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Intermediate Transfer of Inherited IRA to the Taxpayer Is a Taxable Distribution
(Parker's Federal Tax Bulletin: August 2012)

Because an inherited IRA passed through the taxpayer's hands on its way to being deposited in an inherited IRA account, the distribution was taxable. Beech v. Comm'r, T.C. Summary 2012-74 (7/26/12).

Elizabeth Beech's mother died on March 22, 2008. Elizabeth was the beneficiary of her mother's traditional IRA, which was managed by Citi Smith Barney. Citi made two death benefit distributions to Elizabeth one on May 21, 2008, for $2,828 and one on May 23, 2008, for $35,358. The distribution check for $35,358 was made out to Elizabeth. Elizabeth established an inherited traditional IRA with American Funds and deposited the $35,358 into that account in June 2008.

On their 2008 Form 1040, Elizabeth and her husband, Charles, reported an IRA distribution of $38,194 on Line 15a, IRA distributions. They reported $2,828 as the taxable amount of the distribution on Line 15b of their return. The rest was reported as nontaxable. The IRS issued a notice of deficiency, concluding that all of the IRA distribution was taxable. According to the IRS, the Beeches received taxable income when Elizabeth received the death benefit distribution of $35,358 from her mother's IRA.

Under Code Sec. 408(d)(1) and (3), amounts paid or distributed out of an IRA are generally includible in gross income by the payee or distributee unless the entire amount of the distribution is paid into a qualified IRA for the benefit of that individual within 60 days of the distribution (i.e., a rollover contribution). Under Code Sec. 408(d)(3)(C), rollover treatment is not available in the case of an inherited IRA. An IRA is treated as inherited if the individual for whose benefit the account or annuity is maintained acquired that account by reason of the death of another individual who was not his or her spouse. A taxpayer is not treated as having received a taxable distribution from an IRA, however, if funds in the IRA are transferred from one account trustee directly to another account trustee without the IRA owner or beneficiary ever gaining control or use of the funds (that is, in a trustee-to-trustee transfer).

The Beeches argued that their intent was to effect a trustee-to-trustee transfer and that they substantially complied with the requirements of Code Sec. 408(d)(3)(A)(i) and that the Tax Court's decision in Wood v. Comm'r, 93 T.C. 114 (1989), supported their argument. In Wood, the taxpayer retired and received a lump-sum distribution of cash and stocks from his employer's profit-sharing plan. He established an IRA with Merrill Lynch and instructed the account executive to transfer the entire distribution into the IRA to effect a nontaxable transfer of the funds. The account executive assured the taxpayer that the transfer would be made within the applicable 60-day period. The cash and stock were transferred into the IRA within the 60-day rollover period, but because of a bookkeeping error the stock transfer was erroneously indicated as not having occurred until after the rollover period had elapsed. The Tax Court found that the taxpayer substantially complied with the 60-day rollover period because: (1) he requested that the entire distribution be transferred to the IRA, and (2) when bookkeeping entries are at variance with the facts, the decision must rest on the facts.

The Tax Court upheld the IRS assessment. According to the court, while the Beeches intent may have been to effect a trustee-to-trustee transfer, it is well established that a taxpayer's intention to take advantage of tax laws does not determine the tax consequences of his or her transactions. What actually is done, the court said determines the tax treatment of a transaction.

The funds in issue were paid from Elizabeth's mother's IRA to Elizabeth, the court noted, because she was the named beneficiary. Citi issued her a check, and she deposited the funds into an IRA account managed by American Funds. Citing Jankelovits v. Comm'r, T.C. Memo. 2008-285 and Rev. Rul. 78-406, the court held that because the funds were from an inherited IRA, a trustee-to-trustee transfer was the only basis upon which a nontaxable transfer of the funds could be effected.

The Tax Court found the Beeches' reliance on the Wood decision misplaced. Unlike the taxpayers in Wood, the court noted, the Beeches were not asking to be excused from a statutory prerequisite but were asking to be excused from an express statutory prohibition. The court concluded that it could not find that the Beeches substantially complied with Code Sec. 408(d)(3)(A)(i) because Code Sec. 408(d)(3)(C) expressly denies rollover treatment to an inherited IRA.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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