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Regulation and Compliance > Federal Regulation > IRS

IRS Ruling On Trusts And Stretch IRA Treatment

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In a first-of-its-kind private ruling, the Internal Revenue Service permitted an IRA owner to benefit multiple trust beneficiaries of his IRA while retaining the ability of each beneficiary to use his own life expectancy payout. This is a combination that has eluded planners in recent years, under the final required minimum distribution (RMD) regulations.

The use of trusts in IRA distribution planning is a complex planning issue. Under current regulations, trust beneficiaries can be treated as designated beneficiaries of an IRA for RMD purposes if the trust meets certain requirements (commonly known as a “see-through” trust). However, when one trust is named as beneficiary of an IRA, the separate beneficiaries of the trust ordinarily must all use the same distribution period (i.e., the life expectancy of the oldest beneficiary). This accelerates the ultimate tax liability on the IRA proceeds. The maximum tax deferral for multiple beneficiaries is possible only if each beneficiary can use his or her own life expectancy.

In this ruling, the decedent, who we will call David, wanted to divide an IRA between nine beneficiaries by means of a trust instrument while availing each beneficiary of the use of his or her own life expectancy distribution period. David created a single trust (Trust “T”), the terms of which created nine separate trusts at his death. Instead of designating Trust “T” as beneficiary of the IRA, he named the nine separate trusts as beneficiaries. The IRA beneficiary designation form also stated that all the trusts were being established as separate shares. Trust “T” then allocated a specific percentage of the IRA to each beneficiary.

David died later the same year (in 2003), prior to his required beginning date. Trust “T” directed its trustee to create nine separate shares, treating them as in effect at his death. David’s IRA was divided by means of a series of trustee-to-trustee transfers into nine IRAs. Each trust was funded with a percentage of the IRA specified under the terms of Trust “T.” The ruling notes that each trust share was designed to constitute a “conduit” trust for purposes of RMD rules.

The IRS determined that the nine separate trusts were the beneficiaries of the IRA, not Trust “T.” As a result, since each trust had only one beneficiary, each beneficiary would be permitted to use a distribution period based on his or her own life expectancy. The ruling also indicated that the payment of trust expenses would not prevent the trust from being considered a conduit trust, which offers a safe harbor under the designated beneficiary rules.

Another useful provision that was used in this ruling gave a “trust protector” (an independent third party) the power to make a one-time change from the individual conduit trusts into an accumulation (discretionary) trust. While a discretionary trust would be required to take other subsequent beneficiaries into account for purposes of determining the distribution period, it provides flexibility for beneficiaries who may later face creditor problems, divorce or loss of government benefits. The power to switch from a conduit to a discretionary trust did not prevent the conduit trusts from obtaining separate account treatment.

While private letter rulings are binding only for the taxpayer to whom they are issued, they are often helpful as indicators of the Service’s thinking, particularly on key issues that have not been addressed adequately by regulations.

(The number of this private ruling is Let. Rul. 200537044.)


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