Tax Planning for Retirees

MOST RECENT DEVELOPMENTS

Final Regulations under the SECURE Act. – The IRS has issued final regulations interpreting the SECURE Act of 2019. The regulations are effective for tax years beginning on or after January 1, 2025. Because of the complexity of the SECURE Act and its unavoidable ambiguities, the IRS has had the opportunity to choose between alternative interpretations of many provisions of the Act. Unfortunately, the IRS has in some instances chosen interpretations that were largely unanticipated by practitioners. See Chapter 8 of the treatise.

The Regulations Were Completely Rewritten. – More broadly, the IRS decided to completely rewrite the regulations rather than simply amend them to the extent necessary to conform to the SECURE Act. In the rewriting, the IRS made other changes, some of which do not seem to be wholly necessary to implement the provisions of the SECURE Act. For example, the IRS (1) provided new rules for determining which beneficiaries of a see-through trust are designated beneficiaries, (2) revamped the method for identifying designated beneficiaries in the case of powers of appointment, reformations, and decanting, (3) simplified the determination of who is a minor, (4) introduced a new definition of disability for individuals under age 18, and (5) introduced two exceptions (for minors and AMBTs) to the rule that all beneficiaries of a plan must be eligible designated beneficiaries for the plan to qualify for life-expectancy distributions. See Chapter 8 of the treatise.

Challenges to the Regulations in the Current Non-Chevron Environment. – The final regulations were drafted when the Chevron doctrine applied. That doctrine gave the IRS wide latitude to write regulations that interpret ambiguous statutory language, provided the Service’s interpretation was one of the possible “reasonable” interpretations of the statute. However, the Supreme Court has since overruled Chevron. Henceforth, courts must use traditional methods of statutory construction to find the “best” interpretation of a statute. In doing so, courts may not give deference to regulations (although the courts may consider the possible persuasiveness of the regulations). The SECURE Act, and the previous Code provisions that the Act amended, contain many ambiguities that the regulations attempt to resolve. Because the regulations under the SECURE Act were drafted in the more lenient Chevron environment, the IRS likely overreached in some cases. Consequently, these regulatory interpretations may now be easier to challenge than they would have been in the previous Chevron environment. Note that a retiree who is challenging the validity of a regulation should file Form 8275-R, Regulation Disclosure Statement, with his or her return. (Loper Bright Enter. v. Raimondo, 603 U.S. ___ (2024); Chevron U.S.A. Inc. v. Nat. Res. Defense Council, Inc., 467 U.S. 837 (1984).) See Chapter 8 of the treatise.

Continuation of Life Expectancy Distributions Until Final Ten-Year Distribution. – Practitioners had expected that the new ten-year distribution rule applicable to designated beneficiaries would entirely supersede the old rule that required life-expectancy distributions to be made to a designated beneficiary when a participant died on or after his or her required beginning date. Practitioners had also expected that the new successor ten-year distribution rule would entirely supersede the old rule requiring continuation of life-expectancy distributions after the death of a designated beneficiary. Instead, in both cases, the final regulations continue to apply the old rules requiring continued life-expectancy distributions. The new ten-year distribution rules are treated simply as limitations superimposed over the old life-expectancy distribution requirements. Fortunately, for the years 2021 through 2024, the IRS is not penalizing failures to make life-expectancy distributions to beneficiaries who were subject to the new ten-year rules. (Notice 2022-53, 2022-44 I.R.B. 437; Notice 2023-54, 2023-31 I.R.B. 382; Notice 2024-35, 2024-19 I.R.B. __.) See Chapter 8 of the treatise.

The Applicable Age for the Start of Required Minimum Distributions. – The regulations recognize that the applicable age for the start of required minimum distributions is 73 for years after 2023 and before 2033, and the applicable age is 75 for years after 2034. There are no required beginning dates during the years 2023, 2033 and 2034. Because of an error in drafting the statutory language, a retiree born in 1959 would technically satisfy the requirements for both age 73 and age 75 beginning dates. However, proposed regulations specify that the applicable age for that year is 73. (The SECURE 2.0 Act, Pub. L. No. 117165, Div. T, Title I, § 107; Treas. Reg. § 1.401(a)(9)-2(a)(3)(ii); Prop. Treas. Reg. § 1.401(a)(9)-2(b)(2)(v).) See Chapter 8 of the treatise.

