Transfer incident to divorce under 408(d)(6) from an inherited IRA of a non-spouse beneficiary to his/her spouse/ex-spouse IRA

[jevd]

I have a situation where a client is asking if all or a portion of his inherited IRA (he is a non-spouse beneficiary) may be transferred to his spouse/ex-spouse under 408(d)(6).

Both the code and reg 1.408-4 describe an individuals interest. Would you include as an individuals interest in an IRA one held as an "Inherited IRA" which has specific distribution requirements attached to it. If it is allowed to be transferred under 408(d)(6) and the spouse treats it as their own, then you have a de-facto rollover to a non-spouse non beneficiary of the original IRA. Reprint below of appropriate code & regulations.

408(d)(6) TRANSFER OF ACCOUNT INCIDENT TO DIVORCE. --The transfer of an individual's interest in an individual retirement account or an individual retirement annuity to his spouse or former spouse under a divorce or separation instrument described in subparagraph (A) of section 71(b)(2) is not to be considered a taxable transfer made by such individual notwithstanding any other provision of this subtitle, and such interest at the time of the transfer is to be treated as an individual retirement account of such spouse, and not of such individual. Thereafter such account or annuity for purposes of this subtitle is to be treated as maintained for the benefit of such spouse.

71(b)(2) DIVORCE OR SEPARATION INSTRUMENT. --The term "divorce or separation instrument" means --

71(b)(2)(A) a decree of divorce or separate maintenance or a written instrument incident to such a decree,

71(b)(2)(B) a written separation agreement, or

71(b)(2)© a decree (not described in subparagraph (A)) requiring a spouse to make payments for the support or maintenance of the other spouse.

1.408-4

(g) Transfer incident to divorce

(1) General rule. --The transfer of an individual's interest, in whole or in part, in an individual retirement account, individual retirement annuity, or a retirement bond, to his former spouse under a valid divorce decree or a written instrument incident to such divorce shall not be considered to be a distribution from such an account or annuity to such individual or his former spouse; nor shall it be considered a taxable transfer by such individual to his former spouse notwithstanding any other provision of Subtitle A of the Code.

(2) Spousal account. --The interest described in this paragraph (g) which is transferred to the former spouse shall be treated as an individual retirement account of such spouse if the interest is an individual retirement account; an individual retirement annuity of such spouse if such interest is an individual retirement annuity; and a retirement bond of such spouse if such interest is a retirement bond. [Reg. §1.408-4.]

[Appleby]

Marital/community property is usually limited to assets/property earned during the marriage and generally (therefore) does not include inherited property. Consequently, an inherited IRA should not be subject to 408(d)(6)…IMHO....but I am not a lawyer...

[jevd]

Thanks Appleby. I'm waiting to speak to in house counsel now.

[mbozek]

As appleby has pointed out IRAs inherited from another person are not marital property for division in divorce. However, the inherited IRA could be divided and transferred tax free to the spouse of the IRA beneficiary as part of the divorce since the ownership interest in IRA passes to the beneficiary upon the death of the owner. For example the IRA owner could transfer the interest in the inherited IRA and retain a capital asset such as a residence.

[jevd]

Mbozek,

What about the requirement that the non-spouse inherited IRA be distributed over the beneficiary's life expectancy? Does that requirement follow to the transferred account?

[mbozek]

I think mrd only applies to amounts in the bene's inherited IRA- amounts transferrrd to the spouse would be subject to distribution rules applicable to the spouse's IRA. If 50% of the account balance is transferred to the spouse then the bene's IRA distributions will be 50% less.

[BPickerCPA]

I have to disagree with mbozek's response. If, for some reason, an IRA inherited by a non spouse is split in a divorce, the ex-spouse would still have to take distributions on the same schedule as the original beneficiary. It would definitely not become the spouse's IRA.

[mbozek]

Reg. 1.408-4(g)(2) provides that the IRA interest transferred to spouse incident to a divorce shall be treated as the IRA account of such spouse, not the interest of the IRA owner. This would include the date that mrds commence. Under IRC 408(d)(6), the IRA interest transferred to the spouse incident to divorce is to an IRA in the name of the spouse as owner (including the right to name a beneificary), not as a beneficiary of an inherited IRA. This is no different than a spouse under age 70 1/2 who inherits an IRA from a deceased spouse who was receiving mrds at death elects to roll over the IRA to her own account and defer distributions until the year she turns 70 1/2.

