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Separate Share Treatment


Guest tbouman
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Guest tbouman

Based on my reading of PLR 200317041 (Separate share treatment denied for IRA payable to trust), it looks like the IRS changed its position on separate share treatment when an IRA is payable to a trust.

It seems this ruling prevents us from identifying subtrusts for children that are described in the parents' revocable trust agreement as the beneficiaries, and having each child be able to use his or her own life expectancy under the separate share rule.

I presume that now the IRA participant either must accept using the eldest child's life expectancy or create trusts during the participant's lifetime and name them in the beneficiary designation.

Comments?

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Guest peachy

This ruling is a set back to the planners who promised lifetime distributions to beneficiary grandchildren in an IRA Trust. However let us not forget why the Trust is used. The Trust is used to take away the control of beneficiiaries because of age, and very important because they cannot manage money, etc.

Code 408 grants the beneficiary of an inhereted IRA all the rights and priviledges of ownership.

By naming a qualified Trust as beneficiary to the IRA. The IRA is maintained in the name of the deceased taxpayer for the benefit of the taxpayer beneficiaries in the Trust. The trustee can make investment decisions in the name of the deceased taxpayer.(I think)

For the purpose of distribution the trustee must use the life expectancy of the oldest trust beneficiary, if the life expectancy distribution is selected by the trustee in the name of the deceased taxpayer. The trustee has the option of selecting an accelerated distribution in the name of the deceased taxpayer for the benefit of the taxpayer beneficiaries in the Trust, if the Trust grants the power.

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Guest godmom

It looks like the trustee has all the control. What happened to the the rights and priviledges of ownership of the ultimate beneficiary? Does the beneficiary have any input as to where the assets in the IRA are invested? What can the beneficiary do if the trustee is not investing well?

If the beneficiary wants to buy a house, can the trustee be forced to request an accelerated distribution?

When the distribution is made, who pays the taxes, the trustee or the beneficiary?

Comments please

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There are two separate agreements with different legal relationships which need to be reviewed. The IRA account is a contract between the custodian of the IRA and the IRA owner. The owner has all rights including the right to designate the beneficary of the IRA and make investments. When the owner dies the IRA beneficiary suceeds to all the rights of the owner, including investment decisions. After the owner's death the minimum distributions will be paid by the IRA to the trust. Naming the trust as beneficiary will result in the trustee suceeding to the rights of the owner of the IRA.

The second agreement is the trust agrement between the owner and the trustee to administer the trust for the benefit of the benficiaries of the IRA. The trustee's rights and duties are spelled out in the trust agreement. The agreement can give the trustee complete discretion over the distribution of the assets of the trust as well as investment of the assets of the trust. The trust could permit distributions to a beneficiary for health, education, maintence or other bona fide reasons if the trust permits discretionary distributions. The terms of the trust can provide that the trust will terminate upon a specific event, such as the attainment of a specific age of the beneficary or the death of the beneficiary. It is up to the creator of the the trust (the IRA owner) to determine the terms of the trust.

The trust is taxed at trust tax rates for any distributions paid from the IRA (38.6 % for income over 9200). The trust is also taxed on any earnings on trust investments which are not paid to the beneficaries. The beneficaries will be taxed on distributions paid from the trust depending on the character of the income paid from the trust under the tier system.

The beneficaries only remedy would be to bring an actoin against the trustee under state trust law but the bene would have the burden of proving that the trustee was acting imprudently in investing IRA assets. The court would enforce the terms of the trust which could prevent a lump sum payment to the beneficiary if the trustee had the right to determine the amount of money to be paid to the beneficiary each year. If the owner wanted the beneficary to withdraw funds at will the owner could leave the IRA to the beneficiary outright instead of making the trust the IRA beneficiary.

mjb

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Guest godmom

Please clarify the Trust Tax.

It looks like the Trust is Taxed and the beneficiaries are also taxed. Is this double taxation? I was under the impression that the Trust passed the tax to the beneficiaries and was not taxed itself unless it retained interest earnings. Where does the 9200 comes from?

For example if the Trust receives an MRD of $22000 which includes $10000 of interest earned by the IRA for the year. The trustee distributes to two trust beneficiaries as follows:

Beneficiary A gets $10000 which includes $5000 of interest.

Beneficiary B gets $ 10000 which includes $5000 of interest.

The Trust retains $2000.(no interest)

What are the taxes to the Trust?

What are the taxes to Beneficiaries A&B? (Beneficiaries are in 27% tax bracket)

If the IRA is a Roth IRA over 5years, What are the taxes to the trust? To the beneficiaries?

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1. Income taxation of estates and trusts can be complicated. But in general, distributions carry out income to the extent of the trust's income. In the example given, since the trust had $22,000 of income and distributed $10,000 to each of two beneficiaries, each beneficiary is taxable on $10,000, and the trust is taxable on the $2,000 it retained. There are different rules for required distributions and for capital gains. The ability to decide each year whether to make distributions to beneficiaries in low income tax brackets or to retain the income in the trust is a benefit of the trust, though probably not the main reason for leaving assets in trust rather than outright.

Distributions from an estate or trust generally retain their character, so that traditional IRA benefits will generally remain taxable, and Roth IRA benefits will remain tax-free, even if they pass through a trust.

2. Even if each child's trust has to take distributions based upon the oldest child's life expectancy (in addition to PLR 200317041, see PLR 200235038), if the children are close in age, it shouldn't make a great deal of difference. There are lots of reasons for leaving assets in trust rather than outright, such as protecting against creditors, predators and spouses, and keeping the assets out of the children's estates. These reasons apply to IRA benefits as well as other assets.

