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George F. Bearup, J.D. Senior Legal Trust Advisor

February 13, 2023

Deciphering the 50% Excise Tax Waiver

Take-Away: While there is some relief from the 50% excise tax for years 2021 and 2022 arising from confusion over the SECURE Act’s 10-year distribution rule with regard to retirement plans and accounts, there is still  plenty of confusion trying to figure out which beneficiaries benefit from that penalty  relief, and other designated beneficiaries who will not benefit.

Background: In IRS Notice 2022-53 which became public in early October, 2022, the IRS announced that it would waive the 50% excise tax for designated beneficiaries who are subject to the SECUCRE Act’s 10-year distribution rule, but who did not take required minimum distributions (RMDs) in 2020 and 2021 because of their belief that they did not have to take an RMD when the deceased IRA owner died after reaching his/her required beginning date (RBD) of age 72.

  • At-Least-As-Rapidly Rule: The IRS’ Proposed Regulations published in February of 2022 threw a ‘curveball’ with its interpretation of the SECURE Act that if the decedent IRA owner was beyond their RBD, then the designated beneficiary had to take annual RMDs from the inherited IRA at least as rapidly, using the beneficiary’s own life expectancy, with the obligation to fully empty the inherited IRA on the 10th anniversary of the deceased account owner’s death, consistent with the SECURE Act’s 10-year distribution rule.
  • Confusion: Hence the confusion and why some designated beneficiaries of inherited retirement accounts did not take an annual RMD in 2021 and 2022, believing (apparently erroneously) that they did not have to take an RMD until the 10th year after the account owner’s death. [This belief was based upon the ‘old’ 5-year distribution rule that was, and remains, part of the Tax Code, which is silent on the requirement to take an annual distribution from an inherited retirement account.]

Continued Confusion: While Notice 2022-53 provides relief from the 50% excise tax, not all designated beneficiaries will benefit from the IRS’s excise tax waiver. Some examples follow showing  who will benefit, and who will not benefit, from the Notice’s waiver. There may also be some confusion among designated beneficiaries, or perhaps the retirement account owners themselves, with regard to distinguishing the recent waiver of excise tax under Notice 2022-53 and the much broader waiver from taking RMDs under the 2020 CARES Act, which waived all RMDs but only for calendar year 2020.

Example #1- Basic Rule:  Marge, age 75, died in 2020. Marge named her daughter Lisa, age 50, as the beneficiary of Marge’s IRA. Lisa is subject to the SECURE Act’s 10-year distribution rule. Under the Proposed Regulations, since Marge was over her RBD when she died (over age 72), Lisa will have to take annual RMDs from the inherited IRA based on Lisa’s single life expectancy during years 1-9. If Lisa failed to take an RMD for 2021 and 2022, believing that she had until the 10th anniversary date of Marge’s death in which to empty the inherited IRA, she will not be subject to the 50% excise tax for failing to take an RMD in 2021 and 2022 thanks to Notice 2022-53.

Example #2- Successor Beneficiaries: Homer died at age 90 in 2019. Homer named his daughter Lisa as the designated beneficiary of Homer’s traditional IRA  prior to the effective date of the SECURE Act. Lisa, as the designated beneficiary of Homer’s IRA can take annual distributions using her own life expectancy to calculate the RMD because Homer died before the SECURE Act became effective. In 2020, Lisa died unexpectedly. Lisa named her brother Bart as the successor beneficiary of the inherited IRA (from Homer.) Bart must take RMDs from the inherited IRA based on Lisa’s single life expectancy during years 1-9 of the SECURE Act’s 10-year distribution period. Notice 2022-53 provides that if Bart fails to take the 2021 or 2022 RMD from the inherited IRA, after Lisa’s death, he will not be subject to the 50% excise tax.

Example #3- Roth IRAs: Marge owned a Roth IRA. She names her daughter Lisa as the designated beneficiary of the Roth IRA. Under the Proposed Regulations, Lisa as a designated beneficiary who inherited a Roth IRA, is deemed to have inherited it from the IRA owner who died before her RBD, even though Marge was age 75 at the time of her death. This special  ‘rule’ is because Roth IRA owners are not subject to lifetime RMDs. Lisa will be subject to the SECURE Act’s 10-year distribution rule, but she will not have to take RMDs from the inherited Roth IRA account for years 1-9. Accordingly, if Lisa had failed to take a distribution from the inherited Roth IRA in years 2021 or 2022, she will not be subject to penalties associated with the failure to take an RMD in those years. In short, a beneficiary who inherits a Roth IRA does not need the protection afforded by Notice 2022-53.

Example #4- Confusion in Scope of Waiver: Homer owns an IRA. Homer is age 80. Because Homer is older than his RBD, he must take lifetime RMDs for both 2021 and 2022. Homer thinks that the 2022 Notice simply is an extension of the CARES Act waiver with regard to taking any RMDs. Not so. Consequently, if Homer does not take an RMD for 2022,  Notice 2022-53 will not excuse Homer from the 50% excise tax.

Example #5- Not All Beneficiaries Protected: In 2020, Marge, age 75, inherits an IRA from her older brother, Ned age 77. Because Marge is not more than 10 years younger than Ned, Marge is an eligible designated beneficiary. Marge can take annual RMDs from the inherited IRA using her own single life expectancy; Marge is not, however, subject to the SECURE Act 10-year distribution rule since she is an eligible designated beneficiary. If Marge fails to take an RMD in 2022, Notice 2022-53 will not protect her from the 50% excise tax. Marge is still subject to taking annual RMDs from the inherited IRA.

Example #6- RMDs are Not Excused, Just the Penalty: Bart inherited an IRA from his father Homer in 2018. Bart took RMDs each year based on his single life expectancy. Because Bart inherited his father’s IRA prior to the SECURE Act’s effective date, Bart can continue to stretch annual distributions from the inherited IRA over his life expectancy. However, if Bart fails to take an RMD in 2021 or 2022, he will not be relieved of the 50% excise tax, despite the Notice. , Notice 2022-53 does not go so far that the RMDs themselves are waived- only the penalty for the failure to take an RMD.

Example #7- Rollovers: Lisa, age 43, is the beneficiary of Homer’s 401(k) account. Homer died at age 78. Lisa is subject to the SECURE Act’s 10-year distribution rule, including the obligation under the Proposed Regulations to take annual RMDs in years 1-9; the Proposed Regulations require Lisa to take annual RMDs based on her life expectancy in years 1-9 of the 10 year period because Homer died after his RBD. In 2022, Lisa wants to roll over the inherited 401(k) account balance to an inherited IRA. Lisa must first take the 2022 RMD, prior to any rollover. The fixed rule is that RMDs cannot be rolled over. This is so, even though Lisa would not be penalized for failing to take the 2022 RMD without doing a rollover. If Lisa fails to take the annual RMD she will have an excess contribution to her inherited IRA that will be subject to the 6% excise tax for an excess contribution to the inherited IRA.

Conclusion: It remains unclear if the Final Regulations will retain this ‘curveball’ interpretation of the SECURE Act that requires annual RMDs when the deceased account owner was over the age of 72. Notice 2022-53 only tells us that the Final Regulations that implement the SECURE Act “will apply no earlier than the 2023 distribution calendar year.”  The waiver of the penalty is welcome relief, but it is an understatement that the retirement plan distribution rules are an absolute mess, and almost impossible to follow.