Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

The Code allows IRA contributions to be returned to the contributor subject to certain conditions. If three requirements are met (see A–C), the returned contribution gets special treatment for income tax purposes (see D) and for purposes of the penalty on excess IRA contributions (see E). In this book (and in the regulation), a returned IRA contribution that meets these requirements is called a “ corrective distribution ,” regardless of whether it was returned in order to correct a problem (such as an excess IRA contribution) or just because the participant changed his mind. The same rules apply to return of Roth IRA contributions. Reg. § 1.408A-6 , A- 1(d). If an excess plan contribution is returned late, so it does not qualify as a corrective distribution, see F–I. A. Deadline for a corrective IRA distribution. To qualify for the special income tax treatment (see D), the corrective distribution must be “received on or before the day prescribed by law (including extensions of time) for filing such individual’s return for such taxable year.” § 408(d)(4)(A) . For most people, that deadline is October 15 of the year after the taxable year in question; see ¶ 5.6.06 for details on this deadline. B. Income attributable to returned IRA contribution. The amount that must be distributed by the deadline is the contribution itself, “accompanied by the amount of net income attributable to such contribution.” § 408(d)(4)(C) . For how to compute the net income attributable to a returned IRA contribution, see ¶ 5.6.02 . D. Income tax and 10 percent penalty treatment. As explained at ¶ 2.2.02 and ¶ 2.2.08 , the general rule for tax treatment of IRA distributions (under § 408(d)(1) and § 72 ) is that any such distribution is included in gross income to the extent it exceeds the distributee’s basis; and a proportionate allocation and aggregation rule (the “cream-in-the-coffee rule”) applies for purposes of determining how much of such distribution is basis. Returned IRA contributions are an exception to these general rules: If the above three requirements A–C are met, the corrective distribution is not taxable under § 408(d)(1) , and therefore is not taxable under § 72 . § 408(d)(4) . Rather, apparently, the distribution is taxable only under § 61 , which is the general definition of gross income. Accordingly, it appears that the returned contribution itself is not taxable (because it is not “income”); only any net income “attributable” to the contribution that is distributed with it would be taxable. § 408(d)(4) provides that “for purposes of section 61, any net income [that is attributable to the contribution and accordingly is included in the distribution] shall be deemed to have been earned and receivable in the taxable year in which such contribution i s made.” Reg. § 1.408-4(c) , § 1.408A-3 , A-7, § 1.408A-6 , A-1(d). The net income so returned is also subject to the 10 percent penalty under § 72(t) if the participant is under age 59½ at the time he withdraws the contribution , unless an exception applies; see ¶ 9.1.03 (B). C. No deduction taken. The participant must not take an income tax deduction for the contribution. § 408(d)(4)(B) .