Thursday, July 27, 2006

CAUTION NEEDED WITH POST-DEATH IRA ROLLOVERS TO A SURVIVING SPOUSE

Charlotte Gee’s husband died in 1998. He was the owner of an IRA. Charlotte then had the IRA, with a balance of $1,010,998, transferred to her own separate IRA. Charlotte was age 51 at the time.

In 2002, Charlotte directed that a $977,887.79 distribution be made to her from her IRA. She was under age 59 ½ at the time.

APPLICABLE RULE 1: Section 72(t) imposes a 10-percent penalty tax on distributions on IRAs received by beneficiaries under the age of 59 ½.

APPLICABLE RULE 2: Section 72(t)(2)(A)(ii) provides an exception to the 10-percent penalty tax for distributions "made to a beneficiary (or to the estate of the employee) on or after the death of the employee."

THE ISSUE: Can Charlotte use APPLICABLE RULE 2 to avoid a 10% penalty tax under APPLICABLE RULE 1 for her distribution? In a recent Tax Court case, Charlotte argued that the funds from her deceased husband's IRA did not lose their character as funds from her deceased husband's IRA, even though she rolled them over to her own IRA - thus, she should be able to use the APPLICABLE RULE 2 exception.

THE RESULT: The 10-percent penalty tax (here, $97,789) will apply. Once the funds were put in her IRA, they became part of her IRA and thus distributions later made to her were not distributions to a beneficiary after the death of the IRA employee.

The only good news for Charlotte in the Tax Court opinion was that the Court found reasonable cause for Charlotte’s erroneous reporting. Thus, the 20% accuracy related penalty will not apply to her.

Charlotte T. Gee, et vir. v. Commissioner, 127 T.C. No. 1 (2006).
Post a Comment