Nov 1, 2011 12:00 PM

An owner of a Roth IRA can save on taxes by selling his beneficial interest to an intentionally defective irrevocable trust

By Stuart M. Horwitz & Jason S. Damicone

Practitioners traditionally have had limited tools to address a taxpayer's individual retirement account. Since amounts in an IRA can be subject to both income and estate taxes at death, many practitioners think it's best to have the IRA paid to or rolled into a spousal IRA. Others believe that the IRA should simply be paid to a charity. Alternatively, other practitioners try to have the IRA payments stretched over a period of time to take advantage of bracket creep. We propose a new option; one that can eliminate income, estate, gift and generation-skipping transfer (GST) tax with respect to an IRA: Have the owner of a Roth IRA sell his beneficial interest to an intentionally defective irrevocable trust (IDIT).

An IRA is a great income deferral tax technique. However, your client's estate will have to pay significant additional taxes if he dies owning an IRA. Unlike most other types of assets that only trigger estate taxes at your client's death, an IRA triggers income taxes,¹ as well as estate taxes, on the owner's death.² For example, if your client has a $2 million IRA and is in the highest estate tax bracket, he could end up paying around 45 percent in income taxes (depending on your state's and locality's rates and rules) and 35 percent in estate taxes (or more if your state imposes estate taxes). The one good piece of news is that your now-deceased client shouldn't end up paying 80 percent of the IRA in taxes. The proceeds from the IRA are considered “income in respect of a decedent” (IRD).³ Since the decedent never brought the IRA funds into income during his life, the law requires that the IRA beneficiaries do so. Those proceeds are subject to income tax as IRD; however, under Internal Revenue Code Section 691, the beneficiaries would be entitled to a deduction equal to the estate tax generated by the IRD property.⁴

Topics of Interest

Estate Tax	Donor Advised Funds
GSTs	Family Offices
Private Foundations	Life Insurance
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Topics of Interest

Estate Tax	Donor Advised Funds
GSTs	Family Offices
Private Foundations	Life Insurance
2010 Tax Act News	Industry Trends Surveys

E-Newsletter Signup

2011 Trust Glossary

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50 Years Ago This Month

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50 years ago, in May 1962, we featured articles such as: "Future of Canadian Trusteeship" by Arthur H. Mingay", "Training Trust Employees" by Ian M. Marr, "What is a Trust Officer?" by Eric J. Brown, and "Selling Services" by Donald I. Webb.

Conrad Teitell's Guide to Tax Benefits For Charitable Gifts

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