The Ins and Outs of IRAs as Community Property

BY JAMES OZELLO

In a letter ruling late last year, the IRS said that one spouse could have a community property interest in the other’s IRA and that the reclassification of an IRA as marital property was not a taxable distribution. The IRS also said, however, that if a spouse transferred his or her interest in the marital property IRA to a separate IRA, the distribution would be taxable. 

In LR no. 199937055, a husband had two IRAs as the result of a rollover from a qualified plan. His wife had an unfunded spousal IRA. As part of an estate plan, the couple executed a marital property agreement. Under the agreement, the couple classified the husband’s IRAs as marital property. They proposed to divide his IRAs into two equal shares, and transfer the wife’s interest into her separate IRA.

The IRS said the wife had a community property interest in her husband’s IRA under IRC section 408(g). Even though the section contained no specific language regarding such interests, it did not negate any substantive rights under state law, according to the IRS. The service used the general rule that federal statutes do not preempt state laws unless such preemptions are the clear intent of Congress.

The IRS then stated that the reclassification of the husband’s separate IRAs as marital property was not a taxable distribution under section 408(d)(1), because there had been

  • No distribution or transfer of assets from the IRAs.
  • No change in the IRAs’ trustees.

The mere reclassification of the IRAs as marital property did not trigger section 408(d)(1).

However, the IRS said any transfer of a community property interest in the marital property IRAs to an individual IRA would be a taxable transfer. According to the service, the owner of an IRA is the individual in whose name the account was established, and state law does not affect this. In addition, distributions from an IRA are taxed as if the owner of the IRA is the sole owner, even if title does not determine ownership under state law, and even if the spouse’s property interests in an IRA are the same as the owner’s under state law.

Observation. This letter ruling deals with reclassification of individual property to community marital property in a community property state. The ruling may apply in other community property states, but what application, if any, it would have in non-community-property states is not clear.

—James Ozello, Esq., Ozello Tax and Legal Consulting, Ringwood, New Jersey.

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