Saturday, October 27, 2007

REFORMATION OF IRA BENEFICIARY FORM NOT RESPECTED BY IRS

If a decedent's IRA is payable to his or her estate, the ultimate beneficiary typically must withdraw the IRA at a rate now slower than that which would have been imposed on the decedent if he or she had lived (based generally on life expectancy). If the decedent had named the beneficiary directly, the beneficiary could withdraw it out over his or her own life expectancy (that is, slower, if the beneficiary is younger than the decedent). Taxpayers like to take funds out of an IRA as slow as possible (if not actually needed) so that tax on the withdrawals can be deferred and deferral of tax on earnings continues for the assets retained in the IRA.

In a recent private letter ruling a decedent had inadvertently left off his daughter from his beneficiary designation (she had been on a prior version). A new form was requested by the IRA custodian to correct the error, but the decedent died first.

The interested parties were able, after the death of the decedent, to obtain a reformation of the beneficiary designation form by a state court to add the daughter. A ruling was then sought from the IRS, confirming that the reformation would be respected and the daughter could use her own life expectancy.

The IRS did not issue a favorable ruling, citing rules that require a beneficiary designation to be in place prior to death to be effective for these purposes. This was likely a surprise to the daughter and her advisors, since on similar facts in the past the IRS had given effect to such reformations by way of private letter ruling. Further, the IRS has also respected modifications to trusts post-death to qualify them as proper designated beneficiaries. Since private letter rulings are not binding on the IRS except as to the taxpayers to whom they are issued, such a reversal of policy is permissible, albeit unexpected.

PLR 200742026

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