Ira Assignments

ILM 200644020

Full Text:

UILC: 691.01-02, 642.03-02

Release Date: 11/3/2006

Refer Reply to: CC:PSI:B02:BRPoston - POSTU-159830-05

to:
Territory Director, Midwest Area
(Examination, PSP)

from:
Branch Chief, Branch 2
(Passthroughs & Special Industries)

subject: * * *

This Chief Counsel Advice may not be used or cited as precedent.

LEGEND:

Trust = * * *
Decedent = * * *
IRA = * * *
Charity 1 = * * *
Charity 2 = * * *
Charity 3 = * * *
Year 1 = * * *
D1 = * * *
x = * * *
y = * * *
z = * * *


1. Did Trust have gross income under § 691(a)(2) on the assignment of a portion of Decedent's IRA to the Charities in satisfaction of a pecuniary legacy?

2. If Trust had gross income under § 691(a)(2), was it entitled to a deduction under § 642(c)(1) for the portion of Decedent's IRA assigned to the Charities?


1. Trust had gross income under § 691(a)(2) on the assignment of a portion of Decedent's IRA to the Charities.

2. Trust was not entitled to a deduction under § 642(c)(1) for the portion of Decedent's IRA assigned to the Charities.


Decedent died on D1. At the time of Decedent's death, Decedent owned an individual retirement account (IRA), of which the designated beneficiary was Decedent's revocable trust (Trust).

Article I(B), section (1), of Trust provides that upon the death of Decedent, the sum of $100,000 shall be distributed "in cash or in kind" as follows: $x to Charity 1, $y to Charity 2, and $z to Charity 3 (collectively, the Charities).

Article I(B), sections (2), (3), and (4), provide that the residue of the Trust property shall be distributed to Decedent's children outright or in trust as provided therein.

Article II(A)(12) provides that the trustee shall possess the discretion and power to make distributions or divisions of principal in cash or in kind, or both, at fair market values current at a date of distribution fixed by the trustee, without any requirement that each item be distributed or divided ratably.

Trust completed the distribution of IRA in Year 1, by instructing the IRA custodian to divide IRA into shares, each titled in the name of a beneficiary under Trust. Thus, each of the Charities became the owner and beneficiary of an IRA equal in value, at the time of division, to the dollar amount it was entitled to under Trust.


Section 691(a)(1) of the Code provides that the amount of all items of gross income in respect of a decedent (IRD) which are not properly includible in respect of the taxable period in which falls the date of the decedent's death or a prior period (including the amount of all items of gross income in respect of a prior decedent, if the right to receive such amount was acquired by reason of the death of the prior decedent or by bequest, devise, or inheritance from the prior decedent) shall be included in the gross income, for the taxable year when received, of: (A) the estate of the decedent, if the right to receive the amount is acquired by the decedent's estate from the decedent; (B) the person who, by reason of the death of the decedent, acquires the right to receive the amount, if the right to receive the amount is not acquired by the decedent's estate from the decedent; or (C) the person who acquires from the decedent the right to receive the amount by bequest, devise, or inheritance, if the amount is received after a distribution by the decedent's estate of such right.

Section 691(a)(2) provides that if a right, described in § 691(a)(1), to receive an amount is transferred by the estate of the decedent or a person who received such right by reason of the death of the decedent or by bequest, devise, or inheritance from the decedent, there shall be included in the gross income of the estate or such person, as the case may be, for the taxable period in which the transfer occurs, the fair market value of such right at the time of such transfer plus the amount by which any consideration for the transfer exceeds such fair market value. For purposes of this paragraph, the term "transfer" includes sale, exchange, or other disposition, or the satisfaction of an installment obligation at other than face value, but does not include transmission at death to the estate of the decedent or a transfer to a person pursuant to the right of such person to receive such amount by reason of the death of the decedent or by bequest, devise, or inheritance from the decedent.

Rev. Rul. 92-47, 1992-1 C.B. 198, holds that a distribution to the beneficiary of a decedent's IRA that equals the amount of the balance in the IRA at the decedent's death, less any nondeductible contributions, is IRD under § 691(a)(1) that is includable in the gross income of the beneficiary for the taxable year the distribution is received.

