Surviving Spouse Cannot Rollover IRA into Her Own Name

Executive Summary

Surviving spouse (S) was not treated as the payee of the decedent’s (H) IRA, and thus could not take the IRA and roll it over into an IRA in her own name. 

Facts

H died in 2004 at the age of 75, a resident of State W, survived by his spouse S, and son C.  The beneficiary of H’s IRA was Trust T.  S is the sole trustee of Trust T and has complete control over Trust T assets.  H’s IRA was the only asset of Trust T.

Article IV(A) of Trust T states that the trust should pay to S as much of the income, or principal if the income is not sufficient, as the trustee deems advisable for S’s maintenance, support and health.  Any income not distributed is added to principal.

Article IV(B) of Trust T provides that upon the death of S, the remaining principal is distributed to C, if he survives, or to his living descendants, per stirpes.  If neither C nor his descendants survive, then the principal is payable to nephews and nieces of H and S.  The trustee is also to consider other financial resources available to S, before making discretionary distributions to S.

Article V(A) states that although the trustee shall consider other resources of S before making any discretionary distributions to her, the trustee is not limited to making such distributions only when S’s other financial resources are exhausted or substantially depleted.

Article V(B) contains a “spendthrift” clause which provides that no one with a beneficial interest in the trust can assign or anticipate their interests.

Article VI(F) gives S, as the sole trustee, the authority “To exercise any other powers which the Trustee considers advisable for the proper and advantageous management, investment and distributions of the property held in the Trust”.

The Laws of State W provide that a trustee can file an election that causes the trust to become subject to a statute that provides, in part, that in making an investment decision, the fiduciary may consider, without limitation, the expected tax consequences of investment decisions or strategies.  S, as trustee, filed such an election.

A controversy arose among S, C and the nieces and nephews.  C, along with the nieces and nephews took the position that S did not have the right to withdraw the entire IRA, and distribute it from Trust T to S, in order for S to contribute it into an IRA in her own name.  In 2007, Court P of State W ordered that S, as trustee of Trust T, had the discretion to withdraw the IRA, distribute it to herself, and roll it over into her own IRA.

S will then make an “irrevocable” beneficiary designation, naming C, as the primary beneficiary.  C’s descendants, per stirpes, would take if C predeceased S.  If no living descendants of C, then the nieces and nephews would inherit.  In effect, S’s beneficiary designation on her IRA would mimic the Trust T payment terms at S’s death.

Based upon the foregoing, S requested the following rulings from the IRS:

1. That H’s IRA will not be an inherited IRA under Sec. 408(d)(3)(C), with respect to S.
2. That S be treated as the beneficiary of H’s IRA, so that she may take the IRA and roll it into an IRA maintained in her own name.
3. That S will not have to include the amounts taken and rolled over, as income in the year of the rollover.

In analyzing the facts in light of the rulings requested, the IRS noted that “generally, under certain conditions, if either a decedent’s plan or IRA proceeds pass through a third party, e.g. a trust, and then are distributed to the decedent’s surviving spouse who is entitled to receive the distribution, said spouse will be treated as acquiring them directly from the decedent” (underline emphasis in original).  Thus, in those cases, the spouse could take the distribution and roll it into her own name.

Here, however, according to the IRS, the analysis first has to determine whether, in fact, the spouse is entitled, under the provisions of Trust T, and under State law, to receive the distribution.

The ruling then continued with a back and forth, of S’s assertion that she has the power to take the entire IRA, and the IRS response.

First, S cited Article IV(A) of Trust T in maintaining that she can take the entire IRA.  The IRS countered that Article IV(A) gives S as much of the income, and if income is insufficient, as much of the principal, as the trustee considers advisable for S’s maintenance, support and health.  Here S is the trustee and the beneficiary, and the IRS points out that under the law of State W, a trustee making distributions to him or herself is limited by an ascertainable standard relating to the trustee-beneficiary's health, education, support and maintenance as defined in Sections 2041 and 2514 of the Internal Revenue Code.  Therefore, says the IRS, Article IV(A) does not give S the right to take the entire IRA.

Second, S cited Article VI(F), which gives the trustee the right to “exercise any other powers which the trustee considers advisable for the proper and advantageous management, investment, and distribution of the property held in Trust”.  Here the IRS stated that this Article relates to the property IN the trust, and does not confer the right to take the property OUT of the trust, which would effectively terminate the trust, since the IRA is the only asset in the trust.

Third, S asserts that under State W law, she has the right to withdraw the IRA and terminate the trust.  She cited the section that states that in making any investment decision, the fiduciary may consider the expected tax consequences of the decisions or strategies.  S had elected to have this section of State W law apply.  The IRS countered that this section only applies to investment decisions in the trust, and does not address withdrawals from the trust.

The fourth argument was that a court in equity may terminate a trust when the termination is not inconsistent with the settler's intent or does not defeat the purpose of the trust, and all the beneficiaries, current and potential, consent.  Here, the IRS pointed out that Trust T had a spendthrift provision, and under State W law a spendthrift provision cannot be terminated even if all of the beneficiaries agree.  Therefore, says the IRS, Court P did not have the authority to order that S, as trustee, had the right to withdraw the entire IRA balance, and thus terminate the trust.

Thus concluded the IRS, S did not have the power under either state law, or the trust itself, to withdraw the entire IRA balance.

What about the Court P order which said she did?

The IRS said that it is not bound by the Court P order because it is not the highest court in State W, and is contrary to prior decisions by the highest court in State W.  Accordingly, the Court P order is not controlling for federal tax purposes, and any withdrawal by S of the IRA would be unauthorized for federal tax purposes.  In addition, if the remainder beneficiaries did agree with the withdrawal they may be treated as having made a taxable gift under Section 2501.

In making its ruling, the IRS concluded,

1. that H’s IRA will be considered an inherited IRA, since the beneficiary of the IRA is not the spouse,
2. that S is not the beneficiary and thus cannot withdraw the IRA and roll it over into her own name, and
3. that any amounts paid out of the IRA to S will be taxed to S in the year distributed.

The IRS did add an exception to the above.  It pointed out that S is entitled to so much of the income and principal as determined under the ascertainable standard previously discussed.  If the amount so distributed to S exceeds the minimum required distribution for any year, then S, as the spouse of H, would be entitled to roll such excess over into her own IRA.

Discussion

It does seem strange that the IRS went through the analysis it did, and went so far as to say that they will ignore a ruling from a local court, to deny the spouse the ability to roll decedent’s IRA into her own name.  There have been rulings where the IRS relied on less to allow the rollover.  But PLRs are not always consistent, and, of course, cannot be relied on or cited as precedent.

The underlying question here is, what was the intention of the decedent?  If it was to provide for his wife, but control the ultimate disposition of the IRA assets after her death, he succeeded.  Maybe a different trustee would have stopped the ruling request.

On the other hand, my impression is that the beneficiary designation and trust was created without thinking of the possibility that ultimately it would be better for the wife to roll the IRA into her own name.

The two keys for practitioners is (a) what is the ultimate goal of the IRA owner, and (b) flexibility.  There is no guarantee that the financial situation at the time of the beneficiary designation, or creation of a trust, will be the financial situation at the time of death.  Good planning allows for adjustment, when necessary.

Hope this helps you help others.

Cite: PLR 2009-44059