22 Jun Tax Implications of Inherited IRAs
Taxpayers who inheritIRAs also inherit thedecedent’s basis or amount invested in thoseIRAs, regardless of the relationship between the beneficiary and the decedent. Ideally, thedecedent will have filed IRS Form 8606 (Nondeductible IRAs), showing the amountof basis in the IRA. Any remaining basisin the IRA shown on Form 8606 thenbecomes the beneficiary’s basis. However,if the decedent did not file Form 8606,the taxpayer has the same challenges asany IRA owner in demonstrating that heor she has basis in the IRA.
If the decedent had no basis in the IRA at the dateof death, the beneficiary is taxed fullyon distributions from the inherited IRAwhich must equal or exceed the Required Minimum Distribution (RMD). If the decedent did havebasis in the IRA, the beneficiary mustfile Form 8606. The 1099-R issued by thepayer should identify whether there isbasis in the IRA.
Generally, there are several optionsfor how tohandle the inherited IRA,and the RMD rules differfor each option as follows:
1. Treat the account as your own IRA bydesignating yourself as the account owner.If you treat the IRAas your own, you will have to take RMDs if over 70 1/2.However, you may use your own life expectancy for the RMD calculation,so theoretically less will be withdrawn from the accountwith each distribution.
2. Roll the IRA into your own existingIRA or qualified plan subjecting yourself again to the RMD
3. Treat yourself as the beneficiary of theIRA instead of the owner andbegin takingdistributions over your life expectancy.
The basis and Fair Market Value (FMV) of an inherited IRA are kept separate from yourbasis and FMV in your own IRA. If youelect to treat the inherited IRA as your own, the inherited IRA could beaggregated with your other IRAs on Form 8606.
Beneficiaries must begin to take requireddistributions from the account by December 31 following the year of death. If thebeneficiaries are nonresident aliens for U.S.tax purposes, the IRA trustee may need towithhold U.S. tax on the distributions.
If the owner of an IRA dies before reachingthe required beginning date for RMDs,each beneficiary can take required minimum distributions based on their own lifeexpectancy, or take a distribution of theentire account balance by December 31 ofthe calendar year that includes the fifthanniversary of the decedent’s death.
Unfortunately, according to IRC 4974 if an RMD is not taken,a hefty fifty-percent excise tax may beassessed. Penalties arereported on IRS Form 5329. The IRS however may waive the fifty-percent penaltyif there was a reasonable cause for failingto take the distribution such as erroneousadvice given, and steps to correct the error havebeen taken.
If there was a reasonable cause for failureto take the RMD, the taxpayers need not paythe fifty-percent excise tax when they filetheir tax returns. Form 5329 instructionsdirect the taxpayer to complete lines 50 and51 and enter “RC” and the amount of waiverrequested on the dotted line next to line 52.This amount should be subtracted from thetotal, with the tax paid on the remainingamount (line 53).