​The January 1, 2020 compliance date for Revenue Ruling 2018-17 (“Ruling”) has now come and gone but as holders are in the midst of the Spring reporting, they are left scratching their heads due to the lack of guidance from the Internal Revenue Service (“IRS”) and the Department of Treasury. Under the Ruling, the escheatment of an Individual Retirement Account (“IRA”) is considered a designated distribution and is therefore taxable to the owner. As such, the distribution is subject to a 10% federal withholding tax unless otherwise previously directed by the IRA owner.  Once the distribution is completed and tax is withheld, the trustee or custodian must report the transaction to the IRS and the owner on Form 1099-R.

Several trade associations and professional organizations have reached out to the IRS and Treasury for specific guidance regarding the process of implementing the Ruling. The Securities Industry & Financial Markets Association (SIFMA) was the first to lead the charge with a letter sent on July 23, 2019.  In that letter, SIFMA raised practical issues such as:

  • The inclusion of a new distribution code on Form 1099-R to clarify that assets escheated to states are IRA distributions includable in gross income.  The new code will allow for better information tracking of escheated IRA assets for both the custodians of the assets and the IRS as well as better facilitating the ability of investors to reclaim their assets from the states.
  • Relief for sending Form 1099-R to a known bad address since the form contains sensitive investor information, including the taxpayer identification number (“TIN”), account number, and address, among other private financial information.  If the address on the holder’s books and records has already been determined to be a bad address, it does not seem prudent to send a tax form with such detailed information knowing it increases the opportunities for fraudulent activity.
  • Penalty relief for de minimis discrepancies particularly those in the securities industry where the Securities Exchange Commission (“SEC”) requirements utilize a two-day settlement cycle (“T+2”). The Ruling will require that securities be liquidated to pay the withholding tax, while at the same time the SEC requires a T+2 settlement, it is possible that there may be minor discrepancies in the withholding because of differences in the liquidation date and settlement date due to market fluctuations.
  • Exempting illiquid securities from withholding requirement such as restricted securities, delisted securities, and securities without a transfer agent.
  • Restoring assets to an IRA after escheatment without penalty will require specific rollover relief.  SIFMA suggested adding “The distribution was escheated to a state agency” to the list of approved self-certification reasons for missing the 60-day rollover deadline in Revenue Procedure 2016-47.  A rollover under these circumstances will also need to be excluded from the one-rollover-per-year rule.
  • Reporting and withholding in the case of a deceased IRA owner is problematic when the beneficiaries are unknown or cannot be located.  Generally, reporting is done in the name of the beneficiary but will not be possible in all situations so SIFMA requested that the IRS confirm that reporting and withholding occur in the name of the decedent when the IRA assets are escheated to the states. 

The Holders Coalition also worked with its membership to prepare a letter which was sent on November 19, 2019.  This letter primarily echoed the sentiments brought to light by SIFMA and raised the following additional concerns:

  • Contradiction with state law and guidance, the Pennsylvania Treasury issued Policy Guidance in September of 2016 asserting that their statue directing the “transfer of abandoned and unclaimed retirement accounts into the custody of the Commonwealth are not anticipated to implicate early distribution related taxes.”  The guidance goes on to further state “Because neither the owner nor the beneficiary will have constructive possession or control of the account, the transfer to the Commonwealth’s custody should not be taxable, reportable or potentially penalize a premature distribution to the account owner, but instead should be treated as a non-reportable transfer of retirement assets.”
  • Escheating IRA assets in error may occur from time to time.  When the holder/custodian reports and delivers IRA assets held in securities to the state in error, they will need guidance from the IRS on how to reclaim the withholding from the IRS (and state) to make the owner whole and fully restore the retirement account.
  • Backup withholding is a concern in the spirit of owner protection as IRA owner’s nonpayment of tax will likely lead to federal and state failure to file/failure to pay notices.  If the owner if lost, they will not have received the Form 1099-R and would have not known about the distribution and therefore would not have reported the income on their tax return. 
  • The Holders Coalition is still working with the National Association of Unclaimed Property Administrators (“NAUPA”) to facilitate implementing the Ruling for holders to report the data properly to the states on the NAUPA electronic file format.  

