CAN A DECEASED INVESTOR OPEN AN INDIVIDUAL Retirement Account? The question may seem ludicrous, but the Internal Revenue Service took it seriously when a young widow asked the tax authority if she could establish a posthumous IRA for her husband.
The man, who left his 401(k) account to his wife, had died without owning an IRA, which created a tax dilemma for his widow. Because of her youth, she would have been subject to a 10 percent early withdrawal penalty had she rolled the money into a spousal IRA and withdrawn any cash. If she had kept the money in the workplace account, she could have enjoyed penalty-free withdrawals, but the company would have required that the account be emptied within five years. That option was equally unacceptable because she wanted to preserve the ability to stretch at least some of the inheritance over decades.
Her best alternative seemed to be a long shot. With the services of a tax professional, she sought the IRS's permission to do something no one had ever tried before. Specifically, in 2004 she asked the IRS if she could establish an IRA in her husband's name and designate herself as the beneficiary. If that was allowed, she wanted to transfer the 401(k) to the IRA, which would permit her to take any distributions penalty free.
Despite the unorthodox request, the IRS sided with the widow. While the circumstances surrounding this case are quite narrow, it is noteworthy for demonstrating the ability of taxpayers to extricate themselves from messy tax situations by approaching the IRS directly. Every year, hundreds of Americans, just like the young widow, do just that by requesting a private letter ruling.
Private letter rulings or PLRs, which the IRS issues nearly every week, can help individuals who are contemplating a tax maneuver that may rest within the tax code's gray area. At other times, the petitioners may be trying to avoid financial collateral damage triggered by inadvertently violating a tax rule. For instance, the IRS commonly hears from taxpayers who have been ensnared by the 60-day retirement account rollover rule.
In addition to individuals, corporations also seek rulings on such issues as corporate acquisitions and reorganizations, shareholder distributions, bankruptcies and the effect of certain ownership changes on net operating loss carryovers as well as particular earnings and profit questions. "S" corporations, along with some non-corporate taxpayers such as partnerships and trusts, also routinely seek tax relief through PLRs.
By understanding how PLRs work and why they can be worth the hassle and expense, you may be able to help clients who could benefit from a favorable nod from the IRS. For investment clients, the most relevant private letter rulings typically involve retirement plans and trust and estate issues. Botched IRA rollovers, ill-advised Roth conversions, 72(t) calculations and thorny issues triggered by trusts containing IRAs are all common PLR fodder.
Only tax professionals, who are recognized by the IRS, can seek a ruling, which means cases in this highly specialized field are generated primarily by tax attorneys and CPAs. In fact, one insider estimates that only 10 to 15 specialists are considered go-to sources for these filings. Taxpayers can also file on their own behalf, but the complexity of the process makes it daunting and arguably pointless.
But as an investment advisor, you can help identify when a letter ruling might be a feasible solution to what seems like a client's intractable problem. "When I teach investment advisors, I tell them to focus on triaging the issues, spotting the opportunities and using that expertise to involve competent tax advisors," says Robert S. Keebler, CPA, MST, who is a partner at Virchow, Krause & Company, LLP in Green Bay, Wisc. In other words, once you identify a problem, find an expert to carry the ball.
Private letter rulings can also help advisors and financial institutions protect their own bacon by erasing their mistakes. Keebler, for instance, recently submitted PLR requests on behalf of a brokerage firm which mishandled two IRAs. Ed Slott, a CPA and publisher of Ed Slott's IRA Advisor newsletter, who has filed many PLR requests on behalf of advisors after they bungled IRA paperwork, is currently working on one involving a bank that mistakenly cut a check for an IRA distribution from someone else's retirement account. "The cheapest way is to get the IRS to resolve a problem, if it can be done, rather than get sued," Slott observes.
The cost of seeking an IRS bailout, however, skyrocketed in 2006. The average fee for a basic PLR involving an IRA used to be $625. Today's cost--and this is no typo--is $9,000. The previous bargain rate for a 60-day IRA rollover was $95, but it can now reach as high as $3,000 if the IRA is valued at more than $100,000. "We have a situation now where IRS ruling fees will exceed the cost most CPAs and attorneys charge for rulings," Slott observes. "The total cost to a client for a typical PLR on an IRA issue will now be somewhere in the $15,000 to $20,000 range, depending on the professional fees charged."
Clearly, the new pricing schedule will discourage small filers but won't deter those with more sizable assets at stake. "When you've got a quarter-million dollar IRA and you're talking about facing $80,000 in taxes, then you go for the ruling," says Barry C. Picker, CPA, MST and partner in Picker, Weinberg & Auerbach CPAs in Brooklyn, N.Y.
For those undeterred by the fees, the PLR process resembles a private mini-court case. The taxpayer's representative presents whatever arguments and backup documents he or she can to boost the client's chance of success. The vast majority of cases are handled through correspondence with the national office of the IRS. As the name suggests, a PLR only applies to the person who filed the request. But accountants, tax attorneys and other professionals who follow every IRS hiccup can find these rulings helpful for their own clients. "We've told people that if they want to rely on probably 100 rulings on a subject, you probably have a good shot," Slott says. "But if you want a clear-cut, black-andwhite sure thing, you can go for a ruling."
While using a private letter ruling as precedent can be dicey, there is nothing iffy about relying on an IRS revenue ruling. When the IRS considers issues raised by one or more PLRs sufficiently worth making a general statement to the public, it undertakes a more thorough review process that can ultimately produce a revenue ruling. These rulings carry far more weight than letter rulings because they apply to anyone. "The IRS has gone through a more thorough review and has become comfortable with the guidance," observes Mark Luscombe, CCH's principal federal tax analyst.
