Given that you’re reading this book and you may not be a CPA or financial advisor, it indicates that you have a strange reading list and may have read other items on income taxes. If so, you have encountered one of IRS’ principals, “substance over form.” This is a principal that the IRS uses when a taxpayer does everything by the book but in fact exploits the tax rules to save money. IRS can charge that the true substance of the transaction was to evade taxes.
Here’s a place where the IRS says its form over substance. Even though the IRA beneficiary may intend to stretch IRA distributions over his lifetime, and does so using the proper distribution tables and taking timely annual distributions, if the IRA is titled incorrectly, IRS will declare the entire account as distributed and require all taxes.
Before a non-spouse beneficiary starts requirement minimum distributions (RMDs), the IRA must be titled correctly. Each beneficiary’s share of the IRA should be kept separate and the Social Security number changed as soon as possible after the owner’s death. However, the deceased owner’s name must remain on the account. If non-spouse beneficiaries retitle the account to their own names, the funds become immediately taxable.
In the above case, the IRA could be retitled as: Mike Jones IRA (deceased January 10, 2004) F/B/O (for benefit of), Sally Jones. Where there is more than one beneficiary, each would have his or her own F/B/O account.
Every beneficiary should name a beneficiary as soon as he or she inherits an IRA so that there will be someone to continue the payout schedule if the beneficiary dies. This will also avoid probate and other will-related problems. If the beneficiary names a beneficiary, the remaining IRA balance will go directly to that beneficiary with no probate, claims, or other legal obstacles.
In the above case, if Sally dies before her 43.6-year term has expired and there is still a balance in the IRA, then her beneficiary can continue the remaining years left on Sally’s original 43.6-year schedule.
