Mary Kay Foss

At a meeting between the California CPA Society Tax Committee and the IRS a similar question was asked. (These questions and answers are published by CalCPA and the IRS is aware of that, but I'm not sure of the value as precedent). I'm going to repeat that question and the IRS response: Question: During 1998, a taxpayer converts a traditional IRA into a Roth IRA and pays the coversion tax. The taxpayer now has basis in the Roth IRA. Six years later, the fair market value of the assets in the Roth IRA decreases below the basis. At what point, if any, can a loss be claimed? Response: If a taxpayer has received all contributions and earnings from all their Individual Retirement Arrangements (IRA) and the total amounts received are less than their basis in all IRAs, the difference may be considered a loss (see Notice 89-25, 1989-1 C.B. 662, Q&Q 7). Please note that all IRA's, both regular and Roth, must be combined for purposes of this determination. Regular IRAs are only combined with regular and Roth with Roth. In other words, excellent results in one Roth IRA may well offset losses in another. However, if your client has only a single Roth IRA, a loss may be recognized in the year in which the IRA is fully distributed. The loss would be claimed as an ordinary loss and deducted from gross income in arriving at adjusted gross income.

I'm only replying to question 2. It often makes a difference when the IRA is rolled over into the spouse's existing account. This is because if the spouse has passed the Required Beginning Date the new funds would have the same beneficiary as before the rollover. A new IRA allows the survivor to name new (younger) beneficiaries. If the spouse's named each other as primary beneficiaries (either directly or as trust beneficiaries) as of the Required Beginning Date, you will have a relatively short time period for distributions. If the survivor has not reached the Required Beginning Date, you can change beneficiaries for the existing IRA and the new funds up until April 1 after survivor reaches age 70.5.

In scenario II, each beneficiary should be able to use their own life expectancy for benefits. I've never seen anyone question whether separate IRAs would be considered separate plans. Many of my clients will have multiple IRAs with the same custodian (and the same custodial agreement presumably) and name a different child as the beneficiary of each. Ann. 95-99 (1995-48 IRB) in example 6 shows that multiple IRAs are treated separately. That example referes to Notice 88-38 which allows the total RMD to be taken from one account when multiple IRAs are involved. Scenario III is troublesome. At the DOD Trust X has beneficiaries of more than one generation, the subsequent splitting of the trust doesn't seem to allow a longer life expectancy to be used. If the beneficiary designation were something like "the Bypass Trust to be established as part of Trust X" might work if only children were benes of the Bypass and this were the only beneficiary listed. The subaccounts referred to in the Prop Regs at H might work if they were established before the date of death, however, since in your example the Trust will not be split until after the DOD you would need very specific language to make this work. Since the proposed regs were changed regarding trusts in late 1997, I haven't seen any rulings that give specific information that would allow you scenario to work. Good Luck.

I agree with you; I've never heard of a custodial inherited IRA. Your plan document will control what happens. The proposed regs mention 2 choices, the five-year rule or life expectancy. The life expectancy option is common in IRAs but I've never seen it in a 401(a) plan. The five-year rule is the default, if the plan allows it. If the decedent would have rolled his benefits to an IRA before he died, inherited IRAs would be possible but only if the custodian allowed subaccounts (so each child could have his or her own account) and if the custodian would accept a life expectancy election from a minor. Sometimes a court appointed guardian is needed to make such an election. As always when we get to these postings, the answer is: What does the document say?

Try calling John Beater at Pensco Pension Services in San Francisco 415/274-5600. Pensco handles trust deeds and some other unusual assets in IRA accounts. The Form 5498 that is filed May 31 by regular IRA custodians is also used for Roth IRAs. It shows contributions, rollovers and 12/31 fair market value among other things. A box on the Form is checked to indicate that it is a Roth IRA. My understanding is that in California a Roth IRA has the same creditor protection as a traditional IRA; which isn't very much.

Check LTR 9729044. Good luck.

There have been two private rulings issued in the last few years regarding this topic. In the first one, the IRA was split 50-50 and the couple agreed to continue taking the payments 50-50. The IRS ruled that this was fine and no 10% penalty would be imposed. The second ruling was an IRA split that wasn't exactly 50-50 and there was no agreement amonst the spouses. The husband took out his prorata share of the substantially equal periodic payment. The IRS imposed the penalty because there was no requirement that the spouse pick up the remainder of the payment.