[Appleby]

mbozek,

You make a good argument, but I have to agree with Barry. IMHO, what is happening is a transfer of ownership and rights (for lack of a better term). Since the spouse giving up the assets is not a spouse beneficiary or the owner of the IRA assets, he/she has no ownership rights to transfers…ownership rights being ability to treat as own and make contributions to the IRA. Therefore, the spouse receiving the assets must continue maintaining the IRA as an inherited IRA, using the life expectancy options that were available to the spouse giving up the assets...and including the name of the deceased IRA owner in the title of the account

[jevd]

Thank you all. We will refer the client to counsel and have checked with ours. Still waiting their reply. I will advise their opinion when it comes.

[BPickerCPA]

Clearly this is new ground here, and I am not comfortable even with the idea of transferring the IRA incident to the divorce, since it is a beneficiary IRA.

My advice is not to do anything without the security of a private letter ruling from the IRS.

If the IRS takes the position that the spouse had no right to the IRA as a matter of law, and only received it in trade of another asset, they might argue that it immediately becomes taxable to the beneficiary.

To me, it's too risky a move to make without knowing exactly what the IRS thinks.

[mbozek]

A: I dont understand how you can say that the non spouse bene. has no ownership rights in the IRA after the death of the IRA owner. Every IRA agreement I have seen provides that the bene succeeds to all ownership rights under the IRA after the death of the IRA owner including investment decisions, title to the assets, right to make withdrawals, ability to name a contingent bene and ability to transfer the IRA assets to another custodian by a trustee to trustee transfer. The term of mrd in the non spousal IRA is not an interest in which the bene has a transferrable right, because it is required by regulation to apply to the beneficary of the owner's IRA. However, it does not apply to separate IRA owned by the bene. To the extent the non spouse bene has ownership rights in an inherited IRA then clearly those ownership rights are an interest in the IRA which can be transfered to an IRA of the spouse under IRC 408(d)(6) which reg 1.408-4(g) states is solely the interest of the spouse, including the MRD based on the spouse age.

The IRS regs are applicable to each separate IRA. If an Employee who has attained 70 1/2 can transfer his or her interest to a qualified plan to avoid MRD because the MRD rules are not transferred to the employee's interest in the Qual plan then clearly the MRD rules will not apply to the transfer of the non spouse bene interest in an inherited IRA which is transferred to a spouse in a divorce.

[Appleby]

mbozek- I can always rely on you to give my brain a workout

You are right- poor choice of words on my part. For the purpose of the post I had defined ownership rights as being ability to treat as own and make contributions to the IRA…but it still clouds the issue as it means more than just that as you correctly stated.

What I should have said is that the non-spouse beneficiary who is giving the inherited IRA assets to his/her spouse can only transfer (to his/her spouse) the same rights to which he/she (the beneficiary is entitled). Since the beneficiary was not eligible to treat the assets as his/her own, then neither is his/her spouse.

There are only two categories of individuals who can treat an IRA as his/her own 1. The individual who initially established and contributed to the IRA and 2. a spouse beneficiary of the individual who established the IRA....This individual is neither

I agree with everything in your post except the comment

then clearly the MRD rules will not apply to the transfer of the non spouse bene interest in an inherited IRA which is transferred to a spouse in a divorce

Oranges and apples I think – The RMD requirement can be avoided/deferred by transferring/rolling one’s IRA or inherited IRA or QP assets to one’s QP only if one is the owner of the transferee account or the spouse beneficiary of the transferee account.

[mbozek]

A: while in general what you say is correct, there are exceptions in the IRC when the interest is transferred to another taxpayer not only in divorce, but also in the event of bankruptcy when the IRA assets are transferred to the bankrupcty estate. See IRC 1398(f). IF a non spouse beneficiary who is receiving IRA payments files for bankrputcy, the IRA assets will be transferred to the bankruptcy estate and the payments made by the trustee to pay creditors claims will be taxed to the estate, not the bene. The trustee will not have to make mrd payments that would have been made by the bene.

[Appleby]

You make a good argument counselor, but I am still leaning towards the other side of the fence. 1398 allows for the transfer, but I am not sure it is sufficient to determine that the transferee would not be required to continue the RMD.

[mbozek]

There is a tax ct case under 1398(f) where the ct held that the 10% penalty tax did not apply a taxpayer whose IRA was transferred to a bankruptcy trustee because the IRA was the property of the trustee. The Bankruptcy estate was liable for the income and penalty tax on the withdrawals. The taxpayers name was Johnson. If the penalty tax doesnt apply to the IRA owner then neither should the mrd, because the IRA is the property of another person.