IRA distributions on death.

• Author: Riegger, Don

The income tax consequences of individual retirement account (IRA) distributions on death depend on who is designated as the beneficiary. Unlike most property that passes at death, an IRA distribution is taxable as ordinary income to the beneficiary. While this treatment may seem harsh, it is consistent with the intent behind the creation of IRAs--simply to provide a tax deferral for retirement assets. Income deferred by the decedent during his lifetime accrues to the beneficiary and must be recognized. The 10% penalty on early distributions does not apply.

The timing of the income recognition depends on the decedent's relationship to the designated beneficiary. Under the Sec. 408 and 401 proposed regulations, a beneficiary generally must distribute and recognize IRA income within five years, with the entire inherited interest distributed by December 31 of the fifth year following death. Exceptions are included in the proposed regulations and vary, depending on whether the recipient is a surviving spouse, minor child, the decedent's estate, a trust or other designated beneficiary. Failure to make minimum distributions will result in a 50% penalty under Sec.4974.

The intent of the regulations is to limit the time of deferral allowed the beneficiary. The beneficiary is free to accelerate income recognition by receiving a lumpsum distribution or receiving the total amount more quickly than provided as a minimum by the law. The maximum deferral is first dependent on whether or not distributions have "commenced."

If distributions have "commenced," the beneficiary's distributions must continue "at least as rapidly as under the method of distribution being used . . . as of the date of his death" (Sec. 401(a)(9)(B)(i)). "Commencement" of distributions has no relation to actual distributions but rather refers to the "required beginning date." The required beginning date is the latest date an IRA owner can begin distribution without a penalty: April 1 of the year following the year the owner reached the age of 70 1/2. A decedent who elected to begin receiving annual distributions at age 67 and died two years later would not have commenced distributions for the purposes of this test. The provision only applies if the decedent dies after April 1 of the year after he attains the age of 701/2.

Distributions that are at least as rapid as the decedent's method of deferral, but provide the maximum deferral of income, become the distribution method in effect...