IRS Notice 88-38 answers your first question. You figure the distribution from each IRA separately then take the total from whichever account you prefer. Notice 88-38 allows you to combine IRAs with IRAs for RMD purposes; it also allows you to combine 403(B) plans with other 403(B) plans. However you can NEVER satisfy an IRA RMD with a distribution from a 401 plan.

Withholding applies to the entire distribution but is limited to the liquid assets. If only securities were transferred there is probably no funds to withhold from. Check Reg. Sec. 31.3405©-1 which came out in 1995. The penalties for not filing Form 1099-R are the ones you should worry about first.

PENSCO Pension Services, Inc. in San Francisco takes Trust Deeds in IRAs. They may handle qualified plans as well. They're located in San Francisco. 415/274-5600 They have a website as well: pensco.com

Dave gave you the right answer but I just wanted to make one additional point. If the beneficiary does not take out the minimum distribution each year as required, there is a 50% penalty. Proposed legislation would bring this down to 10% but it's still an important issue. Also if the IRA owner died before his Required Beginning Date the beneficiary may have to make an election between life expectancy and a five-year payout. The election must be made before 12/31 of the year after the death. Dave gave you the answer, the plan should tell on what basis the distributions are made.

To clarify my previous response: The basis of stock acquired by after-tax contributions isn't reported on Form 1099-R because it's not part of the lump-sum. All of the information should be available from the employer. I assumed that the $500K value of the 401k plan was all stock. Then if the plan cost was $100k; the basis would be 20%. Working with round numbers may lead to invalid assumptions, I'm afraid.

In case you can't find Kirk's article here is some information: 1. Employee after tax contributions qualify for NUA treatment but the Form 1099-R is likely to report NUA on employer contributions only. 2.a. The Trustee's cost becomes the basis of the employer shares. You will want to convert it to a per share amount. 2.a.i and ii. See above; the $100,000 is not a tax free sale, it is recovered as basis. So if the stock has not appreciated and if you sold $100,000 worth, basis would be $20,000 and $80,000 of NUA would be realized. 2.a.iii. You'd keep records to prove your basis just as you would with any shares purchased on the open market. The NUA portion yields long term capital gain; further appreciation needs a 1 year holding period for long-term. Reporting a sale if the stock has gone up is tricky but not impossible. 2.iv. Except for the quirk in the first year after receipt of the shares due to long term & short term treatment, the sale of the NUA shares is treated like any other stock sale. Capital losses carried forward or created currently can offset the gain. 2.b. If the shares are transferred to an IRA you forgo the NUA treatment forever. It's only available if the employer shares which are part of the lump sum distribution are not rolled over. My clients generally keep some or all of the shares and rollover the balance of the lump sum.

If this question has been answered on an earlier thread please lead me to it. A Merrill Lynch "1999 Pension Plan Comparison Chart" describes a SIMPLE Plan as being similar to a 401k but not limited to 15% or 25% of compensation. Is there no Sec 415© limitation with a SIMPLE Plan? Could a sole proprietor with no employees contribute 100% of SE income (up to $6,000) plus a 3% match? I've looked everywhere I can think of and can't find an answer.

The working rules for hardship withdrawals are found in the 401k regs. I've always associated hardship withdrawals with 401k plans only because 401k plans prohbit inservice withdrawals before age 59 1/2. I've never seen a plan other than a 401k that offered them.

See Reg. 1.408A-4 Q&A 6. The traditional IRA will have to give one MRD before the Roth conversion can occur.

You can't roll your 401k benefits directly into your Roth. You'll need to roll them into a traditional IRA first. A Roth conversion must always come from a traditional IRA.

I understand your problem in my area we have many clients who retire with a large rollover IRA and an expensive house but very little in liquid assets. Our strategy has been to try to create more liquid assets by taking more than the RMD from the IRA each year and having the revocable trust either the primary or contingent beneficiary of the IRA. Often part or all of the residence winds up in the Bypass Trust (at least until the spouse can buy it back for an interest free note secured by the house). We love revocable trusts here in CA and hope you'll join the parade.

