Do I Pay Federal Tax on an Inherited IRA or Just State?

by Alibaster Smith ; Updated July 27, 2017

When you inherit an IRA, you may have to pay tax on the amount you receive. Whether an immediate tax liability applies to your situation depends entirely on your relationship to the original account owner. In general, you must pay income tax on all inheritance amounts, unless you receive your inheritance from a Roth IRA.

Spousal Inheritance

When you inherit money from your spouse, you don't have to take the distribution right away. You may elect to treat the IRA as your own. If you do take the IRA, and treat it as your own, you may make additional contributions to the account or take withdrawals as you would from your own IRA. Alternatively, you may transfer the money from your deceased spouse's IRA into a new IRA that you own and control. If the new IRA is a traditional IRA, you pay no taxes on the transfer.

Nonspousal Inheritance

Nonspousal IRA inheritances must be taken. You cannot treat the IRA as your own. You must take the IRA over a period of either five years or over your lifetime. If you elect a five-year distribution, you must start taking distributions within one year after the original account owner's death. The account must be completely liquidated by December 31st of the fifth year following the account owner's death. If you elect lifetime withdrawals, those withdrawals must start immediately and must be based on your life expectancy using the mortality tables found in the appendix of IRA publication 590. Additionally, the withdrawals cannot extend beyond your lifetime.

Warning

If you do not take your withdrawals according to the IRS rules for nonspousal withdrawals, you will be liable for a 50 percent penalty on the amount you should have withdrawn but did not. This penalty applies for every year that you fail to take the correct distribution amount. This penalty is part of the required minimum distribution penalty (RMD penalty) which is similar to the penalty imposed on the original account owner for failure to comply with required minimum distributions from IRAs at age 70 1/2. Unlike the penalty imposed on the original account owner, this penalty applies to all inherited IRAs (both traditional IRAs and Roth IRAs). So, even though the Roth IRA normally is not subject to required minimum distributions, inherited Roth accounts are.

Tax Due & Penalty Exemption

When taking money under either scenario (spousal or nonspousal inheritance), the 10 percent early withdrawal penalty is waived. Normally, you are liable for a 10 percent penalty on any IRA amounts withdrawn prior to your age 59 1/2. However, the IRS considers this requirement to be met with the death of the original account owner.

Finally, you may be liable to pay federal income tax as well as state tax on your inheritance. Ordinary income tax is due on all inheritance distributions unless you are inheriting a Roth IRA. Since the Roth IRA is tax-free, the Roth is not taxed when passed to beneficiaries. Traditional IRAs are taxed as normal.

References

  • "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu, Robert A. Crane; 2007
  • IRS.gov: Publication 590

About the Author

I am a Registered Financial Consultant with 6 years experience in the financial services industry. I am trained in the financial planning process, with an emphasis in life insurance and annuity contracts. I have written for Demand Studios since 2009.

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