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IRA Trustee Must Withhold Federal Taxes on Amounts Paid to Unclaimed Property Fund

(Parker Tax Publishing June 2018)

The IRS ruled that a payment by individual retirement account (IRA) trustee of an individual's interest in an IRA to a state's unclaimed property fund, as required by state law, is subject to federal income tax withholding under Code Sec. 3405. In addition, the payment by the trustee is subject to reporting under Code Sec. 408(i). Rev. Rul. 2018-17.


Under the facts in Rev. Rul. 2018-17, an unidentified individual, who is a calendar-year taxpayer and a U.S. person under Code Sec. 7701(a)(30)(A), has an interest in a traditional individual retirement account (IRA) trusteed by Trustee Y. The individual has not made a withholding election with respect to her interest in the IRA. Trustee Y is required under state law to pay the individual's interest in the IRA to the state's unclaimed property fund under which a claim for property may be made by the owner. In 2018, Trustee Y pays the individual's interest in the IRA, which has a value of $1,000, to the state's unclaimed property fund.

The IRS was asked to address the following issues:

(1) Is the payment by Trustee Y of the individual's interest in the IRA to the state's unclaimed property fund subject to federal income tax withholding under Code Sec. 3405?

(2) Is the payment by Trustee Y subject to reporting under Code Sec. 408(i)?


Code Sec. 3405 provides federal income tax withholding rules with respect to designated distributions. Generally, a designated distribution is any distribution or payment from or under an employer deferred compensation plan, an IRA, or a commercial annuity. Under Code Sec. 3405(e)(1)(B)(ii), a designated distribution does not include the portion of a distribution or payment that it is reasonable to believe is not includible in gross income. For this purpose, the flush language under Code Sec. 3405(e)(1)(B) provides that any distribution or payment from or under an IRA (other than a Roth IRA) is treated as includible in gross income.

Code Sec. 3405 requires federal income tax to be withheld from two types of designated distributions from IRAs, each with its own withholding rules: periodic payments under Code Sec. 3405(a), and nonperiodic distributions under Code Sec. 3405(b). Under Code Sec. 3405(e)(3), a nonperiodic distribution is a designated distribution that is not an annuity or similar periodic payment. In the case of a nonperiodic distribution under Code Sec. 3405(e)(3), Code Sec. 3405(b)(1) provides that the payor must withhold from such distribution an amount equal to 10 percent of the distribution. Code Sec. 3405(b)(2) provides that an individual may elect not to have Code Sec. 3405(b)(1) withholding apply with respect to any nonperiodic distribution.

Reg. Sec. 35.3405-1T provides rules regarding Code Sec. 3405, including general rules on withholding requirements and specific rules addressing withholding on periodic and nonperiodic distributions, notice and election procedures, and reporting and recordkeeping. Reg. Sec. 35.3405-1 provides rules regarding the medium through which notices required under Code Sec. 3405 may be provided.

Code Sec. 408(i) provides that the trustee of an IRA and the issuer of an endowment contract described in Code Sec. 408(b) or an individual retirement annuity must make such reports regarding such account, contract, or annuity to the IRS and to the individuals for whom the account, contract, or annuity is, or is to be, maintained with respect to contributions (and the years to which they relate), distributions aggregating $10 or more in any calendar year, and such other matters as may be required.

Under Reg. Sec. 1.408-7(a), the trustee of an IRA or the issuer of an individual retirement annuity who makes a distribution during any calendar year must file a report of the distribution for such year. Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., is used to satisfy this reporting obligation.

IRS Ruling

The IRS concluded that the payment of the individual's interest in a traditional IRA to the state's unclaimed property fund is a payment from an IRA that is treated as includible in gross income for purposes of Code Sec. 3405(e)(1)(B)(ii). Thus, the IRS ruled that the payment is a designated distribution for purposes of Code Sec. 3405 and is not an annuity or similar periodic payment under Code Sec. 3405(e)(2). Thus, it is a nonperiodic distribution as defined in Code Sec. 3405(e)(3) and, because the individual with the interest in the IRA had not made a withholding election with respect to the payment, a 10 percent withholding rate applies to the payment pursuant to Code Sec. 3405(b)(1), and Trustee Y must withhold federal income tax of $100 (i.e., 10 percent of the individual's $1,000 interest in the IRA).

The IRS also ruled that, under Code Sec. 408(i), Trustee Y must report the $1,000 distribution from the IRA ($900 of which is paid to the state unclaimed property fund and $100 of which is remitted as federal income tax withholding) on a 2018 Form 1099-R identifying the individual as the recipient.

Observation: The IRS also granted transition relief. Under that relief, a person will not be treated as failing to comply with the withholding and reporting requirements described in Rev. Rul. 2018-17 with respect to payments made before the earlier of January 1, 2019, or the date it becomes reasonably practicable for the person to comply with those requirements.

For a discussion of income tax withholding on pensions, annuities, and IRAs, see Parker Tax ¶212,150.

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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