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IRA beneficiary distributions in death and divorce

Rollover from decedent's IRA to IRA owned by surviving spouse can be made tax-free under §408(d)(3).

When A died, on a date prior to his attainment of age 70 1/2, he owned an individual retirement account (IRA) called IRA 1. A's will named his surviving spouse (B) as the sole executrix of his estate. A also named his estate as the beneficiary of IRA 1.

A's will created Trust X and directed the transfer of the residue of A's estate to B. Trust X. In her capacity as the executrix of A's estate, B intends to satisfy the bequest to Trust X with assets other than IRA 1. B will satisfy the residuary bequest under A's will, in part, with IRA 1.

In her capacity as the executrix of A's estate, B will pay IRA 1 to herself in her capacity as the beneficiary of the residuary bequest in a single sum. When B receives the IRA 1 distribution, B will roll over the entire IRA distribution into an IRA in her own name. This rollover will be made within 60 days of B's receipt of the IRA 1 distribution.

The IRS reasoned that, since B is A's surviving spouse, if she were the direct beneficiary of IRA 1, it would not be an inherited IRA for purposes of the §408(d)(3)(C)bar on tax-free rollover's of inherited IRAs.

As a general rule, the IRS explained, when assets in a decedent's IRA pass to a third party, such as a trust, and then are distributed to the surviving spouse, the spouse is treated as receiving the IRA assets from the third party and not the decedent and the spouse will be denied a tax-free rollover under §408(d)(3) pursuant to §408(d)(3)(C)(ii). Since, however, B is the sole executrix of A's estate with power to allocate estate assets among estate bequests, the general rule does not apply, the IRS said.

The IRS ruled, accordingly, that IRA 1 is not an inherited IRA within the meaning of §408(d)(3)(C)(i). Further, B is eligible to roll over the proceeds of IRA 1 into an IRA established in her own name, tax-free pursuant to §408(d)(3). ,B will not be required to include in income for the year of the rollover the assets rolled over into B's IRA. IRA Distributions in Divorce Taxable
A taxpayer is required to include in his gross income for 1995 the distributions he made during that year from his individual retirement accounts to pay obligations owed to his former wife as part of his divorce, the U.S. Tax Court ruled Aug. 30 (Czepiel v. Commissioner, T.C., No. 2826-98, T.C. Memo. 1999-289, 8/30/99).

The tax court pointed out that Internal Revenue Code Section 408(d)(1) requires taxpayers to include in their gross income IRA distributions that are not excepted from that section. According to the tax court, the only exception possibly available to the taxpayer here was tax code Section 402(e)(1)(A), which governs the transfer of an IRA account incident to a divorce.

However, the tax court found this provision inapplicable because the taxpayer did not transfer his IRA interest to his former spouse, but, instead, received distributions from his IRAs, and then paid the funds distributed to him to his former wife. The court also agreed with the Internal Revenue Service that the taxpayer is liable for the 10 percent additional tax under tax code Section 72(t)(1) with respect to the IRA distributions.

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