February 2021

Is a Qualified Trust Beneficiary Able to Use the 10-Year Rule or Must it Use the 5-Year Rule?

Until the IRS gives guidance to the contrary, my answer is, the trust may use the 10-year rule. However, this memorandum is being furnished because the law is certainly not settled. An IRA trustee must wait to see what guidance the IRS issues. The position of an IRA trustee is difficult until the IRS provides needed guidance.

Clearly the goal of the SECURE Act was to shorten the distribution period for many non-spouse beneficiaries in order to increase tax revenues. The votes in the House and the Senate were nearly unanimous. Most non-spouse beneficiaries must now use a 10-year rule rather than being able to use the life distribution rule which had formerly applied.

The 10-year rule applies only if the beneficiary is a designated beneficiary. The 5-year rule applies to a beneficiary which is not a designated beneficiary. In order to be a designated beneficiary the Code requires the beneficiary be a person. Obviously a trust is not a person. This same requirement applied prior to the SECURE Act for 2002-2019.

Most trust professionals (N. Choate and others) have concluded that a qualified trust which has been designated as an IRA or a pension beneficiary is eligible to use the 10-year rule and not the 5-year rule to close the inherited IRA. Why? They believe the SECURE Act did not change the definition of a designated beneficiary.

What is the authority for this position?
Code section 401 (a)(9) sets forth the law applying to beneficiaries, including the definition of who is a designated beneficiary. Again, in order to be a designated beneficiary the Code requires the beneficiary be a person. These RMD laws require a beneficiary to close an inherited IRA within certain time deadlines. There are laws when the beneficiary is a person and there are laws when the beneficiary is not a person. These laws differ. Prior to 2020 the general rule was that a beneficiary who is not a person had close the inherited IRA under the 5-year rule whereas a beneficiary who is a person was authorized to use the life distribution rule.

The IRS in writing its 2002 regulation created a special tax rule for certain trusts so that such trusts would not be required to use the 5-year rule. In 2002 the IRS clearly presented the attitude that it wanted the then new RMD rules to be taxpayer friendly. One such rule was, a qualified trust was authorized to use the life distribution rule. The basic rule was, the oldest beneficiary of the trust was to be used to determine the RMD distribution period.

So, again note, the authority that a qualified trust is to receive special tax status versus another non-person beneficiary is an IRS regulation. The special treatment or rules is not set forth in the Tax Code.

The SECURE Act could have been expressly written to revise the definition of a designated beneficiary to include a qualified trust. This was not done. One wonders why? My point, there is some doubt whether a qualified trust is entitled to use the 10-year rule. If not, the trust is subject to the 5-year rule. An inherited IRA will become subject to the annual 50% excise tax applying to an excess accumulation if an inherited is not closed as required under the 5-year rule.

So, after the SECURE Act, there are two current questions?
Question #1. Did Congress intend to continue to allow a qualified trust to be treated as a person for purposes of the RMD rules? The legislative history is minimal on this subject.

Question #2. Will the IRS continue to apply its special rule for a qualified trust after the enactment of the SECURE Act? Trust professionals and trust beneficiaries for obvious reasons certainly hope so. A distribution period of 10 years versus 5 years will have very significant economic and tax consequences.

The IRS will be rewriting its RMD regulation. It is a question of when. It might be 1-4 years. Most likely the IRS will again write its RMD regulation so that special treatment is given to a qualified trust versus other non-person beneficiaries. But I believe there is some chance that due to governmental needs for additional revenues that the IRS would decide no longer to grant special treatment to a qualified trust as the SECURE Act does not expressly authorize it.

The sooner the IRS issues guidance on this trust subject the better. I expect the IRS will again write its RMD regulation to give special treatment to a qualified trust. I do believe the influence of the trust industry with the IRS is very strong. Until the IRS issues such guidance a person may wish to change or consider changing their IRA beneficiary designation to a person or persons rather than a trust.