3680 / When is a series of substantially equal periodic payments from an IRA “modified” and what are the results?

A modification to the series of payments generally will occur if the taxpayer makes any of the following: (1) any addition to the account balance (other than gains or losses); (2) any nontaxable transfer of a portion of the account balance to another retirement plan; or (3) a rollover of the amount received, resulting in such amount not being taxable.²

The IRS has determined that a change that does not alter the annual payout (such as a change from quarterly to monthly payments) is not a modification for this purpose.³ The receipt of a qualified hurricane distribution ( Q 3671) also will not be treated as a change in a series of substantially equal periodic payments.⁴ However, once a change to the RMD method has been elected, no further changes may be made to the method of payment.

The IRS has stated that an individual who begins distributions using either the amortization method or the annuitization method may, in any subsequent year, switch to the RMD method to determine the payment for the year of the switch and all subsequent years. Regardless of when the payments began, a taxpayer making such a change will not be treated as having made a “modification.”⁵

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Planning Point: The ability to switch to the RMD method makes the amortization and annuity methods more attractive, particularly for a participant who has a short term need for larger distributions which he or she expects will diminish in a few years. Martin Silfen, J.D., Brown Brothers, Harriman Trust Co., LLC, New York, New York.

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A taxpayer who made the one-time RMD method change late in 2002 was permitted to roll over amounts in excess of the RMD amount back to the IRA in early 2003 even though the 60 day limit ( Q 4016) had elapsed.⁶ The IRS determined that an inadvertent rollover of a small IRA balance into a large IRA from which a series of substantially equal periodic payments was in progress was not a modification.⁷

The IRS has also ruled that a series of substantially equal periodic payments was not modified where, as a result of an error made by the entity distributing the funds, additional distributions were made by the entity from a second account maintained by the taxpayer before the funds from the first account were exhausted. This resulted in two additional, unrequested distributions. The taxpayer was able to provide proof that the error was made after the entity maintaining the account was acquired by another entity. She further certified that she had not requested the additional distributions and did not intend to modify the series of substantially equal periodic payments. As a result, the IRS found that the additional distributions were not a modification of the series of substantially equal periodic payments.⁸

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Planning Point: Qualified plans often make a trailing distribution subsequent to making a lump sum distribution to a former employee’s IRA. The IRS currently holds the position that if the participant has started a 72(t) payout from the receiving IRA, the trailing distribution will trigger a modification. Participants starting a 72(t) payout following a lump sum distribution should consider moving the funds to a different IRA prior to beginning the payout. Robert S. Keebler, CPA, MST, Virchow, Krause & Company, LLP, Green Bay, Wisconsin.

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The commencement of another series of substantially equal periodic payments (i.e., from a different IRA) does not constitute a modification of an existing payout, and the IRS has stated privately that nothing in the IRC or regulations prevents a subsequent payout series.⁹ One case determined that a distribution from an IRA that satisfied the early distribution penalty exception for qualified higher education expenses was not a modification of a series of substantially equal periodic payments from the same IRA.¹⁰