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Taxes on an inherited IRA

 

Dear Tax Talk,
Recently an IRA account was left to me from a deceased relative. Can I liquidate the account without penalty since the account owner was 81 years old? Will I have to claim the income on his or my tax return? Thank you. -- Heath

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Dear Heath,
One of the only good things about death is it forgives a lot of things for taxes. One thing it forgives is the 10-percent penalty on early withdrawals from an individual retirement account.

I assume this deceased relative was not married to you, because that changes the answer. If you inherit a traditional IRA from anyone other than your deceased spouse, you cannot treat the inherited IRA as your own. This means that you cannot make any contributions to the IRA. It also means you cannot roll over any amounts into or out of the inherited IRA. However, you can make a trustee-to-trustee transfer as long as the new IRA account is set up and maintained in the name of the deceased IRA owner for the benefit of you as beneficiary.

Like the original owner, you generally will not owe tax on the assets in the IRA until you receive distributions from it. However, distributions, either in whole or in part, are income to you. You must begin receiving distributions from the IRA under the rules for distributions that apply to beneficiaries (as opposed to the rules that apply to owners).

Since the owner-relative was required to take distributions from the IRA, you need to determine if he or she took the required minimum distribution in the year of death. If not, you'll have to. You can continue to take IRA distributions over your life expectancy (assuming you are younger than the deceased) or you can take it all at once within five years of death. Life expectancy tables are found in IRS Publication 590, Individual Retirement Arrangements.

For example, let's say your uncle died in 2003. You are the designated beneficiary of your uncle's traditional IRA. You are 53 years old in 2004. You use Table I and see that your life expectancy in 2004 is 31.4 years. If the IRA was worth $100,000 at the end of 2003, your required minimum distribution for 2004 is $3,185 ($100,000 divided by 31.4). If the value of the IRA at the end of 2004 is again $100,000, your required minimum distribution for 2005 would be $3,289 ($100,000 divided by 30.4). Instead of taking yearly distributions, you could choose to take the entire distribution in 2008 or earlier.

Since the rules relating to inherited individual retirement accounts are complex and fraught with minutiae, you should consult a professional tax adviser about the particulars of your inheritance, especially if you plan to keep the funds in the IRA to avoid paying taxes or you suspect the owner had basis in the IRA.

 
-- Posted: Sept. 9, 2004
   

 

 
 

 

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