IRS Issues Harsh Ruling Against Surviving Spouse Seeking to Roll Over Part of Son’s Inherited IRA

IRS Issues Harsh Ruling Against Surviving Spouse Seeking to Roll Over Part of Son’s Inherited IRA

Federal tax laws don’t consider community property laws

In Private Letter Ruling 201623001 (released June 3, 2016), a surviving spouse (the taxpayer) requested four rulings to allow her to roll over a part of her son’s inherited individual retirement accounts that were assigned to her as community property by a state court. By concluding, however, that the relevant part of the Internal Revenue Code is to be applied “without regard to any community property laws,” the Internal Revenue Service rejected the taxpayer’s requests.

The State Court Settlement

The decedent and the taxpayer were married in 2004; they lived in a community property state.  They had a child, whom the decedent named as the sole beneficiary of his three IRAs. After the decedent died, the taxpayer filed a claim against her husband’s estate, asking for her one-half interest in the community property they owned together.  

The taxpayer and the estate negotiated a settlement that assigned a value to the taxpayer’s one-half community property interest. A state court approved the settlement, ordering that the IRA custodian assign a certain amount of the son’s inherited IRAs to the taxpayer (his mother), as a spousal rollover IRA.

The taxpayer requested that the IRS issue four rulings: 1) that the settlement amount of the inherited IRAs be classified as the taxpayer’s community property interest; 2) that the taxpayer be treated as a payee of the inherited IRAs; 3) that the IRA custodian distribute the settlement amount to the taxpayer in the form of a surviving spouse rollover; and 4) that the distribution to the taxpayer of the settlement amount from the inherited IRA not be considered a taxable event.

Applying IRC Section 408, the IRS rejected the taxpayer’s requests.

Matter of State Property Law

Section 408(d)(3)(C) states that rollovers aren’t permitted from non-spousal inherited IRAs, and Section 408(g) provides that Section 408 is to be applied without regard to any community property laws. Thus, with regard to the taxpayer’s first request, the IRS stated that classifying the amount of the inherited IRA as the taxpayer’s community property is a matter of state property law, not federal tax law. The IRS thus declined to grant the taxpayer’s first requested ruling.

Community Property Laws Not Considered

The IRS next rejected the taxpayer’s three remaining requests. It noted that the son was the named beneficiary of the decedent’s IRA, not the taxpayer, and the IRA was retitled as an inherited IRA in the son’s name. Because Section 408 doesn’t consider community property laws, the IRS must follow Section 408(d)’s distribution rules and disregard the taxpayer’s community property interest. Thus, the taxpayer can’t be treated as a payee of the inherited IRA and can’t roll over any amounts from the inherited IRA. Moreover, because the son is the named beneficiary of the decedent’s IRA and the taxpayer’s community property interest is disregarded, any “assignment” of an interest in the inherited IRA to the taxpayer would be treated as a taxable distribution to the son. Accordingly, stated the IRS, “the order of the state court cannot be accomplished under federal tax law.”

 

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