Introduction

Congress dramatically changed the legal landscape governing IRAs and other retirement accounts on December 20, 2019, with the passage of the Setting Up Every Community for Retirement Enhancement Act, commonly known as the SECURE Act. The SECURE Act launched into the forefront of advisors’ minds shortly thereafter, with an effective date of January 1, 2020, leaving a mere 11 days for advisors to digest a thicket of provisions that would upend estate plans and disappoint beneficiaries. Lawmakers followed that up in 2022 with a companion law known as “SECURE 2.0.”  On February 24, 2022, the Internal Revenue Service (the “IRS”) issued proposed regulations under the SECURE Act, leading to a flurry of professional analysis particularly with respect to the proposed regulation provisions that contradicted tax professionals’ understanding of the 2019 law. On July 19, 2024, the IRS finalized regulations under the SECURE Act. It also proposed additional regulations under SECURE 2.0.

In addition, the IRS has also issued final regulations under the basis consistency rules enacted in 2015. Those rules are likely most notorious for the severe penalties under the IRS’s 2016 proposed regulations: in particular, that an asset might be deemed to have zero basis if not reported correctly. The final regulations now provide some common-sense improvements to those rules.

This article outlines the key highlights from the final and proposed regulations under the SECURE Act and SECURE 2.0, respectively, as well as the final basis consistency regulations.

Final Regulations under the SECURE Act

Required Minimum Distributions following Owner’s Death

Under the SECURE Act, IRA beneficiaries (with some exceptions) must withdraw the entire IRA over a ten-year period (the “ten-year rule”). The law was silent, however, on whether the beneficiary must take a required minimum distribution every year during that ten-year period, or if they could instead wait until the tenth year to withdraw the entire account. Some practitioners anticipated the latter approach would apply – thus allowing the account to grow tax-free for ten years.

The IRS’s 2022 proposed regulations nixed that strategy for many IRA owners. Under the proposed regulations, if the IRA owner had reached her required beginning date (“RBD”), the beneficiary had to take required minimum distributions (“RMDs”) each year.

The final regulations have retained this rule. If the IRA owner had not reached her RBD, the beneficiary is not required to take a RMD each year. She may allow the funds to remain in the IRA until the tenth year and then take one, lump-sum distribution.[1]

But, to the chagrin of many advisors, the beneficiary will not have this option if the IRA owner had reached her RBD. There, the beneficiary must take a distribution each year, with the entire IRA account being depleted in the tenth year.[2]

The IRS also did not extend the deadline while it worked on the regulations. Therefore, if a beneficiary inherited an IRA in 2020 from her 82-year-old mother (who would have reached her RBD), the beneficiary must take an RMD each year and fully deplete the account by 2030.

RMDs for Elderly Beneficiaries

The IRS’s proposed regulations included a rule known as the “shorter of” rule that penalized elderly beneficiaries. The “shorter of” rule stated that a designated beneficiary of an account owner who died after reaching their RBD must withdraw the entire IRA before the earlier of (a) the final year of that beneficiary’s life expectancy or (b) the final year of the account owner’s life expectancy. For example, Eli dies at age 78 leaving his IRA to his older brother, Peyton. Peyton can stretch the IRA only over his own life expectancy. If Eli had instead left the IRA to his estate – a “non-designated beneficiary” – the estate could have stretched the distributions over Eli’s remaining life expectancy. Because Eli is younger than Peyton, the estate would be able to take the withdrawals over a longer period of time than Peyton.

The final regulations correct this unfairness. Now, Peyton may stretch the withdrawals over the longer of (a) his life expectancy and (b) Eli’s life expectancy.[3]  Clients and their beneficiaries can defer more taxes – and advisors can now sleep easier.

Children as Beneficiaries

The final regulations also provide some helpful guidance where the beneficiary is a minor child. First, the IRS interpreted “child” to include stepchildren and certain foster children as defined in Internal Revenue Code § 152(f)(1).[4]  Next, the IRS confirmed that payments from a trust to a custodian for a minor beneficiary would be considered a distribution for the child’s benefit.[5]

Finally, the IRS enabled clients to leave an IRA to a “pot” trust for multiple young children without inadvertently accelerating the IRA payout. Under the proposed rules, the final payout of the IRA would have been based on the oldest child’s age. This rule resulted in accelerated payouts, particularly where there was a significant gap in the children’s ages.

