Metz Lewis Brodman Must O'Keefe

Metz Lewis Brodman Must O'Keefe

Posted on September 15, 2017

In Private Letter Ruling 201736018 issued September 8, 2017, the IRS ruled that an IRA payable to the owner’s estate could be rolled over by the decedent’s spouse.

If a spouse is designated as the beneficiary of an IRA, the spouse is permitted to either treat the IRA as an inherited IRA or treat it as the surviving spouse’s own IRA.  Each of these options provides an opportunity for a longer withdrawal period and extended income tax deferral.

However, an estate as beneficiary does not qualify as an “individual” eligible to inherit the IRA. See IRS Publication 590-B. Therefore, an IRA payable to an estate must be distributed (and therefore taxed) under the “5-year rule,” meaning that the IRA must be withdrawn and taxed by December 31 of the fifth year following the owner’s death.  This results in unfavorable tax deferral and “bunching” of income into a few tax years, potentially escalating the beneficiary’s income tax rate.

This ruling is significant because although the estate was designated as the beneficiary, the IRS permitted the IRA to be rolled over by the spouse as her own IRA, thereby avoiding the unfavorable tax treatment of having an estate beneficiary.  In this case, the residue of the owner’s estate was payable to a spousal trust under the owner’s Will.  The spouse received a probate court order to terminate the trust and distribute the proceeds directly to the spouse.  Then the spouse applied to the IRS for a ruling the she was effectively the designated beneficiary of the IRA and therefore entitled to rollover the account into her name.

While the taxpayer avoided unfavorable treatment by obtaining a private letter ruling, it was a solution of last resort.  The taxpayer incurred significant costs to obtain court approval of the termination of the trust and to request a private letter ruling.  The private letter ruling filing fee was $10,000 and legal fees likely exceeded the filing fee.  Other taxpayers finding themselves in a similar situation may not rely upon this letter ruling, but instead must apply for their own letter ruling (IRC § 6110(k)(3)).

The ruling provides a great reminder that preventing an unintended beneficiary designation is far more efficient than repairing a botched beneficiary designation post-mortem.  Every retirement account owner should periodically review and update beneficiary designations to ensure that they are up to date and coordinated with estate planning.

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