3. It's possible to draft a grandchild's trust such that it can use the grandchild's life expectancy. However, the drafting will take some effort. See PLRs 200228025 and 200235038.

4. Leaving IRA benefits to a revocable trust may complicate things. There are generally other ways to accomplish the same result. (While not directly related to IRA benefits, revocable trusts tend to be overused. They do not save taxes. In most cases, they do not significantly simplify the estate administration or reduce the expenses of the estate administration.)

5. A trust can be designed to give the beneficiaries a great deal of control, or not, depending upon what is appropriate in the particular case.

6. The above is not intended as specific legal advice. IRA owners (including the previous posters in this thread) should consult with competent counsel, who can give them specific advice as to how best to accomplish their objectives.

Bruce Steiner, attorney

(212) 986-6000

also admitted in NJ and FL

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Guest tbouman

Qualified plan/IRA expert Natalie Choate confirmed my suspicions... the IRS did change its position 100%. This is a significant change as it affects many estate plans. As Bruce began to discuss, there is a tax drawback to the common estate planning procedure of naming a client's spouse as primary beneficiary and the revocable trust as contingent beneficiary. Some clients will still want to name a trust as beneficiary, but I think more will not. Another option of course is to name separate lifetime trusts (those established for children prior to the participant's death) as the beneficiaries in the beneficiary designation. This would still get separate share treatment if all other requirements are met.

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I think there's still some confusion here.

I think it was silly of the IRS in PLR 200317041 to distinguish between leaving the IRA to separate trusts for each child in the beneficiary designation and leaving the IRA to a single trust in the beneficiary designation and then having the trust be divided into separate trusts for each child. But in most cases it won't have much practical significance other than making beneficiary designations more complicated.

In most cases, each child will be a contingent remainder beneficiary of each of the other children's trusts (if a child dies without any issue and without having exercised his/her power of appointment). So, if PLR 200228025 is correct, each child's trust will have to use the oldest child's life expectancy anyway.

There's no need for a separate trust instrument. The children's trusts can be created in the IRA owner's Will.

In any case, why (unless there is some other reason in a particular case) create a revocable trust? And if there is some reason for creating a revocable trust in a particular case, why run the IRA benefits through the revocable trust? As noted previously, revocable trusts do not save taxes, and in most cases do not significantly simplify the estate administration.

Bruce Steiner, attorney

(212) 986-6000

also admitted in NJ and FL

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Guest godmom

Bruce

You keep hinting to possible alternate solutions, other than a qualified Trust. What are they? Lets stick with wastefull non-spouse beneficiaries of the owner of the IRA ($400K) who dies before RMD.

Godmom

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Guest tbouman

The reference to PLR 200228025 is interesting. I just read the ruling again and I interpreted it like Bruce did. However, I also find it interesting that several outlines from seminar presentations I have attended in the past 9 months don't talk about application of the contingent beneficiary factor. At the various functions I attended in Arizona and California, it had always been assumed that we could get separate share treatment even with trusts (and assuming each subtrust has the sibling as a cont. ben). Never heard mention of 200228025. I'm curious whether there are any more PLR's out there hitting on this topic -- perhaps that came out interpreting the final regs as opposed to the proposed regs.

As for the merits of a revocable trust, that's probably a topic reserved for a different message board. However...

I would take issue with the assertion that estate administration is rarely any simpler with a revocable trust. That has certainly not been true in my practice. Avoiding probate is a worthy goal. In addition, many of my clients seek the privacy a trust affords. Other clients have property in several states ... the trust can simplify matters. Also, a trust seems much more reliable than using a power of attorney for incapacity planning. Obviously, a trust does not save taxes. And the decision is unique to each client.

Running the IRA distributions through a trust after the participant's death is not something I normally want to do. But it's a practical necessity for many, including (1) the parents of minor children who want to control distributions beyond age 18 and (2) the parents of older children who they don't trust with a large inheritance. For example, the client who thinks a large inheritance to their children would cause them to quit their jobs and never work again.

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Godmom, the IRA owner can leave the IRA to the beneficiaries in trust rather than outright, in the same way that he/she can leave his/her other assets to the beneficiaries in trust rather than outright. Each beneficiary can have as little or virtually as much control over his/her trust as the client deems appropriate.

The trusts can be created in the IRA owner's Will, or in a separate document.

If the beneficiaries are the IRA owner's children, then most likely, depending upon the terms of the trusts, each trust will have to use the oldest child's life expectancy (see, e.g., PLR 200228025). But if the children are close in age, that shouldn't be a major concern.

T. Bouman, if they don't tell you enough at the seminars you're going to, then perhaps you might want to go to some of the ones where I'm on the panel <g>. See PLR 200235038 for a possible road map (subject to the caveat that PLRs are not binding on the IRS except with respect to the taxpayer to whom they are issued, and the IRS won't rule on IRA distributions unless the IRA owner is already deceased).

While perhaps more a subject for another day and another place, I think it's worth following up on the issue of revocable trusts. I know that some people believe in them with almost a religious fervor. But they do not save taxes, and my experience has been that they don't significantly simplify the estate administration. The tax planning, the estate tax returns, the appraisals, deciding what to do with what assets, deciding what to do with the IRA, and the planning for the beneficiaries, is all the same either way. What's the big deal about probate, or avoiding probate? In most cases, it's just a matter of submitting a few forms to the court along with the Will, a death certificate, and a small filing fee. Since most Wills contain a marital/credit shelter formula, trusts for children, and lots of pages of boilerplate, how many people's Wills are of interest to the public or the media? While there may be reasons for creating a revocable trust in some cases, in many cases they tend to be more of a distraction than anything else.

Bruce Steiner, attorney

(212) 986-6000

also admitted in NJ and FL

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