Under the final regulations, the ultimate payout is based on the youngest child’s age. Thus, an IRA owner may leave their IRA to a trust for the benefit of their two minor children. The trust is not required to empty the IRA until the earlier of (a) ten years after the death of the last surviving minor child and (b) ten years after the youngest minor child reaches the age of majority.[6] Furthermore, the IRS finally provided clarity in the final regulations by defining the age of majority to be age 21.  Thus, the trustee can stretch IRA distributions until each of the children reach age 31.

Naming Trusts as Beneficiaries

Under prior rules, if an account owner left their account to a trust that would divide into separate “sub-trusts” for various beneficiaries at their death, all the sub-trusts were lumped together. For example, if an account owner chose to name their revocable trust as the beneficiary with the understanding that separate sub-trusts would be created after their death for each of their children. The trusts were then required to take distributions based on the oldest beneficiary’s distribution schedule. Thus, a trust beneficiary who could otherwise qualify for the lifetime stretch (such as a beneficiary with disabilities, or a minor child of the account owner) might be required to empty the IRA after only ten years.

The final regulations provide some flexibility for clients, but only if the trust document contains necessary language. Each sub-trust may be treated as a “separate share” so that the trust for the child with disabilities may take the lifetime stretch while the trust for the non-disabled child must withdraw its portion of the IRA over ten years.[7]

To qualify for separate share treatment, the trust must be a see-through trust (as is already required for a trust to qualify as a designated beneficiary). Moreover, the trustee cannot have any discretion in allocating retirement assets among the sub-trusts.[8]  Standard trust terms typically provide that the trustee may “pick and choose” how to fund each trust – for example, by funding one trust with marketable securities and another with real estate. Such standard provisions would disqualify a trust from taking advantage of this rule.

The separate share rule is a happy addition to the regulations because it may allow an account owner to name their revocable trust as the account beneficiary rather than specifying which sub-trust, and in which percentage. This should simplify IRA beneficiary designation forms for account owners with properly drafted trusts. However, there may be situations where the client is best served by allowing the trustee to retain the power to pick-and-choose how to divide a retirement account. In those cases, advisors should continue using the “old” practice of naming the sub-trusts on the IRA beneficiary designation forms.

Proposed Regulations under SECURE 2.0

In addition to the final regulations under the SECURE Act, the IRS also issued proposed regulations under SECURE 2.0.  Although the proposed regulations may change, they provide an important window into the IRS’s priorities and thinking.

Applicability Dates

The amendments to §§1.401(a)(9)-4, 1.401(a)(9)-5, 1.401(a)(9)-6, 1.401(a)(9)-8, 1.401(a)(9)-9, and 1.408-8 are proposed to apply for purposes of determining required minimum distributions for calendar years beginning on or after January 1, 2025. The amendments to §1.402(c)-2 are proposed to apply for distributions on or after January 1, 2025. Thus, these amendments would have the same applicability dates as the corresponding provisions in the final regulations.

Ten Year Rule for Spouses

The proposed regulations create a concerning possibility: that the IRA plan document might require eligible designated beneficiaries to take a ten-year payout instead of a life expectancy payout. This may occur if the account owner dies before the RBD.

If the plan document imposes this ten-year payout on an eligible designated beneficiary, they may have two primary options. First, they may be able to make a section 327 election out of the ten-year rule treatment and instead receive the expected life expectancy payout. Notably, if the spouse inherits their spouse’s IRA in a conduit marital trust that would otherwise qualify for the life expectancy payout, but a section 327 election is required, it is the spouse who must make such election personally and not the trustee of the trust that owns the IRA.  Second, if the plan document imposes the ten-year rule on all eligible designated beneficiaries, the account owner or the beneficiary should consider moving the account to a new, more favorable custodian. Advisors should keep in mind various deadlines for each option.

Transferring Account to a New Custodian

The beneficiary – whether an individual or a trust – may also transfer an account to a new custodian if the beneficiary finds the inherited account is not favorable. For example, as discussed above, the IRA plan might require a ten-year payout even for a spouse. In a situation like that, the beneficiary may require the custodian to make a direct transfer to another inherited IRA with a new custodian. If the beneficiary is the surviving spouse, the beneficiary has two additional options: (a) they may treat the inherited IRA as their own, or (b) they may roll over distributions into their own IRA. Note, however, that the second option is not available even to conduit trusts.

