amount. Where an administrator erroneously distributed an amount in excess of the required
minimum, the IRS ruled that the taxpayer could roll the excess back into his IRA – even though the
normal 60-day rollover period had expired. (Ltr. Rul. 200443034 and 200438046.)
For descriptions of other situations where the IRS has waived the 60-day rollover requirement,
click here. Also, see Chapter 8 of the treatise for a discussion of minimum distribution
requirements; see Chapter 5 of the treatise for a discussion of the requirements for a rollover
from an IRA.
Division of an Inherited IRA Held by a Trust. – If a trust is the named beneficiary of an inherited
IRA, the beneficiaries of the trust may arrange transfers to new and separate inherited IRAs for
each trust beneficiary, provided the trust is a “see through” trust. A see-through trust is a trust with
identifiable individual beneficiaries that is irrevocable or that will automatically become
irrevocable upon the retiree’s death, and that satisfies certain procedural requirements.
However, the beneficiary of such a newly separated IRA who bases his required minimum
distributions on life expectancy must use the life expectancy of the oldest trust beneficiary –
unless the use of multiple trusts effectively allows each beneficiary to use his or her own life
expectancy. (Reg. § 1.401(a)(9)-4, Q&A 5; Ltr. Rul. 200809042; Ltr. Rul. 200537044.) See
Chapters 5 and 8 of the treatise for discussions of divisions of IRAs and trusts and the effect of
the divisions on minimum distribution requirements.
Use of Multiple Trusts to Maximize IRA Tax Deferral. – Generally, dividing an inherited IRA (not
held in trust) into separate accounts or separate inherited IRAs for each beneficiary will allow the
younger beneficiaries to maximize tax deferral on their interests in the IRA by taking distributions
over their longer lifetimes. Unfortunately, though, for this purpose, beneficiaries may not treat as
separate accounts or separate IRAs those interests of the beneficiaries originally held indirectly
through a trust. Nevertheless, a retiree may be able to solve this problem neatly by providing for
multiple trusts or sub-trusts, one for each beneficiary – if certain other requirements are satisfied.
(Ltr. Rul. 200537044.) See Chapter 8 of the treatise for a discussion of the use of trusts in
maximizing tax deferral.
Transfer of Funds from an IRA to a Health Savings Account. – If a retiree does not yet qualify for
Medicare, the retiree may be eligible to make tax-deductible contributions to a health savings
account (HSA). An HSA is an account that pays medical expenses not otherwise covered by a
high deductible health plan.
After 2006, a taxpayer may make a nontaxable trustee-to-trustee transfer of funds to an HSA from
an IRA (but not from a "simple retirement account" or a "simplified employee pension"). The
transfer is not deductible, and the taxpayer may generally make only one such transfer during his
or her lifetime. In addition, the total contributions to HSAs and Archer MSAs for the year (including
the IRA transfer) may not exceed the usual annual limitation on such contributions. (Tax Relief
and Health Care Act of 2006, Pub. L. No. 109-432, § 307; I.R.C. §§ 223, 408(d)(9)) See Chapter 5
of the treatise for a discussion of the taxation of IRAs.
Division of IRA in Divorce with Consequent Reduction of Distributions. – The transfer of one-
half of the funds in an IRA to the taxpayer’s divorcing spouse is not taxable to the taxpayer.
Furthermore, if the taxpayer were receiving substantially equal periodic payments to avoid the 10
percent penalty tax on early distributions, a proper reduction in the amount of those payments to
account for the division of funds will not trigger the 10 percent penalty tax. (Ltr. Rul. 200717026.)
See Chapter 5 of the treatise for a discussion of the 10 percent penalty tax on early distributions.
The IRS Allowed an IRA Loan to a Church Secured by Life Insurance. – The IRS allowed a
taxpayer’s IRA to loan money to a church, with the loan secured by an insurance policy on the
taxpayer’s life. The taxpayer was not a board member or employee of the church and did not own,
control, or have a financial interest in the church. In addition, the church was the sole owner of the
life insurance policy and enjoyed all the rights under the policy, subject to restrictions imposed by
the security agreement. (Ltr. Rul. 200741016.) See Chapter 5 of the treatise for a discussion of
prohibited IRA investments and transactions.