Surviving Spouse’s Election to be Treated as the Participant. – For minimum distributions that are required to begin after 2023, a defined contribution plan may provide that a surviving spouse who is the sole beneficiary can elect to be treated as the participant in the plan. An electing spouse is entitled to use the Uniform Lifetime Table for determining required minimum distributions based on the spouse’s age in each distribution year. For a surviving spouse who dies before minimum distributions are required, the proposed regulations apply the five-year rule, the primary ten-year rule and the life-expectancy rule to the spouse’s designated beneficiaries as if the spouse were the plan participant. (IRC § 401(a)(9)(B)(iv); Treas. Reg. § 1.401(a)(9)-5(g)(3)(i).) See Chapter 8 of the treatise.

Catch-up Minimum Distributions for Surviving Spouse Making Late IRA Ownership Election. – A surviving spouse taking distributions from an IRA under the ten-year rule may elect to take ownership of the IRA even after the later of (1) the calendar year following the retiree’s death or (2) the calendar year the spouse attains age 73 (age 75 after 2034). However, the spouse must first take a catch-up distribution equal to hypothetical minimum distributions that would have been required in prior years assuming the spouse owned the IRA, less the actual distributions received by the spouse. A surviving spouse cannot circumvent this rule by rolling over the funds in the IRA to his or her own IRA. (Treas. Reg. §§ 1.402(c)-2(j), 1.408-8(c)(1), (d).) See Chapter 8 of the treatise.

Special Rules for Minor Children of a Plan Participant. – Before issuance of the regulations, there was a concern that a minor child could not be an eligible designated beneficiary if there were another plan beneficiary who was not an eligible designated beneficiary. Fortunately, the regulations expressly state that a minor who qualifies as an eligible designated beneficiary will not cease to be eligible merely because other designated beneficiaries are not eligible. However, those other ineligible designated beneficiaries generally must be taken into consideration in determining the oldest designated beneficiary on whose life expectancy distributions are based. On the other hand, the successor ten-year rule is always measured from the earlier of (1) the year the youngest minor child reaches majority or (2) the year of death of the last surviving minor child. (Treas. Reg. § 1.401(a)(9)-4(e)(2)(ii); Treas. Reg. § 1.401(a)(9)-5(f)(1)(i), (f)(2)(ii).) See Chapter 8 of the treatise.

Division of a See-Through Trust into Separate Trusts. – The IRS has finally acknowledged by regulation that required minimum distribution rules can apply separately to two or more trusts resulting from the division and termination of a see-through trust. The division must be required by the terms of the trust immediately upon the death of the plan participant. However, there can be no discretion regarding the allocation to the separate trusts of post-death distributions from the plan. Further, trust receipts (during a reasonable administrative period preceding the actual division and termination of the trust) must be allocated to the separate trusts as if they were separated as of the date of death of the retiree. (Treas. Reg. § 1.401(a)(9)-8(a)(1)(iii)(B), (C).) See Chapter 8 of the treatise.

Charitable Beneficiary of an Applicable Multi-Beneficiary Trust. – An applicable multi-beneficiary trust (an AMBT) will qualify as such only if all the beneficiaries are designated beneficiaries. However, certain types of charitable organizations can be treated as designated beneficiaries for this purpose, thus allowing the charities to be named as remainder beneficiaries. (IRC §§ 401(a)(9)(H)(v), 408(d)(8)(B)(i); Treas. Reg. § 1.401(a)(9)-4(g)(3).) See Chapter 8 of the treatise.

Termination of the Interest of a Disabled or Chronically Ill Beneficiary in an AMBT. – The terms of an AMBT may allow for the termination of the interest of a disabled or chronically ill beneficiary (e.g., if necessary to protect government assistance for that beneficiary). But, in such case, the trust terms must continue to provide that beneficiaries who are not disabled or chronically ill do not have any right to plan benefits until the death of all the disabled or chronically ill beneficiaries. (Treas. Reg. § 1.401(a)(9)-4(g)(2).) See Chapter 8 of the treatise.

