This past June, the IRS issued a Private Letter Ruling (201623001) which impacts surviving spouses in community property states. The decedent and the surviving spouse were married in 2004 and lived in a community property state. They had a son, whom the decedent named as the sole beneficiary of his three IRAs. Upon the decedent’s death, the surviving spouse filed a claim against his estate, seeking her one-half interest in the community property they owned together. The claim was settled and the settlement was approved by the court, which ordered that the IRA custodian assign a certain amount of the son’s inherited IRAs to the surviving spouse as a spousal rollover IRA.
Seeking to avoid paying a tax on the amounts paid to her from the IRAs, the surviving spouse requested 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 IRA Section 408, the IRA rejected the taxpayer’s requests.
The IRS first stated that under Section 408(d)(3)(C) rollovers are not permitted from non-spousal inherited IRAs, and Section 408 must be applied without regard to any community property laws. Thus, rejecting the surviving spouse’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 next rejected the taxpayer’s three remaining requests, noting that as the son was the named beneficiary of the decedent’s IRA, not the surviving spouse, the IRAs are “inherited.” Because Section 408 doesn’t consider community property laws, the IRS must follow Section 408(d)’s distribution rules and disregard the surviving spouse’s community property interest. Thus, the surviving spouse cannot be treated as a payee of the inherited IRA and cannot 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, “the order of the state court cannot be accomplished under federal tax law.”
For more information, please contact our trust and estate attorneys, Bernard J. Jackvony, Gene M. Carlino and Rebecca M. Murphy at or email , and . We welcome your comments, questions and suggestions.