Tag: IRAs

Broker-Dealers: IRA Amendments Require Changes to Escheat Processes

Financial institutions holding Individual Retirement Accounts (IRAs) should review their policies in light of the federal Setting Every Community Up for Retirement Enhancement (SECURE) Act, Public Law 116-94.   This legislation, enacted on December 20, 2019, as part of a group of spending bills, is intended to assist Americans in saving for retirement by expanding and enhancing access to retirement plans.  As it pertains to unclaimed property, the new law is significant in that it changes the so-called “Mandatory Distribution Date” – the age by which an account owner must begin taking distributions from an IRA account.  In most states, one of the triggering events for IRA escheatment is “the date . . . specified in the income tax laws of the United States by which distribution of the property must begin in order to avoid a tax penalty.”  Previously, such distributions were required by April of the year in which the account owner reached age 70.5.  Pursuant to the SECURE Act, that threshold has been extended to age 72.  IRA holders should update their procedures accordingly. 

The new rule applies to distributions required to be made after December 31, 2019.

In addition, on January 1, 2020 IRS Revenue Ruling 2018-17 went into effect, generally requiring holders that are reporting and remitting IRA-related property to state unclaimed property funds to report and withhold federal income tax on such assets.  Accordingly, the National Association of Unclaimed Property Administrators has issued guidance detailing precisely how such assets should be reported, and how the impact of any withholding should be reflected, when unclaimed property reports are submitted to the state. 

IRS Extends Compliance Deadline for Withholding & Reporting Requirements on IRA Accounts Remitted to States as Unclaimed Property

Earlier this year, in Revenue Ruling 2018-17 the IRS issued guidance stating that holders of traditional IRAs required to report IRA assets to a state as unclaimed property were required to withhold federal income tax upon such amounts and issue a 1099-R form indicating the owner as the recipient of the funds.  The IRS originally set the compliance date for this guidance as January 1, 2019.

This ruling was not without controversy.  For example, it seems incongruous to impose taxes upon the owner of an IRA on account of that owner taking a “distribution” from the IRA when, in fact, the reason that the proceeds are being transferred as unclaimed property is because there has been no contact with, or activity by, the IRA owner for several years.  In addition, the Revenue Ruling raised practical problems for the securities broker-dealer and/or trustees.  For example, when a securities account such as an IRA is escheated to the state, the state generally takes custody of those securities.  In order to withhold taxes from an IRA containing only securities before escheat, however, would the holder be required to liquidate those securities?  If so, is that consistent with the federal securities laws and/or the holders other duties to the owner?  In light of these questions, the “Holders Coalition” (a group of unclaimed property trade associations and similar entities) issued a comment letter seeking additional guidance.

While the IRS has not directly responded to the questions raised regarding the Revenue Ruling, it did issue a notice this week extending the compliance date until January 1, 2020.  This will hopefully give states and the holder community time to work with the IRS to clarify holders’ obligations with regard to the reporting and remittance of IRA accounts.

Pennsylvania Issues Guidance on Revised IRA Provision, Delays Impact

Last fall, Pennsylvania amended its unclaimed property law to, among other things,  change the ways that Individual Retirement Accounts (IRAs) are covered by the Act.  Under the former law, IRAs were not required to be turned over to the state unless there was an unclaimed distribution or the IRA owner reached the mandatory distribution date specified by the IRS rules.  Under the revised law, the dormancy period begins to run when two account statements are returned to the custodian as undeliverable.  In other words, if a person moves, but forgets to tell his or her IRA custodian within the period of two account statements, the IRA account is on its way to being turned over to the Commonwealth.

As noted in an earlier post, this approach is potentially problematic.  IRA’s are perhaps the predominant “buy and hold” type of investment.  Not only are they designed to provide preferable tax treatment in exchange for holding until a later age, but there are actually hefty tax penalties for failing to hold off on distributions until age 59.5.  The new Pennsylvania laws, however, fail to take this economic reality into account, the dormancy period begins upon the requisite amount of returned mailings, regardless of the age of the account holder or any tax penalties that may occur.

As a result, a number of groups, including the Unclaimed Property Professionals Organization and the Investment Company Institute have objected to the new legislation and/or have asked Pennsylvania to amend or clarify the application of the new IRA provisions.

As a result of these inquiries, the Pennsylvania Department of Treasury issued policy guidance on the application of the new IRA rules.  Unfortunately, the guidance does not address the shortcomings of the revised law, but kicks the problem down the road.  In the guidance, the Treasury Department opines that no adverse tax consequence for the owner is “anticipated”:

The provisions of Section 1301.8 directing the transfer of abandoned and unclaimed retirement accounts into the custody of the Commonwealth are not anticipated to implicate early distribution related taxes. Upon the transfer of an IRA or certain retirement assets pursuant to Section 1301.8, the Commonwealth will act solely as custodian of those assets until such time as the owner or beneficiary is located and reclaims the abandoned and unclaimed property. Because neither the owner nor the beneficiary will have constructive possession or control of the account, the transfer to the Commonwealth’s custody should not be taxable, reportable or potentially penalize a premature distribution to the account owner, but instead should be treated as a non-reportable transfer of retirement assets.

Unfortunately, there is no citation, analysis, or explanation of the reasons for the Treasury Department’s position, nor any indication that there has been any communication with the IRS in order to confirm the Treasury Department’s understanding.  That said, the guidance at least puts off the day of reckoning for this issue, providing that the Treasury Department will “neither demand nor accept” abandoned IRA accounts unless (1) three years have passed since the death of the owner and or (2) the owner has reached the mandatory distribution requirement.  This directive will remain in place while the Treasury Department studies the issue.

 

Pennsylvania Amends IRA Rules

According to the Investment Company Institute, Americans have $5.68 trillion in Individual Retirement Accounts (IRAs).  In a traditional IRA account, a person can make tax deductible contributions to an account that can grow over the years with no tax impact until distribution.  Importantly, individuals must wait until age 59.5 to make withdrawals without a tax penalty (and individuals generally must begin taking distributions at age 70.5).  In other words, an IRA is a prototypical long term investment.  Depending upon the individual’s age when he or she opens the plan, decades can go by before the money is touched, in fact, to avoid tax penalties, it is likely.

The unclaimed property laws account for the fact that long dormancy is expected.  Pursuant to the 1995 Uniform Unclaimed Property Act, the dormancy period for IRAs and similar accounts does not begin to run until (1) the attempted distribution of assets or (2) the date that distribution must begin under the tax laws.

This position is sensible – the whole purpose of these accounts is to put the money away until retirement.

Pennsylvania, however, has recently amended its unclaimed property laws for IRAs.  Under the new law (House Bill 1605) the dormancy period begins to run when two account statements are returned to the custodian as undeliverable.  In other words, if a person moves, but forgets to tell his or her IRA custodian within the period of two account statements, the IRA account is on its way to being turned over to the Commonwealth.

It is unclear if there are any positive impacts from this change, but there certainly could be negative impacts.  Under the former law, if a person moved without notifying his/her broker, their funds would not be escheated until the mandatory distribution date (therefore there is no adverse tax consequence).  Now, if the same move happens, and the property is escheated, the account owner may suffer tax implications as a result of the “distribution” of his or her property to the Commonwealth.

Moreover, it wouldn’t seem that delivering the property to the Commonwealth does not make it any more likely that it will be returned to the owner.  If an individual remembers that he or she had a forgotten IRA account, he/she is more likely to remember (and contact) the broker rather than to contact the Commonwealth.  Accordingly, other than simply bringing more money into Pennsylvania’s treasury, the reasons for this change are not clear.