Closing of Surviving Spouse Loophole

Some commenters noted that SECURE 2.0 created a potential “play” for taxpayers where the younger spouse dies first. For example, if Fred dies at age 68 (before his RBD), survived by his wife, Wilma, age 76. Wilma, having reached her RBD, might consider keeping Fred’s IRA in his account for nine years. During that time, Wilma will not need to take an RMD. Then, in year ten, Wilma could rollover the account to her IRA. Wilma would therefore postpone a significant amount of withdrawals from the IRA. The proposed regulations quash that plan. Wilma would be required to take a “catch-up” distribution from Fred’s IRA before transferring the account to her IRA.[9]

Impact of Outright Distribution to Trust Beneficiary

The final regulations provide rules for the separate application of section 401(a)(9) of the Code with respect to multiple beneficiaries of a see-through trust (within the meaning of §1.401(a)(9)-4(f)(1)). Specifically, §1.401(a)(9)-8(a) of the final regulations permits separate application of section 401(a)(9) with respect to each of the beneficiaries’ separate interests if the terms of a see-through trust meet certain requirements. One of those requirements is that the trust must provide that it is to be divided immediately upon the death of the employee, with the separate interests to be held in separate see-through trusts.[10]

Final Regulations for Consistent Basis Reporting on Property from an Estate

On July 31, 2015, President Barack Obama signed into law several new sections of the Internal Revenue Code instituting basis reporting requirements for executors, and requiring beneficiaries to consistently report the basis of inherited property as the value  of the property established for federal estate tax purposes.[11]  Under section 1014(f), a recipient’s income tax basis in certain property acquired from a decedent must be consistent with the value of the property as finally determined for federal estate tax purposes.  Section 6035 was instituted to facilitate enforcement of this rule, requiring executors to provide the estate tax values to the IRS and to the property recipients on new Form 8971 and its attendant Schedule A. The rules affect recipients of property from a decedent if that property increases federal estate tax liability.

The IRS issued proposed regulations on the topic in 2016.[12] The proposed regulations spurred a flurry of public comments, including detailed letters from the American College of Trusts and Estate Counsel (ACTEC) and the American Institute for Certified Public Accountants (AICPA), among others.[13]  The public comments derided certain aspects of the proposed regulations as, inter alia, unjustifiably harsh, impractical, and confusing.

After eight years of navigating the proposed regulations, advisers now can rest a little easier. On September 17, 2024, the IRS and the Treasury Department issued final rules with respect to sections 1014(f) and 6035.[14]  The final regulations adopted many of the changes proposed by ACTEC and AICPA and provided long-awaited clarity for executors and persons receiving estate property. In the final rules, the IRS made notable substantive revisions to 2016’s proposed regulations that it says are intended to make the regulations less burdensome for both the IRS and taxpayers. Furthermore, technical corrections were made to improve the organization of the rules and refine the language.

Elimination of the Zero Basis Rule

One significant departure from the proposed regulations is the removal of the so-called “zero basis” rule for property that was not reported on the Form 8971. The zero basis rule in the proposed regulations assigned an income tax basis of zero for any asset that was includable in the decedent’s gross estate and would generate or increase the federal estate tax liability, but was not reported on an estate tax return, possibly because the property was discovered after the estate tax return had been filed and beyond the statutory time period for filing an amended estate tax return, or because the property was inadvertently and in good faith omitted.[15] The final regulations removed this rule and avoid an unjustifiably harsh result for the beneficiary who may be at no fault for the actions of the executor.

Removal of Strict 30-day Deadline

Another improvement in the final regulations is flexibility in the deadline for providing basis statements to the beneficiaries. Under the proposed rules, there was a strict deadline of 30 days after the estate tax return was filed with the IRS.[16]  The Form 8971 and Schedule A basis statements report the estate tax value of all assets that the beneficiary has received or will receive. At that juncture in the estate administration, there is often uncertainty as to which beneficiary will receive which assets from the estate, and when, and it could take many months or years even after the filing of the estate return to complete a beneficiary’s distribution. To comply with section 6035, some executors deemed it necessary to include all possible assets the beneficiary might eventually receive from the estate, often blanketing the beneficiaries with more asset information than they might otherwise need or be entitled to and creating confusion.

