November 2020

IRS Issues Multiple Guidance (Relief) With Respect to Payments to a State Unclaimed Property Fund

Some of the relief and guidance is directed at retirement administrators and IRA trustees and some is issued to individuals.

The IRS recently issued additional guidance with respect to a retirement plan administrator’s or an IRA trustee’s duty to withhold federal income tax from a payment which it makes to a state unclaimed property fund and its duty to prepare the Form 1099-R.

A retirement plan administrator or an IRA trustee in certain situations may pay an individual’s account balance to a state unclaimed property fund because it cannot locate the individual. For example, Jane separated from service with ABC corporation four years ago and her vested account balance is $850. The plan has been trying for 3 years to pay her vested account balance, but the plan has been unable to locate her. The retirement plan chooses to pay her funds to the state unclaimed property fund.

Rev. Rul. 2020-24 discusses whether a distribution of a participant’s vested account which is less than $1000 must be or may be paid to a state’s unclaimed property fund if the individual cannot be located.

The IRS guidance is not as clear as it should be in many ways. However, the IRS guidance is clear that the tax withholding rules of Code section 3405 apply and that if any payment is made to a state’s unclaimed property fund that a Form 1099-R must be prepared.

The IRS guidance does not discuss who is the recipient on the Form 1099-R. Is it the individual or is it the state’s unclaimed property fund? Presumably, based on prior guidance issued with respect to an IRA trustee’s duty to withhold federal taxes with respect to the payment of IRA funds to a state’s unclaimed property fund, the Form 1099-R is to list the individual as the recipient as there is a deemed distribution on behalf of the individual.

The IRS guidance does not discuss what rate of federal income tax withholding applies to the distribution. Is it 20% or is it 10%? You would think the IRS would illustrate when 20% was to be withheld for federal income tax purposes and when 10% was to be withheld? The IRS fails to discuss this subject. One wonders when state revenues department will start issuing new guidance so that if there’s to be federal withholding, then there also is to be state income tax withholding.

The IRS grants some transitional relief in Rev. Rul. 2020-24. A retirement plan administrator or an IRA trustee which fails to withhold federal income tax or fails to prepare the Form 1099-R will not fined by the IRS with respect to payments made before the earlier of: the date it becomes reasonably practicable for the person to comply with these requirements or January 1, 2022. The IRS does not define when it becomes reasonably practicable for a payer to comply with these requirements.

In Revenue Procedure 2020-46 the IRS grants additional rollover relief in two situations, one of which is directly related to distributions to a state unclaimed property fund.

First, an individual who had his or her IRA funds or 401(k) funds paid to a state unclaimed property fund has the right to rollover the amount which was withheld for federal income taxes if the individual recovers his funds from the state unclaimed property fund and then follows the IRS procedure for a certified late rollover.

The IRS has amended its procedure for a certifying a late rollover by adding as a qualifying reason, reason #12 which is, the distribution was made to a state unclaimed property fund. To qualify for this relief, the individual must make their late rollover as soon as practicable after the reason or reasons listed for not complying with the 60-day rule no longer prevent the individual from making the rollover contribution. That is, he or she reclaims their IRA funds from the state unclaimed property fund. The individual is automatically found to be eligible to make the rollover as long as the rollover contribution is made within 30 days of the event which had prevented him or her of making the rollover contribution within the 60-day period.

Second, if the IRS audits a taxpayer, the IRS has the authority to determine if the individual qualifies for a waiver of the 60-day rule. This is good news for taxpayers because certainly there are/were situations where a person failed to comply with the 60-day rule for a reason other than one of the twelve listed reasons. Prior to this guidance an IRS auditor may have adopted the strict approach, IRS procedures allow me to grant you relief only in certain situations and your reason is not one of them. Auditors now have the authority to grant relief to a taxpayer.