Few things in the tax code are clearer than this: A surviving spouse named as the beneficiary of retirement plan death benefits of a deceased spouse can roll those death benefits into her own individual retirement accounts (IRA). But one regulation is generating confusion about what happens when these death benefits first go to a trust or estate of which the surviving spouse is the sole beneficiary. As a result, 45 private letter rulings (PLRs) have been published on this question. So far, the Internal Revenue Service's answer has always been, “Yes, go ahead.” It's high time the Service issue guidance to assure everyone that this is the case.

When a surviving spouse is named as the beneficiary of a qualified plan that the deceased employee-spouse could have rolled over to an IRA during his lifetime, then so, too, can the surviving spouse. The surviving spouse in this situation, says Internal Revenue Code Section 402(c)(9), is treated “in the same manner as if the spouse were the employee.” Likewise, when a surviving spouse is an IRA's named beneficiary, the surviving spouse may effect an IRA rollover.1

But what if an estate or trust is the named beneficiary of a retirement account and the surviving spouse's rights in the retirement account — through the estate or trust — are equivalent to those of a beneficiary designated under the retirement plan? Well, then, it's unclear whether these spouses have a right to a rollover. But it's only unclear because of a sentence in Treasury Regulations Section 1.408-8, Q&A-5.

This sentence is forcing taxpayers into a costly and time-consuming detour: They've had to ask the IRS for a private letter ruling. Since Treas. Regs. Section 1.408-8, Q&A-5 was promulgated on April 17, 2002, 45 such rulings have been published. Today, the IRS typically charges an $11,500 user fee, and the cost of preparing a PLR may well exceed that amount. Rulings can take anywhere from a few months to more than a year to obtain.

Spousal Rollover Tests

The nettlesome sentence in Treas. Regs. Section 1.408-8, Q&A-5 imposes a two-pronged test before the rollover can be permitted. The first prong is that the “spouse must be the sole beneficiary of the IRA.” The second is that the spouse also must have “an unlimited right to withdraw amounts from the IRA.”

To clarify the meaning of the first prong, the regulation says: “If a trust is named as beneficiary of the IRA, this requirement is not satisfied even if the spouse is the sole beneficiary of the trust.”

On its face, the regulation prohibits a rollover by a surviving spouse whenever a trust or an estate is the named beneficiary. The same should apply when an estate was named. No exceptions, right?

Wrong. In each of the PLRs issued since the regulation was published, a rollover was allowed, even though an estate or trust was named as the beneficiary of the retirement plan.

You would think the IRS would issue formal guidance that all taxpayers could follow rather than force each new supplicant to seek a PLR on his own behalf.

Wrong again.

It Takes a PLR

It would seem that the IRS is mulling the issue over, one case at a time. In 45 PLRs, the Service has analyzed and ruled on the “sole beneficiary” and “unlimited right to withdraw” requirements in a variety of circumstances.2 There are now essentially 13 scenarios for which the IRS has permitted a surviving spouse to rollover an IRA when a trust or estate was the IRA's beneficiary and the spouse was the beneficiary of the trust or estate:

  • Scenario 1

    An estate is the named beneficiary. The surviving spouse of the decedent is the sole beneficiary of the estate and also serves as sole executor of the estate.3

  • Scenario 2

    An estate is the named beneficiary. The surviving spouse of the decedent is the residuary beneficiary of the estate following a specific bequest. The surviving spouse also serves as sole executor of the estate.4

  • Scenario 3

    An inter vivos trust is the named beneficiary. The surviving spouse of the decedent is the sole trustee of the trust and also possesses an unlimited right to withdraw all trust assets.5

  • Scenario 4

    A testamentary trust is the named beneficiary. The surviving spouse of the decedent is the sole trustee of the trust and also possesses an unlimited right to withdraw all trust assets.6

  • Scenario 5

    An inter vivos trust is the named beneficiary. The trustees are the surviving spouse and a child of the decedent. The surviving spouse of the decedent possesses an unlimited right to withdraw all trust assets.7

  • Scenario 6

    An inter vivos trust is the named beneficiary of one or more IRAs. The trust provides that the trustee is required to distribute the retirement plan accounts or benefits to the surviving spouse.8