Election to Treat Annuity Distributions as Non-Annuity Distributions. – If a defined contribution plan purchases a life annuity contract, the required minimum distribution rules applicable to annuities apply to the annuity contract. If less than the entire balance in a defined contribution plan is used to purchase the annuity, distributions from the remainder of the balance (not used for the purchase) must generally meet the minimum distribution requirements applicable to non-annuity distributions. However, a plan may now allow a retiree to elect to (1) aggregate the value of the annuity and the remaining account balance and (2) treat all distributions as non-annuity distributions. (The SECURE 2.0 Act, Pub. L. No. 117-164, Div. T, Title II, § 204; Treas. Reg. § 1.401(a)(9)-5(a)(5)(iv).) See Chapter 8 of the treatise.

The SECURE Act Applies to 457 Tax-Exempt Organization Plans. – The IRS has concluded that the new minimum distribution rules under the SECURE Act apply to 457 tax-exempt organization plans that provide (1) an individual account for each participant and (2) benefits based only on amounts in the account (even though the account is not funded). (I.R.C. § 414(i); T.D. 10001, Preamble V.) See Chapter 8 of the treatise.

Documentation of Disabled or Chronically Ill Status. – The regulations require that a beneficiary who is disabled or chronically ill submit documentation of his or her condition to the trustee of his or her retirement plan. However, this documentation need not be provided to the trustee of an IRA. (Treas. Reg. §§ 1.401(a)(9)-4(e)(7), 1.408-8(b)((4)(i).) See Chapter 8 of the treatise.

Minor Child Includes Stepchild, Adopted Child, and Foster Child. – The regulations clarify that a minor child of a plan participant includes a stepchild, an adopted child, or a foster child. (IRC § 152(f)(1); Treas. Reg. § 1.401(a)(9)-4(e)(1)(ii).) See Chapter 8 of the treatise.

Extended Rollover Period for Plan Participants Attaining Age 72 in 2023. – If a participant in a qualified plan or IRA reached age 72 in 2023, the participant had until September 30, 2023 to roll over a distribution received from the plan or IRA during the period January 1, 2023 to July 31, 2023. (Notice 2023-54, 2023-31 I.R.B. ___) See Chapter 8 of the treatise.

New Exceptions to the Early Distribution Penalty. – The Code imposes a 10 percent penalty on distributions from tax-favored retirement plans before age 59 ½ unless one of a number of exceptions apply. The SECURE 2.0 Act added several new exceptions:

1. Emergency Personal Expense Distributions. After 2023, the early distribution penalty does not apply to emergency personal expense distributions of less than $1,000 per year. This exception does not, however, apply to distributions from defined benefit plans.

2. Domestic Abuse Distributions. After 2023, the early distribution penalty does not apply to distribution required to deal with domestic abuse. This exception does not, however, apply to distributions from defined benefit plans or plans required to pay spousal annuities. The exception is also limited to the lesser of an aggregate amount of $10,000 or one-half the nonforfeitable benefit in the plan.

3. Distributions to Terminally Ill Individual. The early distribution penalty does not apply to distributions to a terminally ill individual. For this purpose, a terminally ill individual is someone certified by a physician as reasonably expected to die within 84 months due to illness or physical condition.

4. Long-Term Care Distributions. After December 30, 2025, the early distribution penalty does not apply to distributions from an employer plan to pay premiums on long-term care insurance for the employee, his or her spouse, or certain other family members. The distributions for a tax year may not exceed the lesser of the amount of the premium, ten percent of the present value of the nonforfeitable accrued benefit in the plan, or $2,500. The exception does not apply to IRA distributions.

5. Distributions for Qualified Federally Declared Disasters. For qualified federally declared disasters occurring after January 26, 2021, the penalty does not apply to distributions of up to $22,000 for financial relief from the effects of the disaster. The distributions may be taken into gross income over a three-calendar-year period or, alternatively, the distributions may be recontributed tax-free to a tax-favored plan within three years of distribution. An employer may also increase the amount of allowable employer plan loans from $50,000 to $100,000.

