Recent rulings by the IRS sets forth useful guidelines for people with sizable IRAs in their estate, and multiple claimants on the assets within.
The rulings concerned a person who had set up a revocable trust containing an IRA, intended to benefit his five children. The decedent was past the age of 70 ½ prior to his death, and had begun receiving minimum required distributions from the IRA. After the death of the original owner of the IRA, the trustee broke the IRA into five smaller IRAs, which were to be held in trust for each of the children, then distributed at age 30.
This opened a can of worms with the IRS, which issued a series of rulings to deal with the situation. Let’s take them one at a time:
Division of IRAs
In maybe the most important ruling, the IRS needed to determine whether the trustee’s division of the original IRA into five accounts was legal, since IRS regulations preclude separate account treatment when amounts pass through a trust. But there’s no specific regulation that disallows a posthumous division of one IRA into multiple IRA. Therefore, the IRS ruled that the five new IRAs were perfectly legal.
The IRS also needed consider whether trustee-to-trustee transfers constituted taxable distributions or attempted rollovers. Generally, a trustee-to-trustee transfer doesn’t qualify as a distribution when it’s done upon the decedent’s death, as happened here.
But given the unusual nature of the case, it was important to have the tax treatment clarified. Assets distributed from an IRA are usually taxable to the recipient. In addition, inherited IRAs are not generally treated as rollover IRAs, but that needed to be clarified as well.
In both cases, the IRS agreed with the trustee. The transfers leading to the creation of the separate IRAs were not treated as either taxable distributions or as attempted rollovers.
The trustee asked the IRS whether the five new IRAs were to be treated as inherited IRAs, and thus could not be rolled over. In general, IRAs are defined as inherited if they are acquired by reason of an individual’s death (except for surviving spouses).
The IRS ruled that though there were five new IRAs, the beneficiaries had acquired the IRAs by reason of the decedent’s death. Therefore, the five beneficiary IRAs will be treated as inherited IRAs. See-through trust
The trustee first requested that the Internal Revenue Service consider the trust a see-through trust. Rather than forcing the five inheritors to take distributions within five years of the decedent’s death, the status as a see-through trust allows them to hold the IRAs for a longer period.
The IRS decided that the original revocable trust was a see-through trust, meaning the IRA need not be distributed within five years of the decedent’s death. So that’s one decision in favor of the trustee.
Designated beneficiaries and life expectancies
If a trust has more than one designated beneficiary, the beneficiary with the shortest life expectancy (generally the oldest) will be used to determine the distribution period. The same rules transferred here to the new IRAs: The IRS ruled that each of the five beneficiaries could take required minimum distributions over the life expectancy of the oldest of the five who was still a beneficiary of the trust as of September 30 of the year following the decedent’s death.
The end results, then, were positive for the trustee and for the five IRA inheritors. Although there were some setbacks and denials on the part of the IRS, for the most part, the recipients got favorable treatment. And the most important question, whether it was proper to split the IRA into five IRAs, was upheld.
If you have clients with a trust funded primarily or exclusively by an IRA, these are important decisions to bring to their attention. If one of those clients has several children among whom he or she would like to evenly split an estate, this is a strategy worth keeping in mind. The full text of the IRS rulings can be found here.