One of the most discussed and celebrated revenue rulings in recent months (Rev. Ruling 2005-36) occurred when the IRS announced it would allow partial disclaimers of retirement benefits. The ruling addressed a quandary that happens all too frequently: An IRA owner dies before taking his or her minimum required distribution for the year. Since failing to make the withdrawal can trigger a 50 percent excise tax, the IRA beneficiary will naturally want to make the required withdrawal before the end of the year. But what no one previously knew was whether taking that withdrawal would prohibit the beneficiary from disclaiming the rest of the IRA to other loved ones, says Natalie Choate, an attorney at Bingham McCutchen LLP in Boston and the author of two books, including Life and Death Planning for Retirement Benefits.
Private rulings existed that approved accepting some assets, but disclaiming others in brokerage accounts, trusts and estates. There was no ruling, however, that could be applied to retirement accounts, Choate says. The private letters that previously addressed disclaimers of retirement benefits didn't involve required minimum distributions. Before this revenue ruling was announced in 2005, a beneficiary would have had to request his or her own private letter or seek an attorney's legal opinion.
Thanks to the Economic Growth and Tax Relief Reconciliation Act of 2001, one of the most common--if not the most popular--PLR requests coming from individuals involves 60-day IRA rollover snafus. Until the act became law, the chance of a taxpayer being able to restore IRA status to an account where a retirement plan wasn't rolled over in 60 days was grim, says Michael J. Jones, CPA, a partner at Thompson Jones LLP in Monterey, Calif. "The IRS consistently said, 'We're sorry, we can't help you.' " But the EGTRRA allowed waivers of the 60-day requirement if sticking by it, according to the legislation's wording, "would be against equity or good conscience, including casualty, disaster, or other events beyond the reasonable control of the individual subject to such a requirement." Congress, Jones suggests, created the escape hatch because it seemed unfair for retirees to watch helplessly as their retirement accounts blew apart because of a mistake or misunderstanding. EGTRRA's wording, however, left a lot to be interpreted, which is what prompted hundreds of "mother-may-I" letters to the IRS.
Even though one investor's 60-day-rollover circumstances may seem identical to others who received relief from the IRS, an account's custodian will probably require an official piece of paper. "A lot of rulings are just comfort rulings," Keebler says. "Custodians won't let us do what we want to do even though there are a dozen rulings out there already; they want you to get a comfort ruling."
Another fertile PLR area involves IRA trusts. In a typical scenario, someone names a trust as the IRA beneficiary and after his or her death, the spouse or other beneficiaries decide they do not want the cash sitting in a trust because it can limit their ability to stretch the IRA. The IRS has been especially sympathetic to widows and widowers who seek to dissolve an IRA trust and transfer the cash into a spousal rollover.
One of the most creative private letter rulings of 2005 involved IRA trusts (PLR 2005-37044). In that case, an IRA owner--months before his death--established an IRA trust that created sub-trusts for nine beneficiaries. What usually happens in these cases is that the IRA owner names a master trust as beneficiary of the IRA and leaves directions to split up the trust and IRA into distinct shares. This forces loved ones to use the life expectancy of the oldest child to determine required minimum distributions. But in this notable PLR, the IRS said it was okay to name separate sub-trusts as partial beneficiaries on the beneficiary designation form. With the IRS's nod, each beneficiary was allowed to use his or her own life expectancy.
Tax changes can make a PLR request that would have been tagged as a loser in the past seem promising. Revisions in annuity laws in 2004, for instance, prompted Seymour Goldberg, an attorney at Goldberg & Goldberg, P.C. in Melville, N.Y., to seek a PLR for a brother and sister who wanted to stretch a $1 million Keogh they inherited from their father. Unlike spouses, children can't move proceeds from a retirement plan into an IRA rollover, and most companies, including the small firm involved in this case, had no interest in keeping the account open for the beneficiaries' lifetimes. In December, Goldberg succeeded in getting the IRS, for the first time, to approve the use of annuities for stretching out distributions of a workplace plan for non-spouse beneficiaries (PLRs 2005-48027, 2005-48028).
Not every taxpayer with a beef will be eligible to file a PLR request. The IRS will bounce back certain cases. The tax agency, for instance, ordinarily won't issue a letter ruling if the taxpayer's issue is currently being examined by one of its field offices or is entangled in a lawsuit. The IRS also does not issue letter rulings when asked about the potential tax consequences of any proposed federal, state or foreign legislation. And the IRS has zero tolerance for what it calls "frivolous issues." Lumped into that category are taxpayers who insist that tax may only be imposed on coins minted under a gold or silver standard or who claim that the requirement to file tax returns violates the 5th and 14th Amendment protections of due process.
How do you keep track of PLRs? Tax professionals and attorneys typically subscribe to tax services, such as those offered by CCH and RIA, which can cost thousands of dollars. Frankly, that can be overkill for an investment advisor. A less expensive option is to sign up for Leimberg Information Services, which delivers online news on a wide range of issues relevant to investment advisors. A monthly membership is $24.95. You can stay abreast of PLRs involving retirement plans by subscribing to Ed Slott's IRA Advisor, which costs $125 a year, www.irahelp.com.
Another way to familiarize yourself with the nuts and bolts of the PLR process is by reading Revenue Procedure 2006-4 in the Internal Revenue Bulletin, which you can find through the search engine on the IRS Website at www.irs.gov. One of the service's first actions every year is to release its latest PLR guidelines, which can change annually. These guidelines include the procedures for filing a letter ruling, the tax areas that the IRS will review and those that are off limits, as well as the costs.
Lynn O'Shaughness y (firstname.lastname@example.org) is a financial journalist and former reporter for the Los Angeles Times. She is the author of the Retirement Bible and the Investment Bible (both Wiley).