"They turned in some paperwork within the nine-month window as their IRA Custodian had advised in order to be considered a "qualified disclaimer". However, now IRA Custodian is saying they needed something else. They are disputing this."
Just because the custodian claims they missed the deadline does not make it so. The custodian may be correct, of course, but if the dollar amount is significant, it might be worth hiring an enrolled agent to double check.
"The problem here is with the fact that this is a retirement account (specifically, an IRA) which you cannot really "gift" to another person."
This is true if the disclaimer was not properly performed. A retirement account can't be given to someone else. It could be cashed out and the money given to someone else (with the owner-heir paying the tax) but the account can't be given away. However, the inheritance can be disclaimed, and a disclaimed inheritance is not a gift.
Then separately, you need to look at the tax consequences. I agree that if the disclaimer was not done in a timely fashion, the daughters owe the income tax. However, the taxpayer disputes that the disclaimer was untimely. As I said, that may require an expert to look into.
@Tbsfca
1. I believe that a spouse can't legally pick IRA beneficiaries for more than 50% of the account, unless the other spouse signs a waiver. (The spouse can't be accidentally or deliberately disinherited without their agreement.) Did the surviving spouse sign such a waiver? Or are we just discussing the other 50% which was left to the two daughters?
2. If the goal of the daughters is to return the funds to their mother's spouse, why are they trying to disclaim the inheritance knowing the accounts will go to the grandchildren?
3. Assuming the disclaimer was untimely, then I suggest the daughters keep the inherited IRAs in their name and hold the money "in trust" informally for the other spouse. There are several reasons why it may be advantageous for an elderly parent to not have too much ready funds. If the daughters are trustworthy, they can keep the accounts, withdraw a little for their parent (or stepparent) as needed, and take out a little extra to cover their own tax burden. And as @Anonymous_ points out, if the disclaimer was untimely, the daughters have tax consequences anyway, so they might as well keep the accounts in their own names.
The family may also want to discuss the other parent's financial situation with an attorney who specializes in estate planning.
4. If you believe the custodian is wrong and the disclaimer was timely, you will need to pay an expert to prove to the custodian. I suggest an enrolled agent, which is an accountant specially trained and accepted to practice before the IRS.