6. Income Attributable to Corrective Distributions of Excess Contributions to IRAs. An IRA makes a corrective distribution of an excess contribution by timely distributing the amount of the contribution, together with any net income accumulated thereon. Fortunately, though, Congress has provided that the 10 percent penalty for early distribution will no longer be imposed on the income portion of the distribution.

(SECURE 2.0 Act, Pub. L. No. 117-164, Div. T, Title I, §§ 115, 314, 326, 331, 333, 334.) See Chapter 2 and Chapter 5 of the treatise.

Modifications of Exceptions to the Early Distribution Penalty. – The SECURE 2.0 Act modified several existing exceptions to the 10 percent penalty on early distributions:

1. Distributions to Public Safety Officers and Private Sector Firefighters. The exception to the early distribution penalty available to public safety officers who retire after age 50 is now also available to public corrections officers and public forensic security employees. The exception has also been extended to private sector firefighters. In addition, the exception to the penalty is now available to public safety officers and firefighters with 25 years of service with the plan’s sponsoring employer.

2. Recontribution of Qualified Birth or Adoption Distributions. The early distribution penalty does not apply to qualified birth or adoption distributions. In addition, recipients of these distributions can recontribute them tax-free to tax-favored retirement plans. However, Congress has now acted to limit such recontributions to the three-year period following a distribution.

(SECURE 2.0 Act, Pub. L. No. 117-164, Div. T, Title I, §§ 308, 311.) See Chapter 2 and Chapter 5 of the treatise.

The Percentage Limitation on QLAC Premiums Repealed and the Dollar Limitation Reset. – A retiree may defer the starting date of qualifying longevity annuity contracts (QLACs) until age 85 without violating minimum distribution rules. However, in past years, the aggregate QLAC premiums paid during a retiree’s lifetime by all his or her plans and IRAs could not exceed a dollar amount ($145,000 for 2022). Nor could cumulative premiums paid by any one plan exceed 25 percent of the plan’s account balance. Congress has now repealed the percentage limitation and reset the dollar limitation to $200,000 (for 2023 and adjusted for inflation thereafter). (SECURE 2.0 Act, Pub. L. No. 117-164, Div. T, Title I, § 202.) See Chapter 8 of the treatise.

Reduction of Penalty for Failure to Make Required Minimum Distributions. – After 2022, the penalty for failure to make required minimum distributions is decreased from 50 percent of the undistributed amount to 25 percent. The penalty may be further reduced to 10 percent if failure to take a required minimum distribution is timely corrected. (SECURE 2.0 Act, Pub. L. No. 117-164, Div. T, Title I, § 302.) See Chapter 8 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.

Self-Certification of Hardships. – For employer plans that allow hardship distributions, employees may now self-certify in writing that they have suffered a hardship. (SECURE 2.0 Act, Pub. L. No. 117-164, Div. T, Title I, § 312.) See Chapter 2 of the treatise.

Conformance of Treatment of RMDs from Designated Accounts to the Treatment of Roth IRAs. – After 2023, minimum distributions from a designated Roth account are not required during the lifetime of the participant. This change conforms the minimum distribution treatment of designated Roth accounts to the treatment of Roth IRAs. (SECURE 2.0 Act, Pub. L. No. 117-164, Div. T, Title I, § 325.) See Chapter 8 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.

New Life Expectancy Tables and a New Uniform Lifetime Table. – New life expectancy tables and a new Uniform Lifetime Table providing longer distribution periods apply for required minimum distribution purposes for calendar years beginning after 2021. Furthermore, if a post-2021 minimum distribution to a nonspouse beneficiary is required to be determined by reference to a life expectancy initially determined for a year before 2022, that life expectancy is redetermined under the new tables as if the new tables were effective for the pre-2022 year of initial determination. The new life expectancy period is then reduced by one for each year elapsed since the pre-2022 year of the initial determination. For a surviving spouse, however, the distribution period is determined anew under the new tables for each distribution year after 2021. (Treas. Reg. § 1.401(a)(9)-9.) See the Appendix to the treatise.

