IRS Recognizes Favorable Tax Strategy for IRA and 401k Accounts


On Feb. 24, the Internal Revenue Service released draft regulations that, if finalized, will provide individuals with a favorable tax strategy that most estate planners doubted would ever exist.

A common estate planning strategy, which can save federal and estate taxes, protect assets from the rights of a divorced spouse, and insulate assets from lawsuits, is to pay IRA and/or 401k accounts to a trust for the benefit lifetime of the account holder. spouse and/or children. With special drafting, it is also possible to have the income of the trust taxed at the generally lower federal income tax rates of the spouse or children, rather than the generally much higher federal income tax rates. imposed on trusts. Until the Internal Revenue Service released its draft regulations at the end of February, however, it was uncertain whether it was possible to draft the trust deed so that in addition, taxes income are saved on the death of the spouse or children, when the trust assets are passed on to the next generation of beneficiaries.

Prior to the release of the proposed settlement, sometimes referred to as the “SECURE Act Proposed Settlement”, earlier this year, it was widely believed that in order to achieve maximum income tax deferral when IRAs or 401k accounts are payable to an “accumulation trust,” which trust allows the accumulation of IRA and/or 401k plan receipts for estate tax savings, divorce protection, and lawsuit protection purposes mentioned above , there had to be a compromise. Individuals or trusts that took the balance of trust assets on the death of the spouse or child would be required to receive federal income tax base in the IRA or 401k proceeds that were reinvested in other assets, equal to the historical cost basis of the assets, rather than a “grossed up” tax base equal to the fair market value of the assets of the trust at the time of the death of the spouse or child. Therefore, when the assets of the trust are subsequently sold after the death of the spouse or child, there may be significant taxes payable.

Assuming this aspect of the proposed regulations are finalized in their current form, the IRS will now allow maximum deferral of income tax for IRA or 401k accounts that are payable to the accumulation trust (whose period maximum deferral could be either for the life of the beneficiary trust or up to 10 years, depending on the purpose and structure of the trust), and simultaneously allow the tax base of some or all of the trust assets that were purchased with IRA or 401k proceeds must be adjusted to the fair market value of the assets upon the death of the spouse or child. The technical reason for this is that the IRS has announced in its proposed rule that a technique that estate planning attorneys use to create this result (sometimes called a conditional testamentary general power of appointment) will not affect the maximum period of IRA income tax deferral and 401k accounts payable to an accumulating trust.

In higher net worth situations, the adjustment to the tax base on the death of the spouse or child may be limited, but, if the trust instrument is properly structured, in most situations the adjustment of the tax base will be significant, if not complete. It is also important to note that in so-called “dynasty trust” situations, i.e. where the estate tax, divorce and lawsuit protections of capitalization trusts are intended to continue for future generations, this same adjustment of the federal income tax base to each generation may continue for hundreds of years, if not forever.

James G. Blase, CPA, JD, LLM, is a principal at Blase & Associates LLC. To learn more about the estate planning techniques described in this article, see Mr. Blase’s book titled Estate Planning for the SECURE Act: Strategies to Minimize IRA and 401k Taxesavailable on Amazon.


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