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If The IRS Ask Questions, Can Your Actions Be Justified? Thumbnail

If The IRS Ask Questions, Can Your Actions Be Justified?

A couple of years ago I was asked what the tax consequences are when a Roth IRA is split in divorce. After a pause, I answered honestly: “I have no idea…but will find out.” In fact, there is no specific guidance in the Tax Code or in the regulations on how to handle such a transaction. So, the Ed Slott team embarked on a full research effort culminating in a lengthy write-up, presentation and even an Ed Slott IRA Advisor Newsletter article. We included multiple examples in our final report, complex hypothetical scenarios and the rationale supporting our conclusions. Ultimately, we delivered this material to our Elite Advisor members at a subsequent conference.

What are the tax consequences when a Roth IRA is split in divorce? There is no definitive answer, but there are factors to be considered that might illuminate this.

Today’s Slott Report entry is not about the details of transferring a Roth IRA via divorce. However, so no reader is left shortchanged, a summary of some of our conclusions is here: 

  • For a partial split via divorce, contributions, converted dollars and earnings are transferred pro-rata. (An ex-spouse cannot just deliver the earnings, for example.)
  • The existing Roth IRA can be retitled, or the assets can be moved via direct transfer to the receiving ex-spouse’s account.
  • The receiving ex-spouse can choose which 5-year start clock (what we refer to as the “5-year forever clock”) is more beneficial.
  • Existing 5-year conversion clocks transfer to the receiving spouse.

Some of our best educational material comes from real-life inquiries. After years of conversations and phone calls and thousands of interactions, we still receive questions and encounter fresh situations. Occasionally, there is no direct guidance on how to handle some of these scenarios. In such cases, we use our best judgement. In the presence of little to no guidance, we ask ourselves, “If the IRS were to ask questions, can these actions be justified?”

In fact, another unusual question presented itself just recently. Ironically, it was also predicated on a divorce: “My client owns a stretch IRA that he inherited from his father in 2018, which is before the SECURE Act. He was stretching RMD payments over his own single life expectancy. He recently divorced and the court awarded the entire inherited IRA to his ex-wife. Do we change the single life expectancy factor to her age, or leave it the same?”

I sat for a moment, thinking. I told the advisor I wanted to kick his question around with the Ed Slott team. “Give me a few minutes. I will get a consensus and call you right back.”

This is one of those situations where there is no direct guidance. How do we proceed in a justifiable manner that can easily be defended should the IRS ask questions? What is a reasonable path forward? Our conclusion was this: It is our opinion that the inherited IRA should continue using the original beneficiary’s single life expectancy (the son’s). Since that is the factor currently in place, and since that was the proper factor when the account was inherited, it should remain as-is. This seems like a sensible a justifiable solution.

If you find yourself in a unique situation where guidance is limited, first, exhaust all avenues to determine the best course of action. Document your process, and keep one question in mind: “If the IRS asks questions, can my actions be justified?”

By Andy Ives, CFP®, AIF®
IRA Analyst
Ed Slott and Company, LLC

To read more of our blog articles, click here.

Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.

Copyright © 2023, Ed Slott and Company, LLC Reprinted from The Slott Report, 06/14/23, with permission. https://www.irahelp.com/slottreport/if-irs-ask-questions-can-your-actions-be-justified, Ed Slott and Company, LLC takes no responsibility for the current accuracy of this article. 
Investment advisory services offered through Mutual Advisors, LLC DBA California Retirement Advisors, a SEC registered investment adviser. Securities offered through Mutual Securities, Inc., member FINRA/SIPC. Mutual Securities, Inc. and Mutual Advisors, LLC are affiliated companies. CA Insurance license #0B09076. This content is developed from sources believed to be providing accurate information and provided by California Retirement Advisors. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. California Retirement Advisors, nor any of its members, are tax accountants or legal attorneys and do not provide tax or legal advice. For tax or legal advice, you should consult your tax or legal professional.