The new tables also apply to the safe harbor methods for computing substantially equal periodic payments that avoid the penalty on premature distributions from IRAs, retirement plans, and commercial annuities. However, the new tables are generally not applicable until years after 2022 for this purpose. Nevertheless, taxpayers have the option to use the new tables for substantially equal payments beginning in 2022. Furthermore, in any year after 2021, taxpayers may change to the new tables even if substantially equal payments commenced before 2022. (Rev. Rul. 2022-6, 2002-5 I.R.B. ___.)

Proposed regulations limit availability of extended rollover period for loan offsets. – Normally, a retiree has only 60 days after a loan-offset distribution to roll it over to another plan or IRA. In some circumstances though, a participant may roll over the loan-offset distribution any time before the due date (including extensions) of the tax return for the year of the distribution. This extended rollover period is available only for loan-offset distributions after the year 2017, and only if the distribution is due to termination of the distributing plan or failure to meet repayment terms because of severance of the participant’s employment. In the latter event, however, the IRS has stated in proposed regulations that the extended rollover period is not available if the loan offset occurs more than one year after severance of the participant’s employment. (I.R.C. § 402(c)(3)(C); Prop. Treas. Reg. § 1.402(c)-3.) See Chapter 2 and Chapter 4 of the treatise.

Distribution of individual custodial accounts from section 403(b) plans. – Upon termination of a section 403(b) plan containing interests in section 403(b)(7) custodial accounts, the plan may distribute individual custodial accounts (ICAs) tax free if certain conditions are met. In that case, the ICAs may continue to be treated as if they were 403(b) plans, and funds in the ICAs are not taxed until distributed. (Rev. Rul. 2020-23, 2020-47 I.R.B. ___.) See Chapter 2 of the treatise.

Applicability of Early Distribution Penalty to Annuities Held in Trust. – The IRS has ruled that, if a retiree uses a grantor trust to purchase an annuity for a beneficiary, the early distribution penalty will not apply to annuity distributions to the beneficiary after the retiree (the grantor) reaches age 59½ or becomes disabled. Further, the life or life expectancy of the grantor must be used to qualify for the substantially equal payments exception to the penalty. If instead a nongrantor trust is established and purchases the annuity for a beneficiary, the retiree is not the owner of the trust and thus the age 59½, disability, and substantially equal payment exceptions do not apply. However, for both a grantor trust and a nongrantor trust, it is the death of the primary beneficiary (and not the death of the grantor) that will also allow annuity payments without penalty. (I.R.C. § 72(u)(1), 72(s)(6)(B), 72(q)(2)(A), (B), (C), (D); Priv. Ltr. Rul. 202031008.) See Chapter 16 of the treatise for a more complete discussion of the taxation of personally purchased annuities.

Suspension of Minimum Distribution Requirements for 2020. – Congress has eliminated minimum distribution requirements for 2020 for tax-favored plans that are individual account plans (i.e., are not defined benefit plans). Thus, a retiree who chooses to take distributions in 2020 from such a tax-favored plan may roll over even the portion that would have been a required minimum distribution absent the suspension of the requirement. Furthermore, if the usual 60-day rollover period has expired, such portion can nevertheless be rolled over any time on or before August 31, 2020. Although the plan is not required to make trustee-to-trustee transfers of such amounts, it may do so if it chooses. In addition, the direct distribution of such amounts to a retiree by the plan is not subject to the normal 20 percent tax withholding, and the retiree may elect to eliminate other types of withholding tax.

A retiree whose required beginning date (RBD) is April 1, 2020 need not take a minimum distribution for 2019, unless the retiree already did so for 2019. After 2020, the retiree’s RBD must be determined in the usual way without regard to the 2020 suspension. The retiree’s beneficiary must also use the retiree’s normal RBD to determine the applicable method for determining minimum distributions. In addition, if the five-year minimum distribution rule applies to a beneficiary, the beneficiary does not count 2020 as one of the five years. For example, the five-year period ends in 2023, instead of 2022, for a retiree who died in 2017. The new ten-year distribution period for designated beneficiaries is unchanged. (I.R.C. §§ 401(a)(9)(I), 402(c)(4); Notice 2020-51, 2020-29 I.R.B. ___.) See Chapter 8 of the treatise for a discussion of required minimum distributions..

