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Tax Implications of Inheriting an IRA

Tax planning for a large IRA can pose a number of complex problems, resulting in part from the subtle interplay of several distinct and convoluted sets of tax rules.

On the death of the IRA owner, the IRA faces a potential tax double-hit. First, as a general rule, the value of the account is includable in the person’s taxable estate for federal and state estate purposes. Second, payments from the IRA to other beneficiaries are subject to income taxes, based on the “income in respect of a decedent” theory—that no income taxes were paid during the life of the original owner.

The inheritance rules generally appear most favorable to the surviving spouse who, before 70 ½ years of age, may rollover the IRA without an immediate penalty or tax consequence; whereas non-spouse or entity beneficiaries face stricter Required Minimum Distribution (RMD) requirements.

Inheriting an IRA for all beneficiaries, however, can lead to an avalanche of avoidable income tax liabilities or penalties, without the proper planning. For example, distributing the IRA to a generation that doesn’t need the assets may result in taxable distributions and the depletion of assets that could otherwise be avoided. And failure to satisfy an RMD may result in a stiff 50% federal tax penalty of the amount that should have been withdrawn.

At the Law Office of Eric P. Zine, we will work with you to reduce taxes, by exploring the following approaches in light of your objectives and goals:

  • “Spend now” to reduce the estate tax burden by beginning distributions as early as possible, in the hope of drawing down a significant portion of the IRA and thereby removing it from the IRA owner’s taxable estate.
  • Pay later” to defer the payment of the income tax for as long as possible through careful RMD planning and use of the marital deduction; and perhaps skipping a generation (within the generation-skipping tax exemption).

Although planning a large IRA generally involves a range of convoluted and complex tax and distribution rules, there are strategies and solutions that can make this a rewarding process for IRA owners and their heirs. There are many more planning options and much greater flexibility before distributions are taken from the IRA. Failure to adhere to the convoluted tax issues and distribution rules, however, may result in avoidable, taxable distributions and excess taxes and penalties, so careful and insightful planning is imperative.

To learn more about the Tax Implications of IRAs or any other aspect of Estate Planning or Elder Law, call Attorney Zine at 781.930.3003 or e-mail us to schedule a free consultation.