Dear Tax Talk,
My father had an individual retirement account worth about $20,000 that I just inherited at his death. I'm told that now I will have to pay taxes on this money. Is this true? I thought inheritance taxes don't kick in until around $600,000 or $700,000 is inherited.
Yes, as the beneficiary of the IRA that was inherited from your father, you must include any taxable distributions you receive in your income.
The reason you have to pay income tax on this account is because your father deferred paying taxes on the amounts he contributed to the IRA plus any growth in the account over the years it was invested. Plain and simple, the IRS wants the tax on that income at some point and now it comes from you as the beneficiary.
The estate tax you refer to is a separate tax on the gross estate of a person who has died. For 2014, an individual can have up to $5.34 million in his or her gross estate before it is taxed. And yes, IRAs are includible in the gross estate, which leads many people to believe that IRAs are now taxed twice -- once at the beneficiary level and then at the estate level.
However, if you go back to the premise that the income had been tax-deferred all this time, it does start to make some sense.
Please accept my sympathies on the loss of your father and thanks for the great question.