Section 642(c)(1) provides that in the case of an estate or trust (other than a trust meeting the specifications of subpart B of part I of subchapter J of chapter 1), there shall be allowed as a deduction in computing its taxable income (in lieu of the deduction allowed by § 170(a), relating to deduction for charitable, etc., contributions and gifts) any amount of the gross income, without limitation, which pursuant to the terms of the governing instrument is, during the taxable year, paid for a purpose specified in § 170(c) (determined without regard to § 170(c)(2)(A)).

The amount of the balance in IRA at Decedent's death, less any nondeductible contributions, is IRD under § 691(a)(1). If an estate or trust satisfies a pecuniary legacy with property, the payment is treated as a sale or exchange. See Kenan v. Commissioner, 114 F.2d 217 (2d Cir.1940). Because Trust used IRA to satisfy its pecuniary legacies, Trust must treat the payments as sales or exchanges. Therefore, under § 691(a)(2), the payments are transfers of the rights to receive the IRD and Trust must include in its gross income the value of the portion of IRA which is IRD to the extent IRA was used to satisfy the pecuniary legacies.

The terms of Trust do not direct or require that the trustee pay the pecuniary legacies from Trust's gross income. Accordingly, the transfer of a portion of IRA in satisfaction of the pecuniary legacies does not entitle Trust to a deduction under § 642(c)(1).


CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS

This memorandum responds to a private letter ruling request from Trust, requesting various rulings regarding the rollover of IRA to the beneficiaries of Trust and the amendment of Trust to provide for a disabled child of Decedent. These rulings, involving issues under the jurisdiction of T:EP:RA, were granted in a letter dated November 30, 2005, which has not yet been publicly released. After we informed the taxpayer that this office was adverse to the taxpayer on the § 691 issue described above, the taxpayer withdrew that portion of their original ruling request. Because the adverse determination on this issue was not included in the letter issued by T:EP:RA, this memorandum is necessary to inform your office of our position on the transaction.

The taxpayer does not agree that the partial assignment of IRA to the Charities results in a sale or exchange of the IRD element of IRA (and thus gross income under § 691(a)(2), with no allowable § 642(c) deduction for the reasons described above). The taxpayer argues that this conclusion is preempted by the application of § 408(d)(1), which provides that "any amount paid or distributed out of an IRA shall be included in gross income by the payee or distributee." The taxpayer maintains that this rule, requiring actual payment or distribution, prevents the application of the Kenan priniciple and § 691(a)(2) to currently tax Trust since it has not received payments or distributions from IRA.

We disagree with this interpretation. We believe that under Kenan, Trust has received an immediate economic benefit by satisfying its pecuniary obligation to the Charities with property on which neither Trust nor Decedent have previously paid income tax which is a disposition for § 691(a)(2) purposes. We further believe that the language of § 408(d)(1) simply prevents the immediate taxation of IRA recipients on amounts in an IRA which are not currently payable under a theory of "constructive receipt." T:EP:RA, which has jurisdiction over § 408, does not object to our conclusion on this issue.

This writing may contain privileged information. Any unauthorized disclosure of this writing may undermine our ability to protect the privileged information. If disclosure is determined to be necessary, please contact this office for our views.

Please call * * * of this office at * * * if you have any further questions.

Based on searches that lead people to Six Figure Investing, these are the top investment questions people ask about IRAs.  For definitive answers to tax questions in your specific circumstances please consult a tax professional.

General

  • Why trade in an IRA?   Because it allows you to defer or avoid taxes on dividends and capital gains—all of your profits can be reinvested tax-free.
  • What trading restrictions / rules are there for IRAs?   The only universal restriction is tied to IRS rules that do not allow borrowing from an IRA account.  This restriction blocks short selling, leverage using margin, and the sale of naked put or call options.  Brokerage firms vary in what they allow, but generally, you can trade all stocks and exchange traded products (ETFs & ETNs) including leveraged (SSO),  inverse (e.g., SH), and volatility funds (e.g., VXX, XIV, ZIV).  Some trades such as options, leveraged/inverse funds, volatility funds, or futures might require extra paperwork / qualification.
  • What specific restrictions/features do brokers put on their IRA accounts?   Data on a few brokers:
    1. E*TRADE and optionsXpress: Futures not supported
    2. Fidelity:  Futures not supported
    3. Interactive Brokers and TD Ameritrade:  Limited margin for avoiding settlement date restrictions
    4. Optionsxpress: Calendar spreads on cash settled index options are not allowed
    5. Schwab: Cash settled Index options spreads are not allowed, futures not supported
    6. Thinkorswim:  Looks pretty open, including futures
  • Are the trading rules for a Roth IRA different from a Traditional IRA?  There are no differences that I’m aware of.


