The legal theory of escheatment dates way back. It originally comes from old English common law. When a person with no heirs died, their property would revert back to the King. The goal was to prevent property from falling into limbo and disuse. In recent years, escheatment has changed and states have gotten much more aggressive. There has been an increase in state activity to make it easier to claim abandoned property as a source of revenue to plug budget gaps.
Escheatment and IRAs
Because IRAs are not like other property this has raised many issues as to how exactly escheatment should be handled by IRA custodians. To provide some answers, and to be sure that Uncle Sam gets his share of the abandoned property money pot, the IRS has now issued guidance. In Revenue Procedure 2018-17 Withholding and Reporting With Respect to Payments From IRAs to State Unclaimed Property Funds, (released May 29, 2018) the IRS explains how custodians should treat IRAs that are escheated to the state when it comes to reporting and withholding. The IRS guidance makes it clear that any IRA escheated to a state as abandoned property must be reported on Form 1099-R as a taxable distribution. It also clarified that the withholding rules apply. When there is no withholding election made, the custodian must withhold 10% of the distribution.
What Does this Mean for Your IRA?
No one wants their IRA to be escheated for many reasons. Now you can add to the list the fact that the IRS has now made it clear that escheatment will result in a taxable distribution. You will have a tax bill and the state will have your IRA. The only silver lining is that states have procedures to reclaim your funds. Can you deposit those funds back into your IRA? Chances are the 60-day rollover deadline will be long passed. In Private Letter Ruling 201611028, the IRS did allow a late rollover of escheated funds.
The bottom line is that it is best to be proactive and take steps to be sure your IRA is not escheated to the state. Escheatment rules will vary from state to state but there are some things every IRA owner can do. Contact your IRA custodian on a regular basis to keep your account active. Be sure your custodian has your current contact information and check to see that you are getting regular account statements.