In a recent Private Letter Ruling dated September 25, 2020 (PLR #202039002), IRS determined that a transfer to a transferee IRA is not a taxable distribution and that distributions to the beneficiaries of that IRA are not includible in the gross income of the decedent’s estate.
A decedent who had two individual retirement accounts died after his required beginning date. At the time of his death, decedent was unmarried and survived by his son, partner and grandson, each of whom was named in the will as a beneficiary of the estate. The decedent’s estate was the sole beneficiary of the two IRAs. The assets of the two IRAs were transferred into a single IRA titled as the IRA of the decedent for the benefit of the estate. Pursuant to the will, the assets of the two IRAs passed to the son, partner and grandson in equal shares. The personal representative of the decedent’s estate proposed to subdivide the assets held by the new IRA for the benefit of the estate into three separate IRAs via trustee-to-trustee transfers, each titled “Decedent (Deceased) IRA f/b/o Beneficiary as beneficiary of Decedent’s estate.”
Under IRC Section 408(d)(1), except as otherwise provided in Section 408(d), “any amount paid or distributed out of an IRA shall be included in gross income by the payee or distributee, as the case may be, in the manner provided under section 72.” The IRS relied on Revenue Ruling 78-406, 1978-2 C.B. 157, stating that because each of the three transferees’ IRAs had been set up and maintained in the name of the deceased IRA owner for the benefit of one of the estate beneficiaries, the transfer of each of the beneficiary’s one-third interest in the estate’s interest in the new IRA established for the benefit of the estate to each transferee IRA was not a taxable distribution under IRC Section 408(d)(1), nor did it amount to a rollover under IRC Section 408(d)(3). Further, after the transfer to each of the transferee IRAs had occurred, any amounts distributed to the son, partner or grandson should not have been included in the estate’s gross income, and the custodian of the transferee IRAs should not have reported such distributions as income to the estate.
It is generally a bad idea, from an estate planning perspective, to designate one’s estate as the beneficiary of one’s IRA. This is because of the unfavorable income tax and probate implications. Where an estate is the beneficiary of an IRA and the decedent dies prior to the beginning date for required minimum distributions, its assets are required to be distributed in full by the end of the calendar year containing the fifth anniversary of the IRA owner’s death. Most estate administrations do not stay open for five years, thereby increasing the income tax to which the estate may be subject. By contrast, if an individual is a designated beneficiary of an IRA, that individual can defer the distribution of the IRA for at least ten (10) years. Moreover, certain eligible designated beneficiaries can stretch the distribution of the assets over their lifetime. Where an estate is the beneficiary of an IRA, setting up and maintaining transferee IRAs in the name of the deceased IRA owner for the benefit of one of the beneficiaries of the decedent’s estate is a method of mitigating the income tax impact. Even though there have been numerous Private Letter Rulings supporting this type of transfer, there are IRA custodians who argue against allowing the transfer of an estate’s IRA to the beneficiaries of the estate. In such a situation, it may be prudent to provide the IRA custodian with Private Letter Rulings showing the position of the IRS on this matter.