Day Trading

  • Can I day trade in my IRA account?  Typically there are no pattern day trader restrictions on IRAs that have a value of more than $25,000.  However frequent trading in a cash account (typical for IRAs) can lead to violations of the 3-day trade settlement rule.  Unless you are only trading a small percentage of your account balance you will quickly run into settlement problems.  If you break these rules you will get “free riding” or “good faith” warnings/violations (SEC Regulation T violations) that will cause restrictions to be put on your account.  See “Trading in an IRA and avoiding free-riding” for more information.
  • Is there an easy way to avoid “free riding” in my IRA account?   Only buy when you have enough “settled funds” in your account (usually visible in your on-line balances) to cover the purchase. Interactive Brokers and TD Ameritrade have limited margin features for avoiding settlement date restrictions—they essentially waive the 3 day settlement period.


Stock/ ETF/ ETN trading

  • Can I buy stocks on margin in my IRA?  Not if you are trying to get leverage.  While some brokers offer IRAs with limited margin, that capability is only there to manage options strategies and avoid cash settlement issues.
  • Can I sell stocks short in an IRA?   No, but you can buy inverse Exchange Traded Products (ETPs) like SDS (-2X S&P 500) or SH (-1X S&P 500).   With options you can often nearly replicate a short position—by buying puts or call spreads with the short side deep in the money.
  • Can I buy leveraged or inverse ETF / ETNs like SSO (2X S&P500) in my IRA?   Most brokers allow this. You may have to sign a waiver or be qualified first.
  • Can I buy volatility ETNs/ETFs like VXX, UVXY, and XIV in my IRA?  Most brokers allow this.  You may have to sign a waiver or be qualified first
  • Can I use a stop loss order in my IRA account?   Yes, but for stocks / ETPs you should wait 3 days after your purchase to put it in place if you used unsettled funds for the purchase.  Otherwise, you run the risk of violating the SEC’s free-riding rules if the stop loss triggers.  See this post for more information.


Options

  • Can I trade options in my IRA account?  You need to be qualified and allowed trades vary between brokers, but yes you can—except for selling naked calls or puts—the highest risk category.
  • What happens if options in my IRA are assigned?  Option assignment can be a problem if it not covered by cash or offset by other positions in your account (e.g., stock in the case of a covered call, or an offsetting assigned option).   For example, if the short side of your vertical spread is assigned when the underlying goes ex-dividend your account will go short the equivalent amount of the underlying—not a sustainable situation for an IRA account.   You must cover the short quickly, but unless you have sufficient settled cash in your account you may get a “free ride” violation (see Trading in an IRA and avoiding free-riding).   A call to your broker if this situation occurs would be a very good idea.  It might be possible in this case to wait one day before covering and avoid the violation.  Unbalanced option assignment can also happen when the options in a spread expire with one leg in the money and the other OTM. Cash settled options  (e.g. SPX, VIX) don’t have this problem.  See Options strategies in Your IRA Account for more information.  Index options are nice because they are usually European style options that can’t be assigned before expiration—totally dodging the problem, however, there may be some restrictions on them when used to create spreads with different expiration dates.
  • Can I sell puts in my IRA?  You can sell cash secured puts in your IRA if you have approval for that level of options trading from your broker and you have enough cash in your account to buy the requisite amount of the underlying security (100 shares per option) if your puts are assigned.  An alternative is to open put spreads where the long leg strike price is well below the short leg.  This approach doesn’t tie up as much cash and allows limit orders at the lowest possible increment (e..g, one cent for equities).

 

Taxes

  • Can I write off a trading loss in my IRA on my taxes?  Generally no.  Only if you have liquidated the account and your distribution was less than the amount you contributed.  Of course, the converse is also true; you don’t have to pay taxes on gains.  The IRS always seems to have exceptions so check with your tax advisor if you have questions.
  • Will my dividends or capital gains be taxed in my IRA? No, taxes on dividends and capital gains are either deferred (traditional) or avoided (Roth) in an IRA.
  • Can I write off commissions on my trades within my IRA?  No, the tax exemption cuts both ways.  There’s no way to write off expenses like commissions or management fees.

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