Planning after death.

The Internal Revenue Service recently allowed a taxpayer to plan his estate after he died. The taxpayer died on March 2, 1994, with a substantial balance in his individual retirement account (IRA) and before he had began receiving distributions. On March 21, 1990, he had executed a trust that was the beneficiary of the IRA; his wife, mother and three daughters were beneficiaries of the trust. The taxpayer's spouse and mother predeceased him, and one of his daughters died on June 6, 1995. According to the trust instrument, the IRA was to be divided equally between the two surviving daughters. The bank trustee elected to have distributions made to the surviving daughters over the life expectancy of the deceased daughter because she was the eldest and the one with the shortest life expectancy.

Here's where the postmortem planning began. In order to avoid Internal Revenue Code section 408 (d)(3)(c) regulations; which prohibit rollover treatment for inherited IRAs, the bank trustee asked the IRA custodian to separate the IRA into two subaccounts. The bank assigned its beneficial interests as successor trustee in the two subaccounts to the two daughters, and the IRA remained in the taxpayer's name. The creation of the subaccounts provided both daughters with the freedom to direct their own investment activities, to select their own custodian or investment adviser and to receive distributions from the IRA in an amount independent of the actions of the other.

In private letter ruling 9641031, the IRS sanctioned the taxpayer's plan and issued the following five statements to help clear up regulations dealing with IRA distributions.

1. The trust beneficiaries qualified as beneficiaries of the IRA for purposes of determining the distribution period under IRC section 401(a)(9)(B)(iii).

2. The bank trustee could make the election to receive distributions over the deceased daughter's life even though the bank was not the designated beneficiary of the IRA.

3. The designated beneficiary was determined when the taxpayer died. If there were multiple beneficiaries, the one with the shortest life expectancy would be the designated beneficiary for purposes of determining the distribution period under Treasury regulations section 1.401 (a)(9)(1), E-5 (a)(1).

4. The two subaccounts could be established without affecting the IRA's tax-deferred status.

5. The transfer of funds from the main IRA to the subaccounts would not be treated as a taxable distribution under section 408(d)(1).

Observation: This new ruling allowed for some postdeath decision making, but taxpayers should establish multiple IRAs during their lifetimes to provide for beneficiaries with special needs. Each separate IRA can be tailored to the specific needs of each beneficiary. Trusts can be used when needed, but generally only individuals can be designated as beneficiaries.

--Michael Lynch, CPA, Esq., Associate professor of accounting at Bryant College, Smithfield, Rhode Island.