In a series of private letter rulings (PLRs 201628004, 201628005 and 201628006) the IRS denied an estate’s attempt to fix a problem that appeared to have been created by accident by the decedent when his financial adviser changed firms.
The situation was described in the ruling as follows:
Decedent maintained two individual retirement accounts (IRAs) with Custodian A and worked with financial advisors who were employed by Custodian A. Consistent with Decedent’s overall estate plan, Decedent named Trust C as a 50% beneficiary, and Trusts D and E as 25% beneficiaries of the IRAs in a year after the year that included his required beginning date under section 401(a)(9).
Later that year, Decedent’s financial advisors joined another firm and became affiliated with Custodian B. Decedent subsequently met with one of the financial advisors to facilitate the transfer of the IRA assets to Custodian B. The financial advisor provided a beneficiary designation form for Decedent’s signature that named Decedent’s estate as the sole beneficiary. Decedent signed that form and the assets of the two IRAs held by Custodian A were directly transferred to a new IRA (IRA X) held by Custodian B.
The trusts were designed to be “look through” trusts complying with the rules at Reg. §1.401(a)(9)-4, Q&A 5(b) which would have allowed a “stretch out” of the IRA account balances over the life expectancies of the beneficiaries after the death of the account owner, as those individuals would be treated as “designated beneficiaries” under the regulation.
Conversely, an estate cannot be treated as a designated beneficiary, resulting in a much shorter payout, generally over the owner’s life expectancy at his/her death—obviously computed as if the owner hadn’t died.
The trustees of the trusts claimed that the decedent had never intended to change his estate plan, but rather had merely been forced to change custodians. Looking at it from the perspective of a CPA that deals with clients that seems not only plausible but overwhelmingly likely. He almost certainly just those as “forms he needed to sign” to keep working with the financial advisers he had worked with before.
The trustees went to a state court and asked the court to modify the beneficiary designations of the decedent to go back to the original estate plan, with the following results:
Based on its finding of Decedent’s intent, the Court ordered that the beneficiaries of IRA X are Trust C as a 50% beneficiary and Trusts D and E as 25% beneficiaries, consistent with Decedent’s prior beneficiary designation. The order was retroactively effective as if such designation were made on the date Decedent signed the beneficiary designation form for IRA X.
The trustees then asked the IRS to find that, in fact, the IRA qualified for a stretch out payment period.
The IRS declined to do so. The IRS held:
Decedent’s estate was named as the beneficiary of IRA X at the time of Decedent’s death. Under § 1.401(a)(9)-4, Q&A-3, an estate cannot be a “designated beneficiary” for purposes of section 401(a)(9). Accordingly, there was no “designated beneficiary” of IRA X for purposes of section 401(a)(9).
But what about the Court order retroactively changing the beneficiary designation. The IRS held:
...[A]lthough the Court order changed the beneficiary of IRA X under State law, the order cannot create a “designated beneficiary” for purposes of section 401(a)(9). Courts have held that the retroactive reformation of an instrument is not effective to change the tax consequences of a completed transaction. For example, the Tax Court considered the impact of a judicial reformation of a trust agreement for tax law purposes in Estate of La Meres v. Commissioner, 98 T.C. 294 (T.C. 1992). In La Meres, a state probate court order approved the post-death amendment of a trust to eliminate a provision that caused adverse estate tax results, and held that such amendment was retroactively effective as of the date of the decedent’s death. The Tax Court held that such reformation was not effective for tax purposes, explaining that:
This and other courts have generally disregarded the retroactive effect of State court decrees for Federal tax purposes. See Van Den Wymelenberg v. United States, 397F.2d 443, 445 (7th Cir. 1968); Straight Trust v. Commissioner, 245 F.2d 327, 329-330 (8th Cir. 1957), affd. 24 T.C. 69 (1955); Estate of Nicholson v. Commissioner, 94 T.C. 666, 673 (1990); Fono v. Commissioner, 79 T.C. 680, 695 (1982), affd. without published opinion 749 F.2d 37 (9th Cir. 1984); American Nurseryman Publishing Co. v. Commissioner, 75 T.C. 271, 275 (1980), affd. Without published opinion 673 F.2d 1333 (7th Cir. 1981). . . . While we will look to local law in order to determine the nature of the interests provided under a trust document, we are not bound to give effect to a local court order that modifies the dispositive provisions of the document after respondent has acquired rights to tax revenues under its terms. Estate of Nicholson v. Commissioner, supra at 673; American Nurseryman Publishing Co. v. Commissioner, supra at 275; Estate of Hill v. Commissioner, 64 T.C. 867, 875-876 (1975), affd. in an unpublished opinion 568 F.2d 1365 (5th Cir. 1978). As the Seventh Circuit explained in Van Den Wymelenberg v. United States, supra at 445:
Were the law otherwise there would exist considerable opportunity for “collusive” state court actions having the sole purpose of reducing federal tax liabilities. Furthermore, federal tax liabilities would remain unsettled for years after their assessment if state courts and private persons were empowered to retroactively affect the tax consequences of completed transactions and completed tax years.
La Meres at 311-312.
The ruling is consistent with the general view that beneficiaries can be removed but not added by the date when designated beneficiaries are finally determined (September 30 of the year following the year of death).
CPAs should consider advising their clients to continually confirm who is shown as their IRA beneficiaries with the financial institutions holding the accounts regularly. And, as this ruling makes clear, that’s especially true following a change in custodians, even if it occurred just to continue to use a long term financial adviser who changed firms.