Recent letter ruling must be considered before bequeathing retirement account to private foundation.

• Author: Weiner, Alan E.

With the Federal and state estate and income taxes imposed on the benefits of funds received from retirement plan (corporate, Sec. 401(k), Keogh, individual retirement account (IRA), etc.) accounts, philanthropic individuals are being advised to consider naming their private foundations as the recipients of these proceeds.

When a charity (whether publicly supported or a private foundation) receives the proceeds of a qualified retirement plan account,it receives 100% of the account's gross value (unless Sec. 4980A, which imposes a 15% excise tax on an excess retirement plan accumulation, applies). That is, the retirement plan proceeds are not subject to income taxes (which the decedent or the decedent's beneficiaries would have paid), nor are they subject to estate taxes (as the estate will be entitled to a charitable deduction equal to the value of the retirement plan account). Disregarding the estate tax marital deduction, which only postpones the payment of estate taxes until the second spouse dies, the result of such a bequest is that the cost to the decedent's beneficiaries is only 25% (approximately) of the qualified retirement plan account's gross value. Since the normally charitable decedent would have, no doubt, left a substantial amount to charity in any event, the bequest of a retirement plan account should not unduly upset the beneficiaries and, in fact, should please them.

However, the IRS has now released Letter Ruling 9633006, which stands for the proposition that the 2% excise tax, imposed under Sec. 4940 on the net investment income of private foundations, applies to a portion of the retirement plan proceeds received by a private foundation. How the Service arrived at its conclusion is an exercise in obfuscation. Note that, since publicly supported charitable organizations are not subject to the 2% excise tax on net investment income, the letter ruling does not apply to those organizations.

The IRS's error, the authors believe, was in failing to recognize the firewall established under Sec. 691 (income in respect of a decedent or IRD). Simply put, pension income bequeathed to a decedent's beneficiary (whether it is an individual or a private foundation) is IRD under the principles of Sec. 691. Since the decedent would have recognized the pension account proceeds as taxable income, so must the beneficiary; however, in the case of a private foundation, no regular income tax is payable. In fact, if the retirement plan proceeds...