No Premature Distribution Penalty on Birth or Adoption Distributions. – After 2019, the 10 percent penalty on premature distributions from tax-favored plans will not apply to up to $5,000 of distributions occasioned by birth or adoption of a child. The $5,000 limit applies separately to each parent with respect to that parent’s distributions from his or her plans or IRAs. The new provision also allows for later recontribution of the distributions to the taxpayers’ qualified plans and IRAs. The IRS has also announced that, if an eligible plan does not authorize qualified birth or adoption distributions, an individual who receives a permitted in-service distribution that meets the requirements of a qualified birth or adoption distribution may nevertheless treat the distribution as a qualified birth or adoption distribution. The distribution, while includible in gross income, is not subject to the early distribution penalty. The individual may recontribute the amount to an IRA without regard to the usual 60-day rollover requirement. (The SECURE Act of 2019, Pub. L. No. 116-94, § 113; Notice 2020-68, 2020-38 I.R.B. ___.) See Chapters 2, 4, and 5 of the treatise.

“Lifetime Income Investments” Can Be Distributed or Transferred. – Occasionally, a so-called “lifetime income investment” ceases to be an authorized option under a 403(b) plan, an eligible state/local plan, or a qualified plan that is a defined contribution plan. After 2019, if the plan so provides, the trustee of such a plan may transfer a lifetime income investment to the trustee of another qualified plan or IRA, if certain conditions are met. Alternatively, a plan may simply distribute a lifetime income investment to a participant in the form of an annuity contract. For this purpose, lifetime income investments include optional annuities payable over the life of the participant, or the joint lives of the participant and his or her designated beneficiary. They also include optional investments that guarantee a minimum level of income for the life of the participant, or for the joint lives of the participant and his or her designated beneficiary. (The SECURE Act of 2019, Pub. L. No. 116-94, § 109.) See Chapters 2 and 4 of the treatise.

IRA Contributions Allowed After Age 70 ½ Though They May Limit Excludable 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.

In-Service Distributions from Eligible State/Local Government Plans at Age 59½. – In-service distributions from an eligible state/local government plan may now begin at age 59½. In years before 2020, such distributions could not begin until age 70 ½. (IRC § 457(d)(1)(A)(i).) See Chapter 4 of the treatise.

A Taxpayer May Not Use Credit Cards to Take Out Qualified Plan Loans. – In years before 2020, a qualified plan or eligible state/local plan could make qualified plan loans through a credit card arrangement. After 2019, the tax law does not allow a credit card arrangement. (The SECURE Act of 2019, Pub. L. No. 116-94, § 108.) See Chapter 2 and 4 of the treatise.

Qualified Plan Distributions Taxable on Receipt. –The IRS has ruled that a distribution check from a qualified retirement plan is taxable in the year of receipt of the check. It matters not whether the individual keeps the check, sends it back, destroys it, or cashes it in a later tax year. However, this rule does not apply if the recipient could not cash the check in the year received. Nevertheless, the rule has the intended effect of preventing a taxpayer from deliberately deferring taxation of the distribution to the year following the year of receipt. On the good side, the rule also guarantees that an annually required minimum distribution that is received in the correct tax year is also taxed in the correct year even if the taxpayer fails to cash the distribution check until the following year. (Rev. Rul. 2019-19, 2019-36 I.R.B. ___.) See Chapter 2 of the treatise.

