Tax Planning for Retirees

IRA Tax Developments – Part 2

No Bankruptcy Exemption for Inherited IRAs. – Funds in IRAs and Roth IRAs are generally
exempt from forfeiture in bankruptcy proceedings, subject to a limitation of $1,000,000 or more. Unfortunately, though, the U.S. Supreme Court has now held that funds in inherited IRAs (and inherited Roth IRAs) are not entitled to any amount of exemption in bankruptcy.  (Clark v. Rameker, 2014-1 U.S.T.C. ¶ 50,317.) See Chapter 5 of the treatise.

Boilerplate Cross-Collateralization Agreement Not Necessarily a Prohibited Transaction. – An IRA that is an individual retirement account will terminate on the first day of the taxable year of a loan transaction that is a prohibited transaction. However, the Sixth Circuit has held that the mere signing of a boilerplate cross-collateralization agreement (as a condition for opening an IRA) is not a prohibited transaction if the taxpayer has no other accounts that could be subject to the agreement. (Daley v. Mostoller, 717 F.3d 506 (6th Cir. 2013).) See Chapter 5 of the treatise for a discussion of IRAs.

Transactions Between an IRA Owner and an IRA-Owned Entity. – The tax law imposes substantial penalties on an IRA owner who engages in a “prohibited transaction” with his or her IRA (including potential taxable termination of the IRA). Prohibited transactions include loans, lines of credit, or guarantees from an IRA owner to an entity substantially owned by his or her IRA. (Peek v. Commissioner, 140 T.C. No. 12 (2013).)

Prohibited transactions also include compensation paid to an IRA owner for services rendered to an entity owned in whole or in part by his or her IRA. Although the tax law generally provides an exception for reasonable compensation paid by an IRA, the exception does not apply to compensation for services rendered by an IRA owner to an entity wholly or partially owned by the IRA. (Ellis v. Commissioner, T.C. Memo. 2013-245.) See Chapter 5 of the treatise.

Publicly Traded Grantor Trust Holding Gold. – The acquisition of a “collectible” by an IRA is subject to harsh treatment for tax purposes. A retiree or beneficiary must treat the cost or value of the collectible as an immediate taxable distribution. Collectibles generally include gold coins and gold bullion. However, the IRS has ruled that publicly traded shares of a grantor trust holding gold coins and gold bullion are generally not collectibles. (Ltr. Rul. 201446030.) See Chapter 5 of the treatise.

The Trustee of an IRA May Refuse to Invest in Certain Types of Assets. – A retiree cannot compel an IRA to invest in types of assets not authorized by the IRA instrument or allowed by the trustee. For example, the Tax Court has held a distribution to be taxable even though the taxpayer invested the distribution in real estate that he titled in his name as agent for the IRA. The distribution was taxable because the IRA trustee refused to accept real estate as an IRA asset. (Dabney v. Commissioner, T.C. Memo. 2014-108.) See Chapter 5 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.

Rollovers to Simple IRAs Now Generally Allowed. – A taxpayer may now roll over distributions tax-free into a Simple IRA from other IRAs and tax-favored retirement plans, but only after expiration of the two-year period following the taxpayer’s first participation in a Simple IRA. During the same two-year period, the taxpayer may roll over a distribution from a Simple IRA only to another Simple IRA. (IRC § 408(p)(1)(B).) See Chapter 5 of the treatise.

IRA Contributions Allowed After Age 70 ½ Though They May Limit Charitable Distributions. – In years before 2020, a taxpayer over age 70 ½ could not contribute to an IRA even though he or she was otherwise qualified. After 2019, a taxpayer may make such contributions regardless of age. Unfortunately though, the exclusion for charitable distributions is reduced to the extent the taxpayer makes deductible contributions to his or her IRAs in taxable years ending after the taxpayer attained age 70½. The IRS explains that once a portion of the post-70½ deductible contributions has reduced the amount of the charitable distribution that is excluded from income for a taxable year, that portion of the deductible contributions will not again reduce the excludable charitable distributions for any subsequent year. (The SECURE Act of 2019, Pub. L. No. 116-94, § 107; Notice 2020-68, 2020-38 I.R.B. ___.) See Chapter 5 of the treatise.

Tangible Personal Property of an IRA Must Be in the Possession of the Trustee. – A retiree or beneficiary of an IRA must treat the cost or value of a “collectible” as an immediate taxable distribution. Collectibles generally consist of tangible personal property; however, there are many exceptions to the rule. It is important to note that tangible personal property of an IRA that is exempted from the collectible rule must still remain in the physical possession of an independent trustee. That is, the IRA owner will be deemed to have received a distribution of the property if he or she has physical possession of it. For example, an IRA owner was deemed to have received a distribution of gold coins that were in her possession. It was irrelevant whether she enjoyed that possession as an agent of the IRA or its trustee. (McNulty v. Commissioner, 157 T.C. No. 10 (2021).) See Chapter 5 of the treatise.

IRA Charitable Distributions Now Include Amounts Paid to Split-Interest Entities. – A retiree or beneficiary age 70½ or older may exclude from gross income certain distributions (“charitable distributions”) paid directly to a qualified charity by his or her IRA or inherited IRA. For this purpose, charitable distributions now also include one-time IRA distributions paid directly to a “split-interest entity,” defined as a charitable remainder unitrust, a charitable remainder annuity trust, or a charitable gift annuity that is funded exclusively with such charitable distributions. These distributions are limited to an aggregate amount of $50,000 in one taxable year and may not thereafter be made in any subsequent taxable year. (SECURE 2.0 Act, Pub. L. No. 117-164, Div. T, Title I, § 307.) See Chapter 5 of the treatise.