  • Scenario 7

    An estate is the named beneficiary of one or more IRAs. The surviving spouse is not the sole executor of the estate. The decedent's will provides for the establishment of one or more testamentary trusts. The surviving spouse is not the sole trustee of any of these trusts. But the surviving spouse possesses an unlimited right to withdraw trust assets from one of the trusts. Under the terms of the decedent's will, the executor may, but is not required, to allocate the retirement plan account(s) to the trust over which the surviving spouse possesses the unlimited withdrawal right. Acting under the terms of the trust, the trustee allocates the retirement account to the trust over which the surviving spouse possesses an unlimited right to withdraw trust assets.9

  • Scenario 8

    An inter vivos trust is the named beneficiary. The surviving spouse is the trust's sole trustee. The trust provides for the establishment of various subtrusts. Under the terms of the trust, the trustee is required to allocate the IRA(s) to a subtrust over which the surviving spouse possesses an unlimited withdrawal right. The surviving spouse, acting as trustee, allocates the IRA(s) to the subtrust having the unlimited withdrawal right.10

  • Scenario 9

    An estate is the named beneficiary. The surviving spouse is the sole executor. The decedent's will provides for establishment of various testamentary trusts. The surviving spouse possesses an unlimited right to withdraw trust assets from one of the trusts. Acting as executor and under the terms of the will, the surviving spouse allocates the IRA(s) to the trust over which the surviving spouse has the unlimited withdrawal right.11

  • Scenario 10

    An inter vivos trust is the named beneficiary. The surviving spouse is the sole trustee of the trust. The trust provides for the establishment of various subtrusts and grants the trustee the power to pick and choose which assets will be allocated to the various subtrusts. The surviving spouse has an unlimited right to withdraw trust assets from one of the subtrusts. Acting as trustee, the surviving spouse elects to allocate the IRA to the subtrust over which the surviving spouse has the unlimited withdrawal right.12

  • Scenario 11

    An inter vivos trust is the named beneficiary. The surviving spouse is the sole trustee of the trust. Under the terms of the trust, the surviving spouse is entitled to distribution of a percentage of the trust. In partial satisfaction of a bequest of trust assets to the surviving spouse, the surviving spouse, acting as trustee, will cause that percentage of the decedent's IRA to be allocated to the surviving spouse under the provisions of the bequest.13

  • Scenario 12

    An inter vivos trust is the named beneficiary. The surviving spouse is not a trustee of the trust. The trust provides for the establishment of various subtrusts. The surviving spouse has an unlimited right to withdraw trust assets from one of the subtrusts. Acting within the terms of the trust and under local law, the trustee makes an allocation of the IRA(s) to the subtrust over which the surviving spouse has the unlimited withdrawal right.14

  • Scenario 13

    A surviving spouse makes an election under state law to take a share of a decedent's IRA against the IRA beneficiary designation.15

In each of these situations, the IRS approved a rollover to an IRA held in the name of the surviving spouse and treated as an IRA of the surviving spouse. In each ruling, the IRS interpreted the regulation by citing the preamble to T.D. 8987. A representative passage in PLR 200807026 states: “As specifically stated in the ‘Final’ regulations, a surviving spouse may not elect to treat the IRA of a decedent as his/her own if a trust is the beneficiary of the IRA even if the spouse is both the sole trustee of the trust and also the sole beneficiary of the trust.

“The Preamble to the regulations provides, in relevant part, that a surviving spouse who actually receives a distribution from an IRA is permitted to roll that distribution over into his/her own IRA even if the spouse is not the sole beneficiary of the deceased's IRA as long as the rollover is accomplished within the requisite 60 day period. A rollover may be accomplished even if IRA assets pass through either a trust and/or an estate.”

Compare the above PLR quote to what the preamble actually says (emphasis added): “The 2001 proposed regulations clarified that a deemed election is permitted only if the spouse is the sole beneficiary of the account and has an unlimited right to withdraw from the account. This requirement is not satisfied if a trust is named as beneficiary of the IRA, even if the spouse is the sole beneficiary of the trust. As explained in the 2001 preamble, these clarifications make the election consistent with the underlying premise that the surviving spouse could have received a distribution of the entire decedent IRA owner's account and rolled it over to an IRA established in the surviving spouse's own name as IRA owner.

