May, 2018
IRS Issues New Guidance on
Withholding and IRS Reporting For
IRA Distributions To a State
Unclaimed Property Fund
Many states have laws requiring IRAs meeting certain
inactivity rules to be paid by an IRA custodian to the
state's unclaimed property fund. Many states are not all
that concerned about the income tax consequences that
arise from these mandated distributions.
The U.S. Treasury is concerned and it wants it share of
the revenues. It does not want all of these distributions
(i.e revenues) going to a state without some plan of
action as to how and when it will be paid the taxes it is
owed. The U.S. Treasury wants to collect the federal
income taxes it is taxes owed with respect to each and
every IRA distribution. The general tax rule is, a person
is required to include an IRA distribution in their taxable
income and will pay the applicable marginal tax
rate. A person younger than 59½ owes an additional
10% tax unless an exception applies.
The IRS has recently issued Rev. Rul. 2018-17. This
guidance changes old IRS guidance as to how an IRA
custodian is to prepare the Form 1099-R to report an
IRA distribution made to a State's Unclaimed Property
Fund. Under the old guidance the IRA custodian issued
the Form 1099-R to the state and used the state's tax
identification number.
The new guidance requires the IRA custodian to prepare
the Form 1099-R identifying the IRA account holder
as the recipient. Thus, the Form 1099-R will show this
individual as the recipient. The IRA custodian will have
the person's tax identification number and will have a
mailing address which may or may not be currently
accurate. The IRS guidance does not discuss the address
topic.
In the new guidance, the IRS makes clear the IRA custodian
has the duty to withhold for federal income tax
purposes 10% of the amount being remitted to the
respective state's unclaimed property fund. The reason
10% must be withheld is because Internal Revenue
Code section 3405 sets withholding requirements for
non-periodic IRA distributions. The IRA custodian must
remit these withheld IRA funds to the IRS/U.S. Treasury
as other withheld amount. Although the tax rules permits an individual to elect not to have any withholding,
the IRS has concluded that an individual in this situation
will not elect to have no withholding and so the
10% needs to be remitted to the IRS/U.S. Treasury.
The IRA custodian is to remit the other 90% of the IRA
to the respective state's unclaimed property fund.
The IRS will process the submitted 1099-R forms and
the IRS will contact these individuals if these individuals
failed to properly report these distributions on their
tax returns and if they failed to pay the amount owed.
Most taxpayers have a marginal tax rate in the range of
15%-30% so if only 10% was withheld, an additional
amount will be owing.
This new IRS guidance is effective immediately and so
an IRA custodian wants to implement new procedures
as soon as possible. The IRS has issued temporary transition
relief. An IRA custodian must start complying
with the new rules for payments made to a state's
unclaimed property fund on or after January 1, 2019.
However, if it is reasonably practicable for an IRA custodian
to comply sooner, it must comply sooner.
An IRA custodian wants procedures to minimize the
number of inactive IRAs.
The IRS guidance makes clear that it is only traditional
IRA funds which are subject to these new withholding
and reporting rules. The new guidance does not apply
to Roth IRAs, SEP IRAs and SIMPLE IRAs. The IRS guidance
does not explain why these new procedures do
not apply to Roth IRAs, SEP-IRAs and SIMPLE IRAs.
The IRS guidance does discuss the general tax rule
that the withholding rules only apply to an IRA distribution
to the extent it is reasonable to believe the distribution
must be included in the recipient's income. With
distributions from Roth IRAs it is not generally reasonable
to believe the distribution must be included in the
recipient's income.
We expect the IRS in the near future will issue additional
guidance regarding what an IRA custodian is to
do with Roth IRAs, SEP-IRAs and SIMPLE IRAs that must
be remitted to a state's unclaimed property funds. If a
SEP-IRA and/or a SIMPLE IRA is related to an ERISA
employer plan, the position of the IRS and the DOL
most likely is - federal law supersedes any state
unclaimed property law and such funds could not be
remitted to the state.
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