A recent summary decision by the U.S. Tax Court serves as a reminder that inherited IRAs are not allowed the 60-day rollover period. Instead, once funds have left an inherited IRA
, they cannot be placed back in, and they become subject to ordinary income tax.
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In Beech v. Commissioner (T.C. Summary Opinion 2012-74), Mrs. Beech inherited a Citi Smith Barney IRA from her mother in 2008. Citi Smith Barney subsequently made death benefit distributions to Mrs. Beech. At the time, Mrs. Beech established an inherited traditional IRA with American Funds and deposited the death benefit distribution into the inherited traditional IRA. Such death benefit distribution amount was not reported as taxable income on Mr. and Mrs. Beech’s tax return. The IRS issued Mr. and Mrs. Beech a notice of deficiency indicating that all of the retirement income Mr. and Mrs. Beech reported on their 2008 return was taxable income.
While IRC Section 408 provides that a distribution is not includible in gross income if the entire amount of the distribution is paid into an IRA for the benefit of that individual within 60 days of the distribution, such provision is not applicable to inherited IRAs. According, the Court ruled against the Beeches and the death benefit distribution was taxable income for 2008.
This is an issue that we unfortunately see all too often. Taxpayers request or are sent a distribution check from an inherited IRA, not knowing that such amounts cannot be placed back into an inherited IRA. Once the funds have left the IRA wrapper, they are taxable. A taxpayer is not treated as having received a taxable distribution from an IRA, however, if funds in the IRA are transferred from one account trustee directly. As highlighted in the Beech case, handling an inherited IRA incorrectly can lead to immediate taxation of the entire IRA, while a prudent decision can result in a significantly larger tax deferral for the beneficiaries. Accordingly, funds from an inherited IRA should only be moved via trustee-to-trustee transfers.
With the exception of an inherited IRA that is being rolled over by a surviving spouse as a spousal rollover.