Who’s on First?

We’ve all heard the phrase, “Laughter is the best medicine.” When it comes to relieving stress, a good laugh can do wonders. Take it from the Mayo Clinic, who says that it has both short- and long-term benefits, from improving your mood, relieving tension, to even reducing pain₁. And if you think you don’t have a good sense of humor, they even say that humor can be learned!

And who doesn’t need a good laugh these days as we deal with the residual COVID effects, only to face incredible inflation and a potential recession? Sometimes we just need to take a break from the headlines and focus on the lighter side of life. I did this recently myself. After a long week, last Friday I plopped on the couch and browsed through Netflix looking for a comedy. I landed on some old Abbott and Costello sketches, of all things. And who doesn’t remember what’s probably the most famous comedy bit of all time – “Who’s on First”, which shows us how misinterpretations created some pretty funny frustration between the performers.

Of course, being a finance guy, this made me think of the IRS and some recent legislation that has caused a lot of head scratching, making me wonder who’s really “on first” here. Specifically, I’m talking about the IRS’ proposed regulations for the Secure Act. Now, new laws involving taxes always come with some questions, but usually the IRS clears these up promptly. But in the case of the SECURE Act, it seemed like the IRS was floundering for answers, leaving many at risk of paying penalties due to misinformation and in some cases, no information.

 The issue in question has to do with what’s called an “inherited IRA” and how to manage distributions. Before the passage of the Secure Act (the “Act”) in late 2019, beneficiaries of inherited retirement accounts—such as IRAs, 401(k)s, 403(b)s and 457s—had to take required minimum distributions, or RMDs, each year based on their life expectancies. If a beneficiary was younger than the original owner, the RMD amounts would be lower because of their longer life expectancy. This strategy was coined the “stretch IRA” which is defined as the practice of extending an inherited IRA over many years.

The goal here was to defer taxes on the money, which has never been taxed, for as long as possible by minimizing distributions from the account. However, this changed dramatically with the Act. New laws state that a “noneligible designated beneficiary (EDB)” must liquidate the assets of an inherited retirement account within ten years of the original owner’s death. The IRS defines an EDB as anyone other than “a surviving spouse, a disabled individual, a chronically ill individual, a minor child, or an individual who is not more than ten years younger than the account owner.”

Right away there were questions. For example, does the beneficiary need to take a withdrawal every year or can they wait until the end of the ten years and take out a lump sum all at once? There were rumors early on that the latter was the case, but we had no firm guidance from the IRS to rely on.

Then in February 2022, the IRS finally spoke up and issued its proposed regulations on the issue. They stated that not only must beneficiaries liquidate the assets within ten years, but they must make a distribution—based on life expectancy—for each year of the ten-year term. If they didn’t, they would be subject to the hefty 50% penalty tax on the amount that should have been withdrawn.

Many didn’t see this coming, consumers and advisors alike. With regulations not even final yet, many of the beneficiaries didn’t take what is now deemed a required distribution. But luckily the IRS showed some mercy here. 

To remedy the situation, the IRS published notice 2022-53 in October₂. It essentially suspended enforcement of the proposed regulations until January 2023 at the earliest. This means that no penalty tax will be assessed for people who inherited IRAs after 2019 and did not take a minimum distribution in 2021 or 2022. 

If this includes you and you already happened to pay the tax penalty? You can file an amended return to obtain a refund of the tax. But this doesn’t mean you should just automatically put off these distributions. For example, if you happen to be in a lower tax bracket, you might consider taking inherited IRA distributions anyway. This can prevent you from having to take larger distributions in later years that could push you into a higher tax bracket. And tax hikes likely, this could mean these distributions will cost you even more in taxes.

Whatever you decide, make sure you know your options so you’re not playing “Who’s on First” with the IRS!  Not recommended.

Folks, all of us in this office, Jen, Bonnie, Sheri, Jill, Ethan, Angela, and I would like to say thank you to all of our veterans.  Our business is a pro-veteran and pro-America company and appreciate your service to this great Nation.  Happy Veteran’s Day!

Have a great week.

Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield, MA. 

Insurance offered through its affiliate, CutterInsure, Inc. We do not offer tax or legal advice. Jeff can be reached at jeff@cutterfinancialgroup.com. This information is intended to provide general information. It is not intended to offer or deliver investment advice in any way. Information regarding investment services is provided solely to gain a better understanding of the subject of the article. Different types of investments involve varying degrees of risk, including the potential for loss. Therefore, it should not be assumed that future performance of any specific investment or investment strategy will be profitable. Insurance product guarantees are backed by the financial strength and claims-paying ability of the issuing company. Market data and other cited or linked-to content is based on generally available information and is believed to be reliable. Cutter Financial does not guarantee the performance of any investment or the accuracy of the information contained in this article. Cutter Financial will provide all prospective clients with a copy of Cutter Financial’s Form ADV 2A, Appendix 1, applicable Form ADV 2Bs and Form CRS as well as the firm privacy policy. Please contact us to request a free copy via .pdf or hardcopy. 1. https://tinyurl.com/nk77zkpv 2. https://tinyurl.com/yc6m7rd3