Advisory on IRA Required Minimal Distribution (RMD) and Tax Planning Options (Essay Sample)

Memorandum Related to the Benoit Family Case
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Memorandum
To:The TSG Owners
From:
Date:May 29th 2017
Re:Advisory on IRA Required Minimal Distribution (RMD) and Tax Planning Options
FACTS
The Benoit family members, being four sisters named Lily aged 80 years, Irene aged 76 years, Frances deceased at 74 years and Barbara deceased at 68 years; plus Irene’s husband Eddie deceased at 76 years and Lily’s husband George deceased at 67 years; are equal shareholder owners of the Transport Services Group [TSG], in Kansas City. TSG is a successful automobile hire service with an average annual taxable income of $75,000. It is organized as a C corporation, which is any corporation that is subject to taxation as specified under the Internal Revenue Code (26 U.S. Code § 11). This ensures that the six shareholders are taxed separately from the corporation. On the advice of tax experts, TSG provides generous salaries, bonuses and benefits to its six shareholders and permanent employees. This provision helps to sustain them in meeting their daily personal expenses.
In TSG, top leadership positions are rotated among the shareholders to ensure equity in decision making. The arrangement also ensures that the company continues to operate in the absence of any particular individual. Such absence can be due to illness, maternity or personal leave. This arrangement has ensured administrative continuity and made TSG stable for many years.
However, in 2014, all the deceased members of the family, Frances, Barbara, Eddie and George, died together in a plane crash while on their way from the Rose Bowl. Due to buy-sell agreements that were in place, the company survived and continues to be profitable. The problem is how the various Individual Retirement Accounts [IRAs] of the deceased will be distributed and the tax planning options available to the surviving shareholders.
ISSUES & SHORT ANSWERS
1 Determination of the Required Minimal Distribution from IRA for Each TSG Shareholder for 2014.
The first issue that arises is how the required minimal distribution [RMD] of the IRAs will proceed in respect of the deceased persons. Each deceased person has an individual account and thus each is treated separately. There are a rules that govern how each of these accounts shall proceed to be transacted and the persons allowed to do that as seen below.
Frances is widowed and had started receiving RMDs at the age of 65. By the time of her death she was 72 years old. Here sole beneficiary is her son Willie aged 49.
In this case, Willie is entitled to receive the RMDs of his mother which will be the IRA account balance of $ 1.5 million divided by 31.5 which is a $ 47,619 annuity. That is because 31.5 is the IRA estimated life expectancy for beneficiaries aged 49 years, USC 480 §1.401(a)(9)-5). The annuity payment shall therefore last the duration of 31 and ½ years. Alternatively, the five year rule is available to him, §401(a)(9)(B)(ii),(iii).
. The rule states that the entire IRA amount must be distributed by the 31st of December of the fifth year after the account owner’s death. The account is then summarily closed.
In the case of Barbara there is no designated beneficiary. So her account is classified as a no-beneficiary IRA. What it means is that her account can only be distributed using the five-year rule. The rule requires that the savings in the account are paid out in any amounts within a five year period. It can even be paid out as whole in one lump sum, at any point within that period, §408(d)(2)(A). She had not benefited from any RMDs as she was still 68 years, two years short of the age of 70 ½ years, when it would be legally compulsory for her to start receiving the RMDs, Reg §1.408-8. The best option for the surviving siblings would be to subject her IRA funds to a charity or trust for TSG employees. This account has to be dispensed with under the five year rule, as there is no other option, §401(a)(9)(B)(ii),(iii).
In the case of George, his wife Lily is the sole beneficiary. However, she does not take over the account. So she can go for the best way out, which is the five year rule. The distributions will thus be distributed to her within a period of five years, §401(a)(9)(B)(ii),(iii). Given her advanced age of 80, this would be the most viable option available. Another factor that works in her favor is that George died without having attained the age of 72 ½ years in which it is compulsory to start receiving distributions from the IRA. George died at the age of 67.
