IRAs, Disputes Over Beneficiaries, Settlement, Gift Tax?

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By Kathleen Ford Bay, Esq.

Lippincott Phelan Veidt PLLC, Austin, TX

In PLR 201432029, the  IRS ruled that a taxpayer did not have to include in his income distributions,  pursuant to a settlement agreement, from a traditional individual  retirement account (IRA) and a simplified employee pension (SEP) IRA to an estate and a charity, respectively.

Decedent  B had two IRAs when he died, one a traditional IRA and the other a SEP IRA. B named C as primary beneficiary, with whom B had a long-term  relationship, but not a marriage. Various charities were named as  contingent beneficiaries. B died in August 2006; he had not turned  70 1/2. C did not elect to treat either IRA as an "inherited  IRA" and, thus, was required to receive the IRAs by December  31st of the fifth calendar year after B's death — by December  31, 2011. While C was named as successor trustee of a trust included  in B's estate, C chose not to serve as trustee and D, a personal friend and business associate of B's, became trustee.

D  initially filed a report with the probate court including the IRAs  in B's probate estate. Then D withdrew that report and filed one  without the IRAs; this later one was approved (property that passes  per contract and not under the terms of a will — or by intestate  succession if there is no will — is not "probate"  property).

C  arranged for a trustee-to-trustee transfer of the two IRAs (presumably  in the name of B's estate though the ruling does not specify) in November 2006 and named D as beneficiary. C died in April 2007.

D  arranged for a trustee-to-trustee transfer of the two IRAs in May  2007, followed by yet another trustee-to-trustee transfer as part  of "customer service/economic issues." C's estate sued  D in December 2007, alleging facts which, if true, would preclude  D from inheriting the IRAs and also result in D having to pay all  legal fees. C's estate and D were close to a settlement. In September  2007, D arranged for trustee-to-trustee transfer of a portion of the IRAs into IRAs for C's estate.

Before  the court approved the proposed settlement, one of the contingent  charities from B's original beneficiary designations for the IRAs  sued to prevent approval. A year-and-a-half later another settlement  was reached, so that a portion of the IRAs would go to C's estate  and a portion to the charity that had objected to the settlement,  and none would go to D. The court approved the settlement in December  2010.

To  add even more complexity, the financial institution where D had established  IRAs came under new management which, without D's request or involvement,  had established yet another set of IRAs through a trustee-to-trustee  transfer. To implement the court's order, D opened two new IRAs,  one for C's estate and one for the charity.

C's  estate received the IRA set aside for it in December 2010 and March  2011. The charity received the IRA set aside for it in December 2010. (Note that both IRAs were fully distributed before December 31st of the fifth calendar year after B's death.)

D  requested the following rulings: (1) The final settlement when approved  by the court would not result in a taxable gift from D to C's estate  or to the charity; (2) D was not subject to income tax when transfers  were made from IRAs to other IRAs; (3) D was not subject to income  tax when IRAs were transferred to the estate and the charity; and  (4) D was not subject to excise taxes under §49731 and §4974 (related  to overfunding and IRA).

In  its ruling, the IRS noted that the factors involved in determining  that there is no gift in a settlement are: (1) the settlement must  be in resolution of a bona fide controversy of enforceable claims;  (2) the parties' assessments of their relative strengths and their  positions must be considered; and (3) the settlement must be within  the range of reasonable outcomes under the relevant documents and  state law.2

The  ruling also noted that a trustee-to-trustee transfer is not a payment  or distribution of funds under §408(d)(1) and  that it applies regardless of whether the custodian initiates the  transfer or the IRA participant directs it.

For more information, in the Tax Management Portfolios, see Kennedy, 367 T.M., IRAs,  and in Tax Practice Series, see ¶5610, IRAs.


 1 Unless otherwise specified, all "Section"  or "§" references refer to the Internal Revenue Code of 1986, as amended, and the regulations thereunder.

 2Beveridge  v. Commissioner, 10 T.C.  915 (1948); Estate  of Noland v. Commissioner, T.C. Memo 1984-209;  Lampert  v. Commissioner, T.C.  Memo 1956-226; Ahmanson  Found. v. United States, 674  F.2d 761 (9th Cir. 1981).