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Recent IRS Rulings May Necessitate Changes to Estate Plans

November 17, 2003

New Jersey Law Journal

As printed in the New Jersey Law Journal, November 17, 2003

Ferszt is a tax and ERISA member and Roxanna Hammett is a member of the tax practice and estate planning and administration practice at Wolff & Samson of West Orange.

If a trust is named as beneficiary of a taxpayers individual retirement account or retirement plan, its best to look again

Recent Internal Revenue Service guidance may affect the present estate plans of many taxpayers if a trust is named as beneficiary of the taxpayers individual retirement account or retirement plan.

Final Treasury Regulations promulgated by the IRS under 401(a)(9) of the Internal Revenue Code became effective for plan years beginning on or after Jan. 1, 2003, and affect how and when taxpayers are required to commence distributions from IRAs and qualified retirement plans. Section 401(a)(9) of the code generally requires minimum distributions from qualified retirement plans and IRAs based on the taxpayers life expectancy and age or life expectancies of his beneficiaries.

These required minimum distribution rules apply to all account balances and benefits under all stock bonus, pension and profit sharing plans qualified under 401(a), annuity contracts under 403, and IRAs under 408. See Treas. Reg. 1.401(a)(9)-1, Q&A-1 and 1.401(a)(9)-1, Q&A-2.

Under 401(a)(9), an individuals entire IRA interest, or the individuals entire interest in a retirement plan subject to 401(a)(9), must be distributed (a) no later than the individuals required beginning date or (b) over the individuals remaining life expectancy, but beginning not later than the individuals required beginning date. See Treas. Reg. 1.401(a)(9)-2, Q&A-1 and 1.408-8.

If the individual dies before required distributions commence, the individuals entire interest must be distributed over the life expectancy of the individuals designated beneficiary or within five years following the individuals death if there is no designated beneficiary for example, if an individual named his estate as the beneficiary, which does not qualify as a designated beneficiary.

Accordingly, a younger beneficiary will have a smaller amount distributed ach year than would an older beneficiary, and distributions calculated on a ounger beneficiarys life expectancy facilitate greater tax-deferred growth since amounts that remain in the plan or IRA continue to grow on a tax-deferred basis over the life of the beneficiary.

Taxpayers who coordinate the distribution of estate assets with the distribution f assets contributed to a qualified retirement plan or IRA will maximize the utility of pre-death estate planning and can streamline estate administration. When an IRA owner wishes to distribute his IRA interest in a manner consistent with that provided in his estate plan, designating a trust created under the taxpayers will or an inter vivos trust as beneficiary of the taxpayers plan or IRA should result in such uniformity.

If a taxpayer intends to designate a trust as beneficiary of an IRA, however, attention must be paid to the final regulations and recent IRS private letter rulings interpreting them.

In its final regulations, the IRS dictated who will be considered a designated beneficiary for purposes of required minimum distributions.

Treas. Reg. 1.401(a)(9)-4, Q&A-4 specifies that an individual must be the beneficiary, but it states in Q&A-5 that in the case of a trust named as the beneficiary, under certain circumstances, the IRS will look through the trust and consider the beneficiary of the trust as the beneficiary of the decedents plan or IRA for purposes of the required minimum distribution rules.

For a trust to qualify as a designated beneficiary, the following requirements must be met:

* the trust is a valid trust under state law, or would be but for the fact that there is no trust corpus;
* the trust is irrevocable or will, by its terms, become irrevocable upon the death of the employee or taxpayer;
* the beneficiaries of the trust, who are beneficiaries with respect to the trusts interest in the employees benefit or IRA interest, are identifiable within the meaning of Treas. Reg. 1.401(a)(9)-4, Q&A-1 from the trust instrument; and
* the trust documentation has been provided to the plan administrator or IRA custodian.

If the trustee is obligated under the trust agreement or will to create separate shares for the benefit of individual beneficiaries with each share treated as a separate trust, it was thought that the age of the beneficiary of each separate share or subtrust could be employed for purposes of determining the applicable life expectancy under the required minimum distribution rules, thus reducing amounts subject to current income taxation when compared to using the age of the oldest beneficiary of the trust before its division into shares.

From examination of the proposed 401(a)(9) regulations, the IRS appeared to have authorized this look through and separate account treatment for a trust that was designated as plan beneficiary and had a successive layer of subtrusts as its beneficiaries. That is, it seemed to sanction the subtrust structure for 401(a)(9) purposes and the use of the life expectancy of each individual subtrust beneficiary for required minimum distributions from each subtrust.

Thus, it appeared that the IRS, as it did in prior promulgations, was acting to allow continued tax-deferred accumulation of wealth in retirement vehicles.

Three recent IRS private letter rulings indicate, however, that the IRS has now retreated from its earlier position that the life expectancy of each subtrust beneficiary could be used when calculating required minimum distributions under 401(a)(9), rather than that of the oldest beneficiary of the trust before division into subtrusts. See proposed regulations under 401(a)(9), 66 Fed. Reg. 3928 (2001), and Priv. Ltr. Rul. 200234074.

In Priv. Ltr. Rulings 200317041, 200317043, and 200317044, the IRS concluded that the separate account treatment and the use of the subtrust beneficiaries individual life expectancies are no longer permissible under this subtrust structure. [The fact patterns of all three rulings are remarkably similar, and therefore only one ruling will be analyzed.]

For example, in PLR 200317044 (Dec. 19, 2002), the taxpayer established a trust for the benefit of his three children, and named the trust as beneficiary of his IRA. The terms of the trust provided that upon the taxpayers death, the trustee was to divide the trust estate into equal shares to be held and maintained as separate trusts, one for each beneficiary.

The IRS concluded that for purposes of the minimum distribution rules, the life expectancy of the beneficiary that was to be employed in calculating required minimum distributions was that of the oldest beneficiary of all of the subtrusts formed under the conduit trust.

The IRS reasoned that because the decedents IRA amounts passed through a conduit trust into the subtrusts, the use of the life expectancy of each respective subtrust beneficiary was unwarranted. That is, the single trust was deemed the beneficiary rather than the individual subtrusts.

Thus, the IRS concluded that required minimum distributions were to be calculated for all of the subtrust beneficiaries on the life expectancy of the oldest beneficiary.

Although taxpayers can still coordinate the distribution of plan or IRA benefits with the terms of the taxpayers will or trust agreement, under these recent rulings it appears that taxpayers can not make required distributions over different periods of time for each beneficiary of a single trust to allow for greater tax-deferred accumulation.

It is likely, however, that if the decedent in the aforementioned ruling(s) had established distinct separate trusts, rather than subtrusts created upon division of a single trust as beneficiaries of the decedents IRA, the IRS would have determined that the required minimum distributions would have been calculated on the life expectancy of the beneficiary of each trust under the look through rules of the final regulations.

Significantly, while a private letter ruling is not binding on any taxpayer other than the taxpayer who applied for the ruling, it is illustrative of the IRS current position.


In light of the restrictive effect of the final regulations and the IRS 2003 rulings, taxpayers should consult with their tax advisers to ensure that a trust intended to receive plan or IRA distributions under their wills or trust agreements will qualify as a designated beneficiary, and to determine how to best maximize income tax deferrals of qualified plan or IRA distributions.