Overview: This commentary discusses how the suspension of required minimum distributions in 2009 may affect some clients. It should be noted that the information contained in this paper should not be considered tax advice. It is always important to consult a tax expert prior to engaging in actions that may have tax consequences.
 

On December 23, 2008, President Bush signed The Worker, Retiree, and Employer Recovery Act of 2008 (Recovery Act) to allow taxpayers to temporarily suspend taking required minimum distributions (RMDs) from their tax-deferred investment accounts in 2009. This means individuals do not have to take withdrawals from accounts that may have experienced steep declines in value. Not taking RMDs also allows taxpayers to lower their adjusted gross income and take advantage of the following:

 

The Recovery Act allows taxpayers to convert what would have been their RMD into a Roth IRA, allowing for the growth of the account to be income-tax free at withdrawal. For 2009, taxpayers allowed to make this conversion are limited to a modified adjusted gross income (MAGI) of $100,000. The conversion creates the same income-tax position as taking an RMD (had the RMD rules applied), but now places RMD retirement funds in a tax-free growth environment.

Under the general passive activity rules, taxpayers who have “passive participation” in rental real estate activity are generally allowed to deduct up to $25,000 in rental losses. However, deductions are phased out if their MAGI is above $100,000. The suspension of the RMD rules in 2009 might allow taxpayers whose RMDs put them over the $100,000 threshold to deduct their rental real estate losses in 2009.

Married taxpayers who have a MAGI of less than $32,000 ($25,000 if single) will not pay income tax on their Social Security benefits. If their MAGI goes above $44,000 ($34,000 if single), up to 85 percent of their Social Security benefits are taxable. It is possible that taxpayers who do not take RMDs in 2009 may remain under that tax threshold, and thus not have their Social Security benefits taxed.

Taxpayers with non-qualified annuities who want to divest them may be able to do so in 2009 without triggering adverse income tax treatment. Under the tax law, unless the annuity is annuitized, ordinary income is deemed to come out first, followed by a return of capital (that is, cost basis). Avoiding RMDs in 2009 may help these taxpayers divest their non-qualified annuities as they will have less taxable ordinary income this year.

Prior to the Recovery Act, non-spousal IRA beneficiaries (such as children or siblings) were required to take RMDs beginning the year after the IRA owner’s death. The suspension of the RMD rules in 2009 allows IRA beneficiaries to leave the assets in the IRA for an additional year if the RMDs are unneeded.

Under the RMD tax regulations, if IRA owners die before reaching age 70½ and do not name a qualified beneficiary of their IRA (for example, naming their estate), their IRAs must be completely distributed by December 31 following the fifth anniversary of the IRA owners’ death. The suspension of the RMD rules in 2009 means there will be a “tolling” of the five-year rule in situations where the fifth anniversary of an IRA owner’s death falls in 2009. As a result, this situation will allow assets to be sheltered in a tax-free environment for one additional year.

 

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