Spousal Ira Conversion Irreversible???

[Guest fidowatch]

Have an individual whose husband recently died. She converted his IRA to hers. She is under 59 1/2 and he was early 60's. No distributions taken until recently after she converted, she took some funds out. All assets are now in her IRA. Problem is, she has two stepdauthers (His from a previous marriage) that she wanted to give $50k each to by using a disclaimer (She found out about this after converting the assets to her IRA). Her question,

is there any way she can put assets back into his IRA and let the stepdaughters have it by using the disclaimer. In effect, reversing the IRA conversion in her name for a portion of the assets to go to the stepdaughters, allowing the mom to avoid taxes and penalties if she were to gift the assets to them. Can anyone shed light on this or provide any resources on where I can find a definitive answer? My understanding is the IRA she has now is irreversible, she is stuck with the assets in her name and can't move them back in the decedant's account. Any help anyone can provide would be greatly appreciated.

Randy Braidfoot

[Appleby]

Generally, a conversion may be recharacterized ( reversed to the traditional IRA) up to October 15 of the year following the year the conversion was done. ( to get the extension up to October 15, the individual must have file their tax return or an extension, by April 15.)

However, you stated that she already took a distribution from the inherited assets. As per IRC 2518, a disclaimer cannot be done after a distribution of the inherited assets have been taken.

The disclaimer must be done within 9 months after the death of the IRA holder, and before any distribution was taken.

[BPickerCPA]

Appleby and Fidowatch are both using the word "conversion", but I think in different contexts. Fidowatch appears to mean a spousal rollover, not a Roth conversion. A roth conversion can be recharacterized; a spousal rollover (or treating the deceased spouse's account as the surviving spouse's) cannot be reversed.

One a spousal rollover is done, it is too late to disclaim any portion of the account, as Appleby correctly noted.

[mbozek]

There is one possible way that the transaction can be reversed:

If the funds were rolled over to the spouse's IRA within the past 60 days, ask the custodian if the spouse could send the funds back to the deceased's IRA and have the custodian treat the transfer to the spouse as a taxable distribution and an IRA rollover within 60 days. This could take some negotiation with the custodian since spouse took a distribution from her IRA. The funds can be transferred to the daughters from the decedent's IRA without payment of the 10% premature distribution penalty. Payment will not eligible for a disclaimer since the spouse received a benefit from the decedent's IRA (e.g.withdrew funds). However lack of a disclaimer should not cause a gift tax problem-spouse will be viewed as making a taxable gift of $88k (100k- 22 annual exclusion for both donees) for which spouse has a life time exemption of $1m leaving spouse with a remaining gift tax exemption of 912K and no gift tax liability for transfer. If above scenario is not doable spouse could disclaim 100k on other property owned by deceased (assuming that 9 months has not elapsed since death and disclaimer requirments of 2518 are complied with). Real question is why didn't spouse retain counsel to advise her on how to avoid this mess.

[John G]

mbozek - I don't think your proposal is legal. I suggest that this person get some professional assistance now. The facts and circumstances may not have been accurately stated. And I agree that this should have been done months ago.

[mbozek]

The question is what is permissible from an audit perspective--and it up to the custodian to determine what is acceptable under the tax law.

[John G]

Since when is the custodian in charge of deciding the applicability of tax laws and if something may be "acceptable"? That burden falls on the tax payer. Even if it was permissable, why would you want to rely on the advice or interpretation of a custodian. They make lots of errors and have wonderful clauses in their custodian agreements that say they must be held harmless. Don't expect a custodians errors and omissions coverage to solve a tax law interpretation issue.

[mbozek]

Under Reg. 1.408-7 IRA custodians/trustees (not the IRA owner) are responsible for tax reporting of IRA distributions on 1099R forms of all amounts distributed to both the participant and the IRS. The reporting is used by the IRS to determine any tax laibility. Of course, tax reporting of IRA transactions is subject to random audit by the IRS. A taxpayer who relies on a 1099 form issued by a custodian will not be liable for any penalites for substantial understatement of taxes if the return is audted by the IRS and reputable custodians will reimburse their customers for any interest or tax penalities arising from their own actions as a customer relations matter because they do not want to lose the customer's business. The taxpayer is only responsible for paying the tax assessed by the IRS. As a practical matter random audits of IRAs are extremely rare.

[BPickerCPA]

I don't understand the dispute. What MBozek is suggesting results in the IRA being taxable to the spouse followed by a gift from the spouse. You don't need to do any rollovers to accomplish this. You could not avoid taxation to the spouse, because the only beneficiary who can even do a rollover is the spouse, so there is no way to roll it to an IRA and claim the spouse is not the beneficiary of the account.

As an aside, the IRS has told me that if an account is disclaimed in a disclaimer that is NOT qualified (i.e. the disclaimant will treat it as a gift), the disclaimer will not change the designated beneficiary for minimum distribution purposes.