Members of the Holders Coalition also met with NAUPA leadership to discuss some of the practical implementation issues as well as the reporting concerns for the NAUPA electronic file layout.  Consequently, NAUPA sent a letter to the IRS and Treasury departments on November 21, 2019 to discuss the following concerns:

  • NAUPA is unclear as to whether and how a taxpayer that reclaims the proceeds of an IRA from a state will be permitted to reinstate the portion of the IRA proceeds that would not yet be subject to required minimum distributions.
  • NAUPA expressed concerns when proceeds of an IRA are erroneously remitted to the state.  NAUPA is unclear how a taxpayer may cause his or her IRA to be fully reinstated. 
  • NAUPA believes that considerable taxpayer confusion (and angst) will result if these matters remain unresolved.  Employees of the state administrator’s office will be asked by reappearing owners how to address the situations described above and employees will be unable to respond. Similarly, NAUPA does not believe a custodian who turned the IRA over to the state as unclaimed property will be able to provide a reappearing owner wit the appropriate guidance. Ultimately, the IRS will be contacted for direction by the taxpayers.
  • NAUPA argued that developing appropriate protocols in advance of the inevitable issues would be in the best interest of all parties and recommended that the Ruling should not be implemented on January 1, 2020 so the important issues of taxpayer and investor protection can be addressed.  

NAUPA did issue much needed guidance on reporting the tax withholding on the NAUPA II file layout in December 2019 assuming the January 1, 2020 effective date would not be extended:   

Holders reporting these properties should make use of the NAUPA Standard Deduction and Withholding code “TW” to represent “Income Tax Withheld.”
The value “TW” should be recorded in the PROPERTY record in the PROP-DEDUCTION-TYPE field. The amount of Federal Tax Withheld should be stored in the PROP-DEDUCTION-AMOUNT field. This code should be used for any taxes withheld from remitted properties.
The value of the property before the deduction should be stored in the PROP-AMOUNT-REPORTED field. The amount remitted to the state after the Federal Tax Withholding should be stored in the PROP-AMOUNT-REMITTED field.
In the event of multiple deductions, the Tax Withholding code should take priority. Since only one deduction field is available, the state and federal withholdings should be totaled for inclusion. We hope that holders would consider providing additional information to the states for the detail of the deductions.

Finally, On February 13, 2020, the Holders Coalition sent a follow up email to the IRS and Treasury Department with a copy of the original letter as a reminder that the industry is still waiting for guidance from the IRS regarding the practical implementation issues and recommendations related to implementing the Ruling. Without proper guidance from the IRS, holders will be forced to develop their own best practices which may be inconsistent across the unclaimed property community and therefore cause inconsistencies in reporting, customer impacts, backup withholding consequences, corrections of errors, etc. Therefore, it is critical to get guidance from one source of authority.

With the numerous attempts to reach out to the IRS and Department of Treasury for much needed guidance, it is unfortunate that none of the attempts made have been successful at getting a response. This leaves holders in a bit of a conundrum as we are entering the Spring reporting season. As stated above, although holders are very diligent in their due diligence and reporting processes, mistakes will happen from time to time and it remains to be seen how these scenarios will play out. Equally unfortunate is the impact to taxpayers this Ruling will have. By considering the escheatment of the full IRA a distribution, owners will be: forced to liquidate securities without their consent, forced into a taxable event they were not aware of, likely to be bumped in to a much higher tax bracket, forced to pay 10% tax withholding, likely to not receive the Form 1099-R if they have moved and have a bad address on the account, and therefore will be penalized even further by the IRS for not reporting the income on their tax return.

Because of the numerous negative impacts to owners/taxpayers, holders should exercise additional prudence before escheating an IRA account.  Additional customer outreach either by mail or telephone campaign may be beneficial to maintain these accounts. Although it may take more internal resources, the benefit of keeping an elderly person from loosing their IRA account to a state in this situation will far outweigh the cost.

This article is intended for informational purposes and is not to be considered legal advice.