Recovering the 15% excise tax under the TRA '97.

The Taxpayer Relief Act of 1997 (TRA '97) repealed the 15% excise tax on excess distributions for distributions received after 1996. This tax was initially suspended for 1997, 1998 and 1999 by the Small Business Job Protection Act of 1996. The 15% excise tax applied to excess distributions from qualified retirement plans, tax-sheltered annuities and individual retirement arrangements (IRAs). Before repeal of this tax, excess distributions for 1996 were distributions exceeding $155,000.

Individuals who had accrued benefits exceeding $562,500 as of Aug. 1, 1986 could have elected the grandfather rule, which exempted future distributions from the 15% excise tax if they were a recovery of benefits accrued as of Aug. 1, 1986. In years in which an excess distribution was made, the regulations provided two alternative methods to recover the grandfathered amount--the discretionary method and the attained age method. Under the discretionary method, 10% of the distributions received during the year was treated as a recovery of the grandfathered amount; the remainder was subject to the 15% excise tax. In addition, the regulations allowed an election to accelerate the recovery rate from 10% to 100% for the year for which the election was made and for all later years. Some professionals recommended not accelerating the recovery method to 100%, because they believed a lower tax could be achieved by partially offsetting each years distribution by 10%.

The repeal of the 15% excess distributions tax alleviates the need to be concerned about excess distributions or to keep track of unrecovered grandfathered amounts. However, certain taxpayers who have unrecovered grandfathered amounts can still benefit. Taxpayers who used the discretionary method and had only 10% of their distributions treated as a recovery of their grandfathered amount and paid the 15% tax on excess distributions may now amend their returns for open years and elect to accelerate the recovery, of their grandfathered amount from 10% to 100%. By accelerating the recovery rate to 100%, unrecovered grandfathered amounts that would otherwise be rendered useless by the TRA '97 may now produce tax refunds.

Excess Accumulations Tax

The TRA '97 also repealed the 15% additional estate tax on excess retirement accumulations at death for estates of decedents dying after 1996. Under repealed Sec. 4980A(d)(5), a Surviving spouse who was the beneficiary of all the decedent's qualified plans and IRAs could have elected on the decedent's estate tax return to treat the decedent's retirement accumulations as her own and avoid payment of this 15% estate tax at the decedent's death. However, receipt of these accumulations by the surviving spouse was subject to the 15% excise tax (to the extent they constituted excess distributions for the calendar year in which they were received). Any undistributed accumulations from the decedent were added to the surviving spouse's own retirement accumulations and subjected to the 15% additional estate tax at the spouse's death (to the extent that the combined accumulations constituted excess accumulations).

Nevertheless, some surviving spouses did not make this election and additional estate tax was paid by the decedent's estate; these spouses already had substantial retirement benefits, and adding the decedent's benefits to their own would only have increased the amount subject to the 15% taxes imposed on those spouses. Now that these taxes have been repealed, a surviving spouse can claim a refund (if permitted by the statute of limitations) of any 15% estate tax paid by the decedent's estate, by amending the estate tax return and making the Sec. 4980A(d)(5) election. The refund will not be for the full 15% additional estate tax, as the estate would have been allowed an estate tax deduction under Sec. 2053(c)(1)(B) for such additional tax.