Under the new final rules, the executor is not required to send the basis statement for a particular asset until after the determination of who is inheriting that asset, thereby reducing duplicative efforts and confusion.[17]  This change will significantly ease the reporting burden, although it does raise the possibility that the executor will need to send several basis reports if the distribution of the decedent’s assets occurs in multiple tranches.

Subsequent Transfer Rules Narrowed

The proposed regulations stated that beneficiaries who gift their inherited property also must separately report the gift under the estate basis consistency rules.[18]  The final regulations narrowed the scope of these so-called “subsequent transfer rules.”  Now, only trustees must report when they distribute the inherited property from the trust. Interestingly, the IRS’s rationale was partly that trustees, unlike beneficiaries, would be familiar with federal tax laws and able to comply with them. This rationale, though, ignores the fact that many trustees are laypeople, not professionals.

Valuation Questions Remain

One troublesome aspect of the proposed rules has not yet been put to bed. Some commenters on the proposed rules expressed concern that a beneficiary may believe the value of an asset was incorrectly reported on the estate tax return, but that beneficiary may have no input or avenue to challenge the estate’s valuation. The IRS declined in the final regulations to introduce a new or alternative valuation process but noted that it is considering future guidance that would allow a beneficiary to provide evidence to claim a different valuation.

Conclusion

The IRS has issued significant regulations in recent months. First, the IRS’s final and proposed regulations under the SECURE Act and SECURE 2.0 provide needed clarity and some benefits for clients. Advisors must understand these regulations so they can guide their clients through the legal thicket governing retirement plans in the United States. Moreover, in its final regulations on basis consistency, the IRS made significant, common-sense revisions to the proposed regulations to ease burdens on taxpayers and advisors.

Sarah J. Brownlow is a partner at Virginia Estate & Trust Law, PLC, in Richmond, Virginia. She advises individuals and families on estate and tax planning matters and advises fiduciaries on estate and trust administration matters. She has significant experience developing tax-efficient estate and trust strategies for clients in Virginia, New York, and abroad. Sarah lives in Richmond, Virginia with her husband and their energetic and joyful young daughters and dogs.

Scott W. Masselli is an attorney at Virginia Estate & Trust Law, PLC, in Richmond, Virginia. He advises clients in designing thoughtful estate plans that incorporate family goals and estate, gift, and generation-skipping transfer tax planning. He also has significant experience advising fiduciaries in estate and trust administration. Scott lives in Richmond, Virginia with his wife and two sons.

[1] Treas. Reg. § 401(a)(9)(B)(ii)-(iii).

[2] Treas. Reg. § 401(a)(9)(B)(i).

[3] Treas. Reg. § 1.401(a)(9)-5(d)(1)(ii).

[4] Treas. Reg. § 1.401(a)(9)-3(e)(1).

[5] Treas. Reg. § 1.401(a)(9)-4(f)(3)(iv).

[6] Treas. Reg. § 1.401(a)(9)-5(f)(2)(ii)(B), (C).

[7] Treas. Reg. § 1.401(a)(9)-8(a)(1)(iii)(B).

[8] Treas. Reg. § 1.401(a)(9)-8(a)(1)(iii)(C).

[9] Proposed Reg. § 1.402(c)-2(j)(4), § 1.408-8(c)(1)(iv).

[10] Treas. Reg. § 1.401(a)(9)-8(a)(1)(iii)(B).

[11] The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, Public Law 114-41, 129 Stat. 443 (Act). Section 2004 of the Act enacted sections 1014(f), 6035, 6662(b)(8), 6662(k), 6724(d)(1)(D), and 6724(d)(2)(II) of the Internal Revenue Code.

[12] 81 FR 11486 (03/04/2016).

[13] 2016 TNT 122-15 (06/23/2016).

[14] 89 FR 76356 (09/17/2024).

[15] Proposed Reg. § 1.1014-10(c)(3)(i)(B).

[16] Proposed Reg. § 1.6035-1(d)(1).

[17] Treas. Reg. § 1.6035-1(c)(3)(ii).

[18] Proposed Reg. § 1.6035-1(f).