Apparently you are only thinking about income tax in your question. The date of death value is relevent if you're filing an estate tax return. For income tax purposes there are choices. A spouse can rollover a lump sum to an IRA and not pay tax until its withdrawn from the IRA. Depending upon the age of the plan participant, 10 year averaging may still be available. But fewer and fewer people qualify. If there is appreciated employer stock in the lump sum, there is special income tax treatment for the unrealized appreciation. There is no 10% penalty for an inherited benefit, so you don't have to worry about that aspect. A 20% tax is unlikely to happen. The lump sum in not treated as a long term capital gain in total.

I am not an attorney and can only give you an insight based upon what I see in my CPA practice. The trust was not the reason that the non-pro rata parition was allowed. In fact the Rev Rul cited 76-83 relates to a divorce situation. A community property agreement is fairly common in CA whether you have a trust or note. One of the difficulties that the ruling was trying to get around was the inability of the surviving spouse to accomplish a spousal rollover because the trust rather than the spouse was the designated beneficiary. If the spouse (rather than the trust) was the beneficiary, no ruling would have been necessary. For flexibility we recommend that each IRA have a primary beneficiary and a secondary beneficiary. If there is a need to do a disclaimer, a trust as a contingent beneficiary gives some flexibility. One may be able to name a testamentary trust as a contingent beneficiary if you want to stay away from living trusts. I may not be answering your question, but I couldn't tell what you were trying to accomplish.

Yes, a spouse can disclaim a portion of an IRA or a qualified plan benefit. There are many private letter rulings that approve the technique. I'm in a community property state and one of my favorite examples is PLR 9630034. The spouse should disclaim a fraction rather than a dollar amount to avoid adverse income tax consequences. My favorite resources are: Life and Death Planning for Retirement Benefits by Natalie Choate. Call 1-800-247-6553 to order. J.K. Lasser's How to Protect Your Retirement Savings from the IRS by Seymour Goldberg. Order from Amazon.com for best price. Pension Distributions: Planning Strategies, Cases and Rulings by Seymour Goldberg. Call 1-516-222-0422 to order.

I'm not sure even making the election to "mark to market" would help to qualify you for an IRA. You need taxable compensation which IRS defines as (a) wages, salaries, etc (B) alimoney and separate maintenance and © self-employment income reduced by one-half of the SE tax. Mark to market gains aren't subject to SE tax so you'd have to find some other creative way to generate taxable compensation.

It does make sense. A distribution that qualifies for rollover is subject to 20% withholding if it isn'r rolled over. The 10% withholding rate applies to "nonperiodic distributions not eligible for rollover. Dying with money in a qualified plan with a nonspouse beneficiary usually has this kind of result.

Unfortunately the son continues to use the wife's life expectancy. The next question is whether the father had elected recalculation or not. If both spouse's lives were being recalculated, I believe that the son will be required to take all of the funds out by December 31 of the year after the spouse's death. Ordinarily, clients don't know whether they've elected to recalculate or not. First you check with the custodian, if they don't know about the election; you read the plan document to see what the default is. If the plan document is silent and no one can find a specific election, the general default is to recalculate the lives of both spouses. The life of a nonspouse beneficiary cannot be recalculated so obviously if the replacement beneficiary were older than the spouse, recalculation would not be a factor. I've never seen the situation where a change has been made from a spouse to a younger beneficiary that explained whether recalculation was still required or not. The recent private letter rulings that have allowed life expectancies after death when the participant was using a single life indicate to me that someone in Washington has a heart. Will that continue after November?

I hope the beneficiary was the spouse because only a spouse or the participant can roll over a qualified plan distribution. If the beneficiary is not a spouse, the entire amount is taxable (but not subject to the 10% penalty). A beneficiary is not subject to the 72t penalty with an inherited benefit, so age is not a factor. Payments can come out in any fashion and avoid the 10% penalty. The problem is that once a spouse rolls over the distribution it is no longer considered inherited and the 72t penalty is imposed. I hope the actions you describe are just being contemplated rather than already accomplished.