Unclaimed property holders should take notice of IRS rules concerning the escheatment of individual retirement accounts effective Jan. 1, 2020. In Revenue Ruling 2018-17, the IRS ruled that the escheatment of an IRA or annuity to a state unclaimed property fund will be subject to federal tax withholding and reporting. In other words, escheatment will be treated as a designated distribution to the IRA owner subject to withholding at a 10% rate. This assumes there is no withholding election by the IRA owner.
Many states provide that retirement accounts are eligible forms of property subject to a state’s unclaimed property law. Like other property types, IRA distributions that remain unclaimed for a certain period of time (i.e., the dormancy period), are presumed abandoned and are required to be escheated to the state. A number of state laws and procedures must be followed before the property is ultimately escheated.
Revenue ruling 2018-17
The ruling addresses a common scenario involving traditional IRAs where the distribution from the account becomes unclaimed property and no withholding election was made by the owner of the account. For purposes of the revenue ruling, it is important to remember that a traditional IRA is a tax-deferred account, meaning that earnings and gains in the account are not subject to state or federal taxation until distributed. Accordingly, a traditional IRA receives different tax treatment than a Roth IRA, simplified employee pension, a SIMPLE IRA, or a deemed IRA. Effective Jan. 1, 2020, holders are required to withhold the 10% tax on non-periodic designated distributions that have become unclaimed and subject to escheatment using IRS Form 1099-R prior to remittance to the state, if the owner of the IRA account did not make a withholding election.
Under section 3405, the IRS defines “designated distribution” as any distribution or payment from or under an IRA. A designated distribution does not include the portion of a distribution or payment that is reasonable to believe is not includable in gross income (such as from a Roth IRA). Accordingly, any distribution or payment from or under an IRA is treated as includible in gross income.
The new rules present some challenges to holders of IRAs subject to escheat. For example, the withholding rules apply without regard to the nature of the property. Additionally, holders should consider that unless the IRA account consists of 10% cash, the holder may be forced to sell any investment property to withhold the tax. Moreover, state laws are not uniform with respect to the allowance of deduction from unclaimed property remittances. Lastly, since this is a new withholding and reporting requirement, it is likely that holders of IRAs subject to escheat will face unexpected administrative complexities and confusion.
The revenue ruling originally provided a transition period to allow holders with withholding and reporting requirements to make withholding payments prior to Jan. 1, 2019. That transition period was extended by Notice 2018-90 through Jan. 1, 2020. Holders of IRAs should consult with their unclaimed property advisors for more information. For more information on unclaimed property generally, please see RSM’s Unclaimed Property Portal.