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Coordinate Your IRA Beneficiary Designation with the Terms of Your Estate Plan

In a recent Private Letter Ruling (201438014), the IRS issued a taxpayer a triple-whammy. The PLR concerns a trust instrument that identified certain "pecuniary bequests" to be made to charities named within the trust agreement. Unfortunately, there were insufficient assets outside of an IRA from which to satisfy the pecuniary bequests. The IRA, however, did not name the charities as beneficiaries, but rather named the trust. Normally, paying an IRA to a trust results in income taxation on the amounts paid, even if subsequently funneled to charity. So, taxpayer petitioned and subsequently received approval from a State court for a trust reformation allowing for the distributions to the charities to be treated as "direct bequests to the charities" from the IRA and thereby avoid paying income tax upon funding the charitable bequests with the IRA. In the PLR, the IRS disallowed such treatment "because the purpose of the court order reforming the Trust was to obtain tax benefits rather than resolve a conflict…." Consequently, "…under [Section] 691(a)(2) [of the Internal Revenue Code], the payments are transfers of the rights to receive the IRD and Trust must include in its gross income the value of the portion of the IRA to the extent the IRA was used to satisfy the pecuniary bequest legacies." Moreover, the IRS confirmed that the taxpayer would be unable to claim a charitable deduction for the amounts paid to the charities in satisfaction of the bequests as the trust instrument does not "…require or direct the trustee to pay the pecuniary legacies from the trust's gross income."

The moral of the story is that the tax issue could have been avoided by simply better coordinating the various parts of the client's estate plan, including the IRA. If the IRA beneficiary designation was directed to be paid to charity to the extent that the trust assets were insufficient to satisfy the charitable bequests, no income tax would have been due on those payments.

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About this Author

Joseph Tamburello, CPA, Client Tax Specialist, Horwood Law Firm
Client Tax Services Specialist

JOSEPH M. TAMBURELLO, a Certified Public Accountant, is employed as a Client Tax Services Specialist at Horwood Marcus & Berk Chartered. Joe assists clients as well as attorneys within the firm with all aspects of tax and estate planning, administration and compliance primarily relating to individuals, estates and trusts. Joe has worked as a paralegal for over 15 years and at several major law firms in Chicago.