- Escheated Funds from Iras Subject to Federal Tax Reporting and Withholding
- June 5, 2018 | Authors: Vanessa A. Scott; Mary Jane Wilson-Bilik; Brenna M. Clark; Mark W. Smith; Adam B. Cohen; Wilson G. Barmeyer
- Law Firms: Eversheds Sutherland (US) LLP - Washington Office ; Eversheds Sutherland (US) LLP - Washington Office ; Eversheds Sutherland (US) LLP - Washington Office
The payment of a traditional individual retirement account or annuity (IRA) over to a state unclaimed property fund will now be subject to federal tax withholding and reporting, according to Rev. Rul. 2018-17 released by the Internal Revenue Service (IRS) on May 30, 2018. Escheat will be treated as a “designated distribution” to the IRA owner subject to (1) withholding as a nonperiodic distribution at a 10% rate absent a withholding election by the IRA owner and (2) reporting on Form 1099-R. This is not the only instance where the IRS has found a “designated distribution” in the absence of a contemporaneous payment remitted to the taxpayer, although unlike “deemed distributions” there is a transmission of funds here from which tax may be withheld.
- This is a point on which different conclusions can and have been reasonably drawn from the Internal Revenue Code (IRC) and existing authority, as evidenced by the transition provision in the ruling (discussed below).
- In the ruling, the IRS relies on language in IRC § 3405(e)(1)(B) that “any distribution or payment” from an IRA (other than a Roth IRA) shall be treated as includible in gross income for withholding purposes and thus within the scope of the “designated distribution” definition.
- The IRA owner’s ability to reclaim these monies from the state unclaimed property fund is noted in the ruling but does not figure in the analysis.
- For Form 1099-R reporting, the ruling does not prescribe a unique reporting code or other designation that the IRA has been escheated to the state.
- The ruling by its terms is inapplicable to simplified employee pensions (SEPs), SIMPLE-IRAs and deemed IRAs. Although not discussed in the ruling, the section 3405(e)(1)(B) language on which it relies is inapplicable to any arrangement other than a traditional IRA; that is, the underlying statutory basis for the ruling does not extend to Roth IRAs, employer-sponsored plans or commercial annuities.
- The ruling provides transition relief until the earlier of January 1, 2019, or the date it becomes reasonably practicable for the IRA trustee/custodian/annuity issuer to comply. The fair inference is that payors already observing the interpretation adopted in the ruling must continue to do so, while payors that had a different view must revise their withholding and reporting practices no later than for funds escheated from IRAs in 2019.
The IRS ruling comes concurrently with increased state enforcement efforts regarding the escheatment of IRAs. Over the past few years, state unclaimed property administrators have initiated numerous IRA-focused, multi-state audits of banks, broker-dealers, life insurers and other financial institutions. Under the statutes of most states, traditional IRAs are presumed abandoned—and therefore due for escheat to the states—if there is no owner-generated activity in the account for three to five years after the date for required minimum distributions, i.e., age 70½. These standards are non-uniform by state, and several states purport to count the period backwards, presuming that an account is abandoned at age 70½ if there has been no activity within the prior three to five years. The treatment of Roth IRAs is also non-uniform, and state laws vary on whether age 70½ is a potential trigger for escheat.The death of the IRA account owner is also a potential trigger for escheat. Similar to the recent escheat audits of life insurers, some unclaimed property auditors are using the Social Security Death Master File (DMF) as an audit tool for IRAs. The auditors use the DMF to identify accountholders who may be deceased and thereby identify accounts supposedly overdue to the states as unclaimed property and/or to trigger or accelerate dormancy for IRAs. This technique has been controversial in unclaimed property audits, but shows no signs of abatement.