IRS Extends Waiver of Excise Tax for Inherited IRAs, but Not RMDs

On April 16, the IRS issued Notice 2024-35 in which it announced that the automatic waiver of the excise tax that applies to certain 10-year beneficiaries has been extended to 2024. As a result, beneficiaries subject to the 10-year rule and obligated to take annual required minimum distributions get a waiver of the 25% excise tax that could have otherwise applied to their 2024 RMDs. It is important to note that the excise tax is waived, not the RMDs. This distinction determines your options and your RMD obligations.

RMD Waiver vs. Excise Tax Waiver: Why the Distinction Matters

The distinction between waiving the RMD and the excise tax is critical because each affects the 10-year distribution period and rollover options differently.

The Impact on the Maximum Distribution Period

Typically, when the IRS waves RMD for a year, that year is not counted when determining an individual’s RMD obligation. For example, when RMDs were waived for 2020 under the Cares Act of 2020, the five-year rule was extended for another year.

Example: Tasheca inherited a traditional IRA from her uncle Damson in 2017. Damson was 65 years old at the time of his death, which means he died before his required beginning date (before he was supposed to start taking RMDs).

The terms of the IRA agreement provided that Tasheca was subject to the five-year rule, under which distributions are optional for the first four years and the account must be fully distributed no later than the fifth year. As a result, Tasheca would have been required to distribute the inherited account by the end of 2022 if the Cares Act hadn’t been enacted—Year 1: 2018; Year 2: 2019; Year 3: 2020; Year 4: 2021; Year 5: 2022.

However, because the Cares Act waived RMDs for 2020, Tasheca’s fifth year became 2023—Year 1: 2018; Year 2: 2019; Year 3: 2020 (Waived); Year 3: 2021; Year 4: 2022; Year 5: 2023.

Tasheca got an additional year because RMDs were waived for 2020.

The same rule applies when RMDs were waived for 2009 under the Worker, Retiree, and Employer Recovery Act of 2008, where the five years were extended to six years because 2009 is not counted for RMD purposes.

Additionally, there was no need for the IRS to waive any excise tax for 2009 or 2020 because there were no RMDs for 2009 and 2020.

The waiver of the excise tax for the 10-year rule is NOT the same as an RMD waiver.

The 10-year rule was created under Secure Act 1.0 for retirement accounts inherited after 2019, where 1) the inherited account must be fully distributed no later than the 10th year, and 2) distributions are optional for the first nine years after the account owner’s death unless exceptions apply.

The IRS admitted that the language in Secure Act 1.0 did not clearly explain the exceptions, where the following beneficiaries must take annual RMDs:

• A designated beneficiary (who is not an eligible designated beneficiary) who inherited a retirement account from someone who was already taking RMDs because they died on or after their required beginning date.
• A successor beneficiary who inherited an IRA from a primary beneficiary, where the primary beneficiary was taking life expectancy distributions.

As a result of this confusion, the IRS waived the excise taxes for these two classes of beneficiaries; first for 2021 and 2022, then extended to 2023, and finally, 2024. Had these been waivers of RMDs, the 10 years would have been extended to 14 years because those four years would not have been counted. However, because only the excise tax was waived, beneficiaries still have only 10 years to fully distribute their inherited account if they fall under either of these two classes of beneficiaries. Year one of the 10-year period is the year after the account was inherited.

Planning Question

If beneficiaries do not take RMDs because of these waivers of the excise tax, they will have a shorter period within which to distribute their inherited account.

This would mean having to withdraw larger amounts each year, which could negatively impact income tax owed on their distributions. For example, if you inherited an IRA in 2020, and you do not take RMDs for 2021 through to 2024, you would have only six years over which to distribute your inherited IRA.

On the other hand, it could be more tax-efficient to put off RMDs until later if warranted by a change in income circumstances.

Be sure to consult with your tax advisor about your distribution strategies. Your tax advisor should also consider other factors, such as the impact an RMD withdrawal could have on state and other benefits.

The Impact on Rollover Options

If a taxpayer takes a distribution from their IRA or employer plan account, they can roll over that distribution as long as the amount is eligible to be rolled over. The rollover would result in the amount continuing to benefit from tax-deferred growth. Talk to your tax advisor about deadlines and other rules that might apply to your rollovers.

An RMD is an example of an amount not eligible to be rolled over.

When RMDs were waived in 2020 under the Cares Act, eligible individuals who took distributions in 2020 because they thought they had to take RMDs were permitted to roll over those distributions that would have otherwise been classified as RMDs.

Example 1: Lori attained age 72 in 2020 and received a notification from her IRA custodian that she was required to take a RMD of $20,000 from her IRA for 2020. Lori withdrew the $20,000 in January 2020. However, Lori was permitted to roll over the $20,000 because RMDs were waived for 2020.

While a nonspouse beneficiary may not roll over a distribution from an inherited account, the IRS made a technical exception by allowing beneficiaries to “repay” their inherited accounts for the amounts they withdrew in 2020 because they thought they had to take those distributions under the RMD requirements. No such provisions have been made for the two classes of beneficiaries described above. Because RMDs were not waived for these years, distributions taken by these nonspouse beneficiaries may not be rolled over or repaid.

Example 2: Michael inherited a traditional IRA from his mom, who died at age 89 in 2022. Michael is not an eligible designated beneficiary. As a result, Michael must take annual distributions over his life expectancy and fully distribute the account no later than 2032.

Michael took his 2024 RMD of $40,000 in March. The IRS announced the waiver of the excise tax for 2024 in April after Michael took his distribution.

Michael may not roll over or repay the $40,000, because it is an RMD and his RMD is not waived. If Michael had not taken the 2024 RMD of $40,000, he would not be subject to the excise tax because it is waived for beneficiaries who are subject to the 10-year rule and required to take annual RMDs.

Will RMDs Be Waived for These Beneficiaries?

At the time this article is being published, the status remains that the excise tax is waived for beneficiaries subject to the 10-year rule who are also required to take annual RMDs. RMDs are not waived.

A Call to Action to the IRS

The IRS has been moving the goal post for the waiver of the excise tax discussed herein from year to year, and it is uncertain whether they will continue to do so. While the IRS does not make tax laws, it has the ears of the public and the influence to ask Congress to waive RMDs for these affected beneficiaries, thereby extending the 10 years. The sentiment trending on social media is that the continued waiver of the excise tax (and not RMDs) is confusing to taxpayers, and it would be more helpful to waive RMDs, thus extending the 10-year period for impacted beneficiaries. Let’s hope the IRS takes action that favors taxpayers.