Life and Death Planning for Retirement Benefits

123 / 507

Chapter 2: Income Tax Issues 123
The mandatory withholding on eligible rollover distributions does not pose a problem if
someone simply wants to get the money out of the QRP without simultaneously paying any income
tax on the distribution. All such person has to do is have his distribution transferred directly (a
“direct rollover”) into an IRA, so the qualified plan does not have to withhold anything; and then
take the money out of the IRA (electing out of withholding on the IRA distribution).
The person for whom “mandatory withholding” is truly mandatory is the person who wants
to take a lump sum distribution from a QRP in order to qualify for special averaging treatment
. This person cannot roll over any part of the distribution, and so will be forced to pay 20
percent income tax on it through withholding. He can get a refund when he files his tax return for
the year of the distribution, if his total tax payments (including this withholding) exceed his actual
tax liability.
D. Roth conversion of eligible rollover distribution. Under as long as the
recipient elects (under to have the eligible rollover distribution sent directly
to an “eligible retirement plan,” there is no required income tax withholding. “Eligible
retirement plan” is not defined in but is defined in regulations: “ ...[A]n eligible
retirement plan is a trust qualified under section 401(a), an annuity plan described in section
403(a), or an individual retirement plan (as described in Sec. 1.402(c)-2, Q&A-2 of this
chapter).” Reg. A-1(a).
The referenced section states that eligible retirement plan includes an individual retirement
account under Notice 2008-30, 2008-12 IRB 638, A-1, A-6, makes clear that Roth IRAs
are also eligible to receive direct rollovers, and that a direct rollover to a Roth IRA is not subject
to the 20 percent mandatory income tax withholding: “ ...[A]n eligible rollover distribution that a
distributee elects, under to have paid directly to an eligible retirement plan
(including a Roth IRA) is not subject to mandatory withholding, even if the distribution is
includible in gross income.” Despite that clear statement, the IRS’s instructions to employers in
Publication 15-A (2010), at page 22, after stating that eligible rollover distributions are subject to
mandatory 20 percent withholding, states that “However, you should not withhold federal income
tax if the entire distribution is transferred ...in a direct rollover to a traditional IRA, qualified
pension plan [etc.],” making it sound as though mandatory withholding does apply to direct Roth
rollovers.
2.3.03 Exceptions and special rules
A retirement plan is not required to withhold taxes from an eligible rollover distribution to
the extent it is “reasonable to believe” that the distribution is not includible in the payee’s income.
Temp. Reg. A-2. For example, a qualified distribution from a
DRAC or Roth IRA, as a nontaxable distribution, would not be subject to withholding.
If the entire distribution consists of securities of the employer corporation (as defined in
(and up to $200 cash “in lieu of fractional shares”), there is no withholding. If the
distribution consists of securities of the employer corporation plus cash and other property, the
maximum amount the employer is required to withhold is the value of the cash and other property.
In connection with determining the amount required to be withheld from that sort of
mixed distribution, “it is reasonable to believe that all net unrealized appreciation [NUA] from
employer securities is not includible in gross income.” Temp. Reg. A-30; see