How to Tax an Inherited IRA

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If you inherit an IRA, who you inherit it from determines how it can be taxed. If you inherit from your spouse, you have the option to treat it as your own IRA. If you are the beneficiary of someone who is not your spouse, the only option is to hold on to it and take distributions. In either case, you are normally not subject to taxes until the time you begin to receive payments.

Determining Your Tax Liability On an Inherited IRA

Step 1

If you are a surviving spouse, treat the inherited IRA as your own. This means you can continue making contributions or roll it to another qualifying plan. You must be the only beneficiary in order to make contributions. As long as you follow the rules regarding distributions and do not take early distributions you will not be liable for taxes on the asset.

Step 2

Calculate your single life expectancy using the IRS table (see resources below) if your spouse was taking the required distributions at the time of death. If your spouse was not 70 1/2 at the time of death, you do not have to take distributions until the year your spouse would have turned 70 1/2. Record any distributions on Form 8606.

Step 3

Calculate your minimum required distribution as a beneficiary. If you are a beneficiary of an IRA and you inherited it from someone other than your spouse you are prohibited from making contributions or rolling it to another plan. You must take distributions on the IRA the following year using the IRS Single Life Expectancy Table.

Step 4

Determine your tax liability. Whether you are the surviving spouse treating the IRA as your own or a designated beneficiary, your tax liability is based on the distributions you are required to take. If the IRA is traditional and the contributions made into it were deductible, then all distributions paid out of it are taxable. If the IRA contributions were non-deductible, such as in the case of a Roth IRA, then you have what is known as a cost basis and the only taxable portion is the amount over and above the basis.

Warning

Check with the IRS to ensure your IRA does not fall under the 5-year rule that requires a full payout within 5 years of inheritance.

Things You'll Need

  • Form 8606

  • Form 1040

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