Repeal of Recharacterizations of Roth Conversions. –After making a Roth conversion from a traditional IRA or other plan, a retiree may have second thoughts about the desirability of the conversion. In past years, the retiree could solve this problem by transferring some or all of the transferred funds to a traditional IRA from the Roth IRA that originally received the funds. The tax law then treated the recharacterized amount as retroactively rolled over to the traditional IRA from the originally distributing plan or IRA, in a nontaxable transaction. Unfortunately, the year 2017 was the last year a retiree could make a Roth conversion that was subject to recharacterization. Note that if a retiree wished to recharacterize a 2017 Roth conversion, he or she generally had to do so on or before October 15, 2018. (IRC § 402A(d)(6)(B)(iii); Tax Cuts and Jobs Act, Pub. L. No. 115-97, § 13611(b).) See Chapter 6 of the treatise.

View Joint Committee Statement on “Backdoor” Roth Contributions With Caution. –The Joint Committee on Taxation has acknowledged that a taxpayer may avoid the limitations on contributions to Roth IRAs by making contributions to an IRA and converting the IRA to a Roth IRA (so-called backdoor Roth contributions). The acknowledgement came in footnotes to the committee report for the Tax Cuts and Jobs Act of 2017. Unfortunately though, the committee report did not discuss or rule out application of the substance-over-form doctrine to certain preconceived backdoor plans intended to avoid Roth limits by making a Roth conversion immediately after an IRA contribution. Unfortunately also, statements in a committee report are far from binding on the IRS or the courts. See Bobrow v. Commissioner, T.C. Memo 2014-21, for a case in which the Tax Court rejected a formal IRS position favorable to the taxpayer, and instead imposed a harsher statutory interpretation not supported by either the IRS or the taxpayer. For a detailed discussion of the substance-over-form issue, see here. (Conference Committee Report of the Tax Cuts and Jobs Act (HR 1)—Pub. L. No. 115-466_Individual Tax Reform, E.1, footnotes 268, 269, 276, and 277.)

Extended Rollover Period for Some Loan-Offset Distributions Made by Tax-Favored Plans. –Normally, a retiree has only 60 days after a qualified plan makes a loan-offset distribution (i.e., an offset of a plan loan against plan funds) to roll over the distribution to another plan or IRA. Congress has now provided that a retiree may roll over some such distributions any time before the due date (including extensions) of the tax return for the year of the distribution. This extended rollover period is available only for loan-offset distributions after the year 2017, and only if the distribution is due to termination of the distributing plan or failure to satisfy repayment terms because of severance of the participant’s employment. (IRC § 402(c)(3)(C); Tax Cuts and Jobs Act, Pub. L. No. 115-97, § 13613.) See Chapter 2 and Chapter 4 of the treatise.

Qualified Stock or RSUs Derived from Qualified Equity Grants. – For years after 2017, a participant in a qualified equity plan may elect to defer the tax on the bargain element in “qualified stock.” The qualified stock must be issued to a “qualified employee” pursuant to an equity grant awarded by an “eligible corporation.” Such equity grants consist of either stock options or restricted stock units (RSUs), but not both. If an employee receives qualified stock under such a grant, the employee may be able to defer payment of tax on the bargain element for as long five years after the date of vesting. However, the deferral can end earlier upon the occurrence of certain events. (IRC § 83(i); Tax Cuts and Jobs Act, Pub. L. No. 115-97, § 13603.)

Only an “eligible corporation” may award the qualified equity grants. Among other requirements for eligibility, the corporation must have a written plan that provides grants of stock options or RSUs to at least 80 percent of the corporation’s employees. The IRS has announced that the corporation must grant these options or RSUs during the year of corporate eligibility. That is, the corporation cannot take into account grants in other years for purposes of satisfying the 80 percent rule.

When the deferral period ends, the bargain element becomes subject to income tax withholding at the maximum individual tax rate. The IRS has announced that, to guarantee that the employer can withhold income taxes, the employer must put the deferral stock into an escrow, at least until the bargain element is includable in the employee’s income. The employer may then withdraw from escrow a sufficient number of shares to cover the income tax withholding, to the extent the withholding requirement has not otherwise been satisfied. The employer must then deliver the remaining escrowed shares to the employee. (Notice 2018-97, 2018-52 I.R.B. ___.) See Chapter 11 of the treatise.