Personal Sale of Stock at a Loss and Repurchase by an IRA. – The tax law generally does not
allow a taxpayer to deduct a loss on the sale of stock or securities if the taxpayer purchases
substantially identical stock or securities within 30 days after the sale (a so-called "wash sale").
The IRS has now held that the loss remains nondeductible even if the taxpayer's IRA
repurchases the substantially identical stock. Furthermore, in such a case, the taxpayer may not
increase his or her cost basis in the IRA to account for the excess of the IRA's repurchase price
over the taxpayer’s sales price. (Rev. Rul. 2008-5, 2008-3 I.R.B. ___.) See Chapter 5 of the
treatise for a discussion of the taxation of IRAs.
IRA Distributions Paid Directly to Charities. – During the years 2006 through 2009, a retiree age
70 ½ or older may exclude from taxable income certain distributions paid by his or her IRA directly
to a qualified charity. The amount of excludable charitable distributions for a given year is limited
to the lesser of (1) $100,000, (2) the amount of the payments to the charity, or (3) the portion of
IRA funds otherwise deemed potentially taxable. (I.R.C. § 408(d)(8); Notice 2007-7, 2007-5 I.R.B.
395.) See Chapter 5 of the treatise for a discussion of the taxation of IRAs.
Withdrawal of After-Tax Excess Contributions – A taxpayer may avoid penalties on an excess
contribution by withdrawing it before his or her return is due for the year of the contribution.
However, if the taxpayer does not make a timely withdrawal, a subsequent withdrawal is taxable
as an ordinary distribution. (Ltr. Rul. 200904029; I.R.C. § 408(d)(4).) See Chapters 2, 4, 5, and 6
of the treatise for an explanation of the taxation of distributions from tax-favored plans and
arrangements.
IRS Lien Not Extinguished by Rollover to Another Plan or IRA. – If the IRS files a tax lien that
attaches to IRA funds, an owner cannot extinguish the lien merely by rolling over the funds from
the IRA to a qualified plan. (Miles v. Commissioner, T.C. Memo 2007-208, aff'd by unpublished
opinion, 2010-2 U.S.T.C. 50,661 (9th Cir. 2010)). See Chapter 5 of the treatise.
IRA Provisions Placing Restrictions on Distributions. – A retiree may incorporate into an IRA
specific distribution restrictions not otherwise required by the tax law, provided the restrictions do
not interfere with required minimum distributions. For example, the IRS ruled that a taxpayer
suffering from bipolar disorder could incorporate restrictions into her IRA that delayed her
requested distributions long enough to allow her attorney to counsel her. (Ltr. Rul. 201150037.)
See Chapter 5 of the treatise.
Married Individuals and Registered Domestic Partners in Community Property States. – The
taxation of distributions from IRAs (and deductions for contributions to IRAs) are determined
without regard to community property laws. Nevertheless, the IRS and several state courts have
held that community property laws continue to apply to IRAs for testamentary and divorce
purposes. These rulings and cases may also have some applicability to IRAs held by same-sex
spouses and registered domestic partners in states that apply community property laws to such
taxpayers. (I.R.C. §§ 219(f)(2), 408(g); In re Mundell, 124 Idaho 152, 857 P.2d 631, 633 (Idaho
1993); McVay v. McVay, 476 So. 2d 1070, 1073-1074 (La. Ct. App. 1985); Ltr. Rul. 201021048;
CCA 201021050; Ltr. Rul. 8040101; FSA 199935055.) See Chapter 5 of the treatise.
To next page
To previous page
To home page
The author intends that this website provide accurate and authoritative information on the subject matter
covered. However, the information provided on this website is not a substitute for the advice of an attorney,
accountant, or other professional; and the author is not offering legal, accounting, or other professional
advice. The material presented on this website is not intended for use, and may not be used, to avoid tax
penalties. If you need legal advice or other professional help, you should seek (from an independent
attorney, accountant, or other competent professional) advice based on your own particular circumstances.
covered. However, the information provided on this website is not a substitute for the advice of an attorney,
accountant, or other professional; and the author is not offering legal, accounting, or other professional
advice. The material presented on this website is not intended for use, and may not be used, to avoid tax
penalties. If you need legal advice or other professional help, you should seek (from an independent
attorney, accountant, or other competent professional) advice based on your own particular circumstances.
| Copyright © 2005-2012 by Vorris J. Blankenship All Rights Reserved |