If the spouse actually receives a distribution from the IRA, the spouse is permitted to roll that distribution over within 60 days into an IRA in the spouse's own name to the extent that the distribution is not a required distribution, regardless of whether or not the spouse is the sole beneficiary of the IRA owner.”16

Searching for Authority

IRA custodians are reluctant to follow PLRs issued to others — and with good reason. IRC Section 6110(k)(3) states that no one other than the taxpayer to whom a PLR is issued may rely on that PLR.

So, IRA custodians are caught in a dilemma. Treas. Regs. Section 1.408-8, Q&A-5 is confusing because there's a discrepancy between the standard announced in the language of the regulation versus the language of the preamble. IRA custodians balk at going along with such rollovers precisely because the regulations don't actually specify that if the spouse actually receives a distribution from the IRA, the spouse is permitted to roll that distribution within 60 days to an IRA in the spouse's own name. And custodians don't feel that the preamble is authority.

This state of affairs leaves taxpayers and IRA custodians without reliable guidance in an area where the tax stakes are very high: one wrong move and the IRS will assess an income tax, a penalty — or both. And after that, all future benefits of income tax deferral are lost forever. For example, botching a rollover of a $500,000 account could mean immediate payment of a 35 percent federal income tax of $175,000. The after-tax proceeds will have to be invested in a taxable account. Plus, if the impermissible IRA rollover isn't taken out, there's a penalty to pay for an excess contribution. The penalty is 6 percent for each year the excess contribution remains in the IRA.

Clearly, it's time for the IRS to provide guidance. Too many taxpayers feel the need to apply for costly PLRs that each say, “yes.” The IRS should say “yes” once and for all — and end the costly detour to IRS National Office.

Endnotes

  1. Internal Revenue Code Section 408(d)(3).
  2. There are similar private letter rulings (PLRs), holding qualified plans, 403(b) accounts and certain 457 plans could be rolled over, but none of those PLRs raises Treasury Regulations Section 1.408-8, Q&A-5.
  3. PLRs 200324059, 200343029, 200405017, 200406048, 200453016, 200510032, 200526023, 200532060, 200544032, 200611037, 200634065, 200637033, 200650022, 200703035 and 200720024.
  4. PLRs 200440025 and 200644031.
  5. PLRs 200245055, 200440024, 200443035, 200531031, 200543064 (but the withdrawal right, and thus individual retirement account (IRA) rollover amount, was limited to income plus the greater of 5 percent of the value of the trust corpus or $5,000), 200549021 (also held that a trust was a grantor trust by reason of IRC Section 678(a)(1)), 200605019, 200644028 and 200724032.
  6. PLR 200646026.
  7. PLR 200807026.
  8. PLRs 200603032 (surviving spouse was sole trustee), 200639002 (surviving spouse and son were trustees), 200703047 (trust reformed, surviving spouse not a trustee) and 200704033 (reformed and modified after death to achieve result; spouse also granted right to demand retirement account.)
  9. PLR 200807025.
  10. PLR 200346025.
  11. PLRs 200433026 and 200615032 (spouse became sole trustee after other trustee resigned.)
  12. PLRs 200249008, 200402029, 200424011, 200428032, 200509034 and 200707159.
  13. PLR 200449040.
  14. PLR 200705032.
  15. PLR 200438045.
  16. T.D. 8987, 67 F.R. 18988-19028, April 17, 2002.

Michael J. Jones is a partner in Monterey, Calif.'s Thompson Jones LLP and chairs the Trusts & Estates Retirement Benefits Committee

SPOTLIGHT

Feminine Mystique — Helmut Newton pictured fashionista Elsa Peretti as a bunny against a Manhattan backdrop in 1975. (Circulation for Playboy magazine, with its iconic Playboy bunny, peaked in the mid-seventies.) The photo sold on April 10, 2008, for $79,000 at a Christie's auction in New York.