The Basic Exclusion Increased for Gift and Estate Tax Purposes. –For years after 2017, Congress has increased the basic exclusion for gift and estate tax purposes from $5,000,000 to $10,000,000. For the estate of an individual dying in 2018, the applicable exclusion (after adjustment for inflation) is $11,200,000. (IRC § 2010(c)(2); Tax Cuts and Jobs Act, Pub. L. No. 115-97, § 11061.) See Chapter 20 of the treatise.

More Liberal Hardship Distributions from 401(k) Plans. –Before 2019, 401(k) plans could make hardship distributions only from elective deferrals. After 2018, a 401(k) plan may also make hardship distributions from qualified nonelective contributions, qualified matching contributions, and plan earnings. Also after 2018, a retiree need not exhaust plan loans before taking a hardship distribution. Note though that hardship distributions may be subject to the 10 percent additional tax on early withdrawals, unless an exception to the additional tax applies to the distribution. (IRC § 401(k)(14).) See Chapter 2 of the treatise.

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. 2020-46, 2020-45 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.

Automatic Waiver of the 60-Day Rule for a Returned Federal Tax Levy. A waiver of the 60-day rollover rule is automatic for funds returned to a retiree after a federal tax levy on a plan or IRA. However, the rollover must be completed by the due date (not including extensions) of the return for the taxable year the funds were returned. (IRC § 6343(f); Bipartisan Budget Act of 2018, H.R. 1892, § 41104.) See Chapter 2, Chapter 4, and Chapter 5 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.

Refinancing to Cure a Default on a Five-Year Qualified Plan Loan. – In CCA 201736022, the IRS demonstrated how a retiree could cure a default on a five-year qualified plan loan by refinancing and folding the defaulted payments into the replacement loan. In such a case, though, the retiree must comply with much more difficult statutory dollar limitations applicable to the refinancing of loans, unless the term of the replacement loan ends no later than the five-year term that was available for the old loan. The retiree must also refinance before expiration of the period during which the retiree could cure the default by making late payments. See Chapter 2 of the treatise.

Relief from Section 409A for Deferrals Grandfathered Under Section 457A. – Nonqualified deferred compensation payable by certain partnerships or foreign corporations with largely untaxed income is generally taxable under Code Section 457A when the compensation is no longer subject to a substantial risk of forfeiture (i.e., when vested). However, Section 457A does not apply to such amounts deferred before 2009 (grandfathered deferrals). Nevertheless, taxpayers were required to include such grandfathered deferrals in gross income before the beginning of taxable year 2018, or during the year vested if later. The IRS has announced that, if actual payment of the grandfathered deferrals would normally be a violation of Section 409A, the plan may nevertheless make a partial payment that does not exceed the income tax withholding that would have been required by all taxing authorities if the plan had actually paid the entire grandfathered amount. (Notice 2017-75, 2017-52 I.R.B. ___.) See Chapter 9 of the treatise.

Underwriters’ Commissions on IPO of Nonstatutory Stock Not Deductible from Option Exercise Income. –A participant exercising nonstatutory stock options and selling the acquired stock in an initial public offering (IPO) may not treat underwriters’ commissions on the IPO as expenses deductible from compensation income recognized on exercise of the options. Rather, the commissions are capital expenses taken into account in computing gain or loss on sale of the stock, even if the exercise of the options and sale of the stock are virtually simultaneous. (Hann v. United States, 2017-2 U.S.T.C. ¶ 50,308 (Cl. Ct.).) See Chapter 11 of the treatise for a discussion of the taxation of nonstatutory stock options received from an employer.

Sale of a Retiree’s Life Insurance Policy. – A retiree may decide to sell his or her life insurance policy to an unrelated purchaser (even thought the retiree is healthy). If so, the retiree recognizes income equal to the amount realized less the adjusted basis of the policy. In the past, the adjusted basis of the policy was the total premiums paid less distributions, loans forgiven, and the deemed cost of the prior insurance protection. Now, however, Congress has retroactively eliminated the requirement to reduce the adjusted basis for the amount of the deemed cost of prior insurance protection. (IRC § 1016(a)(1)(B).) See Chapter 19 of the treatise for a discussion of the sale of a life insurance contract.