A recent ruling by the IRS demonstrates the importance of naming a spouse as the beneficiary of an IRA in which the surviving spouse has a community property interest. In this case, the husband (who died) named his child as the sole beneficiary of his IRAs. The couple lived in a community property state, and they were married for approximately 11 years before his death. The surviving spouse attempted to have a negotiated portion of the IRAs roll over for her benefit as she argued that she had a community property interest. A spousal rollover is beneficial since she would not only own a portion of the retirement account, but she could defer income taxation until after she was 70½ (no taxation until there was a withdrawal after she turned 70½ years of age). However, the IRS denied the surviving spouse’s request that: (a) she be treated as the payee of the IRAs; (b) the IRA custodian distribute the negotiated amount of the IRA to her in the form of a spousal rollover IRA; and (c) the distribution from the IRA will not be considered a taxable event.

The IRS ruled that since the child was the designated beneficiary and the IRAs had been retitled as an inherited IRA, her community property interest was to be disregarded and she could not be payee or make a rollover. Furthermore, if the child assigned any of child’s interest in the IRA, then it would trigger federal income taxation.

As a result of the child being named as the sole beneficiary, the community property interest of the surviving spouse should be treated as a gift to the child. This is generally not a problem for most Americans for gift tax purposes since you can presently give up to $11,400,000 without gift taxation (although there is a duty to report the gift to the IRS). However, this is likely to result in future litigation when there is a blended family (children by earlier relationship).

Furthermore, there can be quicker income taxation if The Secure Act (which was passed by the House of Representatives on May 22, 2019) becomes law. Presently, when one (other than a spouse) is the beneficiary of an inherited IRA, the beneficiary can stretch the distributions over his or her life expectancy resulting in tax deferral while the IRA continues to generally grow. Under the Secure Act, the ability to defer the income taxation over life expectancy is eliminated as there would be a requirement to withdraw the full amount within 10 years. So, in the case above, the child would be required to make a full withdrawal within 10 years (if the Secure Act is passed). In contrast if there was a spousal rollover then there would be tax deferral until the spouse reached age 70½ and generally tax deferral could be for more than 10 years.

If interested in learning more, consider attending our next free “Estate Planning Essentials” Workshop on Saturday, June 15, 2019 from 10:00 a.m. to 11:00 a.m. by calling us at (214) 720-0102 or signing up online at www.dallaselderlawyer.com or by clicking here

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