Escheat Laws for Abandoned IRAs and Unclaimed Property
Many financial organizations struggle with IRAs that are left unclaimed or abandoned. How must these IRAs or other assets be handled to satisfy both a financial organization’s duty as trustee or custodian and its desire to “clean up” inactive accounts?
In the United States, escheat laws grant individual states rights to abandoned property. Each state has its own laws setting procedures and timelines for reporting and reverting unclaimed or abandoned property to the state. Each financial organization should determine how any relevant state law treats abandoned property. Competent legal counsel should be consulted to provide specific procedures to properly report and pay unclaimed accounts.
Identifying Abandoned IRAs
Section 2 of the Uniform Unclaimed Property Act (i.e., the Act) provides guidance for IRAs (and other deposits at financial organizations) that are presumed abandoned. In general, accounts are presumed abandoned if the IRA owner has not communicated an interest in the account after three years following the date distributions are required to begin. IRAs can be vulnerable because IRA owners can let their accounts grow without any activity (e.g., for Traditional IRAs, until they must start required minimum distributions at age 70½).
- Escheat periods vary by state (five or seven years is common).
- Some states do not start the escheat period until the required beginning date (i.e., April 1 following the year the IRA owner attains age 70½).
State escheat laws normally do not distinguish between IRAs and other accounts. If a financial organization discovers this is true in its state, then it should apply the normal escheat rules to IRAs.
Locating Missing IRA Owners
Each year, financial organizations must report to the state administrator or treasurer those accounts or funds presumed to be abandoned under the Uniform Unclaimed Property Act. Before this is done, however, the financial organization must again attempt to inform the apparent IRA owner at her last known address that the financial organization holds the property.
Reporting Abandoned IRAs to the State
If locating efforts are fruitless, the financial organization must file a report with the state. Individual state law prescribes what information must be included in the report. The report generally is due before November 1 of each year, reflecting property presumed abandoned as of June 30 of the same year. Later in the year the state will publish a notice titled Notice of Names of Persons Appearing to be Owners of Abandoned Property. This notice appears in a newspaper circulating in the specific county that contains the IRA owner’s last known address and reveals information about when and how property may be claimed. In addition, the state must again mail a notice to each missing IRA owner whose last known address is listed in the report.
Paying Unclaimed IRAs to the State
The Uniform Unclaimed Property Act states that within six months after the final date for filing the report, all abandoned property required to be reported must be paid or delivered to the proper state administrator. The financial organization should complete and retain a withdrawal statement, detailing the reason for the distribution. In most states, the government takes custody, not title, of the property. Under the Act, the state waits three years, then sells the property (if other than cash) to the highest bidder at a public sale. If an owner subsequently makes a proper claim to an IRA, the state generally will pay or deliver the IRA to the owner.
The Act protects financial organizations that pay abandoned property in good faith. It also provides for criminal penalties for persons who willfully violate the Act. Failure to report abandoned property is punishable as a misdemeanor offense. Failure to pay or deliver the property to the state is a gross misdemeanor offense.
Withholding and Reporting for Escheated IRAs
Before 2018, it was unclear how federal income tax withholding and reporting for IRA assets that are paid to the states should be completed. Ascensus position on this matter was confirmed by the IRS when it released Revenue Ruling 2018-17 in May 2018.
This revenue ruling states that payments made in this manner are treated as includable in gross income, and therefore are designated as distributions subject to the federal income tax withholding rules for IRAs. If the IRA owner had made a previous withholding election that is on file, the financial organization can honor that election.
Revenue Ruling 2018-17 also states that the distributing financial organization must report these payments on the applicable year’s Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., identifying the IRA owner with the last known address as the recipient, using the owner’s Social Security number, and reporting in Box 7 with code 1, Early distribution, no known exception, or code 7, Normal distribution, as applicable. If the IRA is owned by a beneficiary, code 4, Death, should be entered in Box 7.
The revenue ruling further states that for payments made before the earlier of January 1, 2019, or the date it becomes reasonably practicable to comply with the requirements, the financial organization will not be treated as failing to comply with these withholding and reporting requirements.