Finally, Eddie’s account will be taken over by his wife and sole beneficiary, Irene. This is really a very straightforward procedure since she is the registered beneficiary and his spouse as well, Reg §1.408-8. Combining this account with her own account will result in less compounded taxation for Irene. This is because both accounts would be treated as one and taxed together.
2 The best tax planning options available
Beginning with the first case, Willie should take over his late mother’s account thus including the annuities as part of his regular income. This would result in his current income, plus the annuities being taxed as a single source of income. The taxation rate would thus be lower than if both sets of income were taxed separately, USC 480 §1.401(a)(9)-5). Should he opt for the five year rule, §401(a)(9)(B)(ii),(iii), then he would quickly dispense of the account and invest the money in other personal interests. Under this option, he can also delay withdrawing the amount up to the last possible moment, after 5 years, thus subjecting it to minimal tax.
Barbara’s account can only be closed under the five year rule, §401(a)(9)(B)(ii),(iii). This is the only option since she had not received any distribution from it, and did not leave a specific beneficiary. However, there is still a choice of delaying the ultimate withdrawal for as long as possible, by taking out a lump sum in the final year, §4974(a), (b). The savings could be converted into a trust, endowment fund or charity for the sake of the company staff at TSG. These kinds of funds are not subject to taxation, though the beneficiaries are taxed at individual level.
The easiest way out for Lily would have been to take over her husband’s account as well. That would see her consolidate her two accounts into one. That however is not the best option due to her advanced age. In any case, she opts not to take over the account. So the most viable option is to close it down completely using the five year rule, §401(a)(9)(B)(ii),(iii). Judging by her advanced age, that is the most viable option.
Irene is destined to take over her late husband’s account. This enables the account to become part of her own thus reducing the tax rate, Reg §1.408-8. She will then be able to consolidate her two IRA accounts into one as she can now pay tax for both as one account.
ANALYSIS
How Traditional IRA Works
A traditional IRA has an inherent income referral and shifting device. It is possible to use the instrument to defer income from the IRA for as long as possible so as to avoid paying tax on the savings made. The way it works is that tax is only levied when the fund is distributed, meaning that as the savings are made they are not subject to taxation. Since it is a retirement fund, it is only distributed when the account holder reaches and advanced age when he ostensibly goes on retirement. The lowest age at which the distribution is made is 59 ½ years of age, but one may defer withdrawals up to the age of 72 ½ years when such distribution is compulsory, Reg §1.408-8.
There are a number of ways in which the account holder can benefit from the IRA. The first is to withdraw the entire amount as a lump sum, thus paying tax only once on it, Reg §1.408-8. This envisages a situation where the account holder wishes to close the account, perhaps to invest the money in something else.
Secondly, like other retirement funds, the IRA can be distributed in the form of regular withdrawals to the account holder over their life expectancy and the life expectancy of the designated beneficiary. Such withdrawals are taxable like any other regular income, §4974(a), (b).
Thirdly, such withdrawals can also be taken against the actual life of the account holder and that of the designated beneficiary. It is also transferable to the beneficiary in case the original account holder dies. The beneficiary is stated in writing by the account holder before death.
A designated beneficiary of an IRA account is chosen by the account holder and set in writing to the trustee of the account, Reg §1.408-8. The trustee can be a bank or any other such institution as shall be adjudged fit to hold the savings in respect of the account holder. The beneficiary receives proceeds from the account in the event of the demise of the account holder. Such a beneficiary is usually a spouse or child of the deceased. However, the account holder may appoint anyone they like as a beneficiary. In some cases, the account holder appoints a primary beneficiary and secondary beneficiary. The spouse may be a primary beneficiary while the children may be the secondary beneficiaries.
The use of beneficiaries ensures that there will be someone to inherit the fund in the event that the account owner dies. The secondary beneficiaries serve a similar purpose in case the primary beneficiary dies. However, the beneficiary cannot change the account in his own name but will continue to benefit from it under the name of the account owner, §408(d)(3)(c). It is only in a case where the spouse is the beneficiary and is ten years younger than the deceased that an accoun...