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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