Can an Estate Pass the Tax Liability for an IRA to a Beneficiary?
If you have inherited an IRA from an estate as a named beneficiary, you may have some specific tax obligations that come with it. You can, indeed, inherit a tax liability with the IRA. The rules vary according to the nature of your relationship with the deceased, and the nature of the IRA. Roth IRAs typically are easier for beneficiaries to manage, because of the lack of required minimum distributions.
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Required Minimum Distributions
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To understand the rules for taxation of an inherited IRA, you must understand required minimum distributions. When the original IRA owner was alive, he took tax deductions on contributions and reaped the benefits of tax-deferred growth. Congress never intended for IRAs to be a free ride on taxes, though, and built in RMDs to ensure that the government eventually gets tax revenue on the IRA assets. All withdrawals are taxable as income. If the IRA holder does not make withdrawals by age 70 and a half, the law forces him to begin taking at least some income, and paying taxes, by April 1 of the following year. If he does not make the required withdrawal, the IRS assesses a penalty of 50 percent of the amount that should have been withdrawn. That RMD requirement does not go away when the original owner dies. It passes through to the beneficiary.
Rules for Spouses
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If you inherited the IRA from a spouse, you can elect to treat the IRA as your own by designating yourself as the owner, roll it into another IRA or employer plan, or treat yourself as a beneficiary. If there is an RMD required for the year and you do not take it, or if you make further contributions to it, the IRS will deem that you are treating the IRA as your own. You can only treat the IRA as your own if you are the sole beneficiary. By treating the IRA as your own, you may be able to delay RMDs, if you are younger than your deceased spouse.
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Rules for Non-Spouses
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Non-spouses may not elect to treat an inherited IRA as their own. This means you cannot delay the receipt of required minimum distributions and cannot make rollovers into or out of an inherited IRA. You are responsible for the tax liability arising from any withdrawals you make and the tax penalties for any RMDs you failed to make on time. If the owner died before making his RMD for the year, you may be required to take the RMD for that year that he would have been required to take, had he lived.
The Five Year Rule
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Nonspouses may be required to take the entire inherited IRA balance within five years of the death of the original owner. When this is the case, there is no RMD requirement until the fifth year, when the beneficiary must withdraw the entire amount. However, delaying the withdrawal may result in you paying a higher overall tax bill, as very large withdrawals concentrated in a single year may have the effect of pushing more dollars into a higher tax bracket.
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