An RMD and Tax Waiver Problem -Part 1

       Although New Jersey no longer has an estate tax we still have an inheritance tax and with it a tax waiver. Last week we received a call from Mary who had been appointed executrix of her Aunt June’s estate. June had not taken her required minimum distribution (RMD) amount for 2018 from her individual retirement account (IRA) before her death.

       For those not familiar with the RMD rules, let’s review. IRAs are tax deferred accounts. They are not taxed each year as the investments in those accounts grow. The tax is only owed when the account holder withdraws the funds from the retirement accounts. The longer the assets remain in the retirement account, the longer one can put off paying the tax.

       The government, however, does not allow this to continue indefinitely. That’s where RMD rules come into play. Account owners must start withdrawing funds from IRAs not later than the year he/she reaches the age of 70 and 1/2. The IRS has rules regarding how much must be withdrawn each year, which is a dependent upon the owner’s life expectancy. Failure to withdraw at least the RMD each year can carry a pretty hefty penalty – 50% of the amount that should have been withdrawn but wasn’t.

       Because Aunt June had not withdrawn her RMD amount before she died, Mary contacted the bank to do so before the end of the year. That’s when she was told that until she obtained a tax waiver from the State of New Jersey, the entire IRA would be frozen and she could not withdraw anything. The reason for this is the bank’s application of New Jersey’s tax waiver rules which require Mary to file an inheritance tax return to pay the tax owed on the distributions to Mary and her cousins. When the return is filed and reviewed by the State it will then issue the tax waiver, which releases the lien it has by law on the account. Only when presented with that waiver would the bank agree to release the funds.

       June died in November. She does not yet have all the information needed for us to file an inheritance tax return. That’s why the State sets a deadline of 8 months after death to file the return without owing any interest. It can take that long and sometimes longer to gather together information regarding assets and liabilities. So, then how can Mary ever hope to get the tax waiver in time so that she can withdraw June’s RMD and avoid the 50% penalty? She can’t.

       The problem, however, is not with the timing of all this. It’s the bank’s misapplication of the tax waiver process that is the real problem. Next week I’ll explain why.