Failure to make required minimum distributions from IRA was due to reasonable error, excise tax waived

In two rulings arising from one case, the IRS concluded that a failure to make required minimum distributions (RMDs) from an individual retirement account (IRA) after the IRA owner died because of litigation among the beneficiaries was due to reasonable error. Reasonable steps for each of the two affected beneficiaries to take in order to remedy the shortfall would be to take the RMDs by the end of 2014. If this were done, the IRS agreed to waive the 50% excise tax imposed on beneficiaries under Code Sec. 4974(a).

An owner of an IRA, which was invested in annuities, originally designated a long-time friend as the primary beneficiary of the IRA. Additionally, pursuant to a divorce judgment, the IRA owner was required to maintain the former wife as the beneficiary of a percentage of some of the funds in the IRA. After the IRA owner underwent major surgery, an individual began to live part of the time at the IRA owner’s residence to care for his medical needs. The IRA owner later changed the beneficiary designations for one annuity to 50% for the long-time friend and 50% for the individual, and for two other annuities to 100% for the individual. The IRA owner died in 2006 after his required beginning date for distributions, and the individual received her entire interest in one of the annuities in 2006.

The long-time friend and the former wife filed suit, challenging the beneficiary designation of the individual, resulting in the freezing of all of the assets of the IRA, including the undistributed assets of the annuities. In 2010, a stipulation of settlement was signed by the three beneficiaries, and approved by the court, under which the individual released any claims to any undistributed assets of the IRA, including the annuities. After the stipulation was signed, it was represented that there were delays getting final waivers from the individual and there was a need to make a final allocation determination between the long-time friend and the former wife. During the litigation and until the determination of the allocation between the long-time friend and the former wife, RMDs could not be made for 2007 through 2010. However, the RMDs were made while the parties were waiting for the IRS’s ruling.

The IRS concluded that, pursuant to Code Sec. 4974(d), it was due to a reasonable error that RMDs were not made to the long-time friend and the former wife for 2007 through 2010, and that reasonable steps to remedy the shortfall would be for these beneficiaries to take the shortfall in RMDs for those years by the end of 2014. If these beneficiaries did take the shortfall in RMDs for those years by the end of 2014, the IRS agreed to waive the 50% excise tax imposed on beneficiaries under Code Sec. 4974(a) for the shortfall in those years. The IRS further advised that the beneficiaries include a copy of the letter ruling with their Form 5329, which is used to apply for a waiver of the tax imposed under Code Sec. 4974(a) and is attached to tax returns.

Finally, the long-time friend could receive RMDs related to her allocated interest in one annuity based on her own life expectancy because the individual received her entire interest in the annuity prior to September 30th of the year following the death of the IRA owner, making the long-time friend the designated beneficiary for purposes of determining the distribution period for the RMDs. As to the other annuities, because the individual did not disclaim her interest in those annuities prior to September 30th of the year following the death of the IRA owner, the individual was the designated beneficiary for purposes of determining the distribution period for the RMDs. Therefore, the long-time friend could receive RMDs related to her allocated interest in the annuities based on the life expectancy of the individual. For the same reason, the former wife could receive RMDs related to her allocated interest in one of the annuities based on the life expectancy of the individual.

Source: IRS Letter Rulings 201437025 and 201437034.

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