Courtesy of David & Mary Mellem, EAs
We’re not talking about a normal transfer of an IRA here. We are talking about a taxpayer who transfers an IRA from which the taxpayer was taking substantial equal periodic payments.
First an overview: A taxpayer is generally subject to income tax on distributions from an IRA account (unless the taxpayer has a basis in the IRA). If the taxpayer is under the age of 59½, the taxpayer is also subject to a 10% early distribution penalty. There are various exceptions to the penalty including an exception for substantial equal periodic distributions as provided in IRC Section 72(t)(2)(A)(iv). When a taxpayer is taking distributions using this exception, any modification in the distributions triggers the 10% penalty on all of the distributions including those taken in prior years. Ouch!
Now this letter ruling: This taxpayer was taking substantial equal periodic distributions from an IRA account, reporting the income, but not applying the penalty because of this exception. The IRA was invested in equities which were losing money. After talking with her financial advisor, the taxpayer transferred through a trustee-to-trustee transfer a portion of this IRA account into a new IRA account with a different financial institution. She also transferred another IRA account’s entire balance to this same new IRA account. After the transfers, she heard this could be considered a modification and result in the 10% penalty on all prior distributions. Therefore, she submitted this ruling request. She also requested a ruling on whether a transfer of the funds back to their original IRA accounts (plus/less earnings) would be an acceptable way to avoid the penalty if the penalty is triggered by the first transfer.
IRS issued Private Letter Ruling 200925044 in response to this taxpayer’s request. The ruling states the transfer DOES TRIGGER the 10% penalty on all prior distributions. IRS cites Revenue Ruling 2002-62 which states, in part, “a modification to the series of payments will occur, if after such date [beginning date of the distributions], there is (i) any addition to the account balance other than gains or losses, (ii) any nontaxable transfer of a portion of the account balance to another retirement plan, or (iii) a rollover by the taxpayer of the amount received resulting in such amount not being taxable.” Since the funds were transferred, this violated (ii) in this sentence resulting in a modification. IRS further states the taxpayer CANNOT AVOID this by transferring the funds back to their original accounts.[Another situation of an inadvertent violation A taxpayer ran intto a violation of the equal payments, and had the penalty, when the investment company gave the client too much money in one year. The annual payments were always the same. The investment company had a policy that stated they would only handle accounts with certain minimum balances. When the IRA balance dropped below this level as a result of the latest periodic distribution, the investment company gave the entire remaining balance to the taxpayer. This made that year’s distributions higher than the normal annual payments, which was a change in the payments which triggered the penalty.]
The taxpayer may have other options to help save her IRA from being depleted so fast, such as by changing her withdrawal method to the recalculation method as discussed in Notice 89-25.
This text has been shared with you courtesy of: David & Mary Mellem, EAs & Ashwaubenon Tax Professionals, 920-496-1065 (920-496-9111). firstname.lastname@example.org, email@example.com, firstname.lastname@example.org, email@example.com.
SEMINAR SCHEDULE FOR JULY & AUGUST
Various dates NCPE (National Center for Professional Education). Mary and/or David are presenting portions of the summer Corporations and Partnerships Workshop seminar and the fall 1040 Individual Income Tax Workshops. For more information and registration form, go to www.ncpeseminars.com .
Dates currently scheduled for David and/or Mary in July & August are: July 30-31-Ft Myers, FL; Aug 4-Chicago; Aug 5-Schererville; Aug 6-Pittsburgh; Aug 11-Atlanta, Aug 12-Phoenix, and Aug 13-Seattle. Plus more cities in later months.
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