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September 2018

Proposed Tax Bill in U.S. Senate Would Make A Number of IRA Law Changes. Some Are Major.

Senator Orrin Hatch (R-Utah) is chairman of the Committee on Finance which is the committee originating new tax legislation in the U.S. Senate. He is retiring from the U.S. Senate as he did not run for re-election in 2018. He was first elected in 1976.

Senator Hatch along with Senator Wyden (D-Oregon) have introduced the bill, Retirement Enhancement and Savings Act of 2018. This bill is bipartisan as Senator Wyden is the ranking member of this committee and Senator is the chair Although Senator Hatch has agreed to some of Senator Wyden's proposals and vice versa, other Republicans may not vote to support a number of the proposals. The most controversial of the
changes is the proposed change in the laws applying to inherited IRAs and inherited pension accounts

The following IRA law changes are proposed. Unless stated otherwise, the law changes would be effective for 2019 (i.e. plan years and tax years beginning after December 31, 2018).

  1. Repeal the traditional IRA rule preventing a person age 70½ or older from making a current year traditional IRA contribution. Under current law a person age 70½ or older who has qualifying compensation is able to make a SEP-IRA, SIMPLE IRA or Roth IRA contribution. Consistency suggests a traditional IRA contribution should also be able to be made.
  2. Under current IRS guidance, a person is only eligible to make an IRA contribution if the person has qualifying compensation. In order to clarify the law, the law would be changed to define the term compensation as including any amount paid to an individual to aid the person in the pursuit of graduate or postdoctoral study. That is, certain taxable non-tuition fellowship and stipend payments are to be treated as compensation for IRA contribution purposes.
  3. There are two proposed changes with respect to the rules applying to when an IRA owns S corporation bank stock. These changes are to take effect on January 1, 2018.

    The law would be repealed that an IRA (including a Roth IRA) can qualify as a shareholder of a S corporation only to the extent the stock was held as of a certain date. The changed law is - an IRA (including a Roth IRA) can qualify as a shareholder of as corporation regardless of when the stock was acquired.

    A second corresponding change (i.e repeal) would be made to Code section 4975 (d)(16) which granted a prohibited transaction exemption but only to the extent the stock was held as of the date of enactment. The changed law is - an exemption now applies and it is not dependent on when the S stock was acquired by the IRA as long as the other requirements of Code section 4975(d)(16) are met and other requirements of Code section 4975.
  4. The law would be changed to authorize or create new type of deemed IRAs. The proposed law change shows the political power of the mutual fund companies and the insurance companies. A 403(b) plan is required to be sponsored by an employer. Under current law it is
    not settled what happens to the individual participant 403(b) accounts when the employer terminates its sponsorship. That is, can these 403(b) accounts continue to exist as 403(b) accounts? It appears the IRS position is that such accounts cannot continue to exist as 403(b) accounts.

    The law would be changed to provide that if the party holding such assets has demonstrated to the IRS' satisfaction under section 408(a)(2) that the party has met the requirements to be an IRA custodian/trustee, then as of the date of termination a 403(b) custodial account is
    deemed to be an IRA. And any custodial account will be deemed to be a Roth IRA only if the 403(b) custodial account was a Designated Roth account. The new law does not discuss what is required, if anything, of the various parties so that the new deemed IRAs may be administered. Presumably, the IRS would be required or authorized to furnish additional guidance. For example, would the provider of the custodial accounts be required to prepare 1099-R forms to report such deemed direct rollovers and would such party now the IRA custodian
    required to report such direct rollover contributions as rollover contributions on the participants' 5498 forms.
  5. Revised RMD rules for IRA Beneficiaries and 401(k)/Pension plan Beneficiaries.
    The new laws would apply to beneficiaries of any person dying after December 31, 2018. These proposed changes are major.
    The new proposed RMD rules applying to a deceased individual with IRA and 401(k)/pension assets require an aggregated total be determined for such individual. This individual might have one beneficiary or multiple beneficiaries. Assets within a defined benefit plan would not be aggregated with assets within a defined contribution
    plan or an IRA.
    If an individual dies with IRA and pension assets of less than $450,000 as of his or her date of death, then the current laws will continue to apply. For example, Jane Does dies with assets totaling $145,000, $280,000, or $325,000, then the current laws will continue to apply.
    If an individual dies with IRA and pension assets of more than $450,000 as of his or her date of death, then to the extent of the excess amount, each beneficiary will be required to withdraw their share of the excess within 5 years after the death of the individual. It does not
    appear that the IRS' current 5 year rule could be used with respect to the excess. That is, the IRA or pension plan would not have until December 31st of the year containing the 5th anniversary of the individual's death. 5 years means 5 years and it commences on the date of
    the individual's death.
    The purpose of the new law requiring inherited IRAs and 401(k) beneficiaries to close the inherited IRA or inherited 401(k) plan is to raise tax revenues. Again, the 5 year rule only applies when the decedent has an aggregate balance of more than $450,000 and the designated
    beneficiary is not an eligible designated beneficiary. If an individual dies with IRA and pension assets of more than $450,000 as of his or her date of death and the individual had multiple plans, then the $450,000 amount and the amount in excess of the $450,000, then
    such amounts must be allocated to each plan comprising the multiple plans. The IRS is to write regulations defining how such allocations are to be made to the applicable plans.
    If an individual dies with IRA and pension assets of more than $450,000 as of his or her date of death, then to the extent of the amount less than $450,000, then the current laws will continue to apply each beneficiary with respect to their pro rated amount.
    There is a special exception for certain beneficiaries. The $450,000 limit and the 5 year rule does not apply to these beneficiaries.These beneficiaries will be able to use the life distribution rule. The beneficiary must commence periodic distributions not later then 1 year after
    the IRA account holder dies or at such later date as the IRS may define by regulation. The determination of whether a designated beneficiary is an eligible designated beneficiary is determined as of the date the IRA account holder dies.
    The term used to discuss these beneficiaries are "eligible designated beneficiaries."
    The following individuals will qualify as an eligible designated beneficiary:
    1. the surviving spouse of the IRA accountholder;
    2. a child of the IRA account holder if the child has not
         attained the age of majority;
    3. if the beneficiary is disabled;
    4. a chronically ill individual; or
    5. an individual who is not more than 10 years younger
         than the IRA accountholder.
    Once a child beneficiary reaches the age of majority, any remaining portion within the inherited IRA shall be distributed within 5 years after such date. There is a special rule for a surviving spouse who is the beneficiary of the IRA accountholder. The distribution is not required to commence within one year of the IRA accountholder's death. The distribution is required to commence by the date the IRA account holder would have attained age 70½. If the surviving spouse dies before such spouse commences distributions, then such spouse is treated as the IRA account holder for purposes of applying these beneficiary RMD rules.
    There is an exception for certain existing annuity contracts. The new beneficiary rules will not apply to a qualified annuity which is a binding annuity contract on the date of enactment and at all times thereafter The new law does set forth any discussion that a surviving
    spouse has the right to treat the ceased spouse's IRA as his or her own IRA or to do a rollover. Presumably such rights will still exist.
    Note that there are no special rules for a qualified trust which has been designated as the beneficiary of the IRA. The trust does not qualify as an eligible designated beneficiary. The 5 year rule will apply to the extent the trust is the designated beneficiary and the individual
    had aggregated assets of more than $450,000.

In summary, the proposed changes in the beneficiary RMD rules are complex and will radically change existing law. The public may well wish to express their dissatisfaction with these new proposed rules to their senators and House representatives. There is little attempt to
grandfather existing IRA owners and 401(k) participants who have made contributions after relying on existing law.