IRS Weighs In on RMDs, Fees

Advisors should pay attention to a recent IRS ruling on uncashed distribution checks because it may require clients to take required minimum distributions (RMDs) early, warns IRA expert Ed Slott. The IRS recently warned missing or unresponsive retirement plan participants that uncashed distribution checks from qualified retirement plans are taxable.

“If the IRS really intends to apply the distribution rule to all company plan payouts, advisors will need to advise clients to request distributions,” including RMDs, “early enough in the calendar year to avoid any cross-year confusion, so the client will know that the distribution applies to the prior year, even if cashed or received early the next year,” Slott explained.

Revenue Ruling 2019-19, issued on Aug. 14, applies to a participant who receives, but neither cashes nor rolls over, a distribution check. “Because Internal Revenue Code Section 402(a) provides that any amount actually distributed from a qualified retirement plan is taxed under Section 72 in the year distributed (subject to the rollover rules), the ruling holds that the participant is taxed on the distribution check in the year she receives it, even if she does not cash it,” Eversheds Sutherland attorneys explained in a recent alert.

Slott added that if the IRS also intends “to apply the rule to IRA distributions, that would be another reason for advisors to persuade their clients to take qualified charitable distributions (QCDs) early in the year, to avoid the same confusion as to which year the distribution applies — to the year distributed or the year the check was cashed.”

IRS is ruling that the distribution will be recorded in the year distributed, even if not cashed until a later year, the attorney added. There will be times, however, where a plan sends a distribution check to an ex-employee and the address on file is not correct, Slott continued.

Maybe because the ex-employee moved, or “it may be that the employee does not eventually receive the check until a year later. That employee will have a tax problem, since under this ruling that employee will have been deemed to have received the check and will owe tax for the year of distribution. That will be a continuing issue for these employees,” he said.

Slott warns: “Advisors who have clients that leave companies and expect future distributions from that company’s 401(k) should immediately update the company with any change of address so they receive timely distributions.”

Rev. Rul. 2019-19, Slott explained, was intended to address a question that has long been faced by plan administrators: “What are their withholding and reporting obligations when they issue a check that goes uncashed? The IRS made clear that those obligations arise in the year of distribution and are not changed by the fact that the check is not cashed.”

Does the taxation ruling apply to IRAs as well as to workplace plans? “The IRS gave no indication that the ruling also applies to distributions from IRAs,” Slott said. “However, the IRS did not specifically say that the ruling is limited to Section 401(a) plans,” or 401(k)s.

Annuity Fees

The IRS recently reversed course in private-letter rulings, allowing Nationwide and Lincoln Financial to treat the payment of an advisory fee from a variable, fixed indexed or hybrid nonqualified annuity as a nontaxable distribution. The move has been hailed by fee-only advisors as a means for them to get compensated for their advice.

Over the last 10 years, “the most consistent piece of friction that advisors have come to us about [is] how not being able to take their fee out of a nonqualified annuity was really a headache for them in using this type of product,” Craig Hawley, head of Nationwide Advisory Solutions, said in an interview.

The IRS ruling essentially conforms the tax treatment of properly structured advisory fees from nonqualified annuities with those from qualified accounts such as 401(k)s, 403(b)s and IRAs, which typically are not treated as taxable distributions, Nationwide explained.

Slott explained that the IRS’ ruling is a good one, “for both advisors and consumers,” for two reasons. Under this ruling, which Slott says is “for Nationwide only, the nonqualified annuities will receive the same treatment that IRS has allowed for IRAs and 401(k)s, where paying the fees directly from the account would not be considered a taxable distribution, but rather an expense of the account, eliminating any potential tax on a fee, which would be a double expense.”