In the middle of 2014, a father changed beneficiary forms on two IRAs (one Roth and one a traditional IRA) in which he named as primary beneficiaries his eldest son (50%) and his daughter (50%). The father’s youngest son, and half-brother of the other two, was named contingent beneficiary (thus, he inherits if both eldest siblings died). Later in 2014, the father died and the eldest son died a month prior to the father. The daughter was the remaining primary beneficiary and the rightful owner of the account. The half-brother disagreed and sued the sister.

The bank, the plaintiff and the defendant allowed the defendant (i.e., the daughter) to take the Required Minimum Distributions (RMDs) as the lawsuit transpired. In other words, the defendant received and paid taxes on RMDs taken in 2015, 2016, 2017, and 2018. Also, the 1099-Rs submitted by the bank to the IRS showed that these two accounts were an inherited IRA and inherited Roth and that the defendant was receiving the RMDs as the inherited owner of these two accounts.

Now after four years of litigation, the defendant wishes to settle with the plaintiff, who is demanding half of each of the IRAs and he wants the return of half of the RMDs received by the defendant in 2015, 2016, 2017, and 2018 for both accounts.

It should also be noted: a judge recently (i.e., in 2019) ruled that the 2014 Roth beneficiary forms were invalid because the decease’s eldest son was named on the form even though he had died the day before the father changed the beneficiary forms. The judge said that naming a dead person went against the POA act. (Note: The father didn’t know the son had passed away. And it really shouldn’t matter because the form indicates that if a primary beneficiary predeceases the owner, then the remaining percentage goes to the remaining primary beneficiary.) In contrast, the 2014 Larger IRA beneficiary forms has not been invalidated and is scheduled for trial, which wouldn’t take place until 2020. Regardless, the defendant doesn’t wish to waste any more money or time in this legal battle; she is ready to give into this legal extortion. However, she also doesn’t want to have future problems with the IRS.

We are unclear how this division will work from a tax perspective, especially since there are private letter rulings that show that the IRS has disregarded the retroactive effect of State court decrees for Federal tax purposes.

Some of our questions/thoughts are:

1. Would the IRS even allow for a court order settlement to revert back to prior beneficiaries, especially after actions have been taken over the last four years in that RMDs have been paid out to the defendant and she paid taxes on those monies? (I’m guessing no because you cannot put money back into inherited accounts. In other words, there is no way she can return the money into accounts that already took RMDs.)

2. And if the IRS would not recognize a retroactive effect since RMDs have been taken over the last four years, then can the defendant relinquish ownership of these inherited accounts back to the deceased father’s estate? In other words, the deceased father’s 2014 IRA and Roth beneficiary forms were considered valid from 2014-2018 and thus, canceled out the prior beneficiary forms as stipulated by the bank’s IRA Simplifier contract. Thus, the effect of the court order of invalidating the Roth in 2019 and the proposed court order settlement of surrendering the traditional IRA in 2019 would be similar to now saying that these two accounts have no beneficiaries because we cannot go backwards (the prior beneficiary forms were in 2004 and 1999). If that is the case, then these two accounts would pass to the deceased father’s estate via the father’s pour over will and trust, which indicates that all children inherit equally. And at this point, can the defendant then tell the estate to proportion the percentage distribution so that the plaintiff gets more of the monies in order to account for the prior distributions taken by the defendant? (Remember, he wants half of all distributions paid back.)

3. If the defendant can surrender her rights for settlement to the father’s estate only to retrieve them again; albeit at significantly lesser amounts, but still sustaining the accounts as an inherited IRA and an inherited Roth, then does she still use her age to take RMDs as she did in 2015-2018, or now do both the defendant and the plaintiff have to use their father’s age? (Father was 79 at time of death, defendant was 49 at the time of first RMD and plaintiff was 25).

4. Lastly, if the defendant surrenders the IRA and Roth to the deceased father’s estate, then is it recommended that they not do anything about the prior taxes paid in 2015-2018? In other words, the daughter paid the taxes on the traditional IRA and took the required distributions on both the IRA and Roth as the rightful owner during those years. So I’m guessing the IRS won’t care who pays the taxes as long as the taxes are paid and the RMDs were taken. Granted the plaintiff is benefiting from the sister’s actions but if that’s what it takes to end the lawsuit so be it.

Any guidance would be most appreciated.